Scientific American  [Printer-friendly version]
October 16, 2006


Are higher taxes and strong social "safety nets" antagonistic to a
prosperous market economy? The evidence is now in.

[Rachel's introduction: In 1944, economist Friedrich von Hayek argued
that high taxes create the "road to serfdom." But now an abundance of
scientific evidence reveals that Von Hayek was wrong. In strong and
vibrant democracies, a generous social-welfare state is not a road to
serfdom but rather to high levels of satisfaction, fairness, economic
equality, and international competitiveness.]

By Jeffrey D. Sachs

One of the great challenges of sustainable development is to combine
society's desires for economic prosperity and social security. For
decades economists and politicians have debated how to reconcile the
undoubted power of markets with the reassuring protections of social
insurance. America's supply-siders claim that the best way to achieve
well-being for America's poor is by spurring rapid economic growth and
that the higher taxes needed to fund high levels of social insurance
would cripple prosperity. Austrian-born free-market economist
Friedrich August von Hayek suggested in the 1940s that high taxation
would be a "road to serfdom," a threat to freedom itself.

Most of the debate in the U.S. is clouded by vested interests and by
ideology. Yet there is by now a rich empirical record to judge these
issues scientifically. The evidence may be found by comparing a group
of relatively free-market economies that have low to moderate rates of
taxation and social outlays with a group of social-welfare states that
have high rates of taxation and social outlays.

Not coincidentally, the low-tax, high-income countries are mostly
English-speaking ones that share a direct historical lineage with
19th-century Britain and its theories of economic laissez-faire.
These countries include Australia, Canada, Ireland, New Zealand, the
U.K. and the U.S. The high-tax, high-income states are the Nordic
social democracies, notably Denmark, Finland, Norway and Sweden,
which have been governed by left-of-center social democratic parties
for much or all of the post-World War II era. They combine a healthy
respect for market forces with a strong commitment to antipoverty
programs. Budgetary outlays for social purposes average around 27
percent of gross domestic product (GDP) in the Nordic countries and
just 17 percent of GDP in the English-speaking countries.

Friedrich Von Hayek was wrong

On average, the Nordic countries outperform the Anglo-Saxon ones on
most measures of economic performance. Poverty rates are much lower
there, and national income per working-age population is on average
higher. Unemployment rates are roughly the same in both groups, just
slightly higher in the Nordic countries. The budget situation is
stronger in the Nordic group, with larger surpluses as a share of GDP.

The Nordic countries maintain their dynamism despite high taxation in
several ways. Most important, they spend lavishly on research and
development and higher education. All of them, but especially Sweden
and Finland, have taken to the sweeping revolution in information and
communications technology and leveraged it to gain global
competitiveness. Sweden now spends nearly 4 percent of GDP on R&D, the
highest ratio in the world today. On average, the Nordic nations spend
3 percent of GDP on R&D, compared with around 2 percent in the
English-speaking nations.

The Nordic states have also worked to keep social expenditures
compatible with an open, competitive, market-based economic system.
Tax rates on capital are relatively low. Labor market policies pay
low-skilled and otherwise difficult-to-employ individuals to work in
the service sector, in key quality-of-life areas such as child care,
health, and support for the elderly and disabled.

The results for the households at the bottom of the income
distribution are astoundingly good, especially in contrast to the
mean-spirited neglect that now passes for American social policy. The
U.S. spends less than almost all rich countries on social services for
the poor and disabled, and it gets what it pays for: the highest
poverty rate among the rich countries and an exploding prison
population. Actually, by shunning public spending on health, the U.S.
gets much less than it pays for, because its dependence on private
health care has led to a ramshackle system that yields mediocre
results at very high costs.

Von Hayek was wrong. In strong and vibrant democracies, a generous
social-welfare state is not a road to serfdom but rather to fairness,
economic equality and international competitiveness.