Since the Democratic Party secured a majority of the House of Representatives in the 2018 midterms, a new cohort of legislators led by Alexandria Ocasio-Cortez has eagerly advanced ambitious plans to expand federal spending known as the “Green New Deal” and “Medicare for All.”
These names both recall the mid-20th century, when major expansions of government programs helped the Democratic Party to dominate American politics for a generation. Yet, this winning political formula eventually ran into diminishing returns. After the most popular, most effective, and least costly programs had been established, subsequent expansions of the welfare state became progressively less attractive and affordable.
The Low-Hanging Fruit Has Already Been Picked
Thanks in large part to the creation of the American welfare state, the Democratic Party held unified control of the White House and Congress for 26 of the 36 years from the inauguration of Franklin Roosevelt to the departure of Lyndon Johnson. In that time, the federal government established Social Security, Medicare, Medicaid, food stamps, farm subsidies, disability benefits, unemployment assistance, low-income housing, and welfare benefits for low-income families.
But after total spending by all levels of government rose steadily from 17 percent of the GDP in 1948 to 32 percent in 1975, the growth trend stopped—and the share of GDP consumed by government spending remained at 32 percent in 2019. In the 52 years since LBJ left office, Democrats have enjoyed unified control of government for only eight years.
Expansions of the welfare state were politically profitable in the immediate post-war generation for two principal reasons: First, defense spending fell from 14 percent of the GDP in 1953 to five percent in 1975, so savings could be repurposed into domestic spending. Second, progressive taxation allowed center-left parties to fund substantial expansions of entitlements, such that net benefits were widely diffused and costs were concentrated on a small minority.
This dynamic is not unique to the United States. Across developed economies, the proportion of the GDP dedicated to government spending has consistently followed a similar trend, increasing steadily in the post-war generation, but plateauing in recent decades. A recent study of 16 western European countries found that while expansions of the welfare state in low-spending countries benefitted social democratic parties, in higher-spending countries, ideological shifts to the right were more commonly associated with vote gains—suggesting diminishing returns from the expansion of the welfare state.
In being subject to diminishing marginal returns, government spending is no different from any other economic activity. Elected officials first push policies that offer them the highest rewards at the lowest costs, leaving more challenging and unpopular policies for their successors. The early years of the welfare state addressed acute hardships that could be relatively cheaply remedied, but subsequent program expansions provided assistance for progressively less pressing social needs.
After decades of incremental expansion, the welfare states of the developed world have become like enormous Jenga towers—with various policies delicately layered upon one another to solve an array of challenges and shortcomings over time. This has made the overall structure increasingly hard to alter without destabilizing what has already been built, and greatly complicates the addition of further pieces. A change to public housing eligibility rules today is likely to impact healthcare entitlements or welfare benefits in ways that are far more complex than when programs were created afresh.
This increases the power of the status quo, and makes it hard to reform programs in line with the evolution of priorities or in response to problems that have developed over time—causing commitments to become more costly than when they were first initiated. Over time, interest groups also organize around existing programs: clients work to resist cuts and push to expand the scope and generosity of benefits, assisted by those who make money from delivering services.
Healthcare Soaks Up the Funds
The escalating cost of existing welfare state commitments soaks up most of the growth in tax revenues that might be used to establish new programs. This is particularly true as the population ages, baby boomers retire, and enrollment in Medicare and Social Security benefits climb. In 2018, total Medicare spending was $132 billion higher than it was in 2014—dwarfing the $55 billion cost of the exchange subsidies created by the Affordable Care Act in that year. The Congressional Budget Office projects that federal spending will grow by an additional nine percent of the GDP over the coming 30 years without a single piece of legislation to expand entitlements being enacted.
Rising healthcare costs are particularly challenging to the financing of the welfare state, because they drain other programs of potential resources. Federal healthcare spending has soared from 0.4 percent of the GDP in 1967 to 5.2 percent in 2019, and the cost of existing commitments alone is expected by the CBO to increase to 9.3 percent of the GDP in 2049. This is because healthcare is seen as a basic human need, but it is less satiable than the need for food or housing.
Healthcare costs increase as medical technologies and techniques improve and more can be done for the sick. Whereas a patient suffering a heart attack in 1960 may have (at very low cost) been prescribed bed rest and painkillers, hospitals today may respond with bypass surgery, angioplasty, or an array of drug therapies that send the bill into hundreds of thousands of dollars. Healthcare has always been labor-intensive, but the more complex medical care becomes, the longer specialists need to be trained. As people live longer into old age and disease, they are also likely to need ever-greater amounts of medical care—further driving up the costs of existing healthcare entitlements. Whereas the development of antibiotics and widespread immunization in the early 20th century increased life expectancy by decades at little cost, cutting-edge cancer drugs may cost over $100,000 for a single patient while offering that patient only a few extra months of life. The return on pharmaceutical R&D spending is also falling alarmingly.
Expansions of entitlement eligibility are also subject to diminishing returns. Medicare and Medicaid were initially focused on the neediest elderly and disabled individuals, but have gradually been expanded to low-income children, their parents, and other able-bodied adults. In the 1980s alone, Congress expanded Medicaid eligibility seven times. The further up the income spectrum such entitlements are expanded, the more such spending simply serves to displace privately-funded health insurance coverage rather than to fill unmet needs—yielding less improvement in health for the expenditure of taxpayer funds at each stage. An expansion of Medicare to cover all Americans would largely pick up costs currently borne by those with middle and higher-incomes, while low-income, disabled, and elderly Americans already enrolled in the programs would gain nothing but a share of the enormous burden of paying for the expansion.
To avoid simply picking up costs that are already covered by employers, the ACA limited eligibility for its expansion of Medicaid to those with income below 138 percent of the federal poverty level ($17,609 for individuals in 2020)—an income level just below that which a full-time worker earning the minimum wage would earn in most states. Such benefits for the poor, which phase out as income increases, often establish poverty traps, so that individuals may find themselves not much better off if they move from welfare to work. Indeed, a single mother who in 2012 worked to increase her earnings from $0 to $25,000, would have seen her disposable income and benefits after taxes rise by only $2,000.
Rising Costs of Redistribution
Given such considerations, Arthur Okun, Lyndon Johnson’s chief economic advisor, suggested that government programs to redistribute income ought to be thought of as a “leaky bucket.” By this, he meant that the expense associated with redistribution is not just the administrative costs such a program incurs, but the incentives it establishes to claim public assistance rather than work, to consume rather than invest, to deploy resources less productively, and to develop costly schemes to shelter income.
This has long been understood and agreed upon as a matter of general principle, with conservatives stressing these problems and liberals playing them down. But the benefits of spending programs have tended to be discussed in isolation, while entirely separate literatures have focused on the behavioral responses and costs associated with their financing. Harvard economists Nathan Hendren and Ben Sprung-Keyser have therefore recently attempted to quantify the overall “leaks in the bucket” that the government faces when it attempts to employ different types of policies to redistribute resources.
To do so, Hendren and Sprung-Keyser calculated the “marginal value of public funds”—a term they define as beneficiaries’ “willingness to pay” for a benefit they receive from the government, divided by the “net cost to the government” of paying for the policy. Examining 133 policies over the past half-century, they found a good return for public spending on education and healthcare for children, but that for most policy categories relating to adults the MVPF averaged below one—that is to say, the value beneficiaries placed on government spending was consistently less than the value of the money that was spent on them. In the case of some cash welfare programs, the MVPF was even negative because it served to reduce individuals’ lifetime incomes.
The idea of diminishing returns is familiar in the context of taxes thanks to the Laffer Curve. Hendren and Sprung-Keyser find that the 1981 Reagan tax cut (which reduced the top federal marginal income rate from 70 to 50 percent) “pays for itself,” and calculate the MVPF ratio to be 44 for the 1986 tax reform (which closed loopholes and further reduced the top rate to 28 percent). Though not all tax cuts will pay for themselves, leakage from the redistributory bucket predominates at high marginal rates.
As “blue states” are wealthier and that wealth is more concentrated in the hands of a few, they have tended to redistribute more—inducing left-of-center political dominance. But even left-leaning states reach their limits at some point. Top marginal income rates are now 53 percent in New York City. This has made congressional Democrats eager advocates of increasing federal deductions for state and local taxes on high-earning constituents to lighten the city’s tax burden.
While tax revenue from the rich is limited by the Laffer Curve because the rich already face high tax rates, collecting revenue from lower down the income distributions is constrained by equity and electoral concerns. Indeed, America isn’t a relatively low-tax country because it raises less revenue from the rich, but because it taxes the poor less. In 2019, the wealthiest 20 percent of Americans paid 68 percent of federal taxes. From 1993 to 2016, the average federal tax rate on the bottom quintile of the income distribution was reduced from 10.0 to 1.7 percent. By contrast, in Britain, the poorest quintile in 2017 paid direct and indirect taxes amounting to 76 percent of their market income.
Policymaking in an Era of Diminishing Returns
With little additional scope for more popular redistribution, the Democratic party has since the 1980s tried to reinvent itself by stressing issues of culture and identity. This has yielded a more upscale voter base. In the 2016 presidential election, 34 percent of voters had income over $100,000, and they were split equally between Trump and Clinton. Ahead of the 2020 election, Democratic presidential nominee Joe Biden has, therefore, pledged not to raise taxes for anyone earning less than $400,000—leaving intact the Trump tax cuts for 98 percent of the population, and entrenching 75 percent of its reductions in revenue. This leaves inadequate funds for major long-term expansions of the welfare state.
Though a spike in personal savings and monetary easing during the coronavirus crisis has facilitated a boom in deficit-financed federal spending, this is unlikely to last. With the federal debt already rapidly escalating from 79 percent of the GDP in 2019 to 108 percent in 2021, policymakers will have enough of a challenge paying for existing commitments. Yet, even relatively liberal Democrats remain reluctant to openly advocate major middle-class tax increases.
A Democratic electoral sweep in 2020 is therefore likely to fall well short of the policy dreams of Ocasio-Cortez and her colleagues. Though the left seems to anticipate the filibuster frustrating their designs, voters’ fiscal concerns are the more substantial obstacle to their enactment.
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