Freedom Trends

Size of Government: 10 Years Freedom Barometer

The welfare state that organises healthcare, education, retirement benefits, and a social assistance programme through high taxes remains one of the defining traits of the European social model. But the scope of the welfare state’s redistribution, government and, subsequently, tax rates, differs across the continent.

THE WELFARE STATE REMAINS ONE OF THE DEFINING TRAITS OF THE EUROPEAN SOCIAL MODEL.

The advanced economies (EU15) have significantly lower scores in the size of government indicator, compared to the other countries on the continent. This pattern seems to follow the level of economic development: the more developed a country is, the higher public spending it has (Wagner’s Law). But there are also exceptions to this rule: post-Yugoslav countries (excluding North Macedonia) and Hungary have a significantly higher government spending than their development level would predict. On the other hand, energy exporter countries (such as Russia and Azerbaijan) can finance their spending without the need for high tax rates on income or profits, which artificially increases their score.

THE MORE DEVELOPED A COUNTRY IS, THE HIGHER PUBLIC SPENDING IT HAS, MOSTLY DUE TO INCOME REDISTRIBUTION PROGRAMS.

There are also differences in the quality of public spending and market interference. While in the most advanced countries a low score comes from income redistribution programs targeting the middle class as well as the poor, and government is mostly absent from economic activities, in other regions redistribution is less pronounced, but government is often more involved in economic activities through SOEs, many of which rely on budgetary support.

Most of the countries had relatively stable scores during the previous decade, since the level of government consumption rests mostly on previously assumed obligations which provide little room for discretion by the current government. But there are also countries that significantly break this status quo.

THERE IS LITTLE ROOM FOR CURTAILING THE CURRENT LEVEL OF GOVERNMENT CONSUMPTION THROUGH GOVERNMENT DISCRETION SINCE THE BULK OF IT IS THE CONSEQUENCE OF PREVIOUSLY ASSUMED OBLIGATIONS.

Positive examples include Czechia, Bulgaria and Romania. Slovenia is a peculiar case, since it first witnessed a decline in its score, followed by a rise, due to the tax changes that have taken place since 2016, which decreased the personal income tax burden through a higher tax allowance and the introduction of two new tax brackets, which decreased tax progress, although corporate tax was slightly increased. Romanian tax changes also included a significant decrease of the personal income tax and introduced a new way of calculating social contributions at reduced rates. Moldova and Ukraine have recently reduced their social contribution rates.

RECENT TAX REFORMS MOSTLY AIM AT REDUCING THE LABOUR TAX WEDGE TO FOSTER NEW EMPLOYMENT.

Most of these reforms seem to share a vision of reducing the labour tax wedge to promote hiring of new workers and increase after-tax salaries. Some other countries opted to keep the same tax rates, but to decrease non-tax revenues, which was enabled by a good performance by their economies.

On the other hand, negative examples of countries that decreased their scores during the decade are Croatia, Slovakia, Montenegro, and Turkey. The several waves of tax reforms in Croatia proved to be too incremental to have any significant impact; Slovakia was able to eliminate its high budget deficit but at the higher level of public spending, while Montenegrin highway investment is making the government push unpopular austerity measures since it threatens its solvency

The fiscal prospects of most European countries are bleak. Public debt in most of them is already very high, and any future interest rate increases would take a heavy toll. The traditional challenges to the welfare state come from demographic changes, as population grows older due to lower birth rates. Most of the countries from the East of the continent are also hit by a massive emigration rate to more developed countries in the West.

DEMOGRAPHIC CHANGES LEAD TO RISING COSTS OF RETIREMENT BENEFITS AND HEALTHCARE, WHICH WILL PUT A SIGNIFICANT STRAIN ON WELFARE STATE VIABILITY IN FUTURE DECADES.

All this means that the rising costs of retirement benefits and healthcare for the ageing population will fall on the ever-smaller working age population. The proposed massive immigration from the Middle East and Africa presents challenges since it mostly involves those without the qualifications necessary to easily join the economy and also poses the question of social integration. The rise of AI and job automation also poses challenges through possible higher costs for unemployment benefits and life-long learning programmes for workers that need to change careers, but also through stronger political support for stronger redistributive programs such as universal basic income.

THE RISE OF AI AND AUTOMATION POSES NEW CHALLENGES FOR LABOUR MARKET AND SOCIAL SECURITY SYSTEMS ACROSS THE GLOBE.