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The Wavering State

by Kolja Rudzio and Wolfgang Uchatius Friday, Aug. 26, 2005 at 2:55 AM

"How can the state finance itself in times of worldwide competition without damaging the national econmy? How can it find the old strength without creating new poverty?.. There is no system-conforming way out of this vicious circle.."


Germany has the choice of dismantling the social state or financing the social state through taxes. However neither red-green nor black-yellow want to decide.

By Kolja Rudzio and Wolfgang Uchatius

[This article published in: DIE ZEIT 22/2005 is translated from the German on the World Wide Web,]

Profits soar in the corporate headquarters, unemployment increases in the high-rise towers and the walls crumble in the public schools. The government has no money. So the economist John Kenneth Galbraith described reality. He deplored the opposition between “public poverty and private wealth” and ignited a vigorous discussion about the role of the state in the US at the end of the 1950s.

Profits soar in the corporate headquarters, unemployment increases in the high-rise towers and the walls crumble in the public schools. The government has no money. So the SPD chairperson Franz Muntefering depicts reality. He decries the growing power of capital and triggers a passionate debate over the role of the state in Germany in 2005.

This debate has a very new dynamic these days.

The tasks of the state will be redefined whether Gerhard Schroeder or Angela Merkel wins the new election for the Bundestag. The future government cannot avoid answering the decisive question passed by in the capitalism debate of the past: the question about money.

“In the 1950s with Galbraith, the question was whether the state would become stronger,” the director of the Max Planck Institute for Social Research in Koln, Fritz Scharpf, said. “Whether the state can become stronger is central today.” A strong state is a financially sound state. Only a government that has money can build schools and roads and pay for social services. However the German finance minister Hans Eichel staggers from budget deficit to budget shortfall. The German government cuts where it can only cut – in unemployment benefits, officials’ salaries, road construction or grants for the pension fund. The cities cut funds for senior citizen centers and bookstores and now and then even sell their streetlights. Provinces lower services for asylum-seekers, cut money for the blind and reduce grants for museums and theaters. Nearly every state government postpones rehabilitation of schools and cancels teacher positions.

What is left for state governments? Theoretically new taxes and social security contributions could bring new funds. But what happens in practice? Higher social security contributions make jobs expensive. Then the companies cut even more jobs. Higher business taxes burden the location and more firms go abroad. Higher income taxes insure that little money is left to citizens. Then the domestic demand collapses even more. In short, “we need more redistribution to compensate the losers of globalization but raising the funds for that redistribution becomes ever more difficult,” president of the Munich Ifo-institute, Hans-Werner Sinn, said.

How can the state finance itself in times of worldwide competition without damaging the national economy? How can it find the old strength without creating new poverty?

Perhaps it cannot. Nothing else could remain to the future German government than to leave vast parts of society to the market. In any case, that is the first impression in looking at the statistics. In successful Anglo-Saxon countries like Ireland, Canada or the US, the state does not even collect on average 30 cents from every earned Euro or dollar. The economy has grown enormously in these countries in the last years; unemployment is low. In the heart of Europe, on the other hand, in Germany, France and Italy, the tax- and social security contribution rate is around 40 percent. The economy grows slowly there; unemployment is high.

Is only a small state good for prosperity? On second view, the connection is not simple. In the Scandinavian countries Denmark and Sweden, the state claims half of the economic output for itself. Nevertheless the growth rates are high there. Hardly anyone is without a job for a long time. “There is no clear correlation between the total tax- or social security contribution burden in a country and its general competitiveness or the growth rate,” says Stephanie Garilli, professor at the IMD management school in Lausanne. The state’s way of financing itself from taxes is more important.

Experts distinguish three models of the social state:

· The Anglo-Saxon model in which the state privately organizes large areas of society like education and health care and restricts social security to protection from poverty.

· The continental European model in which a large part of public security is financed by social security contributions paid by employers and their permanent employees, not by taxes.

· The Scandinavian model in which the welfare state is financed by taxes and independent and the barely employed have a claim to comprehensive social services.

For a long time, all three variants seemed suited for organizing the body politic without weakening the economy. Then Germany skidded from one economic crisis to the next. Unemployment rose; reunification involved additional costs. The Kohl government increased the social security contributions to finance the East’s reconstruction and pay adequate pensions and unemployment benefits. Thus a development accelerated in which non-wage labor costs rose continually. Regular jobs were increasingly expensive – and therefore increasingly scarce. The growing unemployment tore new holes in the social treasuries raising the price of jobs again. According to the opinion of many experts, there is no system-conforming way out of this vicious circle. “The continental European model as practiced in Germany and France has failed,” Stefan Collignon, economics professor at Harvard, says.

All those who mistrust capitalism pose a new question: How can the Swedes and Danes still afford the luxuriant social state that seems unaffordable in Germany?

The explanation is first rather capitalistic. Northern Europeans collect money from consumers and normal taxpayers and largely spare businesses. Two levers help them. One consists in a high profits tax. For example, when a Danish family buys a new wardrobe for 1000 Euro, a 250 Euro profits tax is due. With this money, the Danish state subsidizes kindergartens, state pensions and unemployment insurance. Around 80 percent is financed by taxes. The social costs do not disadvantage producers in Denmark against competing countries with low wages. Jobs are not burdened with social security contributions. The same profits tax is due in purchasing a wardrobe produced in Poland or Chechechnya.

The second lever used by the Scandinavians is the dual income tax. Wages are taxes while income from capital – business profits, interests and dividends – are hardly encumbered. Thus Finland, Norway and Sweden have cut in half their tax rates for capital income. Instead of a maximum 72 percent as in the past, they only demand 28 to 30 percent. These rates are the lowest of all industrial countries. Despite slight relief, the tax burden for employees in Scandinavia is still very high and strikes higher –income groups. The top tax rates are at 52 to 56 percent. Therefore the Koln social researcher Fritz Scharpf describes the Scandinavian system as “socialism within one class.” Redistribution no longer occurs between capital and labor but only between better-paid and miserably paid workers and employees.

Unlike the Germans, the Scandinavians in this way maintain their generous social state without frightening away investors – and simultaneously provide for social balance. Rich and poor are nowhere as close together in Europe as in Scandinavia.

This way is possible in Germany according to the opinion of economic researchers. A new upswing in the labor market would occur if the future German government would finance the social system more strongly through taxes instead of social security contributions on wages. The non-wage labor costs would fall; additional jobs would be viable again.

According to calculations of the German Institute for Economic Research (DIW) in Berlin, far more than 500,000 new jobs are needed to finance that part of the social system through taxes that is not part of social security, so-called services without social security like maternity benefits, early pension or retraining courses paid by the Federal Labor Office. These are all tasks for the general public, not for payees. All taxpayers should be responsible.

Around 84 billion Euro are involved together with the costs burdening social security in the wake of reunification. If this money were raised through taxes instead of social security contributions, “undesirable trends of the last decade could be corrected,” the DIW experts wrote.

There are different ideas about what taxes should be raised in the countermove. The DIW-researchers recommend a combination of profit-, wage-, income- and corporation taxes as well as reintroducing the property tax. Experts at the Institute for Labor Market and Vocational Research in Nurnberg who make similar calculations emphasize that the profits tax could be raised in a time-delay manner for counter-financing, in other words a year after the reduction of non-wage labor costs. Consumer demand should be prevented from going to seed.

Finally, the economics council of experts regards the current dual income tax in Scandinavia as a reform option. Through this model, the government advisors explained, the state could gain its funds without expelling the increasingly mobile capital: “This leads to an improvement of growth conditions and the chances of employees for higher incomes.”

With reforms according to this model, the state would only be financed differently and would not need to shrivel. The state could be more effective if it organized the social system better. “In Germany, most taxes and transfers go from the right pocket to the left pocket,” the president of the Kiel Institute for World Economy, Dennis Snower, complains. Instead of promoting the truly needy, members of the middle class in Germany are supported through state services as in the education system – that is, those who paid high social security contributions receive as much as was taken from them. What is the purpose of society?

“We must organize the social state more efficiently,” the Ifo head, Hans-Werner Sinn, urges. The unemployed should receive more money as allowances for their own services instead of being paid for idleness through unemployment benefits.


In the past, black-yellow and red-green did little to raise public revenue in a very competitive way or organize the social system efficiently. Neither red-green nor black-yellow presently has a concept. Which social model can be effective in our crisis-ridden land: the Scandinavian or the Anglo-Saxon?

“Germany stands like Buridan’s ass between two haystacks and cannot decide,” says Stephan Leibfried, professor of social policy at the University of Bremen. On one hand, the government has enormously lowered the taxes for employers and employees in the last years. The tax rate in Germany is lower than neither all other industrial countries. On the other hand, social security contributions are higher in Germany than almost anywhere else. At the same time the state reduces social security. Thus the government wavers to and fro between the Anglo-Saxon model of the strong market and the Scandinavian model of the strong state without making up its mind.

Like the ass in the essays of the French philosopher, Jean Buridan, the state dies of starvation at the end.

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