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Are the Welfare State and Distribution Really that Bad for the Economy? Effects of Reciprocal Altruism, Consumer Rivalry and Second Best

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  • van der Ploeg, Frederick

Abstract

Democratic countries with substantial inequality and where people believe that success depends on connections and luck induce political support for high tax rates and generous welfare states. Traditional wisdom is that such policies harm the economy, but there is not much evidence that countries with a large welfare state and substantial redistribution have worse economic performance and welfare. One important reason is that governments have been careful to invoke the principles of reciprocity and mutual obligations in the design of the welfare state. Unemployment benefits conditioned on work experience, no misconduct and search effort harm the economy less. Indeed, conditional benefits may even boost employment in an economy with efficiency wages. A second reason is that people care about relative incomes and become unhappy if others earn and consume much more than they do. This explains why people do not seem to get happier, even though societies grow richer and richer. With such consumer rivalry the government wishes to correct for the rat race, even if there is no need for redistribution, by taxing labour. A third reason is that in modern economies many distortions are present and removing one at a time may worsen economic performance. Conversely, increasing tax progression in economies with non-competitive labour markets induces wage moderation and boosts employment. A final reason is that countries with large welfare states typically introduce various pro-growth policies as well.

Suggested Citation

  • van der Ploeg, Frederick, 2005. "Are the Welfare State and Distribution Really that Bad for the Economy? Effects of Reciprocal Altruism, Consumer Rivalry and Second Best," CEPR Discussion Papers 4918, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:4918
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    Cited by:

    1. Bas Jacobs & Hongyan Yang, 2013. "Second-Best Income Taxation with Endogenous Human Capital and Borrowing Constraints," CESifo Working Paper Series 4155, CESifo Group Munich.

    More about this item

    Keywords

    altruism; demand management; design of welfare state; happiness; mutual obligations; redistributive taxation; relative incomes; second best;

    JEL classification:

    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H53 - Public Economics - - National Government Expenditures and Related Policies - - - Government Expenditures and Welfare Programs
    • J50 - Labor and Demographic Economics - - Labor-Management Relations, Trade Unions, and Collective Bargaining - - - General
    • J60 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - General

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