Mr. Okun explains the compromise with a metaphor: providing a social safety net is like using a leaky bucket to redistribute water between people with different amounts. While bringing water to the thirstiest can be noble, it is also expensive as water is lost during transport.
In the real world, this leakage occurs because higher taxes distort incentives and hamper economic growth. And these taxes are not just the explicit taxes that fund benefits such as public education or health care. They also include the implicit taxes incorporated into the services themselves. If these benefits decrease when your income increases, people are discouraged from working. This implicit tax distorts incentives in the same way as explicit taxes. This doesn’t mean that there is no point in trying to help those in need, but it does require being aware of the downsides of doing so.
Which brings us back to Western Europe. Compared with the United States, GDP per person in 2019 was 14% lower in Germany, 24% in France and 26% lower in the United Kingdom.
Economists disagree on why European nations are less prosperous than the United States. But a leading assumption, put forward by Nobel Prize winner Edward Prescott in 2003, is that Europeans work less than Americans because they face higher taxes to fund a more generous social safety net.
In other words, most European countries use this leaky bucket more than the United States and experience larger leaks, resulting in lower revenues. By aiming for more compassionate economies, they have created less prosperous ones. Americans should be careful to avoid this fate.
Compassion is a virtue, but so is respect for the talented, hardworking, and successful. Most Americans are descended from immigrants, who left their countries of origin to find freedom and forge their own destiny. Because of this history, we are more individualistic than Europeans, and our policies rightly reflect this cultural difference.
That’s not to say the United States has already struck the right balance between compassion and prosperity. It is an ongoing tragedy that children are more likely to live in poverty than the general population. That’s why my favorite provision in the Biden plan is the expanded child credit, which would reduce child poverty. (I’m also in favor of policies aimed at climate change, which is an entirely different problem. Unfortunately, the Biden plan misses the opportunity to adopt the best solution – a carbon tax.)