Studies in American Political Development, 19 (Fall 2005), 173–195. Financing the Welfare State: Elite Politics and the Decline of the Social Insurance Model in America Andrea Louise Campbell, Massachusetts Institute of Technology Kimberly J. Morgan, George Washington University While there is a vast and rich literature on the bene- surance model, financing two of the most significant fits and services provided by the welfare state, few government programs in American history: Social Se- scholars have investigated how these programs are fi- curity and Medicare. Since its passage in 1935, Social nanced. The tax side of the budget equation is cru- Security has alleviated much senior poverty, while cial for the ability of welfare states to exist and ex- Medicare provides access to healthcare for a popula- pand; without a stable and growing source of tion often lacking insurance. As universal entitle- revenues, the welfare state can neither meet its exist- ments, both programs are enormously popular with ing obligations nor increase its responsibilities. The the public, and have enjoyed support even through mode of finance can be particularly important, as times of fiscal difficulty and rising antitax sentiment. some taxes are more visible or contested, and thus Despite the economic and political success of these more difficult to raise. For example, because there programs, policy-makers have turned away from the are limits to how much revenue can be raised with social insurance model in recent decades, arguing progressive income taxes, many industrialized coun- that a limit has been reached in the public’s willing- tries finance large social programs through contribu- ness to pay these taxes. As a result, the existing pro- tory finance, that is, payroll taxes. Levied over a broad grams have not been put on stable long-term footing. swath of the population, these taxes generate a large Moreover, proposed expansions of the welfare state, amount of revenue, yet are politically acceptable be- including improvements in Medicare, long-term care cause people see them as payments that entitle them coverage, and access to health insurance for the unin- to benefits in return. sured, have foundered, in large measure owing to Payroll taxes are central to the American social in- their lack of financing.1 Why have elites rejected this highly successful We thank John C. Campbell, Eric Patashnik, Eric Schickler, Theda mode of financing social policy? Why have they Skocpol, Rick Valelly, Julian Zelizer, the anonymous reviewers, and turned their backs on payroll tax funding, especially seminar participants at Harvard University for their comments on when the average citizen appears willing to pay high- an earlier draft. Previous versions were presented at the 2003 er payroll taxes, when American tax rates are still American Political Science Association annual meeting and the 2004 Polity History Conference. The early stages of this research were supported by the Robert Wood Johnson Foundation Scholars 1. In the following paragraphs we discuss the role of financing in Health Policy Research program. in the addition of a prescription drug benefit to Medicare in 2003. © 2005 Cambridge University Press ISSN 0898–588X/05 $12.00 173 174 ANDREA LOUISE CAMPBELL AND KIMBERLY J. MORGAN quite modest compared to those in other western in- ber of program expansions would have been popular dustrialized nations, and when program expansions among the mass public, but were blocked from con- or the long-term stability of Social Security could have sideration by the anti–payroll-tax preferences of po- been achieved with relatively modest increases in pay- litical elites. In rejecting expansions of contributory roll contributions? finance, policy-makers have foreclosed possible im- We find that political elites, who initially formed a provements in the American safety net that would broad consensus around this system of financing, prove popular with average citizens. At a minimum, abandoned the payroll tax model after the mid-1970s existing programs could have been shored up, en- despite continued public support for it. Moreover, suring their long-term fiscal stability. the new consensus against payroll tax finance en- compasses both liberals and conservatives. We ex- THE NATURE AND SIGNIFICANCE plain this by a series of political changes that altered both who was involved in debates over social insur- OF CONTRIBUTORY FINANCE ance and the political landscape around them. First Why study payroll taxes? Thus far, few people have; was the breakdown of a relatively autonomous, insu- while there is an enormous literature about the wel- lated policy-making community around social insur- fare state’s many spending and service programs only ance in the 1970s. This opened the stage to a wide a handful of scholars have examined the various range of voices, many of them critical of payroll tax fi- methods for financing.2 Yet, the availability and mode nance, at a time when the major social insurance pro- of welfare state finance have tremendous conse- grams faced growing financial difficulties. While so- quences for both politics and public policy. Without cial insurance programs had hitherto been shielded the ability to raise the necessary revenues, policy-mak- from this kind of scrutiny, contributory finance came ers can neither create nor expand social programs under particular criticism in the new debates for its unless they are willing to engage in deficit financing avowed regressivity and negative effects on economic (as with the 2003 Medicare reform). growth. In many countries, payroll taxes finance health in- As the chorus of negative voices grew, there was a surance, pensions, disability, and unemployment com- second major change in American politics, one that pensation. Payroll taxes differ from income taxes in would move politicians further from median opinion that they entitle the payee to a benefit in return. Of- and turn their attention toward the affluent. While ten, payroll taxes are paid by both an employee and the average American remained supportive of the employer as a percentage of wages, although in some contributory finance model throughout this period, countries, and for some programs, the burden lies en- wealthier citizens became less favorable toward social tirely with either the worker or employer. By contrast, insurance. Efforts to trim program growth in the late income taxes are part of “general revenues” in that 1970s and early 1980s diminished the expected life- they do not have an earmarked purpose, but are avail- time returns from Social Security and Medicare for able for general spending. Although they might be the affluent, and they increasingly turned against the used to cover the cost of social insurance, general rev- programs even as the average citizen remained favor- enues can also be rerouted to other priorities. able. This divergence in public opinion emerged at Not all social insurance programs are financed en- precisely the time when political changes increased tirely by contributions; in fact, most European coun- the incentives for politicians to follow their own poli- tries use a mix of payroll taxes and general revenues cy preferences and those of the affluent – now op- to finance social insurance. However, contributions posed to payroll taxation – rather than those of the are still an essential part of these programs for the average citizen. The incentives for lawmakers to pur- sense of entitlement they create in the payee, making sue their own policy goals and those of the privileged him or her more willing to pay these taxes. It is for this rather than hew to median public opinion were in- reason that social insurance programs have proven so tensified by a number of factors: increased incum- popular throughout advanced industrial states as a bency advantage; candidate-centered elections; and means of offering social protection. Using the lan- the importance of the wealthy and the interest groups guage of “insurance” conveys the sense that the gov- into which they are organized for campaign finance. ernment is insuring the public against the risks of a The politics of welfare state finance offers a case study loss of income. Whereas the “premiums” paid by em- of this process, revealing the stability of mass prefer- ployers and/or employees to these social insurance ences on the major social insurance programs, yet a growing elite-mass gap on how to pay for them. The rejection of payroll tax finance by elites – both 2. Notable exceptions are Junko Kato, Regressive Taxation and political elites such as politicians, policy analysts and the Welfare State: Path Dependence and Policy Diffusion (Cambridge: advocates, interest group leaders, business leaders, Cambridge University Press, 2003); Julian E. Zelizer, Taxing Ameri- ca: Wilbur D. Mills, Congress, and the State, 1945–75 (Cambridge: and academics, and economic elites within the mass Cambridge University Press, 1998); and Sven Steinmo, Taxation public (the affluent) – has been crucial in shaping and Democracy: Swedish, British, and American Approaches to Financing the politics of the welfare state. We argue that a num- the Modern State (New Haven, CT: Yale University Press, 1993). ELITE POLITICS AND THE DECLINE OF THE SOCIAL INSURANCE MODEL IN AMERICA 175 and Iceland both have larger welfare states that are fi- nanced through income taxes, yet Denmark faced a powerful antitax movement in the 1970s against these high marginal rates. Similarly, the liberal welfare re- gimes all have experienced strong antigovernment and antiwelfare state political movements since the 1970s, with the high level of taxes as a major target. The tax revolts suggest the political limits of progres- sive financing. The power of payroll taxes as an expansive mode of finance lies in two features: the lower visibility of these taxes; and their appeal to individual self-interest.6 While filing income taxes is an annual process that confronts the individual with precisely how much of Fig. 1.