Commentary

U.S. Should Learn from Europe’s Welfare State Mistakes

Our long-run outlook is grim, but at least we still have time to reform the entitlement programs and save America from Greek-style fiscal collapse.

The conventional wisdom among economists is that a nation gets in deep trouble when government debt reaches 90 percent of GDP. That’s generally true, but it would be much more accurate to say that a nation gets in deep trouble when debt approaches 90 percent of GDP and the fiscal outlook shows even more red ink.

But this distinction doesn’t really matter much for the United States and Europe. Thanks to a combination of entitlement programs and aging populations, both face a bleak fiscal future. A 2010 study from the Bank for International Settlement shows that government debt in most industrialized nations will soar above 200 percent of GDP (in some cases, much higher) within the next few decades.

At some point, investors are going to realize that the United States is on an unsustainable path.”

The only major difference is that European nations are farther down the path to fiscal collapse. The welfare state was adopted earlier in Europe and government spending among euro nations now consumes a staggering 49 percent of economic output. This heavy fiscal burden, especially when combined with onerous tax systems, helps explain why growth is anemic.

But the United States is only a couple of decades behind. According to long-run forecasts from the Congressional Budget Office, the burden of federal spending will reach European levels as the baby boom generation retires.

At some point, investors are going to realize that the United States is on an unsustainable path. Whether that’s 10 years from now or 20 years from now is anybody’s guess.

What we do know, however, is that Greece, Portugal, and Ireland already have stuck their snouts in the bailout trough, and it’s probably just a matter of time before Italy, Spain, and Belgium are in the same category. Heck, they’re already receiving indirect bailouts from the European Central Bank, which is buying up their dodgy debt in hopes of postponing the day of reckoning.

The one silver lining to this dark cloud is that the United States still can turn things around. Greece, Italy, and other welfare states have probably passed the point of no return, but it’s still possible for American lawmakers to fix the entitlement crisis by turning Medicaid over to the states , modernizing Medicare into a premium-support system, and transitioning to a system of personal retirement accounts for younger workers.

If those reforms don’t take place, the consequences won’t be pleasant. To be blunt, there won’t be an IMF to bail out the United States.

Daniel J. Mitchell is a top expert on tax reform and supply-side tax policy at the Cato Institute.