Financing the Welfare State

Abstract

Insight into the level and nature of taxes and social insurance contributions may be important for the perception of citizens about the costs of public provisions and - associated with this - for their behavioral responses. From the theoretical literature on tax illusion and from several empirical studies we conclude that when a clear relation is experienced between the payment of social contributions and accrued rights, employees perceive contributions more as prices than as taxes. Because of this these contributions will have fewer distorting effects on the labor market than general taxes. Reforms of social insurance programs that strengthen buildup elements, for instance through the introduction of social saving accounts, would therefore have favorable labor market effects.

Keywords: welfare state, tax illusion, economic effects of contributions, social saving accounts