As governments worldwide grapple with mounting fiscal pressures, we find ourselves at a critical juncture where policy choices have profound implications for social welfare and inequality. Our recent paper, entitled “How should we assess fiscal policies in response to emerging development challenges?” forthcoming in the China Economic Review, provides a framework for assessing these policies, but the real-world applications are becoming increasingly urgent as nations prioritise military spending and protectionist trade policies over social welfare programs.
The new fiscal reality
The global fiscal landscape has fundamentally shifted. The United States, carrying a staggering US$36 trillion in debt, exemplifies the precarious balance between revenue generation and public expenditure. Meanwhile, the resurgence of tariff wars—with the US imposing sweeping tariffs on Chinese and Indian goods and threatening similar measures against European, Canadian, and Mexican imports—represents a regressive tax that disproportionately burdens low-income households who spend a larger share of their income on consumer goods.
This shift comes at a particularly troubling time. Military spending across NATO countries has surged past 2% of GDP following geopolitical tensions, while social spending faces cuts. The Stockholm International Peace Research Institute reports that global military expenditure reached US$2.4 trillion in 2023, even as poverty reduction programs stagnate. This reallocation fundamentally violates the principles of fiscal progressivity we outline in our framework—where government policies should enhance social welfare while minimising poverty and income inequality.
Tariffs: The hidden regressive tax
Tariffs function as indirect taxes that exhibit strong regressive characteristics. When the US imposed 25% tariffs on Chinese imports, studies showed that American consumers bore 90% of the cost through higher prices. For a family earning US$30,000 annually, these tariffs effectively impose an additional tax burden of approximately US$800 per family—a 2.7% reduction in purchasing power. For those earning US$300,000, the same nominal cost represents only 0.27% of income.
Using our progressivity framework, tariffs exhibit a negative Kakwani index, indicating their regressive nature. The concentration curve of tariff burden lies above the Lorenz curve of the income distribution, meaning poorer households pay a disproportionate share relative to their income. This violates the fundamental principle of vertical equity in taxation—that those with greater ability to pay should bear a larger burden.
The debt-defence dilemma
The fiscal arithmetic is stark. The US federal deficit approaches US$2 trillion annually, with interest payments alone exceeding US$1 trillion—surpassing the entire defense budget. The EU faces similar pressures, with average debt-to-GDP ratios exceeding 90% while committing to increased defence spending. Australia, though in a relatively better position, has seen its debt triple over the past decade while reducing unemployment benefits in real terms.
This debt accumulation constrains future fiscal flexibility precisely when aging populations require expanded healthcare and pension systems. In 2023, the International Monetary Fund warned that without policy changes, public debt in advanced economies could reach 140% of GDP by 2030. Yet rather than addressing this through progressive taxation on wealth or capital gains—which our research shows can enhance both equity and social welfare—governments increasingly rely on regressive consumption taxes and tariffs.
The social welfare imperative
Our decomposition analysis reveals that fiscal systems’ impact on social welfare depends critically on three factors: progressivity, the average tax rate, and horizontal equity. Current policies fail on all counts. Tariffs are regressive, military spending generates minimal or even negative social returns compared to education or healthcare investments, and tax systems increasingly favour capital over labour income, creating horizontal inequities.
Consider the counterfactual: reallocating just 10% of global military spending to social programs could fund universal basic healthcare in all developing nations. A wealth tax of 2% on fortunes exceeding US$50 million could generate US$500 billion annually while affecting only 0.1% of the population—embodying the progressive principles that maximise social welfare.
A path forward
The solution requires returning to fundamental principles of fiscal policy design. First, replace tariffs with progressive income and wealth taxes that satisfy our vertical equity axioms. Second, evaluate all government expenditures through their social welfare impact—infrastructure and education consistently outperform military spending. Third, address horizontal inequities by closing loopholes that allow capital gains and inherited wealth to face lower effective tax rates than wages.
The fiscal challenges facing modern governments are not insurmountable, but they require political courage to implement progressive policies that may face resistance from powerful interests. As we demonstrate in our research, the mathematical relationship between fiscal progressivity and social welfare is clear: progressive systems that treat equals equally and unequals unequally in proportion to their circumstances maximise societal welfare.
The choice before policymakers is stark—continue down a path of regressive taxation, mounting debt, and declining social welfare, or embrace progressive fiscal reforms that enhance both equity and economic sustainability. The tools for evaluation exist; what’s needed now is the political will to use them.
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