Politicians cannot hide from UK finances

economy, finance, public services, taxation, UK politics

Author(s):  Nick Pearce, Gavin Kelly
Published date:  27 Sep 2012
Source:  Financial Times (£)

As the conference season continues, the same question hangs over each gathering of the party faithful: what does the bleak fiscal outlook mean for politics during the rest of the decade? To date, there has been bluster about "tough choices" but very little of substance about their actual content.

For now the focus must remain on growth but soon unpleasant fiscal decisions will come to the fore. If we assume the structural deficit is eliminated over the next five years, public spending cuts will comprise the vast majority (97 per cent) of fiscal consolidation during the first two years of the next parliament. If health and aid budgets keep their protected status, other departments face reductions of 6 per cent a year. Simply to keep the average rate of public service cuts to its current annual pace of 2.3 per cent would require £10bn a year of extra welfare cuts or tax rises by 2016-17.

All this assumes the NHS can survive with no real increases in spending until at least 2017, despite a history of increases of 4 per cent a year. It also implies that defence spending as a proportion of gross domestic product will continue to fall, requiring a further review of the UK’s security posture. Spending on education will do well to remain constant as a share of the economy.

If all this sounds gloomy then steel yourself: it is probably an understatement. The Office for Budget Responsibility’s growth forecasts are rosy and their fiscal projections could be downgraded this autumn. Besides, any incoming government is likely to increase resources on at least some priorities, meaning even more pain elsewhere.

There are other choices. The deficit could be tackled more slowly, though it is unlikely that the parties will adopt sharply contrasting positions on this. Different decisions could be made on spending cuts.

George Osborne’s axe has spared areas such as universal benefits for the elderly and pension tax relief for the affluent. If it fell on these, the savings could fund new priorities such as childcare or soften welfare cuts. And there are some obvious – if hard to execute – sources of revenue: charging national insurance beyond the state pension age; a financial transactions tax; and reformed property taxes. Together these could alter the incidence of cuts in the next parliament and create a slightly more balanced mix between spending reductions and tax rises.

However, charting a least bad course through the next parliament is only the start. Our fiscal problems will not abate when the deficit recedes. Spending pressures related to the ageing population will add 1.5 per cent of GDP to public spending between 2018 and 2030, and about 5 per cent of GDP to NHS spending by 2060. All of which means that if we are to rise to the demographic challenge while protecting collective health services and an already reduced welfare state for people of working age, then we have to face up to the longer-term weakness of the tax base.

Beyond 2020 more revenue will be required – even assuming reform to improve the efficiency of services – and not many taxes are up to the job. If raising the basic and higher rates of income tax is ruled out by the main parties then this may force a hard look at the reform and extension of value added tax, with offsetting measures for those on low incomes. A lesson from more egalitarian Nordic countries is that the quantity of tax is as important as its progressivity, since larger revenues enable redistribution via public services and transfers.

For now this sort of thinking will inevitably be scoffed at. Consumption taxes, like income taxes, are politically toxic. Electoral calculations will stop any of the main parties entering the next election with anything other than tax rises carefully targeted at popular villains such as bankers. No one is likely to broach the long-term fiscal black hole, at least until living standards have been steadily rising for years.

But at some point Britain’s tax base will need to be widened if the scope of our collective services is not to be narrowed. Fiscal activism is essential for today’s challenges but fiscal realism must follow. That means being tough-minded about the scale of spending cuts but in time it will also mean being prepared for new thinking on tax.


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Nick Pearce, Director