The taxless recovery

This is no ordinary recovery. Not only has it taken a hell of a long time to do not very much, it’s seen collapsing productivity and very little wage growth, even for those who appear to be highly skilled. As a result of all this, even though the economy grew at over 3 percent, the tax revenues didn’t increase at the same rate.

As Sarah O’Connor reported in the FT:

[T]ax receipts have grown just 2 per cent so far this year, compared with the 5 per cent growth the Office for Budget Responsibility forecast in March.

As Ben Chu’s chart shows, most of the rise in tax revenue since the recession is due to VAT.

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Record numbers of people in employment, it seems, hasn’t led to record levels of income tax.

When you break out the figures for income tax, as Michael O’Connor did earlier this week, there is a marked difference between receipts from those on PAYE and those on self-assessment.

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Falling self-assessment receipts are, for the most part, a symptom of falling self-employment incomes. Around three-quarters of the employment growth since the recession has come from self employment yet between them, the self-employed are still delivering a lot less tax. We won’t see the final 2013 HMRC figures for self-employment incomes until January but these charts suggest that the spectacular fall in self-employment earnings between 2008 and 2012 hasn’t improved by much. Probably the closest estimate we have for self-employed pay since 2012 is by Laura Gardiner at the Resolution Foundation. The low tax receipts indicate that self-employed earnings may have continued to fall or are, at best, stagnating.

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Things might be about to get worse for some of the self-employed. As Ben Dellot explains, the new Universal Credit system could leave many of them worse off. According to the RSA’s calculations, 37 percent of the self-employed earn less than the minimum income floor, which is set at around the full-time minimum wage. (That sounds about right. A study by the IFS found that 40 percent of the self-employed earn less than the minimum wage.) Not all the self-employed currently claim tax credits but those who do, and who fall below the income floor under the new system, will find their benefits cut. The self-employed now account for almost a fifth of tax credit claimants so this is likely to affect a lot of people.

It is yet another symptom of the uncertain situation in which many people find themselves. The low tax take and stubbornly high social security costs are two sides of the same story. The number of people in employment might have increased but a lot of that employment is insecure and doesn’t pay very well.

Income tax, VAT and National Insurance are three of the state’s biggest sources of revenue. If any one of them fails to deliver as promised, the government is in a financial hole. People whose employment status and earnings are precarious don’t deliver much in tax. This isn’t a normal recovery. Along with the other epithets being used to describe it – low-wage, slowest-for-a-century, low-productivity and so on – we can now add another; taxless!

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A high-skill, low-wage recovery

“Labour economics used to be easy,” lamented David Blanchflower in Monday’s Independent. He continued:

All you had to do was watch the unemployment rate and that told you most of everything. As it went up things were bad and pay weakened. When the unemployment rate fell that meant the economy was getting better and that meant pay rises. Low unemployment meant big pay rises. High unemployment meant smaller rises. Simple.

But, over the past few years, falling unemployment hasn’t led to higher wages in the UK or the US. If anything, wages have continued to fall as employment has picked up.

The picture is even stranger when you look at skills. Employers have been talking about skills shortages for some time now. Earlier this week, the UK Commission for Education and Skills (UKCES) published a paper saying that Britain is already facing a skills challenge and that the country will need 2 million more highly skilled workers by 2022.

UKCES expects the skills profile of the workforce to polarise over the course of this decade, as there is an increased demand for jobs at the high and low skill end while demand falls in the middle.

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That’s not what seems to have happened since the recession though. The ONS data on skills indicate that the employment recovery has been largely a highly skilled one. This chart in the Bank of England’s inflation report shows that, while a lot of the very recent job growth has been in lower skilled occupations, most of it since 2010 has been among the higher skilled. (Definitions are based on the Labour Force Survey categories.)

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I wondered how much of that might be due to the self-employed bigging themselves up in the Labour Force Survey. As the ONS said:

The nature of self-employment is such that many people manage their business and are therefore likely to state they are in a managerial role despite the level of responsibility they may have.

Using at the ONS data and applying the definitions the Bank used, I broke the same period down between employed and self-employed.

Skills1 2010-14

Among the employees, even more of the increase is accounted for by those in the highest skill groups, so bang goes that theory.

Take the figures over a longer period, since the start of the recession, though, and things look even more skewed.

Skills1 2008-14

Almost all the increase in employment since the recession has been among the more highly skilled groups. There are still fewer medium and low skill employee jobs than there were six years ago.

There’s something else funny going on here, though. We’ve just had the longest decline in wages for half a century. It looks even worse if you include the self-employed.

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Since the recession, pay has fallen by about 12 percent yet, over the same period, almost all the net gain in employment has been among the most highly skilled occupational groups. So we have a more highly skilled workforce earning a lot less.

Some of this may be due to the hours people are working, or not working. All the net increase in employment since the recession has come from self-employment or part-time jobs. Last week’s figures showed a slight fall in the number of employed full-time jobs for the second month running. There are still fewer people in full-time employment than there were in 2008.

That said, hourly pay rates have fallen too. The reduction in earnings isn’t just because people have gone part-time and not done as much work. The amount they are paid per hour has also fallen. In recent years, the drop has been particularly steep at the top end.

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This suggests that, while Britain’s workforce may be more highly skilled, employers either don’t have enough work or are not paying a premium for those skills.

Of course, some of this might be due to the zeitgeist. It may be that people are becoming more inclined to talk themselves up when they answer the Labour Force Survey. A decade of programmes like the Apprentice may have convinced us that we are all managers and professionals now. Somehow I doubt it though. The increase in jobs is skewed so far towards the high skilled that an increased tendency to talk up our jobs couldn’t explain all of it.

Could it be that the distribution of skills is wrong? Perhaps people are skilled but not in the things that employers are prepared to pay a high premium for. There has been a lot in the media about skills shortages but a UKCES paper earlier this year found that only 4 percent of employers said they couldn’t fill vacancies because they couldn’t find people with the right skills. More common was the problem of insufficient skills within the existing workforce. 15 percent of employers reported having staff in jobs whose skills did not fully meet the job requirement. 13 percent said that the skills of their employees were either not relevant to their jobs or there was little opportunity to use them. This suggests that some highly skilled people may have been taking lower-skilled jobs.

Whatever the explanation, none seems entirely satisfactory. If the UK has skill shortage it is a very strange one if it is not bidding up wages. It is very odd that pay has fallen so spectacularly at the same time as highly skilled employment has risen. We hear a lot about the UK becoming a low wage, low-skill economy but, if these figures are a true reflection of what’s going on, it looks more like a low-wage high-skill recovery.

It reminds me of a question one of my lecturers tossed out to the class many years ago: Is a skill still a skill if nobody is prepared to pay for it?

I don’t think we ever came up with an answer to that one.

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The 2015 Dilemma (Revised Edition)

Two reports on the public finances were published at the weekend. These things usually come out during the week but both the Institute for Fiscal Studies and the Resolution Foundation had to squeeze their press releases into the couple of days after the Scottish referendum result (which would have thrown everything up in the air) and before the party conferences.

Both papers look at the spending plans of the three main parties as they have been outlined so far. All parties say they will eliminate the deficit by the end of the next parliament. The only differences are how quickly they will do so and which definition of the deficit they use.

Broadly speaking, the main difference is that the Conservatives say they will eliminate the entire deficit by 2018-19 whereas Labour and the Liberal Democrats aim to eliminate the deficit on day-to-day spending but continue to borrow for capital investment.

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As the Resolution Foundation says, working out what that means in practice is quite difficult:

Assessing precisely what is implied by these differing plans depends on a number of unknown policy details (as well as inevitable economic uncertainty). It is not possible based on current information to say anything definitive about the differences between these plans. But by way of adding to the debate, we can establish a number of indicative scenarios based on what we think are plausible interpretations of these different approaches. As more information is provided these scenarios will obviously change. Taking this speculative approach, the main options and trade-offs are set out in the chart below.

Spending-review-chart-20141

In other words, the longer you take to reduce the deficit, the fewer public service and welfare cuts you have to make by 2018-19 but the more you have to borrow or raise taxes.

These different scenarios – all highly speculative – clearly have differing implications for the size and shape of the state in 2018-19. They also involve different trade-offs. One the one hand, more gradual trajectories clearly have the advantage of reducing the immediate burden on public services and on households. But that choice comes at a price. Other things being equal, faster approaches will bring the stock of debt down more quickly therefore reducing the share of government funds allocated to debt interest payments as well as leaving the economy better placed to absorb future shocks and pressures.

Based on the OBR numbers, both the IFS and the Resolution Foundation came up with a similar figure for the shortfall. To avoid any more cuts to social security or public service spending, or any additional borrowing, the next government will need an extra £37 billion a year. Unless that is raised in tax, the government will have to borrow more or cut more during the next parliament.

So far, all three parties have been fairly quiet about tax, apart from the odd promise that won’t actually raise much money. The difference between the main parties, therefore, is not cuts or no cuts but how deep the cuts should be and over what period. It all means more austerity, it’s just that the blend is different.

Beyond that, there isn’t much detail. As the IFS says:

For all the main UK parties, based on the latest official forecasts for the economy and public finances, achieving their fiscal targets will require further tax increases, or cuts to welfare spending or public services in the next parliament. None of the parties have yet provided the electorate with full details of these tough choices.

Even what little detail there isn’t very plausible. For example, George Osborne’s £12 billion of welfare cuts, highlighted on the Resolution Foundation’s graph, looks to me like a big Chinny Reckon.

It’s unlikely that the next government, whoever is running it, will be able to eliminate the deficit without tax increases. Welfare cuts wouldn’t save much and so the cuts to public services would just be too big unless a major reduction in state provision is planned. It’s also nigh on impossible to rise these extra taxes just from the rich, which is perhaps why politicians are so reluctant to talk about it.

So far, then, the parties stated plans give us a flavour of what might happen but not much detail. The projections from the IFS and Resolution Foundation tell us that there will certainly me more cuts and there will probably be extra borrowing. Most probably, there will also be extra tax increases.

The 2015 dilemma remains, as ever, the about the trade-off between them.

The 2015 Dilemma (Revised)

Public Spending Venn 2015-2

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Pirate Day joke

One night, far out at sea, a young pirate is talking to the pirate captain.

“Cap’n,” he says, “‘Ow comes is it you’s got an ‘ook for an ‘and?”

“Ha ha harrr. ‘Twas like this. We was just leavin’ Port Royal when we was attacked by a Navy frigate. I fought a desperate battle with their cap’n. I ran ‘im though but not before he’d chopped my ‘and off and taken it with ‘im to his watery grave. Ha Ha Harrr!”

“So Cap’n, ‘ow comes is it you’s only got one leg?”

“Ha ha harrr. We was comin’ back from a raid in the Bahamas when we was shipwrecked in a storm. I ended up in a fight with a shark. I stabbed ‘im in the eye with my dagger but not before he’d bitten my leg off and taken it with ‘im to Davey Jones’s Locker. Ha Ha Harrr!”

So Cap’n, ‘ow comes is it you’s got a patch on your eye?”

“Ha ha harrr. We was about to set sail from Plymouth. I was looking’ up to the heavens to see if there be a storm brewin’ when a seagull flew over and crapped in my eye.”

“But Cap’n, you doesn’t lose an eye just cos a seagull craps in it.”

“Ha Ha Harrr! You does when you forgets you’s got an ‘ook for an ‘and.”

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Nine thoughts on the referendum result

A few thoughts on the referendum result.

1. I’m pleased about the result. We’ve saved ourselves a lot of pain.

2. When people think there is a likelihood of real change, they will come out and vote, even if only to prevent it.

3. Some people are making too much of 2. As any manager knows, it’s easy to motivate people when there is a clear and immediate goal. Much of government and party politics is about the tedious day-to-day and the ambiguous long-term. It’s much more difficult to get people excited about that. It is unlikely that general elections will get 86 percent turnouts, no matter how honest and authentic the politicians are.

4. We’ve got all this to come again if there is a referendum on the EU. Most of the arguments about uncertainty and instability apply as much to a UK exit from the EU as they do to a break up of the UK. Some of the people who deployed these arguments against the Yes campaign will be saying the opposite when it comes to leaving the EU.

5. At some point someone (most likely the IFS) will make a stab at working out the cost of ‘the Vow‘ and its implications for the rest of the UK. It won’t be cost neutral. It will probably have to be added to that growing list of unfunded spending commitments in the next parliament.

6. This result raises a whole series of new questions, especially about England. If some powers are to be devolved to Scotland, Wales and Northern Ireland, they are devolved to England by default, yet England has no representative body. Devolution to England, though, is barely devolution at all. The referendum has led to calls for decentralisation from all corners. From Northumberland to Cornwall, devolution is where it’s at. How this is all going to work is anybody’s guess.

7. Expect more ugliness. I have stayed out of most of the debate because I haven’t had time to do much more than stick out a couple of blog posts. From what I hear, though, both the online and street level arguments got quite nasty. I saw a couple of Twitter attacks on Frances Coppola and Jonathan Portes. When you are losing an argument, make stuff up, claim that people are in the pay of bankers (or whoever is today’s bête noire) and insult their families. We’ll probably see a lot more of this. An English backlash is already being stoked up. The nastiness on all sides will get worse as the election gets closer.

8. Despite everything I’ve said so far, some of this might lead to changes that will make our country better. I’m a devolution sceptic, which is an unfashionable position at the moment, but I’m keeping an open mind. The jolt Westminster has received from the world outside London is no bad thing. Perhaps we could do something radical like relocate the government.

9. I’ve picked a great time to go on holiday. I can go and buy my Euros now.

 

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Breaking up the UK – everyone’s a loser

The rest of the world thinks we are mad, as well they might. Viewed from outside the UK, the minor differences which separate the Scots from the rest of us don’t look like that big a deal. Why would you want to break up a prestigious well functioning state with a good credit rating on a whim?

New York Times economist Paul Krugman has written several posts in the last week, starting with Scots, What the Heck? and the most recent Maastricht in a Kilt

It would be one thing to make the sober case that independence is worth it despite the economic costs and risks; but the SNP has been claiming that there are no costs and risks, which is just wrong.

He links to a strong post from Simon Wren-Lewis which accuses the SNP of “Fooling yourselves and deceiving others.”

Scotland’s fiscal position would be worse as a result of leaving the UK for two main reasons. First, demographic trends are less favourable. Second, revenues from the North Sea are expected to decline. This tells us that under current policies Scotland would be getting an increasingly good deal out of being part of the UK.

He goes on:

Is this a knock down argument in favour of voting No. Of course not: there is nothing wrong in making a short term economic sacrifice for the hope of longer term benefits or for political goals. But that is not the SNP’s case, and it is not what they are telling the Scottish people. Is this deception deliberate? I suspect it is more the delusions of people who want something so much they cast aside all doubts and problems.

And concludes:

I have no political skin in this game: a certain affection for the concept of the union, but nothing strong enough to make me even tempted to distort my macroeconomics in its favour. If Scotland wants to make a short term economic sacrifice in the hope of longer term gains and political freedom that is their choice. But they should make that choice knowing what it is, and not be deceived into believing that these costs do not exist.

He’s right about the costs to Scotland but I’m not sure he’s right about not having skin in the game. I reckon we’ve all got skin in the game. Those of us in the rest of the UK certainly have but so have people in other countries. None of them want to see a weakened economic and military partner. The UK, for all its faults, is one of the countries that helps to bring stability to the world. That’s why so many foreign governments are getting worried about the prospect of a Yes vote.

Alex Salmond is, no doubt, glad that the SNP’s original plan to hold the referendum in 2010 did not come to pass. A vote so soon after the financial crisis would have been held in an atmosphere of gloom when people were less inclined to take risks. But things are looking better now, as economies around the world have started to grow again. The danger seems to have passed.

Look a bit more closely, though, and it hasn’t. We are still in the post-2008 crisis. It is becoming clear that this recovery is like no other post recession period we have ever seen. The usual rebound, with a couple of 4 percent growth years to make up for lost time, doesn’t look likely to happen. The OBR is forecasting real annual GDP growth rates of around 2.5 percent for the rest of this decade. We called that sort of growth a slowdown in 2002. Now we’re calling it a recovery.

Some may blame the Tories for this and say that it strengthens the case for independence. But putting all the blame for the slow recovery on the Coalition is as silly as putting all the blame for the rise in debt on Labour. To an extent, the same problem is facing most developed economies and certainly all of the major ones. We look with envy at America’s growth rate yet even this is weak by the standards of previous recoveries. US growth is slowing down and the Eurozone’s has stalled. Even the Swiss are in trouble.

Yesterday, the OECD cut its global growth forecasts. As the FT reported:

Fears of disruption following a Scottish vote for independence and intensifying conflicts in the Middle East and Ukraine have damaged prospects for the world economy, the Organisation for Economic Co-operation and Development said on Monday.

In an update to economic forecasts published in May, it said the outlook had darkened for 2014 and 2015 for almost all the world’s large economies, partly as a result of one-off hits to growth early this year and partly stemming from geopolitical risks.

This is not like the post-recession booms we had in the last half of the twentieth century. This century’s version is built on shakier foundations. Last week, Larry Summers repeated his secular stagnation warning (see previous post). America, he argued, is now in a period of much lower economic growth and radical government action will be needed, just to keep it at around 2 percent over the next decade.

If that’s true for the US, something similar is probably true in Europe, where what Summers called “the brutal demographics of an ageing population” are that much worse. As this chart from the Resolution Foundation shows, it looks unlikely that the UK will get back to trend growth, as we did in previous recessions. Or, to put it another way, trend growth is now well below the postwar 2.6 percent.

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You could probably draw a similar chart for most developed economies. It is probable that most have experienced a permanent loss of GDP. All of us are now in a period of much lower economic growth than we have been used to. Quite how much lower is anybody’s guess, though hopefully it won’t be as low as some people think. What we are seeing now, though, may be as good as this recovery is going to get.

Since the Second World War, we have built a whole society on the assumption that growth would continue at somewhere between 2.5 – 3 percent. All our assumptions about living standards, what the state should provide and how much better off the next generation will be than the last may turn out to be wrong. Those of us who assumed the postwar world would go on forever are in for a shock.

It’s a sign of just how fragile the global recovery is that the OECD has cited the Scottish referendum as one of the factors behind the slowdown. Warning that it “would take many years to unlink ties between Scotland and the rest of the UK”, the OECD described Scottish independence as a “geopolitical risk”. This not just an issue for Scotland or the UK. A lot of other countries have skin in the game too.

All developed economies are facing at least a decade of weak growth, ageing populations and relatively high debt. Despite all the politicians’ bluster, most will have to run deficits at some point. As this paper from NIESR yesterday reiterated, the borrowing costs of both Scotland and the rest of the UK would almost certainly go up after independence, whichever way the existing national debt is allocated. That means all of us paying more taxes to fund debt repayments. I can’t see how that is good for anyone except the lenders.

I haven’t the space to go into the military implications or the impact on public services but both would be complex and damaging. From whatever angle you look at it, Scottish independence leaves the entire country worse off. We are all in the same leaky boat. The idea that some people can take their bit of the boat somewhere else and everything will be fine is a fantasy.

As they look back at the 21st century, historians will probably wonder why, when they should have been preparing for a period of slow growth, rapid ageing and debt hangover, the people of the UK decided instead to spend precious time and resources smashing up one of the most secure and propserous countries in the world. At a point when the global economic recovery is still so fragile, breaking up the Union is not good for Scotland, not good for the UK and not good for the rest of the world either. As the FT said last week, there must be a better way than this.

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The brutal maths of public spending

More on the OBR’s Crisis and consolidation in the public finances report. (See yesterday’s post.) Chapter 6 contains lots of information and commentary on the government’s proposed deficit reduction strategy.

The OBR’s charts neatly sum up a lot of what I’ve been trying to say about the outlook for public spending. Debt interest is set to rise and social security costs to fall very slowly, so most of the deficit reduction has to come from cuts to public service spending.

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The government is not planning to raise much additional tax so, to get the public finances back to where they were last time the country had a surplus, at the beginning of the century, it must offset the increased welfare and debt interest payments with a big cut to capital (CDEL) and day-to-day (RDEL) public service spending.

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As the report comments:

Interestingly, the levels of total receipts and total spending that we forecast for 2018-19 are very similar to those recorded in 2001-02 at around 38 per cent of GDP. So on current Government policy we are not expecting the UK to become a significantly higher spending and higher taxing, or lower spending and lower taxing, economy in 2018-19 than we were the last time the budget was broadly in balance 14 years ago. Receipts are expected to be just 0.6 per cent of GDP higher than in 2001-02 at 38.1 per cent of GDP and spending just 0.1 per cent of GDP higher at 37.8 per cent of GDP.

So in one sense, the state gets back to roughly the size it was when Tony Blair went into his second term. The 2018 state will look very different from the 2002 one though.

[T]his similarity in the aggregates masks a big change in the composition of spending. We forecast that in 2018-19 the Government will be spending around 4 per cent of GDP (£66 billion a year in today’s terms) less on public services and capital spending than Labour did in 2001-02 and around the same amount more on welfare, debt interest and other annually managed expenditure.

Because there is more money to find for welfare and debt interest now, that 38 percent of GDP doesn’t leave us with anywhere near as much to spend on public services. Without tax increases, reducing the deficit to 2002 levels can’t be done without big cuts to public services.

This next chart illustrates the brutal arithmetic of public spending. Overall spending goes up in cash terms and the real terms cut of 4 percent looks quite small. But by the time welfare, debt interest and other AME spending have taken their slices, real terms public service spending (Total DEL) falls by 23 percent. Add in the effects of population change and per capita public service spending drops by 27.5 percent.

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I was quite pleased when I saw this because the figures are not that far off the ones I came up with when I did a back-of-the-fag-packet calculation 5 months ago. I wasn’t scaremongering. The numbers really are that big.

On top of this is the stated aim of protecting the budgets for NHS, schools and overseas aid. This means that the amount left for everything else would be even less. The OBR estimates that cuts to the rest of public service spending would be around 36 percent in real terms, which is similar to the IFS figure. It doesn’t say how this would translate into a per capita amount. Someone with more time than I have at the moment can work that out but it will be a large number.

At this point the OBR’s remit stops. Its job is to look at the government’s spending plans and explain what the fiscal implications are. Whether or not these plans are achievable is for other people to judge. Rightly, it doesn’t go into discussions about how a government spending 28 percent less per person on public services will cope when more of those people are elderly and when the demands on services are that much greater. It is not the OBR’s job to comment on the implications of these plans for individual public services either. For example, whether the protected budget will be enough to stop the NHS from running out of money before the end of the decade is someone else’s call.

So that article in the Daily Mail which claimed that the OBR has ‘praised’ the government’s spending plans is utter garbage. It didn’t say Britain is on track to deliver these savings, as the Mail claimed. It simply said that, if the savings are achieved, based on what else we think will happen to the economy, these will be the results. To have endorsed or criticised the plans would be well beyond the OBR’s brief.

In its conclusion, the OBR says (my emphasis):

If our central forecast proved to be correct, this would deliver the first budget surplus for 18 years and would represent one of the largest deficit reductions among advanced economies in the post-war period.

In other words, since the creation of the modern welfare state, not many people have tried this. These are huge spending cuts, both by historical and international standards.

The OBR has provided the information, then, but it’s up to politicians, public service providers and others to interpret it and assess the implications. Most of those who have looked at the figures in any detail doubt that a per capita 28 percent reduction in public service spending is achievable. At least, not without the state withdrawing from the provision of some services or charging for them at the point of use.

Everyone else, including most of our politicians, is keeping quiet.

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