Future governments face tough choices – whatever their politics

The CBI and IPPR published a report on the future of public services last week. It warned:

Britain faces a longer-term fiscal challenge. The Office for Budget Responsibility has estimated that by 2030 Britain will once again move into deficit because long-term trends look set to increase the demand on public services while restricting future tax revenues.

The paper calls on politicians to start a public debate now about the scale of this challenge and the kind of decisions it requires us to make.

Start a debate? Some people have been banging on about this for ages.

The report’s projections of age-related spending are less pessimistic than some I have covered in previous posts. It predicts a rise of around 2 percent of GDP by 2030 and 5.6 percent by 2060. However, it also points to a number of unknowns, such as economic growth (or lack of it), migration, birth rates and unexpected behaviour change which might put pressure on public spending over the next few decades.

Then there’s climate change, the other thing, beside the cost of ageing, which keeps council chiefs awake at night.

We know that the climate is getting warmer: this is a trend that politicians have so far been unable to stabilise and which could either be controllable or potentially catastrophic in its impact particularly in the developing world.

Who knows what the cost of flood defences, failed harvests and increased migration from drought or flood ravaged countries might be?

Furthermore, says the report, tax revenues will not keep pace with the increased costs.

In contrast to growing demand on spending, tax revenues are projected by the OBR to increase just very modestly from 37.6 per cent of GDP at the end of 2015/16 to 38.2 in 2030/31 and 38.5 per cent in 2060/61, an increase of just 0.9 percentage points of GDP – equivalent to £13 billion in today’s terms. This reflects a number of factors:

  • a rise in income tax, VAT and capital taxes as a proportion of GDP, because these are taxes paid proportionately more by older people
  • a fall in the share of national insurance contributions (NICs) because pension income is exempt
  • falls in revenues from fuel, oil and gas, and tobacco duties.

The inevitable result is that, if we want to keep ourselves in the manner to which we have become accustomed, but we don’t increase the tax take, a deficit will open up sometime in the middle of the next decade.

When Adil Abrar came up with the term ‘Peak State‘ I had one of those I-wish-I’d-written-that moments. Peak State neatly summed up something I’d thought for a while – that state provision had peaked and that the generous welfare and public services of the late Twentieth and early Twenty-First Centuries would be a historical blip.

Last time I wrote about this, I was accused on a couple of forums of being a Shrink-the-State Tory. But confusing the Peak State and Shrink-the-State arguments misses an important point.

Ever since the foundation of the welfare state, public spending has been, on average, around 40 percent of GDP. It goes up in recessions, for the most part because GDP goes down. In good times, it’s usually somewhere in the mid to late thirties.

That has always been enough to cover the costs of welfare and public services. But ten years or so from now it won’t be. The increased pressure on the public purse will mean that, if spending is to be kept at 40 percent of GDP, some of the things we currently take for granted will have to go. In other words, even without trying to shrink the state, further cuts to welfare and services are inevitable.

The alternatives are considerably higher taxes, which the British have always proved reluctant to pay, or running a deficit which, given the level of state debt, would be unsustainable.

As the IPPR puts it:

Whichever party is in power over the next two decades the fiscal environment will remain tight and will impose upon our leaders the need for difficult and unpopular decisions. They would be wise to lead a public debate now on the kind of choices that will confront us. These pressures are not unmanageable, still less an excuse to retreat from providing high-quality services. Nevertheless, with more people living longer and a smaller relative number of taxpayers to fund older people’s pensions and services, something will have to give.

Which means tough choices about spending priorities and urgent improvements in public sector productivity.

Rick Muir, one of the report’s authors, said in the New Statesman:

Any future government will have to make very difficult choices. The way forward is to create a broader, more sustainable tax base, take big strategic decisions about which services we as a country should prioritise and get serious about raising public sector productivity over the long term.

The report’s conclusion is stark:

This paper has set out a major challenge facing Britain and one which has yet to be the subject of serious public debate. The OBR estimates that by 2030, on current trends, Britain will sink back into deficit unless we take some action in the next 10 years to raise the growth rate, contain expenditure or increase taxes.

In times of plenty Britain did not have to address these questions, because buoyant revenues from the City and rising house prices meant that we could invest more in public services without paying much higher rates of personal tax. Those days are now over and as a country we will have to choose……What is clear is that Britain needs to start debating those big choices now so that whatever course is taken carries with it the support of the British people.

None of this is good news for ideologues of the right or left. With new demands on state spending, keeping it at around 40 percent of GDP will be hard enough. The 33 percent of GDP called for by the Taxpayers’ Alliance is probably unachievable without causing serious civil unrest.

But those on the left who hope that public services and welfare will return to pre-recession levels when a Labour government gets back into power may be disappointed too. Ed Balls was condemned as a traitor when he said that a Labour government would not be able to reverse Tory cuts. It was not a u-turn, though; more a reflection of the grim reality. A Labour government elected in 2015 would have little room to manoeuvre. It costs more to rebuild than you save by cutting. With rising pressure on public finances and high levels of debt, turning the clock back to 2007 will be impossible without big, and politically unpalatable, tax increases.

It’s not good news for the public sector unions either. The ‘no cuts’ dogma will become unsustainable. Those who set themselves against the reorganisation of public services will find their stances increasingly difficult to justify. Things are not going to get back to normal for the public sector. Permanent pressure to reduce costs is the new normal.

The task for this decade is to design a state that can handle the next one. Doing that will mean making some decisions that a lot of people won’t like. As with all difficult problems, the longer we leave it, the worse it will be.

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9 Responses to Future governments face tough choices – whatever their politics

  1. Another sobering and extremely well argued “peak state” post there, sir.

    Your concluding point – that “the task for this decade is to design a state that can handle the next one” – is a particularly interesting one.

    By coincidence, I’ve published a post on the XpertHR blog today, looking at the Coalition Government’s programme of radical employment law reform, and the possible motviations behind it: http://www.xperthr.co.uk/blogs/employment-intelligence/2012/06/is-the-coalition-government-wa.html

    In this post, I quoted words from William Hague’s recent Telegraph interview, which seem to suggest that radical reform to the labour market and the welfare system will be the legacy of the Coalition Government.

    If this does indeed turn out to be the legacy of the Coalition Government come the 2020s (as Hague believes it will be), does this mean that Cameron and co are already embarked on designing “a state that can handle the next one”?

    And could it end up being the case that politicians across the board will welcome this model come (say) the mid-2020s?

    Very interesting, but very complex, questions to ponder there!

  2. Pingback: Future governments face tough choices – whatever their politics - Rick - Member Blogs - HR Blogs - HR Space from Personnel Today and Xpert HR

  3. Thank you for this very interesting post. The issue will be difficult to resolve successfully within the existing political system whereby parties with conflicting interests compete to remain in power rather than create long term sustainable solutions to society’s problems. Things will have to change …

  4. B.O. Locks says:

    Yeah, labour market reform. That will help. Abolish the minimum wage, hire and fire workers at will. let top pay rip through the stratosphere. Yeah, this will resolve the future. As usual, the CBI and its business “think” tank colleagues are bang on the money. Cretins.

    As for climate change, is not our future safe in the hands of James Delingpole and his Libertarian fellow whackjobs who say that it doesn’t exist. There, that’s the solution to that one sorted – deny it.

    As for the deficit, this can be reduced, even eliminated, by increasing taxes. Perhaps a land tax should be introduced. Governments in the Nordic countries take a higher share of GDP in taxes than does the UK government. The UK norm of 40% is an arbitrary figure. There is no reason why the tax take should not be 50% or 60%. Laffer? Bollocks.

    The Club of Rome published a warning about the forthcoming doomsday scenarios in its 1974 report entitled The Limits to Growth. What contingency plans has our, or any other, government formulated to accommodate these scenarios? None, is my guess. People deserve the government they elect so I guess we shouldn’t complain. It’s just that I feel afraid for the generation growing up now who have had nothing to do with the creation of the distopian world which they may well be obliged to inherit.

    Life in the future looks like it will be nasty, brutish and short for our children and for succeeding generations.

  5. Jim says:

    All absolutely true, apart from the bit about the climate warming up causing more problems. The globe has not warmed for nearly 15 years now. I’d be more worried about colder times ahead if I were you – economic growth is considerably harder in cold times than warm ones.

    • B.O. Locks says:

      @Jim

      Not sure that economic growth is harder to achieve in colder climates. Travelling towards the equator, from either the north or south, economies in general become poorer, Iceland and Norway, both colder than the UK have done well in economic terms. Northern Europe does better than southern Europe. Southern Europe does better than Africa. A similar analysis produces a similar trend for North America and for Asia. Of course there may be exceptions (Singapore for example) but in general the rule seems to be a good one.

    • guthrie says:

      Seriously, that’s a lie. The Earth continues to warm, as can be seen by comparison of any data set you care to mention. The most obvious being the amount of energy being stored in the oceans, which is steeply increasing and has done for the last couple of decades. The only way to get the no warming in 15 years lie is to pick 1998 when we had a monster el nino and ignore the 2 or 3 times since that it has been beaten, albeit not by much.

  6. We’ve had almost 12 months worth of doom-mongering about future fiscal sustainability since the OBR’s July-2011 report. This suffered from 3 flaws which the CBI/IPPR report perpetuates:

    1) “In contrast to growing demand on spending, tax revenues are projected by the OBR to increase just very modestly”. The OBR’s assumptions about tax highlight a number of areas where technological and social change will reduce revenue, such as fuel efficiency and lower levels of smoking, but exclude the possibility of new revenue streams, i.e. tax on goods and activities that haven’t been touched or invented yet.

    Their brief includes extrapolating current tax policies, but does not include opining on tax composition. For example, they note that one of the biggest areas of revenue growth over the period will be inheritance tax, because there will be many more old people with capital. They do not comment on additional capital taxes such as a mansion tax or a land value tax.

    2) The OBR assumes the single biggest factor in the growth of health service demand is increased longevity. The report further “assumes that projected increases in life expectancy will be spent in poor health – an expansion of morbidity” (op cit, pgs 77-78).

    But the reason why we are living longer is because we are becoming healthier. There is no reason to believe that we will each of us use more health services in the future, either proportionate to our lifespan or in absolute terms. You can only have one terminal illness. The improvement in diet, the reduction in air pollution, and the decline in smoking mean the yoof of today are already healthier than those born during the baby boom, let alone those born and raised in the hungry 20s and 30s (today’s geriatrics).

    3) The OBR believes that health sector wages will grow faster than productivity, thus pushing up health costs. This is based on the premise that the health sector is relatively labour-intensive. As most productivity gains come from capital investment, this means the sector tends to improve at a below average rate, while the pressure on wages seeks on-average increases.

    However, the past is not always a guide to the future. It is just as reasonable to anticipate future productivity gains coming through greater preventative care and more investment in technology, both of which could result in proportionately lower labour growth. It’s worth noting that the one thing that will ensure excess headcount growth is privatisation, as that will add new managerial and commercial roles.

    If you adjust for these three factors, the future debt-to-GDP ratios looks a lot less scary. In essence, the OBR are guilty of Malthusian pessimissm.

    The ideological rationale of the CBI and the IPPR is less about shrinking the state per se and more about giving capital access to bigger markets. The flip-side of all the worry about increased health demands it that it assumes health will be a major growth sector. This is what is driving privatisation.

    See http://fromarsetoelbow.blogspot.co.uk/2012/03/were-doomed.html for more.

  7. Excellent post.

    Your recommendation that ” The task for this decade is to design a state that can handle the next one.” is absolutely spot on. This requires both courage and empathy.

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