Sorting out the public finances Part 1 : Changing the debate

This is the first of a 5 part approach to sorting out public spending. The later parts include: A fiscal turnaround plan for the UK regions whose deficits are much worse than Greece; Sorting out which generation should be paying for what.

Part 1 – Two ideas to change the debate about public spending?

It is no wonder that Western governments have got into such a fiscal mess – it’s almost impossible at the moment to have a meaningful public debate about the right overall levels of taxation and spending. There tends to be lots of fragmented debate about individual taxes (e.g. fuel duty, inheritance tax, personal allowances for income tax, bingo taxes, etc). There is an equally fragmented debate about individual areas of public spending (e.g. new roads, the police, social care, unemployment benefits, etc). But there is little meaningful debate about the right overall levels of taxation and spending – beyond the ideological preferences of the left and the right for more, or less, of it all. Nor is there any relationship in most people’s minds between what happens to particular taxes and what gets spent on particular services. This means that most people want to see taxes come down (especially the ones they notice the most) and public spending go up (especially on the services or benefits they most appreciate). In the absence of a proper joined-up debate, we drifted into the absurdity of 2009 where the Government was spending like a Scandinavian (almost half of our national income) and taxing like an American (little more than a third of our income). The result was the highest annual deficit of any developed country. Since 2010, at least, most people in the UK now agree that Government’s expenditure should not exceed its income. By 2018, after 7 years of painful austerity, we should achieve a balanced budget. It will be the first time in 20 years. But it won’t be job over. The pressures on public spending (e.g. from the ageing population) could easily overwhelm a less than robust tax base (e.g. falling revenues from fuel efficient, low carbon cars).

We need a better way to debate what we want Government to spend and what we’re willing to be pay in tax. It can be meaningless to debate how much in aggregate a Government should tax and spend. Whether it should take 20% of our income (as in Mexico) or nearly 60% (as in France) depends on the roles and ambition we give Government. There are some fixed elements of the current UK political consensus ( a universally free and high quality health service; free schools; a universal and meaningful state pension; redistribution of money to poorer areas; etc) which mean that public spending, and hence UK tax, will always be fairly high. Conversely, UK private spending in these areas will be relatively low (e.g. on private health). Sometimes the headline numbers for Government spending are so striking that they spark the debate – e.g. 20 years ago, the Swedish Government was spending two-thirds of national income, prompting a tough fiscal regime to get down to today’s half of national income; in healthcare, the US Government spends far more per capita on healthcare than the UK, in spite of our having the NHS and US government spend on health being less than half of the total public and private spend. In these extreme cases, it becomes clear that something must be done, but, as Obama has learnt, far from clear what solutions the public will wear. But with the UK’s extreme deficit now falling, there is a danger that public and political attention drifts away from the major fiscal challenges we still face.

Is there a fresh way to engage the public in this fiscal debate? I have two suggestions:

(1) Every public body (be that a Government department or a local public body) which spends money should raise its own income, by setting a tax which is clearly and exclusively linked to that public body. So rather than the Treasury raising all of Government’s taxes and pooling the funds, the Secretary of State for Health, for example, would set an NHS Tax to fund his proposed level of spending on the NHS.

(2) The level of spend for each service or benefit should be explicitly set, by each Government, as a percentage of our national income. This would allow a public debate about the priority accorded to the particular service or benefit, and how it compared to other countries. For example, this was how Tony Blair publicly set the ambition in the early 2000s that the NHS should receive 8% of GDP, to be in line with other rich Western countries. .

How could this type of hypothecation work? Let’s look at each proposal in a bit more detail.

(1) All the spenders have to raise their own taxes

This is a radical idea that would spell the end of the Treasury’s fiscal role as we know it. Under this principle any department or public body which spends money should be directly responsible for raising the money to pay for its spending. They would have their own specific and exclusive tax. The relevant politician would determine the level of the tax to meet their own spending needs. For example, the Secretary of State for Health would determine the NHS tax and be accountable for it, as well as the spending which it funds. Clearly, in central government each Minister would need to get Cabinet support for their proposal (as they do for all policy decisions), but it would be their decision on tax and spending.  Moving to this system may not be as hard as it sounds. It’s possible to align existing taxes with existing spenders, rename the tax to show its hypothecated purpose and give the relevant politician the power to take this forwards. 

– National Insurance could be renamed “NHS Insurance (NHSI)”. The current NI tax and NHS spend roughly balance. The nature of the NI tax ( a percentage of wages, paid through a mix of employer and employee payments) is very similar to health insurance payments in other countries. The Secretary of State for Health would determine taxation policy for the new NHSI – the amount to be raised, the balance of contributions between employers and employees and the progressive burden of the tax on different payers. 

–  Income Tax could be renamed “Pensions and Disability Tax”. This would include all payments to pensioners (State Pensions, Pension Credits, etc). It would also include DWP’s disability benefits (DLA, AA) and Local Government’s social care budgets. This spending would consume all of the income tax receipts. If the public recognises this, it should lead to a more grown up discussion about the affordability of our entitlements and the trade-offs between tax and spending. For example, if people understand that raising the retirement age by 1 year avoids adding 2p in the pound to the basic rate of income tax, we will have a better informed political debate. 

– Corporation Tax could be renamed “Income Guarantee Tax”. This would fund the cost of all employment-related benefits – tax credits, housing benefit for working age people, unemployment benefits, childcare support. This spending roughly balances with Corporation Tax receipts. Linking the two would illustrate the cost to taxpayers of having a minimum income guarantee. It would also make the point to employers that their taxes could be lower if they provided more and better paid jobs. 

– VAT could be renamed “Education Tax”. VAT receipts would be enough to cover pre-school, schools, further education, higher education, apprenticeships and adult skills. The level of VAT and, critically, the exemptions from it would be determined by the Education Secretary. This might assist a more grown up debate about some of the exemptions – e.g. the tax-free status of clothes for well-off children – versus the need to spend on children’s education. 

– Wealth Taxes and Business Rates could be renamed “National Security Tax”. The wealth taxes include capital gains tax, inheritance tax, stamp duty and share duty. Together with business rates, this would provide enough revenue to fund the budget for National Security spend, including defence, intelligence and the national crime agency. There might be two taxes – the property taxes (business rates and stamp duty, for example) set by the Defence Secretary and the wider wealth taxes (e.g. CGT) set by the Home Secretary – in order to get the funding split right.

Excise duties could be renamed “Investment Tax”. These revenues comes from duty on fuel, tobacco, alcohol and gambling. They would pay for future public assets, e.g. in transport, science, flood defences, business investment or social housing.This would tie a consumption tax on “bads” to investment in our future prosperity. This would give a new moral high ground to this tax base. 

– Smaller departments could, similarly, get their own taxes. For example, Airline Passenger Duty could be the tax base for the Department of Culture Media and Sport, as it would cover their costs and is linked to tourism, both in-bound and out-bound. Similarly, DEFRA could be funded by environmental taxes like the landfill tax and aggregates tax, or DECC by the climate change levy. 

– Council Tax in this system would more closely match local authority and local Police spending – as large elements of spending (in adults and children services would be funded through the national tax system e.g. via the Pension and Disability Tax). There would be some complexity (as always) to make sure that individual areas had the right funding.  

 

Some people will struggle with the idea of spending ministers being tax-setters. But how is the idea of a Defence Secretary setting a tax on property any different to a County Council Leader setting a tax on property to pay for adult social care? It promises a new type of political debate – as spending ministers may aim to be known as tax-cutters, or charges could be introduced to reduce taxes, or entitlements expanded in exchange for a visible increase in the tax, etc.

2) Setting spending targets for each service or benefit by percentage of national income.

Clearly, it is important that whatever money is allocated to a service or benefit is spent well. Spending more is not necessarily a good thing – if money is wasted, or could be better spent elsewhere, or better spent by someone other than Government. Similary, spending less is not necessarily a bad thing – if the same or better can be achieved with less, or if there is something better to do with the money. However, it is also true that, assuming it is spent efficiently, the level of public spending on a particular service or benefit is an expression of our collective priorities and expresses our values. Firstly, it shows how much of our private income we’re willing to give to Government for a specific service or benefit. Secondly, it shows how much we value one thing over another. So, for example, we are spending about 2.5% of our national income on defence. This is roughly half the proportion of income spent by the US, but roughly double the proportion spent by the Germans and Scandanavians. By contrast, we spend just under a fifth of our income on social protection (pensions and welfare payments), compared to the Americans who spent less than a tenth, whilst the French and Danes spend a quarter of their income. David Cameron promised at the last Election to increase overseas aid spend to 0.7% of our national income, which has been achieved in spite of the austerity budgets and makes the UK the first western country to hit this international target. The UK has poor levels of private sector investment in R&D. This depresses our total spend (public and private) so that the proportion of our national income spent on R&D is roughly half that in Japan and some Scandanavian countries, as well as being a long way behind the US. This puts pressure on Government to compensate for low private levels of investment. So, for governments, these sort of decisions are partly a matter of keeping up with our competitors, partly an expression of political priority and partly a pragmatic means of controlling spending. There are 3 elements to this allocative decision:

(a) How much of the national income ought a country like ours to be spending on an issue, e.g. providing pensions;

(b) How much of that total spending should come through the tax system, e.g. balance of state versus private pensions;

(c ) How much can be afforded by the taxpayers at  a given time, e.g. the level of state pension that can be afforded. 

There are 6 big fiscal decisions which cover 90% of the debate :

(i) Collective funding of health services

(ii) Provision of State Pensions and Disability Benefits

(iii) Guaranteed incomes for working age individuals and families

(iv) Collective funding of education, from pre-school, through school to colleges and universities

(v) Scale of investment in national infrastructure

(v) Scale of economic investment, e.g. R&D, skills,  (including the cost of tax reliefs as well as spending)

(vi) Scale of our international commitments in defence, diplomacy, aid and national security.

Wouldn’t it be refreshing if the next Election was an explicit debate about the proportions of our national income we should devote to each of these areas and how much of that should be via the tax system? This would require an unprecedented engagement of the public in setting fiscal priorities – tax by tax, spend area by spend area. It would make explicit that getting more services or benefits requires taxes to go up, and vice versa. It would also force the ideologues (big spenders, little spenders) to argue specifically the rights and wrongs of taxing and spending for a particular service.

If we combine these two ideas together, then we will have individual politicians (central and local) accountable for raising enough tax to fund their individual services and benefits. And, hopefully, we will have reconnected the public with the fiscal choices they face – getting them to take more responsibility for either reducing spend or raising taxes to pay for what they want.

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2 thoughts on “Sorting out the public finances Part 1 : Changing the debate

  1. Paul has set himself up as a catherine wheel of ideas. Not all do more than flare and entertain but what a service he provides, inviting us to challenge afresh the wicked issues we are conditioned to think are unsolvable.

    His latest post -one of a series no less – sparkles with clarity, seeking to reduce highly complex issues that define Government in modern economies to a beguiling clear prescription.

    I like transparency and for that reason I like hypothecation. I am probably alone amongst those loyal to local government (LG) in saying this.LG leaders have long argued against hypothecation, saying it restricts discretion, by which is really meant, it constrains local power.

    Ever since the state started spending money there has been a central Treasury. From fighting wars in the 1200s, The Treasury has calmed the right to dictate priorities ever since.

    So the first practical riposte to Paul’s prescription is that it will never happen because power will never be so comprehensively surrendered.

    But imagine if it did?

    Modern economies are not about large histrionic sweeps of the tiller. There are about small adjustments. Policy change is incremental. Fundamentals are rarely questioned.

    Governments and would be governments seek to appeal by finding new, relatively small change ideas they can promise and by seeking to represent they can manage “events”.

    If this is true the marginal changes that competing politicians might offer would translate into marginal tax changes running to three decimal points. This will not enliven politics.Politics is barely numerate now. This will not help.

    Dividing Government into separate tax baronies might aid transparency but will kill efficiency. Each mini government will soon want its own PR machine. Cross spending area collaboration will recede.Spending areas will no doubt seek to cross charge in a wasteful way.

    So it has obvious pitfalls.

    But there is something here and if Scotland goes alone we might yet see a near neighbour living a version of this in real time.The chance and requirement to re-cast a whole set of national accounts offers great opportunities for debate about competing priorities.

    The Scots have brought many great inventions to the world. Maybe they might yet bring digital national accounting out from the current stilted analogue age.

    Derek Myers

  2. Basic problem with this approach is that it implies that tax is spread equally. In fact over half of the population is a net gainer. Tax is a way for politicians to bribe voters with other peoples money. What is really needed is a cap on the amount of tax payable by those who contribute and so end the idea that it is fair for the majority of people to be subsidised by a minority

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