No salvation in fiscal policy

By Philip Booth, Professor of Finance, Public Policy and Ethics, St. Mary’s University, Twickenham 

Yesterday, I ended a presentation to sixth-formers by commenting that nobody would want to be Rishi Sunak. Of course, in the strict sense that is not true – indeed, many of the people to whom I was talking might well have had ambitions to be Chancellor of the Exchequer. Of course, what I meant was that the Chancellor was facing the most difficult combination of circumstances of anybody in his position since the mid-1970s. It is in this context that we have to consider the widespread calls to increase government spending on welfare. 

Last year, government spending was about 45 per cent of national income and taxation about 38 per cent of national income. And this is before the big surge in spending caused by Covid-19. Since then, the economy has shrunk dramatically. As we know, the electorate is resistant to spending cuts: in the 2010-2015 period, government spending in real terms (that is after inflation) was cut by just 0.5 per cent per annum and this led to mass protests. It is difficult politically to square the fiscal circle with spending cuts. At the same time, the tax take is more or less at its peacetime high. 

Although it was right for the government to borrow more money to deal with the Covid-19 pandemic, our national debt has now reached worrying levels. After declining from its post Second World War peak, it shot up in the financial crisis 13 years ago and has never gone back to a sustained declining path since. The pandemic is likely to take the national debt well over 100 per cent of national income. We can borrow to smooth the costs of a crisis, but anybody who thinks we can increase the national debt on a sustained basis in normal terms over many decades is living in cloud cuckoo land. 

What makes the Chancellor’s position so difficult, is that this is only the start of our problems. Before the Covid-19 crisis really got going, the Office for Budget Responsibility (OBR) produced its annual Fiscal Sustainability Report. It suggested that, on current policy (that is with tax rates unchanged and thresholds increased in line with government plans and making reasonable assumptions about health, pensions, social care and other spending), the national debt would rise to 400 per cent of national income over the next 50 years. To stabilise the debt, taxes would have to rise by a total of 15 percentage points of national income over that period (in other words increase by 40 per cent over and above their current level). 

That’s okay, people might think. There are political choices to be made. We should ask the rich to pay a bit more tax. We can be a bit more like Sweden. However, tax increases of this magnitude are not about asking some people to pay a bit more tax. They would take the burden above that in any developed country. Indeed, it could not be done without hitting the less-well-off and choking off economic growth to such an extent that there would be huge suffering. 

In fact, looking at other countries’ tax systems is instructive. In Scandinavian countries they do have a higher tax burden. However, this is a burden which falls very much on the less well off too. In Denmark, an individual will pay 25 per cent value added tax on everything – including children’s clothes, fuel and food. An individual earning £9,000 a year would pay direct tax of about 16 per cent of their income and then pay VAT on their spending. In the UK, an individual on such low earnings would pay no direct tax and no VAT on food, children’s clothing, fuel and a number of other exempt items. 

The interesting feature of tax and welfare systems in developed countries is that they are very different from each other, but their redistributive effect is remarkably similar. Indeed, the UK is firmly in the top half of the league table for the extent to which its tax and welfare system redistributes money from rich to poor. 

The fundamental reason why the government’s position is so difficult is demography. A rising proportion of old people explains nearly all the OBR’s dire projections. Unfortunately, it is too late to do anything about that. The time for encouraging saving to pay for pensions, health and care costs or for the government to run surpluses so that it had a buffer to deal with the ageing of the baby boomers was 25 years ago. Many of us wasted a lot of energy making that case then. 

We are genuinely resourced constrained in a way we have not seen before. To have reached what seems like the maximum taxable capacity of the economy whilst spending needs accelerate due to demography is nothing short of a fiscal disaster. 

At least Catholic social teaching has some other places to look when it comes to thinking about how we might help the poor. Indeed, it has never regarded the government as the main source of welfare. We might, for example, look at housing policy. Restrictions on house building, largely arising from well-off vested interests campaigning against house building, have meant that between 1969 and 2019, UK house prices have risen by 3.7 times over and above inflation. In Germany, over the same period, house prices have risen by 20 per cent. This is an unmitigated disaster for the poor. It is a major explanation for poverty in the United Kingdom. This is not about a lack of social housing: we have the third highest level of social housing in Europe. It is about planning constraints on housebuilding.  

We might also look to the family. In the UK, 22 per cent of children live in lone parent households. This compares with an EU average of 17 per cent, 15 per cent in Germany and 12 per cent in Holland. Persistent poverty is two-and-a-half times greater in lone parent families than in couple families. We might ask, what is tax and welfare policy doing to support family formation? The answer is that it is more or less uniquely bad in Europe from that perspective. What can civil society institutions and charities do to support the family? What can the Church do to change culture? 

This is a difficult discussion. It can easily seem as if we are blaming lone parents. This needs to be turned round. Life as a lone parent is very, very difficult. We should have every sympathy with them. But government policy, civil society and the Church need to simultaneously help build stronger families whilst supporting those families in difficulty for whatever reason. This will help reduce poverty significantly as well as having many other positive spin-offs. 

The great tradition of Catholic social teaching has, of course, always had lessons for government policy. But the common good is the responsibility of all individuals and institutions in society. We do need to recognise that there is no easy solution to the many problems the country faces arising from fiscal adjustments. Simply complaining that the government is not spending enough money is not a prudent response (in any sense of the word). And we should be aware – the situation is going to get worse over several decades. We need to look in other directions if we are to find lasting solutions to the problem of poverty. 

The views in this blog are of the author and not CSAN policy.