Rebalancing the books

Five years ago, the Fabian Society’s 2013 commission on future spending choices published proposals for public spending under a Miliband-led government. In the intervening years both the economic and the political terrain has changed beyond recognition. It is therefore time to return to the ground covered by the commission and today we launch Public Finance Choices for the Left, a two-month online debate convened by the Fabians and ICAEW.

The 2013 Fabian report was published when the fiscal deficit was still very high. The commission recommended real increases in spending but it said this should be at a slower pace than GDP growth until the public finances were in balance. Now the deficit on current spending has been eliminated. This creates the economic headroom to start to debate post-austerity spending choices, since Labour’s proposed fiscal framework seeks to balance only day-to-day spending. The next Labour government will not necessarily have to raise taxes or cut spending just to shrink the deficit.

The political context is transformed too. Austerity fatigue has set in and the proportion of people who want an increase in tax and spending has risen fast since 2015, according to the British Social Attitudes survey. We have a radical left-wing Labour leadership which has shifted the ‘Overton window’ when it comes to the limits of conceivable tax and spending choices. The Brexit referendum has revealed deep public unease with the British body politic and created the greatest political crisis the UK has faced since 1945. Future governments will need to deliver answers to Leave voters that go well beyond the technical design of Brexit.

On the left, perhaps the political change is best symbolised by the different personalities and instincts of Labour’s two shadow chancellors. Ed Balls was a social democrat schooled in an era when Labour was paranoid about media attacks on every tax or spending pledge. By contrast, John McDonnell sees little point in obscuring his commitment to higher spending and tax. At the 2017 election he promised to raise taxes by four times as much as Balls did in 2015.

But in other ways, perhaps Balls and McDonnell are not so very different. Then and now, Labour is signed-up to fiscal discipline with credible rules to set public debt on a downward path and keep borrowing under control. Both the 2015 and 2017 manifestos presented an orthodox fiscal prospectus of European social democracy. Labour under Jeremy Corbyn promised to go further and faster than under Ed Miliband. But the tax and spending plans the party presented last year would have only taken the UK towards the median among OECD countries for revenue raising and public spending.

What’s more, the central recommendation of the 2013 Fabian commission remains just as true today as it was back then. The commissioners’ call was for politicians to lift their eyes to the horizon and think backwards on public spending choices from the viewpoint of a decade or more ahead. The report called for a ‘2030 vision’ because once you have a long-term direction of travel for tax and spending the short-term choices fall into place.

The left should sign-up to this long-term perspective now. First Labour should explicitly state that overall spending as a share of national income needs to rise in the 2020s in order to deliver the welfare state that people want. Second, the party needs to make the case for a rebalancing of spending. Unless action is taken we will pour ever more money into support for older people (no bad thing in itself) and squeeze spending on education, children and investment. To illustrate this point Figure 1 shows how, in the next parliament, Conservative policies will see health, care and pensions rise from 35 per cent to 38 per cent of total government expenditure.

Figure 1: Actual and projected public spending in key areas

Sources: Fiscal Sustainability Report (OBR, 2017 and earlier editions); OBR Public Finance Databank; expenditure and caseload forecasts (DWP Spring 2017); Fabian Society calculations and assumptions. Note: programme spending for 07/08 and 10/11) is not all corrected for subsequent revisions to GDP; 27/28 totals assume non-pension social security is uprated by CPI.

Politicians should also think about the size of individual spending programmes in terms of GDP. The last Labour government famously did this with respect to NHS spending and international development and since then the UK has also explicitly signed-up to the NATO target for defence spending. But in other areas the long, grinding years of austerity mean that the reference point for budget-setting has become existing nominal or real spending. This translates into declining expenditure relative to the size of the economy.To make strategic choices Labour needs to think about public spending in relation to the size of the economy. The faster the economy grows the more it will be possible to increase revenues and spending. But the flip-side of this is that Labour will need to cut its coat according to the cloth. If economic growth remains sluggish or if there is a major recession in the coming years, the economy will be smaller and the spending choices will be harder. Admittedly, if economy-wide earnings grow less fast, then less money is needed to raise pensions and public sector pay. But it is far easier to reprioritise between budgets when the size of the pie is growing at a decent pace than when the choices are zero-sum.

This austerity mindset led Labour to come unstuck at the last election with respect to the fight against poverty. The party proposed a modest increase of around £4bn to the Conservative’s welfare spending plans. But these plans were themselves predicated on something close to a cash freeze for social security spending and a cut of 0.3 percentage points as a share of GDP. As a result, Labour’s 2017 proposals would have increased poverty and income inequality, which is remarkable given the party’s left-wing leadership.

So what options should the left be considering? In many cases the default should be for spending to rise in line with economic growth. But in some areas expenditure needs to rise by more than this to reflect population and health trends – in particular pensions, NHS and social care spending. Meanwhile, in other fields Labour will want to make a policy choice to increase spending faster than GDP. For example, in 2017 the party committed to increasing capital investment and education spending by more than 1 per cent of GDP each. Both these proposals have much to commend them. As figure 1 shows, before the financial crisis education spending was 5 per cent of GDP and it is 4 per cent today which cannot be right for a society committed to high skills and social justice. And if investment choices are made wisely then debt-funded capital investment can pay for itself through higher future growth.

But when you look at all the options side-by-side the costs start to mount. Across health, care, education, social security and investment over 5 years, Labour could easily wish to increase public spending by 4 percentage points of GDP from around 37.5 per cent in 2022 to 41.5 per cent in 2027. Even this would leave little room for new entitlements (such as free higher education or social care) unless the economy was growing briskly: most of the money would be needed to adequately fund existing provision. Under this scenario spending would shift from being a bit below the UK’s post-1945 average at the start of the next parliament, to a bit above it by the end in line with spending from 1965 to 1985. Raising spending to this level would place the UK in the middle of the pack when it comes to public spending in advanced western economies.

This is not radical socialism but it would be a significant transition over a fairly short space of time. During that period the tax take is projected to rise by only 0.5 percentage points on present policies. Labour says it will borrow to pay for extra investment but it would need to raise taxes to pay for higher current spending. To meet its fiscal rules the party would probably need to increase revenues by more than 2 percentage points of GDP, which is in line with the package it proposed at the 2017 election. The difference is that a higher share of the money would need to pay for business-as-usual not new promises.

Last year, most of the party’s tax policies directly targeted big business and people earning over £80,000 (although the effects would have rippled out across the economy). From an egalitarian perspective this is highly desirable but it remains to be seen whether these measures would raise as much as Labour hopes –because of tax-minimising behavioural responses by firms or high-earners). Nevertheless, Labour can probably find ways to raise spending on this sort of scale without the accompanying tax rises being too visible for most families.

Beyond that it would be a different matter. Sooner or later, extra spending can’t just be paid for by the top 5 per cent. If the long-term plan is for a Scandinavian welfare state then taxes for everyone will have to rise. A significantly larger state, alongside balanced public finances, eventually requires that ordinary households pay more.