How will the UK manage its public finances in the decades ahead? With great difficulty, is the answer. Its public sector balance sheet and long-term fiscal outlook are in poor shape. The implications are also clear: in addition to managing the public sector balance sheet as wisely as possible, the country will have to increase taxes. But that will be impossible to do without courage, both intellectual and political. Will this happen? I fear not.
According to the International Monetary Fund’s latest Fiscal Monitor, the UK’s public sector net worth is minus 125 per cent of gross domestic product, second-worst (after Portugal) of the 31 countries analysed. French public sector net worth was minus 42 per cent, Germany’s minus 20 per cent and that of the US minus 17 per cent. The Office for Budget Responsibility’s Fiscal Sustainability Report of July 2018 predicts that the picture will get worse. On current policies, the primary fiscal deficit (before interest payments) and debt would be 8.6 per cent and 283 per cent of GDP, respectively, 50 years hence.
Huge uncertainties exist around such forecasts. Nonetheless, the underlying reality is clear. The UK is an ageing country with politically compelling commitments to spending on health, education and social welfare. These commitments were cut to the bone after 2010. Gavin Kelly of the Resolution Trust makes this point powerfully in a recent article. Even Theresa May recognised this reality in the case of the National Health Service, making a huge unfunded commitment last June.
The prime minister also claimed that this would be funded by a “Brexit dividend”. Those without her sense of humour know that either some other spending must be cut or taxes must rise. The politics and long-term forecasts, together, make clear it must mainly be the latter. This challenge would exist whatever happens over Brexit. That merely makes the fiscal challenge bigger, because Brexit seems sure to have a sizeable negative effect on the economy and tax revenue over the long term.
Can the additional revenue be raised and, if so, how? That ought to be a focal point of serious political debate.
The answer to the first question is a clear “yes”. A large number of countries are both substantially richer than the UK, while also raising significantly greater revenue as a share of GDP. According to the IMF, Germany’s real GDP per head, for example, is 16 per cent higher than the UK’s, while revenue is 45 per cent of GDP against the UK’s 37 per cent. So raising revenue, without destroying the economy, is quite possible in principle. At the same time, it is obviously difficult to do so: the UK’s ratio of revenue to GDP has not been above 42 per cent since the early 1950s and has not risen above 40 per cent in the past 35 years.
The evidence of history suggests, therefore, that there is great resistance to turning the UK into a country with taxes comparable to those of successful northern European welfare states. The important question, then, is whether it would be possible to raise revenue in a way that does little, if any, economic damage (or even brings benefits), while also being politically sustainable.
The preliminary answer is an encouraging one. The UK tax system is such an incoherent mess that it would not be at all difficult in theory to raise taxes while improving economic efficiency and the distribution of income. Paul Johnson, director of the Institute for Fiscal Studies, made this point in the Financial Times last year. He focused on the unreasonably light taxation of capital and wealth and the way in which this benefits the prosperous elderly. I would stress the need to focus on the taxation of rents, not just from land, as Henry George recommended, but elsewhere, as Paul Collier argues in his recent book, The Future of Capitalism. Taxation of rents and “bads”, such as pollution, must be the start.
Unfortunately, the victims of new taxes are always far louder in opposition than beneficiaries are in support. Moreover, a new tax often seems offensive. That makes reform difficult in almost all circumstances, but even more so when the aim is to raise, rather than lower, the overall tax burden. This creates a form of Catch-22 in current politics. A big reason for reforming the tax system is to make it less costly to fund higher spending over the decades ahead. But the fact that the reforms will be designed to raise revenue will make them more politically unpalatable than they would otherwise be.
Is there a way out? No easy one exists. But the starting point must be with a debate on what the country wants and how to fund it. The pressures will not vanish. Politics has to find an answer.