While the sun may be shining more brightly on the country’s finances compared to a few years ago, there is no excuse for not finishing the job of fixing the roof, argues Evgeny Pudovkin.
Speaking almost exactly two years ago at the Conservative manifesto launch, the then Prime Minister David Cameron pledged to restore the UK’s entrepreneurial spirit. “In Britain we’ve always shown we have the ingredients, the will to overturn what’s inevitable”, Cameron declared, “and with a strengthening economy behind us – this buccaneering, world-beating, can-do country – we can do it all over again”. The UK, he continued, “is on the brink of something special” and his party will form a new transformative government.
Cameron’s agenda – before Brexit derailed it – involved spending cuts and public-sector reforms. These included changes in benefit indexation (saving the exchequer £4 billion), Iain Duncan Smith’s reform of Universal Credit and, admittedly, the not altogether thought-through NHS reorganisation. The deficit as percentage of GDP was slashed from above 10.1 per cent in 2009/10 to below four per cent by 2016 (according to ONS data), while the level of public spending fell from 46 per cent in 2010 to just over 40 per cent of national income.
By contrast, today the task of getting public finances in shape doesn’t cause much excitement. Even within the government’s ranks, calls grow to relax austerity. Britain’s commitment of Thatcherite fiscal discipline is waning. Apparently, we are all Raeganites now. The penchant for budgetary laxity, prevalent among the right-wing governments in the US, has now spread to Britain.
Politically, fiscal consolidation has indeed proved a tremendous task. The Tories’ attempt to reform social care underscores that point. The Prime Minister pledged to make it mandatory for older people to pay for their care until their assets are depleted to £100 billion. Yielding to political pressure, she then changed her mind: there would after all be a cap on how much the elderly will have to pay (right now it is £23,250). But even if the cap is lifted up to £75.000, this will still loosen the coffers a great deal compared to the initial idea. As Ryan Bourne from the Cato Institute explains, the original proposal was one of the few that, if implemented, would have removed a substantial burden from the taxpayer.
But the economic reality cannot just be wished away. Almost a decade since the financial crash the government still runs a deficit. The UK’s debt still stands at 89 per cent. Should any significant downturn in the global economy occur, Britain is out of ammunition to withstand it (especially considering zero-bound interest rates).
The government borrowed about 2.6 per cent of GDP over the last financial year. Assuming there will be no systemic crises, Theresa May’s pledge to achieve a surplus may perhaps be realised.
However, even this congenial scenario leaves some persistent challenges unsolved.
Yet tough choices will have to be faced in the future. This is not the time for the Tories to give up on fiscal prudency. As the Institute for Fiscal Studies acknowledges in its recent report, both the pension system and the NHS will in the medium-term start straining the UK’s fiscal position. Thus, pensioner benefits are forecast to rise by 0.9-1.8 per cent of national income (£18-37 billion in today’s terms) between now and 2067. Spending on health is projected to increase by 5.3 per cent of GDP, or £109 billion. Hard decisions will have to be taken to cope with these pressures.
It is not just the quantitative side of public finances that requires attention. The quality of the tax system is also a problem. Even Donald Trump’s Republicans have got round to fixing the US tax code. The UK should follow suit.
The first conundrum is the sheer complexity of the tax system itself. New laws are created faster than the superfluous ones are eliminated. This, in turn, reduces its transparency and makes life harder for businesses. Indeed, it is with the aim of overcoming this hurdle that the Office for Tax Simplification (OTS) was created.
Second, there is a need to lift the burden from taxes on earnings and income and start taxing spending more. That would provide more incentive for companies to create growth. This is also what the US congressional representatives Kevin Brady and Paul Ryan offer in their blueprint for tax reform.
Third, taxation requirements may not apply equally to all items. As PwC’s Andrew Sentence pointed out, though VAT is 20 per cent does not apply to all products. Printed books, for example, are exempt from VAT, while the e-book faces the 20p rate of VAT. The tax was introduced in 1973 and has since gone through little reform. But it seems the tide is turning. The OTS is due to report on the proposed changes to the present system in a few months.
The world may, as John Maynard Keynes observed, be ruled by bright ideas. Yet they can only be realised if there is political will. No matter how meticulous these expert reports will be, the final word always reserved by MPs. On the bright side, the task of tax reform leaves a room for bipartisan work. Much like Blue Dog Democrats in the US, the more sensible wing of the Labour party could team up with the Tories to deliver on a sensible agenda.
Kicking the fiscal can down the road brings short-term political relief. Yet it is only a matter of time before the government will be mugged by reality. The sun may be shining brighter compared to the situation a few years ago. But that is no excuse for not fixing the roof.