Squaring the circle on public spending

Control of public spending and deficits seems to be going haywire – in Europe and in the UK too.

In France, President Hollande has simply said ‘Non’ to the 3% deficit limit rule which was formerly a requirement for countries to be part of the Eurozone. The European Central Bank has hinted that, never mind austerity, even money printing won’t be enough to restore growth. And in the UK David Cameron has promised £7.2 billion of tax cuts in the next Parliament, even though NHS spending is to be ring-fenced.  So far, there has been no explanation of how this is to be funded.

Austerity doesn’t win any votes

This is austerity fatigue. We know the public votes against austerity politicians – just look at the parade of EU governments voted out of office since 2009.  And we know that the public don’t see the benefits of sound economic management or even economic recovery when real wages continue to stagnate or decline, and the pound in your pocket buys less.

As has been observed, not all 3 per cents are the same: 3% GDP growth + 0% wage growth is less attractive than 1% GDP growth + 2% real wage rises.  In the UK we have the former – hence the threat for the government of a ‘voteless recovery’. Of course, growth would be higher if companies didn’t leave cash on their balance sheets and stopped doing  share buybacks, and chose instead  to invest it in  more productive ways. I’ll talk about this more in future blogs.

Easy money now, but you can’t put off the day of reckoning

At one level, fiscal rectitude may not matter as much as it used to. Capital markets don’t seem to punish over-spending governments and reward disciplined ones any more.  Bond spreads for government debt (the price governments pay for their debt, relative to one another) are topsy-turvy, so there is no penalty for excessive public spending. And governments can print digital money through Quantitative Easing Programmes should they need it – the UK has done £375 billion this way, while the stubborn annual deficit of £100 billion remains largely untouched, and this year may be rising.

But at some point, as with all debt, there comes a day of reckoning – not necessarily as governments default, but as they pass on this indebtedness to individuals and families.  That’s why we do need to try to help governments balance the books: at the end of the day, their debts are OUR debts, or our children’s debts.

Here are three reforms to enable the UK government to get spending under control and fund the £7.2bn tax cuts David Cameron has promised while still protecting the NHS:

1) Make pensions tax relief fairer.

The current arrangements where higher-rate taxpayers get tax relief at their marginal rate is expensive and unfair. Over two thirds of the tax subsidy goes to the better-off.

Moving to a standard tax relief rate of 25% would be fairer, would give a greater incentive to those who most need to save for old age, and cut the government’s bill by about £8bn annually. Initially unpopular with richer voters, it will have to happen at some point anyway – a bit like what happened to mortgage tax relief.

2) We need to reform contributory benefits.

Contributory sickness (ESA) and unemployment benefits (JSA) cost the government over £5 billion annually, if you combine the cost of the benefits and the lost tax revenue. They’re complicated to administer and are not genuinely ‘contributory’ – merely another aspect of tax and NI.

They could be scrapped and replaced with a simple insurance-based solution that makes use of the structures put in place for pensions auto-enrolment.

A genuinely contributory system can be built which could give people  the same or  better income replacement than the present contributory welfare system. And it would cost less: £10 per month or around the same as one lottery ticket a  week. The carrot for people to join the scheme and their employers to administer it, would be  reduced national Insurance contributions, particularly skewed towards small employers and the lower paid.

Using half the savings generated from pension tax reform (half of £8 billion, i.e. £4 billion) and 40% of the savings from reforming contributory benefits (half of £5 billion i.e. £2.5 billion) to cut NI contributions by £6.5 billion annually, would make a real difference to incomes, and to jobs. NI is a tax on employment, after all.  And this would still generate £6.5bn out of the £7.2 billion needed to fund the tax cuts announced at the Tory Party Conference.

3)  Let’s rebuild Britain’s cities.

The third reform, slower but bigger, is the one that would easily deliver the remaining £0.7 billion requirement and start to cut in to the much bigger structural deficit, where the Chancellor has promised £40 billion of cuts in the next Parliament. We need to push forward with UK city and infrastructure regeneration. Cities drive growth.

A swift set of local funding deals will give core cities the freedom to push on with privately-funded regeneration and give Government a lift to GDP growth and a corresponding rise in the tax take. Deals like the one Manchester has in place can be replicated easily. If the result is a (very conservatively-estimated) 1% rise in GDP,  then the public sector deficit starts being  eroded quickly.

None of the changes are too difficult to deliver. They could and should have been delivered already. Each combines greater discipline in public finances with benefits for the individual and better overall growth in jobs, take-home pay and the economy.

Let’s get on with it.

I also want to hear from you:

What would you propose the government does to get spending under control so that our children might have a better start in life?