With that thought, you should be reading this blog religiously. These articles, for instance, put the current fiscal position, and the promises of our esteemed candidates, in perspective. It would be a shame if you got a question where you could use this material, but you assumed that if you understood the principles of tax and spend that would be enough:
We can take out without paying in — that’s the Miliband illusion
ELECTIONS are great for nosy writers like me. Everyone is a potential voter. What surprises me is how much intimate information I can elicit just by uttering the word “election”. Total strangers launch into detailed descriptions of their personal finances. How much they earn, what they pay in rent or mortgage, what they are getting in benefits. Many people have seen their benefits fall (not pensioners, whose entitlements have been cherished and embellished by the coalition). Even with inflation down, they remember that they felt better off under Labour.
People are not immune to the argument that there is no money left. Most understand that we can’t spend beyond our means for ever. And they are quick to accuse other people of taking too much from the state: the lazy neighbour; the divorcée on legal aid; the family who inherited their council house. Yet decent, hard-working people feel strongly about any threat to their own entitlements. No one is particularly grateful that the coalition has allowed them to keep more of their own money before they start paying tax — the policy that Tories and Lib Dems boast about. Nor do they thank the government for a recovery they have either not yet felt or have already banked.
This is human. Social psychologists such as Robert Cialdini have extensively documented the ways in which we feel losses more deeply than gains. Heartfelt proofs of Cialdini’s thesis flooded my inbox in 2013, when the government decided to remove child benefit from households where one parent was earning more than £50,000 a year. Many high earners were furious. A Church of England vicar wrote to me complaining that his daughter, who had five children, could not possibly manage without it. It didn’t seem to occur to him that she could have chosen to have fewer babies. Or that it was not fair for a household earning at least twice the national average income to expect other taxpayers to chip in.
We all want someone else to take the pain. The rich dread the mansion tax. The poor dislike the benefit cap. Frontline public sector workers loathe wage freezes. The salariat who have worked long hours to get promoted into good jobs resent the landed gentry and the super-rich who, as The Sunday Times Rich List shows today, are continuing blithely on an upward trajectory while others struggle.
No democracy finds it easy to tolerate cuts in public spending. Our politicians have been brought up to spend, not cut. Since the financial crisis, indebted western governments in hock to international lenders have struggled with electorates that do not want to face the harsh new reality, especially when average wages have been falling. Low interest rates have inflicted terrible damage on savers, especially the elderly, in Europe and America. But the “easy money” of zero interest rates has inspired less protest against governments than spending cuts.
As the world becomes ever less secure, and so do our livelihoods, we seek comfort in illusions. One is the mantra that “I’ve paid in, so I’m entitled to take out”. We pay seemingly endless taxes — income tax, council tax, national insurance, VAT — but more of us than we imagine may actually be net recipients of state largesse.
Three years ago the Centre for Policy Studies think tank tried to work out how many people were receiving more in state aid, health and education than they were paying in taxes. It calculated that 53% of households received more in benefits than they paid in tax in 2010. Even the middle fifth of earners were getting more on average than they put in, according to this thesis. Only the top two-fifths of households were paying their way.
You can quibble with the exact figures, for various reasons. What is more important is how they have changed over time. Even if you exclude pensioners, who have been increasing in number and so inflating the recent figures for net recipients, the proportion of working-age households that seem to have “taken out” more than they “paid in” has jumped from 29% in 2000 to 40% in 2010.
This is a dramatic change however you cut the numbers (which the Office for National Statistics provides on its website). It was partly a consequence of Labour’s higher spending on public services, funded by borrowing. It was also a result of Gordon Brown’s determination to expand the scope of the welfare state. As chancellor, he increased the number of households in receipt of tax credit from about 700,000 in 1997 to something approaching 4.7m by 2010. By creating a whole new class of benefit recipient, he gave more middle earners a stake in the status quo. This made it even harder to tell voters the truth when the money ran out.
For all the huffing and puffing about austerity, the coalition has only begun to slow public spending. This has inflicted real pain, particularly on social care budgets, because the government has had to spend so much on debt interest. But with an ageing population, if so many working people are net recipients rather than contributors to the state, public spending levels are unsustainable.
There are only two alternatives to cutting spending: borrow more or raise taxes. There is a limit to both, though. Borrowing sounds nice and distant — unless you’re Greek, or Spanish, even French. And the limits to how much the government can soak the rich were demonstrated by Friday’s announcement that HSBC, fed up with paying the bank levy that George Osborne has just hiked again, is thinking of quitting London.
Osborne has managed to extract unprecedented wads of money from the wallets of the rich. What Ed Miliband likes to call “Cameron’s tax cut for millionaires” — the reduction of tax rate on those earning over £150,000 a year from 50% to 45% — has resulted in the top 1% of earners paying 28% of all income tax. The richest 0.5% now pay almost three times the total tax paid by the bottom half of all taxpayers. Infuriating though some of the super-rich may be, living in their bubbles of bling, this makes it rather important that they do not leave the country.
What, then, is the real choice at the election? On Thursday the Institute for Fiscal Studies (IFS) predicted that a Conservative-led government would cut spending by about 18% in unprotected departments, if it sticks to its deficit goal; and that a Labour-led government would increase national debt by about £90bn, despite its claim to be “relentlessly focused on the deficit”.
The IFS accused Labour of being “considerably more vague” about its plans. That’s saying something, given the Tories’ reluctance to detail their spending cuts.
Secretly, we voters want it both ways. Despite it being impossible, we’d like fiscal responsibility without pain. That is what Ed Miliband is selling. The fact that so many people would like to believe this illusion is, I guess, a victory for Gordon Brown.
camilla.cavendish@sunday-times.co.uk
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Elections have a remarkably telescopic effect on political thinking. Hardly long term to begin with, the debate all too often ends up compressing the nation’s future into only five years. For economics, given its pretensions to shaping history, the whole experience becomes rather petty.
Take the disputes over where the Tories will find £3 billion to lift the 40p income tax threshold to £50,000, or whether Labour can raise £1.2 billion from a mansion tax. Set against the dismal long-term prospects for the UK’s public finances, it’s all noisily irrelevant — a bit like watching two people squabbling over an umbrella while a tornado tears up the street behind.
Make no mistake, a storm is brewing. The true state of Britain’s public finances is dire — far worse than suggested by the official figures, which are simply bad. According to the Office for National Statistics, borrowing in the past financial year was a mighty £87.3 billion, or 4.8 per cent of GDP. As awful as that sounds, it was better than hoped. Unfortunately, it wasn’t the whole story.
Britain’s public finances are calculated in a rather generous way, in line with European Union rules. The real cost of public sector pensions, as well as future commitments on private finance initiatives and nuclear decommissioning, is ignored. If we lived in UK plc and the nation’s finances were subject to the same scrutiny as a company, the reported level of borrowing would almost double.
In the year to 2014, this “accounting deficit” was £77 billion larger than the official deficit. Using the same rules, there was also £450 billion more debt, largely because of unfunded public sector pension promises. The figures come from the “whole of government accounts”, a formal measure of the country’s long-term financial challenges. Those are real costs that one day will have to be borne. So the deficit today is arguably closer to £160 billion — about a quarter of government revenues. Britain’s debt is also larger than the national income, rather than four fifths its size. And that’s the good news.
Unless more savings are made, the deficit will rise by another £70 billion in today’s money by 2060 purely as a result of the country’s changing demographics. As intergenerational dependency rises, with more old people reliant on fewer workers to pay their pensions and cover the cost of their healthcare, the hard yards made in the past five years will be undone.
The OBR reckons that borrowing will automatically increase by 4.7 per cent of GDP, putting the UK’s public finances back on to an “unsustainable” trajectory. If net immigration falls below 100,000 a year or productivity growth, which has stagnated since the crisis, fails to recover to 2.2 per cent a year, the public finances will look even worse.
Which brings us back to the general election. The longer these problems are ignored, the more expensive they become.
In its 2014 Fiscal Sustainability Report, the OBR presented two ways of dealing with the debt by 2060. The first was a one-off £15 billion additional dose of austerity in 2020, amounting to 0.9 per cent of GDP. The alternative was to do 0.3 per cent a decade, amounting to a cumulative tightening of 1.7 per cent of GDP — almost £30 billion in today’s money. Both are workable solutions, but the OBR’s projections clearly demonstrate that delaying has a price.
Looking over a narrow five-year horizon, none of this shows up. As a result, unsurprisingly, the problems always end up being the next government’s problem.
For once, though, this election is different. The Tories plan to start paying off Britain’s debt by 2018. Assuming that they held power until 2030, the Institute for Fiscal Studies reckons that UK debt would be down from 80 per cent to 52 per cent of GDP. That would be £270 billion less than under Labour, according to the IFS, although Ed Balls disputes its assumptions. The Tory plans don’t go far enough to address the long-term state of the public finances, but they are a big step in the right direction.
For the first time since 1992, there is a chasm between the parties on the economy. Paul Johnson, director of the IFS, has been banging this particular drum for months. Russell Brand and his acolytes say that politicians are all the same, but this time they are — emphatically — not.
Put simply, the Tories want a small state to afford low taxes and prudent public finances. Labour balks at what that would mean for public services. Labour offers compassion today, the Tories a plan on the public finances for tomorrow. Ultimately, however, there can be no escaping the demographic juggernaut. Seen through our grandchildren’s eyes in 2060, the Tories would look compassionate against a Labour party in denial.
One assumption that the OBR makes in its fiscal sustainability analysis is that tax thresholds and benefits will be uprated in line with earnings growth rather than inflation beyond 2020. It’s hard to see how that could hold once the debt started to spiral, which would mean more people being dragged into higher rates of tax at the same time as inequality between those in work and on benefits widened — the worst of both worlds.
There are legitimate questions about whether the Tories can honour their promises. If the recently dissolved parliament is any guide, they will break their rules and deliver a slower deficit reduction than pledged in their manifesto. But, for once, at least they are fronting up to the long-term threat and aspire to give the country economic shelter. An umbrella, after all, really isn’t going to help, given the size of the storm clouds approaching.
Philip Aldrick is Economics Editor of The Times
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