Since the financial crisis erupted in 2008, governments in advanced countries have been under significant pressure. In many countries, tax receipts abruptly collapsed when the economy contracted, income dwindled, and real-estate transactions came to a halt. The fall in tax revenues was in most cases sudden, deep, and lasting. Governments had no choice but to raise taxes or to adjust to leaner times.
In some countries, the magnitude of the shock was such that a large tax increase could not fill the gap. In Spain, despite tax hikes worth more than 4% of GDP since 2010, the tax-to-GDP ratio was only 38% in 2014, compared to 41% in 2007. In Greece, tax increases amounted to 13% of GDP during the same period, but the tax ratio increased by only six percentage points. Elsewhere, political limits to tax increases were reached before the gap could be filled. Willingly or not, priority is being given to spending cuts.
Disillusion about future growth adds to the pressure. The productivity record has generally been weak over the last few years, and this suggests that growth in the years ahead could be slower than previously expected. Revenue growth thus looks insufficient to match the surge in age-related public spending on health and pensions.
This is a very different crisis from those experienced in the 1980s and the 1990s. Back then, the main issue was political: the legitimacy and efficiency of public spending was under attack. In the words of US President Ronald Reagan, government was the problem, not the solution. The state, it was loudly proclaimed, had to be rolled back.
By contrast, today’s concerns are economic. Partisan disagreement about the proper scope of government remains, but there is no overall rejection of state intervention. Often, it is not interests or ideologies that make public spending cuts unavoidable – just facts.
How can governments rise to the challenge? The risk they face is clear enough: absent a profound reengineering, inertial spending – owing to entitlements and civil-service wages – is bound to crowd out spending on new priorities and new policies.
Already, the countries that have been forced to cut the most have generally sacrificed public infrastructure investment. Research is another area at risk. Social investment in programs that pay off over the long term, such as pre-school child care, is suffering from financial constraints. National security is not given the priority it deserves, despite growing threats. Last but not least, makeshift solutions such as protracted wage freezes may eventually erode the quality of public services.
Fortunately, there are a few things governments can do to mitigate the effects of inertial spending. For starters, they can simply systematise evaluations of the efficiency of public money. In most countries, such assessments are still rare and haphazard: Parliaments often enact policies without knowing whether they are worth the money, and it may take a very long time before ineffective or inefficient policies are terminated. That is why enabling legislation for spending programmes should contain sunset clauses, with extensions subject to independent evaluation.
Second, spending reviews, too, should be systematised. Setting priorities – whether to spend more on education and less on pensions, for example, or whether to invest in infrastructure or in research – entails hard choices that should be made explicit. In an ideal world, these choices would be the focus of electoral debates and parliamentary work. But behind every budget line is a constituency tempting policymakers to eschew hard decisions. That is why structured spending reviews are useful: they force officials to bridge the gap between ends and means and encourage informed democratic decision-making.
Third, governments should equip themselves with a reengineering budget. As private companies know, transformations – deep changes in the way things are done – often cost money before they bring savings. This may be because the changes require investment in new technology, retraining of employees, or simply buying stakeholders’ consent. Money earmarked in the budget for such reengineering of government programs would be a good investment.
Fourth, governments should promote public-sector innovation. Contrary to popular prejudice, local governments and public agencies do innovate; what is missing is a mechanism to select and disseminate innovations in the same way the market selects new products or cost-saving processes. A better way to deliver a public service may remain unknown for years. That might well change if governments took simple steps like allocating more funding on a project basis and organising contests. For example, schools in disadvantaged neighbourhoods should be allowed to tender for funds for educational innovation.
Last but not least, people should be empowered. Citizens want a more nimble state that tailors its operations to local needs. In the digital age, they want it to meet new standards of speed, reliability, and personalisation. They increasingly challenge the traditional view that efficiency and equality imply less individual choice. And they want the government to be open, to guarantee access to data, and to make its efficiency and effectiveness directly observable.
These are powerful forces for change, and embattled governments should harness them to the goal of achieving the reengineering they so urgently need. The alternative is to accept the deterioration of the quality of public services, which would lead only to a loss of government legitimacy and, with it, a diminishing willingness to pay taxes.