It is time to talk about rais­ing taxes

Financial Times USA - - COMMENT - Martin Wolf martin.wolf@ ft.com

The UK con­fronts huge chal­lenges. Brexit threat­ens its po­si­tion in the world. The stag­na­tion of pro­duc­tiv­ity threat­ens its eco­nomic fu­ture. But there is an­other chal­lenge: the sus­tain­abil­ity of public fi­nances.

Will the UK public sec­tor be able to pro­vide the ben­e­fits the public ex­pects in re­turn for the taxes it is will­ing to pay? The an­swer to that ques­tion seems to be “no”. If so, will the prom­ise to pro­vide some uni­ver­sal ser­vices be aban­doned? Will taxes be raised? Or will debt be allowed to grow un­til it has to stop?

In Jan­uary, the Of­fice for Bud­get Re­spon­si­bil­ity pub­lished an in­ter­est­ing analysis of the long-run pres­sures on the public fi­nances. Its cen­tral pro­jec­tion was that UK public sec­tor net debt would rise from 87 per cent of gross do­mes­tic prod­uct in 2016-17 to 234 per cent 50 years later.

Non-in­ter­est spend­ing is fore­cast to rise from close to 38 per cent of GDP in 2016-17 to 44 per cent by 2066- 67. Mean­while, rev­enue would, on cur­rent poli­cies, re­main be­tween 36 and 37 per cent of GDP. The con­se­quence of the per­sis­tent gap be­tween tax and non­in­ter­est gov­ern­ment spend­ing is that bor­row­ing and debt grow ex­plo­sively.

As­sume, in­stead, that a re­spon­si­ble gov­ern­ment de­sired to lower net debt to 40 per cent of GDP, which is roughly where it was be­fore the fi­nan­cial cri­sis, so giv­ing it­self the room to man­age the next shock. It would need to im­pose a per­ma­nent an­nual in­crease in taxes or cut in spend­ing equal to 4.3 per cent of GDP (£ 84bn in to­day’s money) in 2022-23.

Al­ter­na­tively, the gov­ern­ment could achieve the same re­sult by ad­just­ments of 1.5 per cent of GDP in each decade. If these ad­just­ments were to be via taxes alone, the lat­ter would have to rise to 44 per cent of GDP five decades hence. The needed ex­tra rev­enue would be 80 per cent of the to­tal gen­er­ated by the in­come tax.

Close to 90 per cent of the over­all in­crease is driven by the rise in health spend­ing, which is fore­cast to grow from 7.3 per cent of GDP in 2016-17 to 12.6 per cent by 2066-67. The other sig­nif­i­cant sources of in­creased spend­ing are pen­sions (fore­cast to rise by 1.8 per­cent­age points) and long-term care (up by 1.1 per­cent­age points). These three items ac­count for more than the to­tal in­creases in non-in­ter­est spend­ing — 140 per cent of it, to be pre­cise.

The UK is an age­ing coun­try. Since its peo­ple have re­jected large-scale im­mi­gra­tion and pre­sum­ably do not in­tend to choose a col­lapse in life ex­pectancy, they must ac­cept the im­pli­ca­tions. These are that taxes will have to rise.

In fore­cast­ing health spend­ing, the OBR made the as­sump­tion, in line with best in­ter­na­tional prac­tice, that “non-de­mo­graphic cost pres­sures . . . add 1 per­cent­age point a year to health spend­ing growth in the long term”. Fore­casts for health spend­ing are highly un­cer­tain, par­tic­u­larly over such long pe­ri­ods. Yet these are plau­si­ble.

As the OBR noted in an ear­lier study, UK health spend­ing has tended to rise over time, rel­a­tive to GDP. This is per­fectly nor­mal: real spend­ing on health rose faster than real GDP per head across the OECD, the group of mostly rich na­tions, be­tween 2000 and 2015.

More­over, the level of UK spend­ing is far from ex­ces­sive by the stan­dards of its peers. In 2015, ac­cord­ing to OECD data, ag­gre­gate UK health spend­ing was 9.8 per cent of GDP, against 11 per cent in France, 11.1 per cent in Ger­many, 11.2 per cent in Ja­pan and a mind-bog­gling 16.9 per cent in the US.

There may be some fat in the UK. But it can­not be all that large. More­over, if we mea­sure ef­fi­ciency by the re­la­tion­ship be­tween the amount spent on health and out­comes, the UK is in the mid­dle of the pack among OECD mem­bers. The out­lier is the US, with its poor out­comes and ex­tremely high costs.

In the decades ahead, the pres­sure to in­crease spend­ing on health, pen­sions and long-term care, rel­a­tive to na­tional in­comes, will be in­ex­orable. The UK has a strong and jus­ti­fied con­sen­sus that ev­ery­body ought to be pro­tected against the risks of ill­ness, dis­abil­ity and longevity. Such pro­tec­tion is, it is agreed, not only right but brings huge so­cial ben­e­fits. The costs must also be di­vided ac­cord­ing to peo­ple’s means: oth­er­wise too many would be in penury. The pos­si­ble means of pay­ment then are tax­a­tion or com­pul­sory (means-ad­justed) in­sur­ance pre­mi­ums. But these are just dif­fer­ent la­bels for the same thing.

The im­pli­ca­tion is clear. With cur­rent com­mit­ments, rev­enue must rise rel­a­tive to GDP. It would then be close to the ra­tio of rev­enue to GDP of to­day’s Ger­many or the Nether­lands. The al­ter­na­tive is to aban­don pil­lars of the wel­fare state. This is a de­bate the coun­try must have. It should start now.

In the decades ahead, the pres­sure to in­crease spend­ing on health and pen­sions will be in­ex­orable

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