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 non-interest 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.
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