How to realise the left’s ambitions for a higher public spending and fiscal sustainability?

Ross Campbell, ICAEW's Director of Public Sector, analyses how a future Labour government can ensure the public finances are sustainable in the long run. Here he argues that an equilibrium must be struck between creating the conditions to encourage economic growth, running government efficiently and setting sustainable tax rates, to ensure fiscal sustainability.

To ensure the public finances are sustainable in the long run, means that revenues have to grow at the same rate as spending. Or since we are starting from the position of a public deficit, faster than government spending.

If spending is to be higher and sustainable then it places an even greater emphasis on ensuring that the UK economy can sustain a higher tax take, over the long run.  In considering this question, we examine the various policy levers of:

Taxation

The challenge of making a tax system sustainable is in the design. It must be a system that does not act as a disincentive to business and maintains  public consent. For example, the recent reversal of the position on National Insurance contributions for the self-employed raised issues about public consent to higher rates of tax.

There are broadly two strategies to increase tax revenues:

• Raise taxation as a proportion of the economy –by increasing existing tax rates, improving collection or expanding the score of taxation to new areas.
• Increase the overall size of the economy and the overall tax take through stimulating economic growth. Considered under ‘economic stimulus’ below.

The strategy of increasing tax rates or introducing new taxes has sometimes been counterproductive. For example increased rates of tax can, and do, act as a disincentive to economic activity at the margins.

There is a lower incentive for people to engage in additional work when the gains from doing so diminish, or talented people and capital move overseas. While capital controls might be introduced, this may result in a reduction of inward investment. For example, the reversal of the position on National Insurance contributions for the self-employed raised issues about public consent to higher rates of tax.

Secondly, to improve  tax take through economic growth will demand that businesses within the UK are taxed in a way that is proportionate and fair. 

This is not only a domestic issue within our own state. The UK exists in a community of states and the taxation of profits by businesses and individuals is subject to many treaties Due consideration needs to be given to what the impact of bringing more profits within the scope of UK taxation might be on our treaty obligations. For example, VAT rates across Europe.

Economic stimulus

The strategy of stimulating the economy, is not always straightforward to realise in a sustainable way. Invariably it requires some form of investment, the reduction of taxation or the relaxation of regulations. In most cases this implies an upfront cost, Relaxation of taxes and regulations can contribute to  unsustainable bubbles in asset valuations (eg the 1980s property boom) or leading to additional costs for government following a bust (ie the aftermath of the 2008 financial crisis). 

The challenge for any government is to find and maintain that equilibrium and avoid the wide swings between boom and bust, that we have seen in recent years.

Public spending

The debate around public spending is all too often couched in terms of whether enough money is being spent, rather than whether the money that is spent is being spent effectively.  This debate includes themes like:

• efficiency and productivity of public bodies;
• spending on prevention rather than cure, in a range of public services; and
• structural problems that prevent effective delivery of joined up public services (eg the transition of the elderly from the health and social care systems) which drive unnecessary cost into some organisations.

With overall public spending in excess of £800bn per annum, even relatively small improvements in the effectiveness of existing spending can reduce or offset the need for higher taxation. Therefore helping to match higher spending ambitions elsewhere.

By changing service delivery models, many governments have experienced significant savings.  This includes increased use of on-line or automated service delivery, something that recent governments have made success in doing.

Alternative approaches

Of course there are other ways to raise revenues: governments can introduce or increase charges for access to public services, or use their assets more effectively than they do.

1. Charges for access to public finances

There are many examples from around the world of things that other governments makes charges for, that are not currently charged for separately in the UK. These range from contentious issues like a fee for a GP appointment, through to things that are less so, like road-pricing. All such charges are usually not introduced without some controversy, as introduction of fees for higher education has shown. Even where means tested and with relief for those on low incomes, significant resistance is still likely.

2. Effective use of assets

Most governments control a significant number of assets, for example land, buildings or intellectual property. Many of which have the potential of producing higher economic returns in alternative use. To realise the benefits of these assets, a government must use an open minded and rigorous approach.

This includes the possibilities and challenging the received wisdom about locations and methods of service delivery. For example, whether an alternative asset could be used to provide the service at lower overall cost. including measures like moving out of a city centre site to a cheaper location and renting out the original site.

This is different for intangible assets, such as intellectual property, or rights of access. The challenge here is unlicensed assets and also whether the market will pay a return for access that makes the cost of the licencing exercise worthwhile. In the case of the 3G/4G auctions, the return to government was very worthwhile.

The sale of government assets is a way to raise a short term receipt but once sold, it will generate no further direct value. It is worth considering, however, whether the transfer of an asset out of government will generate value to the exchequer. Particularly if its use in the hands of another party creates a net contribution to taxable economic activity.

In summary

A future government will need to pursue a twin track approach. Especially if it were to introduce a higher overall level of sustainable spending on public services. It would likely require a blend of these various policy levers.

First, it must ensure that the tax system has clear incentives for enterprise and investment in economic activity to attract and retain talent and capital in the UK. 

Second, it needs to be structured in a way that makes sure activity conducted in the UK is taxed here in a fair and proportionate way.

There is an equilibrium to be struck between creating the conditions to encourage economic growth, running government efficiently and setting sustainable tax rates.That equilibrium has been struck at different points in different countries. If it is to be struck at a point where tax rates are high, incentives for business and enterprise will also need to be high. But in addition to choices on tax rates and incentives, the optimal use of government assets is also essential.