Tax and Fiscal Policy

No salvation in fiscal policy


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Earlier this week, I ended a presentation to sixth-formers by commenting that nobody would want to be Rishi Sunak. Of course, in the strict sense that is not true – indeed, many of the people to whom I was talking might well have had ambitions to be Chancellor of the Exchequer. Of course, what I meant was that the Chancellor was facing the most difficult combination of circumstances of anybody in his position since the mid-1970s. It is in this context that we have to consider the widespread calls from charities to increase government spending on welfare.

Last year, government spending was about 45% of national income and taxation about 38% of national income. And this is before the big surge in spending caused by Covid-19. Since then, the economy has shrunk dramatically. As we know, the electorate is resistant to spending cuts: in the 2010-2015 period, government spending in real terms (that is after inflation) was cut by just 0.5% per annum and this led to mass protests. It is difficult politically to square the fiscal circle with spending cuts. At the same time, the tax take is more or less at its peacetime high.

Although it was right for the government to borrow more money to deal with the Covid-19 pandemic, the national debt has now reached worrying levels. After declining from its post World War II peak, it shot up in the financial crisis 13 years ago and has never gone back to a sustained declining path since. The pandemic is likely to take the national debt well over 100% of national income. The government can borrow to smooth the costs of a crisis, but anybody who thinks it can increase the national debt on a sustained basis in normal terms over many decades is living in cloud cuckoo land.

What makes the Chancellor’s position so difficult is that this is only the start of our problems. Before the Covid-19 crisis really got going, the Office for Budget Responsibility (OBR) produced its annual Fiscal Sustainability Report. It suggested that, on current policy (that is with tax rates unchanged and thresholds increased in line with government plans and making reasonable assumptions about health, pensions, social care and other spending), the national debt would rise to 400% of national income over the next 50 years. To stabilise the debt, taxes would have to rise by a total of 15 percentage points of national income over that period (in other words increase by 40% over and above their current level).

That’s okay, people might think. There are political choices to be made. We should ask the rich to pay a bit more tax. We can be a bit more like Sweden. However, tax increases of this magnitude are not about asking some people to pay a bit more tax. They would take the burden above that in any developed country. Indeed, it could not be done without hitting the less-well-off and choking off economic growth to such an extent that there would be huge suffering.

In fact, looking at other countries’ tax systems is instructive. Scandinavian countries do have a higher tax burden. However, this is a burden which falls very much on the less well off too. In Denmark, an individual will pay 25% value added tax on everything – including children’s clothes, fuel and food. An individual earning £9,000 a year would pay direct tax of about 16% of their income and then pay VAT on their spending. In the UK, an individual on such low earnings would pay no direct tax and no VAT on food, children’s clothing and a number of other exempt items.

The interesting feature of tax and welfare systems in developed countries is that they are very different from each other, but their redistributive effect is remarkably similar. Indeed, the UK is firmly in the top half of the league table for the extent to which its tax and welfare system redistributes money from rich to poor.

The fundamental reason why the government’s position is so difficult is demography. A rising proportion of old people explains nearly all the OBR’s dire projections. Unfortunately, it is too late to do anything about that. The time for encouraging saving to pay for pensions, health and care costs or for the government to run surpluses so that it had a buffer to deal with the ageing of the baby boomers was 25 years ago. Many of us wasted a lot of energy making that case then.

We are genuinely resourced constrained in a way we have not seen before. To have reached what seems like the maximum taxable capacity of the economy whilst spending needs accelerate due to demography is nothing short of a fiscal disaster.

At least Catholic social teaching has some other places to look when it comes to thinking about how we might help the poor. Indeed, it has never regarded the government as the main source of welfare. We might, for example, look at housing policy. Restrictions on house building, largely arising from well-off vested interests campaigning against new development, have meant that between 1969 and 2019, UK house prices have risen by 3.7 times over and above inflation. In Germany, over the same period, house prices have risen by 20%. This is an unmitigated disaster for the poor. It is a major explanation for poverty in the United Kingdom. This is not about a lack of social housing: we have the third highest level of social housing in Europe. It is about planning constraints on house building.

We might also look to the family. In the UK, 22% of children live in lone parent households. This compares with an EU average of 17%, 15% in Germany and 12% in Holland. Persistent poverty is two-and-a-half times greater in lone parent families than in couple families. We might ask, what is tax and welfare policy doing to support family formation? The answer is that it is more or less uniquely bad in Europe from that perspective. What can civil society institutions and charities do to support the family? What can the Church do to change culture?

This is a difficult discussion. It can easily seem as if we are blaming lone parents. This needs to be turned round. Life as a lone parent is very, very difficult. We should have every sympathy with them. But government policy, civil society and the Church need to simultaneously help build stronger families whilst supporting those families in difficulty for whatever reason. This will help reduce poverty significantly as well as having many other positive spin-offs.

The great tradition of Catholic social teaching has, of course, always had lessons for government policy. But the common good is the responsibility of all individuals and institutions in society. We do need to recognise that there is no easy solution to the many problems the country faces arising from fiscal adjustments. Simply complaining that the government is not spending enough money is not a prudent response (in any sense of the word). And we should be aware – the situation is going to get worse over several decades. We need to look in other directions if we are to find lasting solutions to the problem of poverty.

This article was first published on the CSAN blog.

 

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.


1 thought on “No salvation in fiscal policy”

  1. Posted 10/03/2021 at 11:21 | Permalink

    Amen to that. Speaking as a Methodist rather than a Catholic, I have for some time bemoaned the uncritical assumption in some Christian circles that tax and government is a universal good – whereas the question should always be, how can we collectively as a society, best sort out this particular problem. That may be through central governmental action, but it may be on other occasions that a £ or $ taken in tax could be better employed by non-governmental action (e.g. by companies in creating jobs). Jesus seems to have had a fairly ambivalent view of taxes (Matthew 22:15-21) and even Romans 13 is not without qualification.

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