Recent crises have shown that UK macroeconomic decision-making needs to be drastically reformed. Much of the focus has been on monetary policy and the performance of the Bank of England. But there are greater problems with fiscal policy and the role of the Treasury.
The autumn budget statement leaves the UK’s deep-seated fiscal problems unresolved. The ratio of government debt to gross domestic product stays too high. The tax burden is forecast to rise to its highest level in 60 years. Prolonged high borrowing and the rise in interest rates have taken the annual debt interest bill to over £100bn.
Public services, many of which are already struggling, face a further squeeze. The cuts in national insurance and the extension of generous investment allowances for companies do little to alter the overall prospect: they partially rearrange the pain in favour of companies and those in employment at the expense of funding for public services.
There is no evidence that either the squeeze on public services or the rising tax burden are accepted by the electorate. The prospect is for a continuation of fruitless disputes on whether to cut taxes or spend more on services when the scope for either of these is limited.
What is the solution?
There is little appetite for policies to reduce the debt-to-GDP ratio following its sharp rise since the 2008 financial crisis and the pandemic. There is some support for policies to improve growth, though no two sets of proposals to do so seem the same.
There is little consensus on what these policies should be. Strategies for growth are valueless unless they include specific proposals and a realistic assessment of the time needed for them to have observable effects. Any that require public sector investment – such as green investment – have the immediate effect of increasing borrowing. Others, such as changes to the planning system, require legislation to be drafted (possibly after public consultation), need time-consuming parliamentary approval and would involve changes to administrative arrangements. Any beneficial effects on GDP and tax receipts would probably occur in the parliament after next at the earliest.
It would be possible to improve fiscal policy by bringing together the decisions on levels of service, the efficiency with which they are provided and how they are to be paid for. This would require the Treasury to share its right to decide tax proposals with spending departments and to abandon its longstanding hostility to hypothecation of revenues to a particular service. It would also involve the acceptance of taxes or charges linked to services that have traditionally been regarded as free even though they are not.
One way forward would be to start with a service such as health and fund it separately from the rest of public expenditure by a specific levy on personal (and maybe corporate) incomes. Total spending on health has risen sharply in recent decades to a level that compares well with many European peers. Yet problems with the service have intensified, there are concerns about the efficiency with which additional funds are spent and there has been a significant shortfall in investment.
The objective of a new system should be to bring spending and revenue decisions together for important services. This proposal does not assume that, because a specific tax or charge would be for a much-valued service, taxpayers would be happy to support high charges. The objective is to improve decision-making and efficiency.
The health secretary and chancellor would decide on a level of spending, any efficiency and productivity improvements to be targeted and the charge or tax to pay for the service. The Office for Budgetary Responsibility would certify whether in its opinion the charge would cover all current expenditure (including the servicing of health investment). The charge or spending would be adjusted until the OBR was satisfied that all spending was fully financed.
Under such a system, health care would still be free at the point of use, though it would – as now – obviously not be free in a wider sense. The system for charging could be as progressive as desired: it could involve a small or no charge for the poorest and higher rates of contribution as incomes rise.
The health secretary and chancellor would agree the investment programme for health, which (in the absence of a resumption of the last Labour government’s public-private partnership policy) would be financed by government borrowing. The servicing of this borrowing would be covered by the health charge. Such a framework for specific services would fit into a policy, which most political parties support in principle, for government to borrow only for investment. Other government expenditure that does not have its own charge would be paid for by general taxation at a reduced level.
Given the importance of health in public finances and the politically sensitive and at times feverish nature of the debates it can generate, this would be a good place to start. Moving to such a system in a formal way would require careful preparation, consultation and parliamentary process. It should be possible to start with a virtual process that brings together all the decisions on spending, efficiency targets and the required charge.
Slow and inefficient processes
Traditionally decisions on public expenditure were taken without detailed consideration outside the Treasury of the implications for tax. There was typically an autumn announcement on public expenditure plans, followed months later with tax proposals announced in the Budget with little if any prior discussion with cabinet ministers apart from the prime minister.
The gradual move to two fiscal events every year accompanied by OBR forecasts of the consequences of decisions has improved the framework. But ministers responsible for individual services are not usually involved in decisions on how they are to be paid for.
These arrangements make virtually impossible simultaneous and rational decision-making on the budgets for individual services, the efficiency with which they are provided and the revenue needed to pay for them. The reported proposal in Lord Francis Maude’s review of Whitehall to separate the management of public expenditure from the Treasury would exacerbate this problem.
It would be better for the Treasury to keep its responsibility for spending, tax revenues and the financial system, but where possible involve ministers responsible for specific services in decisions on revenue as well as spending totals in their areas of responsibility. The alternative is to continue the status quo with the proponents of more health expenditure and lower taxes talking past each other.
Peter Sedgwick was a senior UK Treasury official, Vice President of the European Investment Bank from 2000-06, Chair of 3i Infrastructure PLC from 2007-15 and Chair of the Guernsey Financial Stability Committee 2016-19.