Next UK government must be brave on policy reform

Immediate and longer-term problems need to be addressed urgently

Regardless of which party is selected to form the next UK government on 4 July, there should be no presumption that the country’s economic policy problems can all be satisfactorily resolved in the first 100 days. A combination of immediate and longer-term reforms is needed to control the ratio of government debt to gross domestic product, enhance growth, reform the provision of public services and promote a more efficient and equitable tax system.

The main problems are with fiscal policy. There is an urgent operational need to take decisions for financial year 2025-26. Longer-term plans require detailed review and should be announced with the 2025 budget.

Where to start?

In an ideal world the next government would plan for the ratio of debt to GDP to fall sooner and by a greater amount than the present government envisages. This would leave the UK better placed to cope with future shocks. This is unlikely to happen. While the next government will seek to avoid fiscal decisions that produce a rise in forecast borrowing from already high planned levels – as in the disastrous 2022 Liz Truss experiment – it is unlikely to put government borrowing on a firmly downward path because the necessary increase in taxes and cuts in public expenditure would be unacceptable.

The next government will probably retain the current fiscal rules for government borrowing, which envisage the debt to GDP ratio falling from just under 100% at the end of the fiscal planning period. Decisions on taxes and spending would be taken so that the Office for Budget Responsibility judges that this target for borrowing would be met.

Even with this unambitious approach to borrowing, current fiscal ‘plans’ envisage implausibly low growth in total public expenditure from 2025-26 onwards. The unrealism of this scenario needs to be confronted in an early autumn fiscal event. For schools, the health service and local authority services there is an urgent operational – and in some cases legal – requirement to set providers’ budgets this autumn for 2025-26.

The current aggregate spending totals would involve severe cuts in many of these services. Given the difficulties with, for instance, the justice system and many local authority services together with the pressure for increased defence spending, the practice since 2010 of giving priority to health and education while squeezing the rest of public spending is no longer feasible.

After the election the Treasury will receive a flood of emergency bids for large and immediate spending increases from new ministers who will argue that the prospects for provision of their services are even worse than had been anticipated. The prime minister and chancellor will not be able to refuse all these bids. In the absence of major cuts in service provision – something not envisaged in the election campaign – and if borrowing is not to rise substantially, there will have to be an increase in taxation. The hunt will be on for relatively uncontroversial revenue increases not involving the main rates of income tax, national insurance, VAT or corporation tax – for instance by reducing exemptions and allowances.

The next government may also have to steel itself to increase tax rates – maybe by ‘temporary’ surcharges or rate increases – blaming the worse-than-expected fiscal conditions and state of public services. An overriding aim of the autumn fiscal event should be to avoid decisions that make longer-term reform more difficult.

Looking ahead

There are certain obvious areas for longer-term reform that should be urgently assessed in the first months of the next government. Current public spending arrangements largely separate the responsibility for expenditure from the role of raising the finance to pay for it. Those responsible for spending have little incentive to balance service needs with the willingness of the electorate to pay for them. The bulk of finance for the devolved administrations and local authorities comes from central government. There should be a review of longer-term spending plans and an increase in the extent to which responsibility for spending is combined with the role of raising the necessary revenue.

There is a widespread desire for an industrial policy to raise investment and growth. The option of funding a large increase in public investment through extra public borrowing financed by gilt issuance is not available in the UK – in contrast to the US, which benefits from the dollar’s role as the world’s principal reserve currency. Past industrial policies have contained few specific policy measures. The desire to ‘streamline’ the planning process will require specific proposals and legislation, the details of which remain vague, may be politically problematic and will take time to enact.

Another aspiration is to combine private finance for investment with the limited amount of public finance available while government borrowing remains so high. Something like an expanded version of the last Labour government’s public private partnerships will need to be designed. Even if there is an effective industrial policy with concrete innovations any positive effect on growth rate would be fully felt in the parliament after next.

The difficulties of financing public sector investment while government borrowing is so high mean that a fundamental review of certain aspects of Bank of England practice is urgently needed. At a time when high public sector borrowing and the vast gilt issuance that this produces severely constrain planned public sector investment (most noticeably for environmental objectives) it is questionable why the Bank of England is selling off its assets (largely gilts) acquired during the period of quantitative easing at a rate of £100bn per year. Furthermore, the decision – not followed by the Federal Reserve or the European Central Bank – to guarantee the Bank’s quantitative tightening operations against loss is currently costing the Treasury and thereby reducing available fiscal headroom.

Work on public sector productivity and efficiency by the Office for National Statistics shows a troubling picture of deteriorating performance, especially since the Covid-19 pandemic. This is a particularly sensitive area as there is a reluctance to criticise the performance of those in public services that tend to be poorly remunerated. Yet, with the enormous pressures on public services, it is essential that this nettle is grasped so that public sector productivity increases if service provision is to be significantly improved at a reasonable cost.

The beginning of a parliament is the least bad time to decide on fundamental reforms that would add credibility to medium-term fiscal plans. Without ambitious reforms the next government will be forced to take even more unpalatable decisions on taxes and public services.

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.

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