Political squabbles must give way to fiscal courage

1 October 2009

All politicians of consequence now recognise the necessity of extensive and rapid repair to Britain’s public finances. IMF forecasts suggest that Britain will have the highest level of debt in proportion to GDP of the G7 economies by 2014 unless serious action is taken.

Standard & Poor’s credit rating agency warned in May that the outlook for Britain’s prized AAA status was negative, providing a serious warning to all that public finances must be stabilised if interest costs are to be kept at a reasonable level and a ratings downgrade avoided.

With an election looming Britain does stand at a crossroads and the next government will have a chance to genuinely reshape the state for the positive. There can be little doubt that public spending has been fundamentally mismanaged over the past twelve years and there are serious doubts as to the efficacy of the money ‘invested’. Public sector spending has risen by 4% a year in real terms over the past decade, above the growth in the economy.

The NHS has seen a 6.3% increase but an independent audit found that 40% of all money invested between 2003 and 2007 was absorbed by pay increases. Indeed this is a broader trend; state employees’ earnings have increased ahead of private sector workers for nine years whilst enjoying generous pension arrangements.

Money has also been misdirected, with the number of state employees increasing by 11.5% to 5.8m consuming £158bn in pay, one quarter of overall spending. The state therefore requires definite and deliberate pruning, combined with targeted increases in taxation, to lay the foundations for a more sensible and sustainable programme of investment once public finances have been stabilised.

As is to be expected politicians have been reluctant to unveil the scale of cuts and tax increases needed due to fear of voter backlash in the coming election.

Despite being promised a ‘real debate’ parties have continued to succumb to sentimentality and engage in electioneering at the expense of substantive discussion; neither David Cameron’s ring-fencing the NHS from spending cuts nor Gordon Brown’s pledge to keep support for schools constant can be justified. The right approach is to evaluate all programmes from scratch and determine where reductions in spending will be most effective.

Vince Cable sounds many of the right notes but all signs indicate he is preaching to the choir and will likely not see much of what he proposes come to fruition.

The most effective method would be to set tight budgets at the centre and get people on the ground in local government to root out inefficiencies motivated by the removal of the spending cushion of the last decade.

Taxes should also be raised. Receipts will most likely not return to previous levels as revenues from both financial services and real estate have been at cyclical peaks. Even under the Labour plan to increase national insurance and the top rate of income tax to 50%, tax revenues in 2012-13 will still be 2% less than was budgeted for in 2008. Another tax lever will have to be pulled, and one significantly larger than Vince Cable’s ‘mansion tax’, most likely VAT.

If the right choices are made then a fitter, leaner and better state will emerge. Indeed a leaner state, requiring less borrowing to support, would be better insulated against the type of crisis we have recently faced, as it would have a greater capacity for fiscal expansion and stimulus.

What is required is a rational debate from all parties and the political fortitude to accept a reduction in spending and services today for a more stable future.

James Patterson, a third-year Historian at Pembroke College, is President of the Cambridge University Investment Club.