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Four ways the Chancellor can afford higher public spending – not including accounting games

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The TUC is calling on the Chancellor to take four key steps in this week's Budget.
Philip Hammond. Christopher Furlong / Getty Images
Christopher Furlong / Getty Images

We're calling on him to end the public sector pay capupgrade our workplaces, take swift steps to address the living standards crisis and expand public investment.

It’s been argued that we can’t afford to fix existing problems as the economy slows down.  But the opposite is true: we can’t afford not to.

Here’s four ways that spending can be afforded. And then one extra looking at how the government might use accounting tricks to build houses, even though they have been affordable all along.

1. Don’t cut taxes

The most obvious place to start is to not cut taxes. In the name of ‘tax competition’, the government has stuck to its goal of an ultra-low corporation tax rate. There is no evidence that this incentivises investment: most obviously vigorous cuts over recent years (chart below) have not been matched by a vigorous increase in investment, rather by concerns about underinvestment (see e.g. Bank of England analysis).

UK corporate tax rate

Source: KPMG

2. Leave it longer to reduce the deficit

The IFS also note that the Chancellor could spend some of the headroom he has built in on the basis of current targets. More generally it could be argued that enough progress has been made on deficit reduction to permit higher spending and at least some temporary relaxation of rules, given the very real needs of the economy.

Certainly in the great scheme of things the deficit is hardly a historic high, though it is still above the long-term average.

Public sector net borrowing, % GDP

It may even be that the Chancellor has to do this. If the OBR substantially downgrade their expectations of the future strength of the economy – as their Forecast Evaluation Review suggested (see discussion here) this will mean reduced public revenues. So if the Chancellor wants to not cut spending even further he will have to take a wider deficit on the chin.

3. Strengthen the economy (1): public investment

But the more constructive approach would be active policies to strengthen the economy

As Jack Jones discusses, the UK investment performance is close to the bottom of the league table of advanced economies.

Investment is regarded as the most beneficial kind of spending because it not only boosts demand but also adds to capacity and so strengthens the supply side of the economy. The Bank of England (in their quarterly bulletin) have observed that the private sector is too nervous to invest:

The survey suggests that increased uncertainty about the future economic environment and the business owner’s reluctance to take on risk were the main non-financial obstacles to investment … And uncertainty was an obstacle for firms of all sizes. Earlier external studies have also found that increased uncertainty has been an important cause of weak investment since the crisis.

Under these conditions economics 101 says the public sector should step up.

Moreover, interest rates are rock bottom.

The OECD (e.g. June 2017 Economic Outlook, p. 51) go as far as saying that investment spending can be ‘budget-neutral’ – with spending paying for itself through strengthening the economy.

Nothing should stand in the way of this spending. Across the country there are people who stand ready to do decent jobs of real worth.

4. Strengthen the economy (2): higher incomes mean higher spending 

But the same is likely to be true of all types of spending. If you put money into peoples’ pockets, they will spend that money and that spending will strengthen the economy through the demand channel alone – see discussion ‘Why multipliers matter’.  Most obviously this is the case for a public sector pay rise, or a general increase in public service spending.

IPPR analysis this week gave a sense of the potential impact. They argue that while a public sector pay rise in line with inflation would cost £5.8bn, the same spending will lead to increased taxes and reduced benefit spending of £2.25bn so the ‘net cost’ ‘falls to £3.55bn’. They also recognise that the OBR multipliers that they use are contentious: “OBR multipliers are currently lower than those estimated by other economists”. Using variants of IMF multipliers, IPPR conclude that up to as much as £4 billion could be returned to the exchequer.  As we have previously argued (earlier multiplier link) there is a case that the multiplier is larger still.

The likelihood is that higher spending will pay for itself, just as spending cuts have damaged the economy and ensured any recovery in the public finances has proceeded at a snail’s pace. 

The caveat is whether there is capacity available to expand production to meet the increased aggregate demand. IFS and OBR all warn that this is not the case - and with the rate rise last week the Bank indicated they think likewise. But this is highly contentious. We can all see through low(ish) unemployment as driven by low quality work, and desperate need for decent work across the UK.

Going back to the previous chart, notice that under the Attlee government – probably the most important peacetime expansion of public services ever – the deficit was reduced.  If we keep assuming that there is nothing that can be done, then nothing will be done.

  1. And one thing he definitely shouldn't do: Use accounting tricks to increase housing investment

The need to build more housing is obvious. In this context last week’s ONS announcement of a reversal of a decision on housing associations may be relevant. See this letter from the ONS to a HM Treasury official.

This decision had added £60-70bn to public sector debt, and so when reversed will reduce debt by the same amount.  (A big change even given total public sector debt of £1.8tn.) According to the Financial Times the deficit will also be reduced by £5bn a year, and the government plan to use this reduction to support spending rather than adjust fiscal targets.

This reversal results from an earlier reclassification of housing associations from the private to the public sector, on the grounds that public officials appeared to have ‘control’ of operational policy (the key characteristic in such cases). The government therefore set in motion changes to reduce the influence of public officials [The Regulation of Social Housing (Influence of Local Authorities)(England)], and yesterday when these were implemented housing associations reverted to the private sector.

It may now be that housing associations are free to spend and borrow to their heart’s content. So we get housebuilding, but not by government. And maybe this is perfectly sound; maybe the social housing that is desperately needed finally gets built.

Nonetheless the wider issues around this kind of so-called ‘classification change’ are controversial – the most obvious example being public-private partnerships (variously rebranded as PPPs or PPI or PF2) – see the excellent work of the people vs PFI.

Most obviously the tail is wagging the dog – the rules for statistical classification are dictating how the provision of social housing is operating. Surely institutions and financial processes should be organised according to how they work best.

One very obvious problem is that in the private sector borrowing costs are likely to be higher than in the public. (And the associations appear very heavily reliant on borrowing, given the total debt of £60-70bn and the annual deficit of £5bn.)

Moreover it is not clear to what extent the private sector provision of social housing might be subject to market forces which inhibit building to an adequate extent.

There are then more general questions about how meaningful it is to target public debt, given it can shift so substantially for reasons largely unrelated to the condition of the economy.

Outside housing, two schemes for subsidising banks (effectively) – Funding for Lending and the Term Funding Scheme – have raised the public debt by £170bn. This one is particularly mind boggling.

Given a refusal to use fiscal policy because of worries about the scale of public debt, policymakers have devised monetary schemes that directly and very substantially increase the public debt.

The whole area is a mess, fostered by senseless and counter-productive targets and fiscal policies. Policy should act according to the needs of the economy, not artificial and politically motivated targets.

Annex: countries with CT rates lower than the UK.

Bahamas

0

Bahrain

0

Bermuda

0

Cayman Islands

0

Guernsey

0

Isle of Man

0

Turks and Caicos Islands

0

Vanuatu

0

Uzbekistan

7.5

Hungary

9

Montenegro

9

Andorra

10

Bosnia and Herzegovina

10

Bulgaria

10

Gibraltar

10

Kyrgyzstan

10

Macedonia

10

Paraguay

10

Qatar

10

Macau

12

Moldova

12

Cyprus

12.5

Ireland

12.5

Liechtenstein

12.5

Albania

15

Georgia

15

Iraq

15

Kuwait

15

Latvia

15

Lebanon

15

Lithuania

15

Mauritius

15

Oman

15

Palestinian Territory

15

Serbia

15

Romania

16

Hong Kong SAR

16.5

Singapore

17

Taiwan

17

Switzerland

17.77

Belarus

18

Ukraine

18

Brunei Darussalam

18.5

[United Kingdom

19]

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