Very basic politics #1: three ways to deal with the deficit

First, a disclaimer. I am not very informed about UK party politics or about how our parliamentary system works. I know people who are much more informed in these matters (but I won’t link to them because they have party affiliations and I don’t want to advocate a particular party).

But I do want to talk about political principles. This is the first in what I expect to be a short series, where I want to tackle the very fundamentals that we vote on.

The key issue underlying much of the electioneering this time around seems to be the deficit. Every year, Britain spends about £100 billion more than it receives in tax and other income. As a result our cumulative national debt is rising, and currently stands somewhere north of £1.5 trillion. That’s about £24000 per person, and increasing. Paying the interest on this loan costs the country £40 billion per year, which is going on for £700 per person. It’s not a sustainable situation in the long term.

What to do?

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The most fundamental choice is whether to reduce the deficit or not. (Note: politicians sometimes talk about reducing the debt. That is not what any of them are actually proposing to do in the short term. They propose to reduce the rate at which the debt is increasing. The Conservatives claim they will run the country at a surplus by the end of the next government.)

Arguably the most important contribution that the Green party have made to this election campaign is to establish that reducing the deficit at this time is a choice. It’s not something that is imposed on us by inescapable economic necessity.

Everyone accepts that continuing to grow the national debt indefinitely is unsustainable — and simple maths shows that this is correct, as eventually a point would be reached where the entire GDP would be required just to keep up the interest payments. The question is when to deal with the deficit. Most parties want to do it now, but the Greens’ position is that the world at large is still in recession and this is the wrong time to be dealing with a structural problem. Better to ride out the global recession with the country in a healthy state, they argue, then return to the problem of the deficit when conditions are better.

I think that option deserves some scrutiny — even if it only turns out to be to demonstrate that it’s a bad idea. It disappoints me that hardly any attention has paid to it — perhaps because the clowns at UKIP have been successful in steamrollering the debate with their anti-foreigner rhetoric, leaving no time for substantive issues.**

Can the Green approach work? I don’t know, and I’m not sure anyone really knows. That’s why I want it to be discussed.

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All the mainstream parties, though, seem to agree that the deficit needs to to tackled, and that it needs to be done now.

How can you reduce the deficit? There are two ways. Since the deficit is the difference between revenue and spending, you can reduce the deficit either by increasing revenue or by decreasing spending.

Decreasing spending means cuts in public services, an approach known as “austerity”. That is the path that our Tory*-LibDem coalition has pursued for the last five years, and it’s the reason why libraries are closing, the NHS is not sufficiently funded to cope with our ageing population, and astronomical numbers of people are having to turn to food banks. One of the surprises from the LibDems, who are usually perceived as in the centre or somewhat to the left, think that the way we address the deficit should be just over 50% spending cuts.

The other option is increasing revenue, which means raising taxes. The LibDems think about half of the deficit reduction should come from increased taxes; the Tories, who of course were the majority party in the government just ended, think that none of it should, and that whatever else happens, taxes should not be raised. They are so committed to this that they even want to bring in a law making it illegal to raise taxes for five years.

One of the disappointments of the present political landscape is that there is no major party that offers the alternative of tax rises as the way to address the deficit. Traditionally, this would have been the Labour party’s position, but since the rise of Tony Blair’s “New Labour“, its policies in this area have grown closer and closer to those of the Conservatives*, with the lamentable result that UK politics has become more about personalities and less about identifiable differences in policy and ideology. Now we have a situation with Labour shadow-ministers claiming that if they form the next government they will be tougher on benefits than the Tories.

Whether you prefer the Tory or traditional-Labour approach, it has to be a bad thing that the electorate is no longer offered a choice between these approaches. It’s also a surprising state of affairs, given that most people when polled think that the richest should pay more tax. The best that can be said is that among the big three parties, Labour and the Lib Dems are less committed to a no-tax-rises policy than the Conservatives.

So there you have it: the three ways to deal with the deficit are:

  • Put the problem off until the global economic situation is better (Green Party)
  • Spend less money by cutting public spending (Conservative)
  • Raise more money by increasing taxes (traditionally Labour and LibDem, but not so much now)

Those are all the options. Every possible response to the deficit is some combination of these three approaches.

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Up to this point I have tried to be purely descriptive and uncontroversial. Hopefully no-one will need to disagree with much that I’ve said. But I want to finish this piece with my own opinion. If you’re not interested in opinion but only in facts, then now would be a good time to tune out.

My opinion, then.

Cutting public spending, including benefits, disadvantages the poorest people in a society — the people who have nothing else to fall back on (otherwise they wouldn’t be on benefits in the first place). Meanwhile, increasing taxes disadvantages the richest people in a society — the people who are earning enough to be taxpayers.

Put in those terms, this seems to me like a stark moral choice. It’s better that rich people should pay from the much they have, than that poor people should pay from the little they have. So if we’re to address the deficit now, I favour doing so by raising taxes while maintaining public spending at its present level — or better still, increasing it to its level at the start of the last government. (I say that even though I personally would lose out much more from tax rises than from spending cuts.)

I would be interested in hearing the reasoning behind opposing views.

[Read on to #2: what is government spending for?]


* Note for Americans: in UK politics, “Tory” is for some reason the nickname of the Conservative party; so Conservative and Tory are used interchangeably. The Conservative party (with a capital “C”) tends to have values somewhat aligned with those of political conservatives (with a small “c”) in the USA, but the correspondence is very far from perfect. Basically, when dealing with UK politics, it’s probably best to forget what you know about the meanings of “conservative” and “liberal” from US politics.

** Exception to my no-party-politics rule: I’ll make no effort to hide my contempt for UKIP, who are not so much a serious political party as a dirty-foreigners-are-to-blame echo-chamber, led by “man of the people” Nigel Farage, who was educated at a public school*** and worked as an investment banker.

*** Another note for Americans: for historical reasons, “public school” in the UK means the very most exclusive and upper-class of the private, fee-paying schools. What you call public schools, we call state schools, and the vast majority of children attend them.

26 responses to “Very basic politics #1: three ways to deal with the deficit

  1. The question is – is cutting the deficit the fastest way to bring down the debt?

    If taking the £100Billion and spending it on things that cause the economy to grow faster means that the debt (while growing) is a smaller part of the economy then we shouldn’t be paying it down, we should be growing faster.

    A lot of this depends on fiscal multipliers – the effect that spending government money has the size of the economy as a whole. There’s a fascinating article here:
    http://blogs.ft.com/gavyndavies/2012/10/21/high-fiscal-multipliers-undermine-austerity-programmes/
    which shows what the IMF found – for every £1 the government cut, the economy shrank by up to £1.70 – meaning that we then bring in less taxes, and make it even harder to grow our way out.

  2. You missed the nuclear option: default. Not that I’m advocating it, just noting that there are more than three options.

  3. Well, I can’t blame Andrew Ducker for leaping ahead slightly what was slated to be part 2 of this series — what actually is the value of government spending? And should we even call it spending rather than investment?

    But you’re right that there’s an argument to be made that even if our goal is the purely economic one of clearing the debt as quickly as possible, cutting the deficit may not be the best way to do it. I should have made that point.

    And cjp39 is also correct, of course, that there is is a theoretical fourth option, which is just not repay the debt. But I don’t see anyone advocating that, so I didn’t consider it worth discussing in the article. (Is anyone advocating it?)

  4. “simple maths shows that this is correct, as eventually a point would be reached where the entire GDP would be required just to keep up the interest payments”

    There is a fourth option: (somehow) grow GDP to the point where we _can_ easily keep up with the interest repayments. Tax revenues will rise and public spending can remain the same. This, I think, is what Gordon Brown’s government was gambling on towards the end of his term.

    You could argue that this is similar to the Greens’ position: ride out the recession until the economy recovers. You phrase their position as “put the problem off”, meaning deal with it later; this is “the problem will go away by itself”.

    Then, of course, we get into just _how_ you do that.

  5. Yes, Roger, I consider “grow the economy until we can run at a surplus” to be essentially the same as “wait till the economy grows to the point where we can run at a surplus”. But you’re right that the connotation is different, as it suggests we’re actually doing something to make it happen. I find myself at this point thinking of the shoe-shop intensifier ray.

  6. I’m sure everybody would instinctively like to tax the rich more – most of us aren’t rich after all – and somebody earning over 100K can surely afford to pay more. The problem, first identified in the late 70s, is that doing so, beyond a certain point, actually reduces your tax intake. The very rich, who pay the largest share of tax in this country, have more options for evading (legally or otherwise) high taxes than the poor, as well as simply moving themselves or their accounts offshore. Investment and business startup rates also suffer. This isn’t a theoretical problem – in the early 80s when rates of personal tax on the wealthy were reduced, the amount of tax they paid actually went up significantly.

    Increasing tax on the wealthy is always a popular (populist) measure, but if it doesn’t actually work and also turns the debate into a divisive ‘them and us’ discussion then perhaps the coalition have made the correct choice.
    Just as a thought exercise – if increasing the top rate of tax from 45 to 50 reduced the total tax intake would you still advocate it? Would the desire for equality override actual outcomes?

    I don’t subscribe to the jejune notion that all politicians are evil. In the case of the Tories, I often get to see the idea presented that the Tories want reduced taxation on the wealthy ‘to help their rich friends’. That is asinine. However ideology is still present in both parties, usually up until the point whoever has been elected strolls through the doors of the treasury and sees the figures. This is probably why all three of the traditional parties (at the leadership, not the grassroots level) have started to clump in the centre, and why the green party advocate a very different approach.

    I didn’t get to read the article Andrew Ducker (no relation to Mike Ducker?) posted (behind a subscription) – but is that hypothesis linear? ie should we just borrow a trillion quid and see our economy grow by 1.7 trillion? At that rate of return pension funds should probably reconsider their current strategies. It seems to have a lot of faith in the efficiency of government spending, and doesn’t appear to fit the experience of countries like Canada (made cuts, rode out the recession relatively unscathed) and Venezuela (increased taxes and spending massively, now a basket case)

  7. “For every £1 the government cut, the economy shrank by up to £1.70”

    Without further information, that sounds like the right choice, then. Assuming the government don’t tax their own investment (that would be stupid, right?), and assuming a basic tax rate of 20%, that means they would have got a mere 14p in taxes in exchange for a £1 debt.

  8. Very clear piece Mike, the only bit I didn’t understand was your statement about Lib Democrats reducing deficit 20% by raising taxes. I thought it was 50:50 split. I am rubbish with economics, so the fact that I only misunderstood this bit is credit to you. I eagerly await the next instalment…

  9. It’s also worth noting that cutting spending on poor people is piling up “debt” for future years. Cutting spending on schools will produce a poorly educated populace, fewer high skilled jobs, and a lower GDP. Cutting spending on benefits increases homelessness, which is extremely costly, and the amount the NHS has to spend on associated problems such as malnutrition. Increasing taxes on the rich has a slight associated downside that a few of them might choose to leave the country, but I’m not aware of anyone newsworthy who claims they “would leave the country if X got elected” having done so.

  10. Sarah (that’s salsalpinkkat for those who don’t know),

    That 20% figure was a mistake — left over from an earlier version of this article that I’d half-fixed but missed this bit. Now repaired, thanks for spotting it!

  11. Phew- that means I understood it all- impressive work on your part. I’ve heard Robin’s argument a lot and in an ideal world I’d actually like equal tax paid by everyone who can afford to pay it- so the basic level would rise to protect the poor. (As I believe is common practice in Scandinavian countries. I’d lean towards moving in that direction…

  12. You’ve accepted a misconception, and omitted an option.

    First, if the Greens say that we should put off tackling the deficit because the world economy is still in recession, they’re simply wrong. This shouldn’t be particularly surprising, because for all that their hearts are in the right place, the Greens are lousy at arithmetic. The world has been out of recession for over five years now, buoyed up by strong growth in developing economies.

    Second, the government could simply tell the Bank of England to print a £1.5 trillion note, then use it to pay off the debt. There are very good reasons not to do so, but it’s an option.

  13. Nice analysis Mike. Lots of key values questions here. Of course austerity isn’t really primarily a response to the deficit , it’s a political preference for a small state and low taxes..

  14. Basically everyone agrees that one should spend counter-cyclically, ie run a deficit in recessions and a surplus [1] in the intervening years.

    Trouble is, the people who are crying “stimulus!” at the bottom are the same people who continued to run a deficit at the top of the last boom (in the US as well). And who knows, they might still be stuck in stimulus (see: difficulty in raising interest rates/stopping QE) when the next slump comes around.

    Like it or not, somewhere near the bottom is the only time it’s ever politically feasible to trim the budget (or raise taxes).

    [1] or at least a deficit less than your long-term growth rate.

  15. futilelaneswapper

    According to HMRC, the contributions from the tax paying public break down as follows.

    45% rate, income > 150k: 1% of tax payers, contribution 27.9%
    40% rate, income > 42k: 15% of tax payers, contribution 36.8%
    20% rate, income > 10k: 81% of tax payers, contribution 33.2%

    The remaining 2.1% is made up of dribs and drabs from elsewhere.

    There are a couple of points to be made. For people on incomes of 150k or more the effective tax rate they now pay is now nearer to 62%, because of the combined effects of National Insurance and Personal Tax as well as the removal of personal allowances on earnings of more than 100k. The effect is less for people in lower tax brackets because they don’t lose their personal allowances. Secondly, in order to pay for taking more lower paid people out of the taxation system entirely, the numbers of people now paying 40% tax has risen sharply, due to the reduction in the threshold at which it becomes payable. In 2010/11, when George Osborne became chancellor, just over 3 million people paid the 40% rate. That number now stands at more than 4 million. Twenty five years ago, under Thatcher, only 1 person in 20 paid tax at the 40% rate. Now, more than 1 in 6 do.

    The fundamental reason for the problems we are facing now is that in the years between Thatcher and Cameron, the cost of running the UK has risen astronomically, but the UK economy has not grown equivalently to compensate. Consequently we are now living way beyond our means. The Green party believe that we don’t have to address the deficit immediately, but they are wrong, both economically and morally. We are not in a recession, but we are still spending more than we can afford and we are mortgaging our children’s future to pay for the good times now. At the same time, it is hard to know where further spending cuts are going to come from that won’t continue to worsen the situation for the poorest among us. It seems that unless we want to abandon all pretence of living in a decent society we will have to increase tax revenues. Of course every major party has said it won’t do this (at least, not directly). But i suspect every major party secretly knows its inevitable. They just don’t want you to know, in case you get scared and don’t vote for them. But if you’re not scared (or even if you are) and you’d like to know just how much extra tax needs to be raised, read on…

    The UK has approximately 29 million tax payers, supporting a population of nearly 65 million people, of whom about 42 million are adults. The projected annual cost per capita of running the state in 2016 is £11,500. To reach break even point (i.e. no more public sector borrowing), UK taxpayers would theoretically need to be paying an average of 22.5k each to balance the books. In practice of course, Corporation and other taxes also contribute to the public purse so this extra burden would not be borne entirely by the private citizen. Nonetheless after accounting for these other contributions, the projected deficit for 2016 is an eye-watering 46bn GBP, which is equivalent to an additional 1,600 GBP per UK taxpayer.

    So if we want the shortfall to be met by taxation, the question arises as to what the new rates of tax need to be, and how their thresholds are to be determined. I don’t have any answers of course, but to put this question into perspective, if somebody on an ‘average’ UK salary of 26k were faced with an ‘average’ additional 1,600 annual tax bill it would equate to a personal tax increase of 50%, or a tax rate of 30% rather than 20%.

    This comment is already plenty long enough (sorry), so I’ll stop now.

  16. There’s nothing wrong with a long comment – it’s a complex question and deserves the comprehensive (and interesting) response you gave it.

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  18. Roger Lipscombe, growing GDP is exactly how *every* government pays its debts. It’s unnecessary to talk about reducing the debt: it’s perfectly sustainable for debt to grow forever, as long as its long-term growth rate is less than the rate of growth in GDP — and this is what almost all govenrments that don’t default actually do.

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