October Budget 2: How much do UK taxes need to rise to end public spending austerity?

 

Austerity is a term used in many different ways, but this post will involve numbers, so I need to be precise about what I mean by ending austerity. I want a measure to capture how the provision of public services (including welfare provision) is significantly poorer than people might expect given general levels of prosperity. Note that this definition makes austerity about the level of public services, and not their rate of change. Many people use austerity as shorthand for cuts to public spending, and particularly the period from 2010, but it makes more sense here to treat austerity as reflecting the level of public services relative to some norm defined by general levels of prosperity.

We know we are currently living in a period of public sector austerity by looking at sector specific indicators: hospital waiting times are unusually high, court cases are being delayed for months or years, and so on. (For a detailed analysis covering four key sectors, see this Institute for Government report.) However it is much more difficult to know how much extra spending is required to get all those indicators back to more normal levels.

Some of the spending required to restore public services may be in the form of a one-off increase in public investment, to make up for a lack of investment over the past 14 years. As John Burn-Murdoch showed here for example, investment in the NHS collapsed after 2010. There are excellent reasons why one-off or ‘catch-up’ increases in spending should be financed by borrowing rather than tax increases, while permanent spending increases should be matched by higher taxation. As a result, my focus in this post is on permanent rather than one-off increases in public spending. I will discuss public investment in a later post after talking about fiscal rules.

The aggregate measure I will focus on is public social spending as a share of GDP [1], as defined by the OECD, which I talked about at length in an earlier post. This mainly includes public spending on health and welfare (including state pensions), but excludes education and defence. [2] According to OECD data, UK public social spending was 23.1% of GDP in 2010. I will use this number as a date specific baseline level of public social spending which clearly cannot be described as austerity. It is date specific because this number needs to be updated over time because of trends in health spending.

UK health spending as a share of GDP roughly doubled from 5% to 10% between 1980 and 2010. The reasons why, in order to provide the same level of services, spending on health as a share of GDP needs to rise over time are well known, and include a steadily ageing population. The share of health spending in GDP has also been rising over time in most other countries. It therefore seems reasonable to assume that to maintain 2010 standards of provision, and ignoring the pandemic, this share of health spending in GDP would have needed to increase to around 12% by 2022. In contrast, actual UK health spending as a share of GDP remained pretty flat between 2010 and 2019 (before the pandemic), but the quality of health services clearly deteriorated over that period, as waiting times data shows.

That would imply that austerity free public social spending would have been around 25% of GDP in 2022. OECD data has actual public social spending at 22.1% of GDP in 2022, suggesting a gap of about 3 percentage points of GDP between levels of public spending and what is required to get back to 2010 standards i.e. to ‘end austerity’. UK GDP in 2022 was £2270 billion, so 3% of GDP in 2022 is about £70 billion. If either the GDP share of education or defence (not included in the OECD’s definition of social spending) also needs to rise, then the spending gap will be above 3% of GDP..

Unfortunately the UK’s current position is even worse than this, because the forward plan the current Chancellor has inherited involves austerity getting worse, not better. As was widely discussed during the election (and which was first noted in this blog back in March 2023) the previous Chancellor pencilled in additional cuts to spending over the next five years, to make his tax cuts look affordable. Total current public spending as a share of GDP is set to fall from 44% in 2024/5 to 42.5% in 2028/9. That could mean that 1.5% of GDP of social spending needs to be added to the 3% noted above to end austerity in five years time, giving us 4.5% of GDP’s worth of additional public spending (over £100 billion) required to end austerity.

Perhaps this number can be reduced because Labour can find some areas of wasteful public spending that the previous government was reluctant to cut for ideological reasons. Perhaps additional investment in the public sector, and even public sector pay increases, can improve public sector productivity. But a strong argument can also be made for increasing the share of GDP going to education and defence, which would raise this number. Finally these are, off course, ballpark numbers designed only to give a rough idea of magnitudes required.  

Higher public spending that is temporary, even if temporary means a decade or two in duration, can and generally should be paid for by higher borrowing. However the additional public spending required to end austerity is permanent, and that means it needs to be matched by higher taxes. That in turn implies taxes as a share of GDP need to rise as a share of GDP by a similar amount to public spending [3]

The OBR in their last forecast estimated that taxes as a share of GDP (national accounts definition) will be 37% in the financial year 2028/9. We are frequently told that this share is at record levels, but it is almost never said why this has to be so. As I explained here the trend rise in health spending is bound to mean the share of taxes in GDP keeps rising, because since the end of the ‘peace dividend’ there is no offsetting major area of public spending where spending is steadily declining. We should therefore ignore past UK history as an indicator of what taxes should be. If the Chancellor keeps the current falling debt to GDP rule (see a later post on the fiscal rules on why she shouldn’t) then under the last OBR forecast to get public spending up by 4.5% of GDP would require total taxes to rise to become 41.5% of GDP by 2028/29.

If that seems incredibly high, it is still below the level of taxes as a share of GDP in France, Austria, Finland, Belgium, Italy and Denmark in 2022, and it is likely that a few other European countries will be above 41.5% by 2027. Comparisons with the US, and therefore the whole of the OECD, are meaningless because US taxes don’t pay for universal healthcare.

Of course Reeves is not going to raise taxes on that scale in one budget. However, ending public sector austerity should be a realistic target for Labour to aim for over a ten year period. Labour’s mission on health should involve getting back to how Labour left the health service when it was last in office. If they want ten years in office it makes political sense to raise taxes and spending sooner rather than later. The problem the Chancellor has is that an increase in taxes of the order of magnitude required to end austerity is very hard to achieve while keeping her commitment not to raise income taxes, employees NIC or VAT.

I will look in more detail at what taxes Reeves could raise in a future post. The next post in this series will be about whether some of those tax increases can be avoided by adopting better fiscal rules, on why changing the current rules would be sensible anyway, and how that process should start in October.

[1] The reason I divide public spending by GDP was explained in my first post on the October Budget.

[2] Defining permanent, non-austerity levels of spending in both education and defence is more difficult because the former is influenced by demographic swings, and the latter by medium term but hopefully not long term threats.

[3] Matching tax increases to current and permanent spending increases makes sense over the medium term when output is at a level that ensures inflation is constant, so that what is added to aggregate demand in terms of higher public spending is taken out by higher taxes.

Transforming the politics of immigration

 

Much public discussion about immigration, including much of the print and broadcast media, negates rather than promotes understanding. The most obvious example is that polling companies still ask voters whether they think immigration is too high, and those in the media treat the results of those polls as indicative of what voters really think. As a result, much media discussion about immigration views it as a problem, and the solution involves reducing the number of immigrants coming to the UK.

Why do I think that negates understanding? In my view it is like asking voters whether they think taxes are too high, and then framing all public discussion of taxation around how to get taxes down. With taxes we know (now at least) better than that. The right question to ask is whether people want lower taxes and lower public spending, because the two go together. If I do a google search for polls about whether taxes are too high, most results present voters with that tax/public spending trade-off. The opposite is also true. Asking politicians how they would pay for additional public spending has become ubiquitous (although less so for Conservative politicians who want to cut taxes).

If we exclude asylum seekers, students and dependents, then most immigration today involves people coming to the UK to do specific jobs. Making it more difficult for firms to employ immigrants would have consequences, just like reducing taxes has consequences. This is why, when voters are asked about skilled immigrants, they have substantially more favourable views than for immigration in general. Furthermore, although voters want less rather than more low skilled immigration, when specific occupations are mentioned that antagonism is substantially reduced. As Stephen Bush noted recently, there is public dismay at the recent drop in immigrants into the health and social care sector.

Of course one reason we don’t have more joined up discussion of immigration is that large sections of the media and the political class don’t want us to. It suits a Conservative opposition to pretend that immigration is always too high, and to blame the government for this. In fact it’s worse than this. The whole Conservative political project today relies on talking up the ‘problem of immigration’, and their media arm is more than happy to oblige by talking about ‘waves’ and ‘invasions’ in much the same way as it did last time the Tories were in opposition.

When Labour was in opposition it felt obliged to nod along to most of this, and only raise their hand to object at some of the most egregious policies, like the Rwanda scheme. After all, they knew that if immigration was a problem the voters would see the government rather than the opposition as responsible. Now Labour are in government the situation is very different, but so far the rhetoric coming from Labour has not noticeably changed. In this respect it appears to be following a similar path to the later Blair and Brown governments.

In a powerful piece, Nesrine Malik suggests this is both regrettable and inevitable. She writes

“What [Keir Starmer] should say is that immigration is not “out of control”. That we do, in fact, have control of our borders, and that the vast majority who come to the country are allowed in after meeting an extremely high visa threshold. That we do in fact, invite many of them in, to fill gaps in our health and care sectors, and that those who come as students, or to work in the private sector, pay hefty residence permit fees and pay twice for the NHS, in taxes and in NHS surcharge.

[Keir Starmer] will not say this, because the illusion that immigration is something that a government can fully “control”, that is not subject to economic dynamics and the needs of public infrastructure, is important to maintain. Shattering this illusion makes it difficult for a government to present itself as having a “solution” to the problem of a country that, as Starmer previously said, needs to be “weaned” off immigration.”

While I’m convinced that such an approach is regrettable (who wants public discussion based on falsehoods), I am far from convinced that keeping it so is in Labour’s interests. While the government may benefit in the short term from falling immigration numbers, there will come a point when that trend is reversed, and the Conservative media machine will make sure everyone knows about it. When that happens, a Labour government is no more likely than the last Conservative government to implement measures that will significantly control numbers, because of the economic damage that will do. In that situation, keeping the debate at the primitive ‘immigration is a problem’ level will hurt Labour a lot.

According to some reports, those around Starmer believe that if they can show the government can work to improve people’s lives, and restore faith in government, this will lessen the attraction to voters of right wing populist attacks on immigration. This is a reasonable point. As I have noted before, austerity is associated with an increase in votes for right wing populist parties, because socially conservative voters are very susceptible to claims that poor services are due to increased use by ‘outsiders’.

However there are two reasons why the immigration issue will not go away under a Labour government. First, it seems highly likely that it will take some time for Labour to return public services to acceptable levels (‘to end austerity’). Second, the experience of the last Labour government suggests the political right can still use immigration as a powerful weapon even in economic good times.

Having a more sensible debate is not inconsistent with ‘weaning the UK’ off immigration, if this means ending the situation where pay in certain sectors is so poor that immigration is necessary to fill vacancies. However many of those sectors are in the public sector or depend on public sector finance, so once again changing that situation is likely to take considerable time, which leaves Labour vulnerable to right wing attacks on immigration when numbers stop falling. It is also obvious that a Labour government should end cases where immigration is used by unscrupulous employers as a means to exploit their workforce.

So it seems clear to me that it is not in Labour’s interests to keep the debate on immigration at its current primitive level, where immigration is always seen as a problem and trade-offs are ignored. As in other areas, Labour’s approach to this issue in opposition (what Mark Thomas calls a ‘small target strategy’) will not work when it is in government. This isn’t a call for Labour politicians to be ‘braver’ in talking about immigration. It is instead an argument that making the debate better and more informed is in Labour’s own longer interests.

The reason for this is straightforward. As long as the public debate refuses to acknowledge the benefits of immigration, it gives the political right the space to make false claims about why immigration is a problem. They can claim, in particular, that immigrants are responsible for poor public services, whereas the reality is that on average immigration benefits the public finances, and immigrants provide much of the manpower in key public services. When Labour politicians fail to counter these false claims, they leave the impression among many voters that these false claims are true.

As I noted here, pretending to be ‘concerned about immigration’ but not doing anything significant to reduce numbers because of the impact this will have on the economy has played a key role in bringing down three recent Prime Ministers. Attitudes towards immigration have become more favourable since Brexit in part because the benefits immigrants bring have become clearer. It is to Labour’s advantage to build on that, just as it is to the Conservative’s and Reform’s benefit to reverse it.

The time for Labour politicians to start changing the public debate on immigration is when aggregate immigration numbers are falling, which means this is an issue they need to address sooner rather than later. Whether the Labour leadership recognise this is another matter,

October Budget 1: can economic growth end austerity?

 

The October Budget will tell us a great deal about how Rachel Reeves will act as Chancellor during this Labour government. As a result, before the Budget I intend to write a number of posts setting out the main macroeconomic issues as I see it. This first sets the scene, by questioning the idea that improvements in public services will come from better economic growth.

In her 2024 Mais lecture Chancellor Rachel Reeves said that

“it is through growth and only through growth that we can sustainably resource strong public services, raise living standards, and compete internationally.”

During the election, when Labour was pressed on how it would find money to improve public services while at the same time ruling out raising taxes on working people, the fall back position seemed to be that this would come from growth.

At first sight this idea is straightforward, and can be encapsulated in the following sentence. Higher real growth means rising real incomes, and higher income brings in higher taxes at existing tax rates, providing the finance for extra government spending, which allows the employment of more doctors, nurses, teachers and so on. However this simple intuition can be very misleading. To see why, consider the following very similar sentence. With higher inflation, higher nominal growth means rising nominal incomes, and higher income brings in higher taxes at existing tax rates, providing the finance for extra government spending, which allows the employment of more doctors, nurses, teachers and so on. The only change I have made to the original sentence is to replace the word ‘real’ with ‘nominal’, but the idea that inflation helps fund additional public sector jobs sounds wrong.

It is wrong, if by inflation we mean price and wage increases across the board, including wages in the public sector. Higher taxes in nominal terms are mainly going to pay for higher wages in the public sector, and there is little or nothing left over to increase public sector employment. But exactly the same point can apply if we are talking about real growth, depending crucially on where that growth is coming from. The most obvious example is real growth due to an increasing working population. More people earning incomes will raise total tax revenue, and those additional taxes can pay for more doctors, nurses, teachers etc, but the number of doctors, nurses or teachers per working person will be much the same.

The more interesting example is where economic growth comes from higher private sector labour productivity. This normally leads to higher private real wages, and therefore higher taxes. But if real wages in the public sector keep pace with those in the private sector, then these higher taxes mainly pay for higher real wages for public sector workers rather than for more doctors, nurses or teachers. [See postscript for a bit more explanation.]

This point is very familiar to economists since the 1960s, when William Baumol argued that rising real wages in jobs that saw productivity growth would lead to higher real wages in service sector jobs, particularly public sector services like health and education, where productivity growth was much harder to achieve. Baumol suggested that this kind of unbalanced growth, with productivity in service sectors lagging behind productivity elsewhere in the economy, was the typical pattern in all economies.

Of course the benefits of real or nominal growth in terms of higher wages may be unequally shared. Public sector workers may have their wages reduced relative to those in the private sector, which will leave some money to be spent on additional public sector workers. That is exactly what the last Conservative government did, except some of that money went on tax cuts rather than higher public sector employment. But Labour have made it clear that for the moment at least that is not a strategy they will follow, for the very sensible reason that it is not sustainable. Reducing the relative pay of public sector workers creates both industrial unrest and staff shortages, which is why Baumol assumed it wouldn’t be the norm.

The only way growth gets you significantly more doctors, nurses and teachers is if labour productivity gains are spread throughout the economy, including the public sector. But the idea that, for given levels of expenditure, better public sector productivity will allow the employment of more doctors, nurses and teachers is both simple and obvious. If that is what people mean by growth delivering better public services, why not mention public sector productivity directly?

The same reasoning shows why data showing trends in public sector spending can be a very misleading indicator of changes in the quality of public service provision, even when that data is shown in real terms. Higher real spending on education, for example, may reflect a combination of higher real wages for teachers combined with little productivity growth, rather than more teachers being employed.

This is why, whenever I look at trends in public spending over time, I try to look at public spending relative to GDP, and how that measure has changed in the past. That controls for inflation, but it also controls for real growth that is spread across public as well as private sector workers. As a result, public spending relative to GDP gives you a better idea of whether public services are getting better or worse than numbers that only control for inflation.

While public spending relative to GDP is a better measure of the provision of public services than either real or nominal spending levels, it still may give a misleading picture. In education, for example, it is important to look at changes in the total population of pupils. In health, as I have noted many times, factors like an ageing population mean that spending relative to GDP tends to rise over time in almost all OECD countries, so a constant level of health spending relative to GDP (as we saw from 2010 to 2019) is consistent with a deterioration in service provision, leading to increased waiting times for example.

If the idea that growth naturally helps end austerity is misleading, there is a more subtle sense in which it may enable it. To put it at its most simple, it may be politically easier to increase tax rates when real incomes are growing strongly compared to when they are stagnant. In terms of resources, higher taxes moderate the growth in private sector spending relative to increases in productivity, which frees up labour that can then be diverted to providing better public services.

However, using growth in this way to end austerity appears to have been ruled out by the Chancellor with her pledge not to raise taxes on working people. Instead she will have to rely on increasing more minor (in terms of revenue raised) taxes. In my next post on the October Budget I will look at how much taxes have to rise to achieve in any meaningful sense an end to austerity.

Postscript (22/08/24)

Feedback suggests I should have added something to make this clearer. Suppose, for simplicity, that all public spending goes on the wages of public sector workers, and that total taxes = total public spending. Now imagine an X% increase in private sector productivity, which leads to an X% increase in private sector wages. Public sector wages rise by X% to keep relative wages unchanged. For higher growth to pay for additional doctors, nurses or teachers, taxes would have to rise by more than X%. They might do so at the margin because of real fiscal drag, but the great majority of the tax increase will pay for higher public sector wages.   

Racist riots and the Conservative party

 

There is no doubt that the actions of the most senior members of the Conservative party have encouraged the riots by right wing racist thugs that we saw recently in the UK. That encouragement was not some unavoidable consequence of legitimate policy positions, but through actions or words that senior Conservative politicians could have avoided without changing any policies. Yet ironically these riots during a leadership election give the party a unique opportunity to turn a page, and turn their back on Farage type populism. The signs are they will not take that opportunity.

In this post I will give two examples of how the Conservative party encouraged right wing thugs to attack hotels housing asylum seekers or attack Mosques. The first is by calling asylum seekers that come to the UK by small boats from France ‘illegal’. The second is by tolerating, even at the most senior level within the party, Islamophobic language. [1]

The 2021 Nationality and Borders Act, introduced by Priti Patel, criminalised those who arrived in the UK without authorisation, even if they subsequently claimed asylum. From that point on, Conservative politicians almost without exception referred to anyone crossing the Channel in small boats as illegal migrants, and much of the media followed suit. This had no policy purpose. This act, unlike subsequent legislation, didn’t stop the government processing asylum claims, and anyone who successfully claimed asylum was not immediately arrested because they had come here illegally. Most ‘illegal migrants’ who came via small boats claimed asylum, and most of those claims were granted.

So why introduce the term ‘illegal migrant’ for asylum seekers if it made no difference? If you talk about refugees, that immediately brings to mind why people are seeking asylum - war or persecution - which generates among most people sympathy with the refugee. If instead you talk about illegal migrants, that brings to mind criminality rather than sympathy. This is classic populism: create a category of people who are outsiders and do what you can to demonise those outsiders.

Of course this was not the only aspect of how the Conservatives treated asylum seekers that was gratuitously inflammatory. Cutting back on resources to process asylum claims meant a large backlog of people were caught in limbo waiting for government decisions, many of which the government housed in hotels. Those being processed were not allowed to work. This was a gift to those like Farage who could suggest that ‘illegal migrants’ were being gifted free accommodation at the taxpayers expense. More generally Conservative rhetoric encouraged the idea that the UK could be highly selective about the countries from where asylum claims would be considered, which goes against the whole concept of a refugee. Calling them illegal was a rhetorical device to make that seem acceptable.

All this encourages racists to attack the hotels where asylum seekers are staying waiting for their claims to be processed. It doesn’t excuse that behaviour, nothing does, but by denigrating those who should have our (provisional) sympathy it makes it easier for racist thugs to believe that such attacks are justified. Elite rhetoric can easily normalize far-right views and behaviour.

The new Labour government very quickly started using the term ‘irregular’ rather than ‘illegal’ migration for those coming here via small boats. James Cleverly, one of the candidates for leader of the Conservative party, said 

“Changing 'illegal migration' to 'irregular migration' will be seen as an invitation to the people smugglers". 

Another, Robert Jenrick, tweeted “you misspelt illegal”. A third candidate is Pritti Patel, who started the whole thing off.

Islamophobia is a generic problem in the Conservative party. Prime Minister David Cameron had no problem joining an Islamophobic campaign against Sadiq Khan for mayor of London, with remarks he later had to apologise for. In a more recent contest for London mayor, then Conservative MP Lee Anderson had the whip suspended for saying “Islamists” have “got control” of Khan, but many Conservative MPs went on the record to criticise that suspension. The deputy prime minister, Oliver Dowden, declined to say whether Anderson’s comments were Islamophobic.

Baroness Warsi, former co-chairwomen of the Conservative party, has said that the party is using anti-Muslim rhetoric as a campaign tool. Suella Braverman, a former Conservative home secretary, suggested that Islamists are in control of the UK, with sharia law and "the Islamist mob" taking over communities. Former Conservative Prime Minister Johnson wrote about the niqab, a face-covering veil worn by some Muslim women, as resembling "letter boxes" and compared those who wore them to bank robbers. Conservative MP Nusrat Ghani claimed that a party whip told her that she had been sacked from her role as transport minister because her Muslim faith "was making colleagues uncomfortable".

That Islamophobia remains. Returning to the contest to be party leader, here is Robert Jenrick recently saying that anyone publicly shouting ‘God is the Greatest’ in Arabic should be immediately arrested. Imagine the reaction if a candidate from any political party had said that anyone shouting hallelujah should be immediately arrested. If the Conservative party uses anti-Muslim rhetoric as a campaign tool, whether against political opponents or internally, then it has to shoulder some responsibility for rioters who attack mosques.

The fact that over 50% of Conservative party members have a negative attitude to Muslims, and almost half think Islam is a threat to the British way of life, is no excuse for Islamophobic statements from Conservative MPs and ministers. Nor is  political pressure from Nigel Farage and Reform an excuse. As I often note, a former Conservative Prime Minister once sacked a Conservative minister for a racist speech, even though that speech was pretty popular among many voters.

There is therefore a precedent for the Conservatives to draw a line that they do not cross on both racism itself and populist language which encourages violence against minorities. Rather than keeping Farage close and competing for those that vote for Reform by mimicking what Farage does, they could attempt to portray Farage as unacceptably extreme. One way to do this became evident during the election, by highlighting Farage’s links to Russia and his lack of support for Ukraine.

Ironically the recent riots have provided another opportunity. The comments by Farage immediately after the murders in Southport have rightly been condemned. Among Conservative voters at least, these recent events have led to a large decline in Farage’s popularity. There may be no better time for a Conservative leader to draw that line as Edward Heath once did.

Unfortunately for all of us that hasn’t happened yet. At the time of writing the bookies favourite to be the next leader of the Conservative party is Robert Jenrick, who thinks asylum seekers should be called illegal and who thinks anyone saying God is the Greatest in Arabic should be immediately arrested. [2] The reason he is favourite to win may reflect the views of Conservative party members, but those in turn reflect a right wing press that demonises immigrants and Muslims. Other candidates for leader have largely kept quiet in the face of the race riots their party’s rhetoric has encouraged.

The root cause of all this is in my view economic. Few Conservative MPs seem prepared to countenance moving to the left on economic issues, by for example following popular opinion and proposing to raise taxes to get better public services. That traps them into relying on socially conservative policies to win votes, and to give those issues salience among enough voters they end up becoming populists, demonising minorities and encouraging racists.

[1] There are many more examples, such as the deliberate downgrading - without evidence - of the threat of far right extremism. These are all examples of a more general phenomenon, which is the adoption of right wing populism by the Conservative party that I discussed here.

[2] Jenrick has also said he would vote for Trump if he was a US citizen.

If Labour is serious about defeating right wing populism, it needs to reform large parts of the media

 

The new Labour government aims to counter the “snake oil charm of populism”. Right wing populism suggests that minorities or outsiders represent a threat to the national majority, and it thereby encourages and excuses the racism we have seen expressed by gangs of thugs terrorising parts of UK cities over the last week.

For too many in the media, as was evident on election night, right wing populism means the likes of Nigel Farage. But as I emphasised here, right wing populism in the UK is far more widespread. The rhetoric used about immigration and asylum by nearly all Conservative MPs is populist. Brexit happened because of right wing populism. Much of this country’s press could reasonably be described as promoting right wing populism. The kind of violence we have seen over the last week has been for many years formented by the language of mainstream political parties and mainstream media.

Good, competent government that does not deliberately set out to inflame divisions within society is important in reducing the appeal of right wing populism. Governing to ensure economic divisions within society are reduced rather than increased is another. Ensuring that prosperity and public service provision in the country as a whole does not stagnate compared to other countries also helps. Unfortunately, even achieving all of these things does not ensure that right wing populism will not prosper.

This is because right wing populism is increasingly seen by particular monied elites as a means of obtaining political power and financial benefits. This is most transparent in the US, where billionaires seem quite happy to openly support a candidate for President that tried to overturn an election he lost and a political party that appears beholden to that candidate and indifferent to democratic norms. In the US, who has the most money to spend is one determinant of who wins elections. There is some evidence that the same is true in the UK, and funding for UK parties increasingly comes from very wealthy individual donors.

While the very wealthy providing financial backing to right wing populists during elections is clearly a problem, in my view a problem that is just, if not more, serious is the very wealthy trying to influence what information the public receives by their funding of media outlets that support right wing populism. Some wealthy individuals have always done this, of course, but the problem is growing, not shrinking, with Musk's takeover of twittter, the advent of GB news and the descent of the Telegraph from a once reasonably serious right wing paper into something almost unhinged (and which may soon be bought by the owner of GB News). This trend is evident in many advanced democracies.

An essential part of democracy is that voters should be able to receive information (news) that is not slanted to fit a particular political viewpoint. When this doesn’t happen then voters receive propaganda, and all the evidence suggests that propaganda can be very effective at influencing how people think and how they vote. When the propaganda involves right wing populism, it isn’t manufacturing consent but rather manufacturing discontent. Misinformation about immigration and asylum seekers is pervasive among right wing politicians and the media. Islamophobia has become endemic on the political right and its press, and feeds the racism so evident among the gangs creating havoc in our cities.

Media outlets can produce propaganda whether they are owned by the state or by individuals. When those from the political right talk about a ‘free press’, they usually mean freedom from the state, not freedom from the views of an individual media owner. In a democracy the media should provide information free from the direct or indirect control of either the state or individual owners. As we saw with the last government and the BBC, state ownership is no guarantee that a media organisation will not advance right wing populist themes, or pander to the populists.

The UK has already suffered serious harm as a result of media outlets that promote right wing populist ideas. The economic costs of Brexit were well known before the 2016 referendum, but a combination of propaganda from most of the press and a broadcast media that balanced that propaganda against the truth meant that many voters didn’t believe those costs would occur. They now have. This shows us that impartiality is a very weak defence against propaganda. If right wing populists claim that Turkey is about to join the EU, and this is balanced against knowledgeable views that they are not, the populist view is promoted without being negated.

Balancing propaganda with the truth may be better than propaganda alone, but it is a totally insufficient way of dealing with propaganda. As Hanna Arendt may have said:

“The ideal subject of totalitarian rule is not the convinced Nazi or the devout communist, but people for whom the distinction between fact and fiction and the distinction between true and false no longer exist”

The moment a truth is presented as merely a claim one side in an argument makes, it delegitimises the concept of truth.

Introducing more media competition in these circumstances doesn’t help, because media outlets rarely just include news. Instead news is often combined with opinion pieces, gossip about celebrities and a whole host of other features that help determine what media outlet any individual consumes. Just as we should not want the information people receive to be determined by the political views of an individual billionaire, we also shouldn’t want them to be determined by which outlet has the best celebrity contacts. Particular social media outlets remain dominant because of network effects.

The only way I can see to stop media outlets producing propaganda is through an effective regulator ensuring that they do not. Unfortunately UK regulators, particularly under the last government, have often proved anything but effective. In some areas direct public sector control is an alternative, but in the case of the media it obviously is not. Effective regulation requires ensuring the independence of the regulators from both those they are regulating (preventing revolving doors) and from politicians.

The reason a media regulator like Ofcom needs to be independent of politicians is obvious. As we saw with Boris Johnson, a right wing populist leader will quickly replace the leaders of a media regulator with those who will follow the populist’s wishes. But this is a generic problem across all regulators. Those who are being regulated can influence the regulator directly, but they can do so indirectly by getting politicians to do that work. I would be interested in ideas about the best way to solve this problem, or for those who say it cannot be solved what the alternative is.

Obviously the kind of media regulator I have in mind goes well beyond what Ofcom currently does. Ofcom’s treatment of GB News has been pathetic. GB News produces propaganda, and should not be allowed a broadcast licence. In my view any print or broadcast media outlet that provides news should be regulated to prevent it producing propaganda. What counts as propaganda and what does not is an important topic with no clear or neat dividing lines, but we are currently so far from where that dividing line is with GB News or some of the right wing press that this discussion at the moment is academic.

For obvious reasons a Conservative government is almost certain not to make media regulation more independent and effective, so the only way this will happen is under a Labour government. Yet Labour politicians, particularly when in opposition or when politically weak, can easily be persuaded by media owners not to pursue measures that might threaten those owners. It seems that this has happened with the second stage of Leveson inquiry. (If you think that inquiry should go ahead, see here.)

Yet if Labour is serious about defeating right wing populism, it cannot let the media landscape become increasingly the plaything of very rich individuals wanting to push a right wing populist agenda. The time to tackle this problem is now, when Labour’s majority is secure and it remains popular in electoral terms. There is no reason to delay, and any delay makes action less likely to happen.

Was yesterday’s announcement austerity redux?

 

Rachel Reeves yesterday wanted to establish in the public mind the extent of the fiscal mess that the last government had left behind. She was absolutely right to do so. As I wrote at the beginning of this year, the last government by giving incredible numbers to the OBR had made fiscal policy a joke. Sunak and Hunt did this because they wanted to cut taxes, when what was needed were higher taxes and higher public spending. As I also said, the previous government’s asylum policy was not sustainable, implying growing costs. As the OBR has now said, last week they were made aware of “one of the largest year-ahead overspends” outside the pandemic.

In the year after the Coalition government was elected in 2010, its ministers relentlessly pushed the line that the austerity they were imposing was necessary because of Labour’s recklessness with the public finances. This was a double lie. First the large budget deficit was the result of a huge recession created by the Global Financial Crisis, and second basic macroeconomics told us that austerity was the wrong response to that deficit in a recession. That austerity not only crippled the recovery but it probably did nothing to improve the public finances. But thanks to our media that double lie was believed by a large percentage of voters. When governments really are irresponsible with the public finances, as the last government was, voters need to be told.

The economic environment today is very different from 2010. Rather than being in the middle of the deepest recession since WWII with interest rates at their floor, we are instead in a situation where interest rates remain high because of domestic inflationary pressures. Service price inflation remains well above the Bank’s target. (We will see if the Bank begins cutting rates this week.) For this reason alone, to say that Reeves has begun repeating 2010 austerity is just silly.

Part of the adverse reaction before her announcement came from briefing focused on cuts to public investment. As the FT reported on Saturday (with similar reports from the BBC)

“Rachel Reeves is set to officially delay a raft of “unfunded” road and hospital schemes as the chancellor seeks to fill an estimated £20bn fiscal hole she claims was bequeathed by the last Conservative government.”

Cutting public investment [1], which is by definition investment in the public’s future, to fill short term holes in the public finances is often called ‘Treasury Brain’, because it happens so often. But this is a little unfair to the Treasury. It happens so often in part because politicians know that the short term political costs of cutting public investment are generally less than cutting current spending or raising taxes.

To say that public investment projects are unfunded is nonsense, because public investment, unlike current public spending, should be matched by borrowing, not tax increases. There are two reasons why investment is very different from current spending in this respect. First, investment in a project is by definition temporary, so it makes sense to match variations in public investment with variations in borrowing so taxes remain relatively constant. Second, investment benefits future rather than current taxpayers, so it would be unfair for current taxpayers to pay for it.

For these reasons to appear to focus on cutting public investment to plug immediate gaps in the public finances, particularly from a Chancellor who has stressed the importance of public investment in encouraging economic growth, seemed very odd. As a BBC economics correspondent put it just before her speech, this government wanted to be known as builders not blockers, but now it may become known as scrappers.

Although some road and rail projects will be cut, in her speech Reeves added a more significant cut on current spending, involving ending the winter fuel payment for all but the poorest pensioners. As part of the overspend involves the cost of settling the junior doctors dispute and following the pay review bodies recommendations for other public sector workers, then some cut in current spending would at some stage probably be required to partially offset this increase in current spending. (Some will also be offset by departmental savings i.e. cuts.)

It would have been far better for Reeves yesterday to confine herself to talking about why current spending was higher than previously thought, giving the news on public sector pay, making the announcement on winter fuel allowance, and then say that she would of course make further adjustments to taxes and spending to ensure her fiscal rules were met in October. Why bother with the additional announcements, particularly those that involved cutting public investment?

A clue may come from Sam Coates at Sky News, who wrote

“Ms Reeves has been advised that "we couldn't leave a shortfall that big without immediate action" - presumably on account of market reaction - so the overspend gap will be narrowed (but not closed) by "very very painful" immediate savings to the 2024/5 budget.”

Reeves actually mentioned the Truss mini-budget at the start of her statement when justifying the need to take immediate action. Perhaps she and/or the Treasury felt the markets might get spooked by the news on public sector pay and they needed a whole list of cuts to stop that. If this was the case it shows awful naivety about how markets work.

Does yesterday’s announcement show that Reeves prefers cutting spending to raising taxes? Not at all. The main announcement about future policy was higher pay for public sector workers, paid for by most pensioners and some cuts to services. While higher public sector pay was essential, many might have liked to see that combined with higher taxes [3] rather than cuts to benefits and spending, but it is right to wait until the October budget for that.

Unfortunately I do think that yesterday’s statement did present two hostages to fortune as far as public investment is concerned. The first involves the pre-announcement briefing, which suggested that cutting public investment was a sensible response to current shortfalls in the public finances. It is not. The second involves language. Saying “if we cannot afford it we cannot do it” repeatedly plays to the idea that the government is like a cash constrained household, when it clearly is not. In particular, it is never true that we cannot have public investment because we cannot afford it. What binds governments are their own fiscal rules, not the kind of budget constraint faced by a cash-constrained household.

Are these academic quibbles? No, because as we saw in 2010 such confusion can lead to the promotion of terrible policy. More to the point such language can come back and bite those who use it even when the user knows better. A government, unlike an opposition without its own media, is in a position to increase the quality of macroeconomic discussion, rather than fall back on mediamacro type language because it’s to their short term political advantage. If the current Labour government is ever hit by a global recession, don’t be surprised if its political enemies say ‘if we cannot afford it we cannot do it’. [4]

One final thought. I still fear that Labour are underestimating the extent of money they are going to need to spend to restore public services. Promises they made during the election also limit the amount of taxes they can raise. Yesterday was the ideal opportunity to say that those promises had been made on the basis of false information. It was now clear that cuts to national insurance contributions over the last year were unaffordable, and that they would be reversed by Labour. That opportunity has been missed.   

[1] To argue that these are not really cuts but rather past government announcements that were never in departmental budgets is, I’m afraid, never going to wash with the media for good reason. If you cut a project the previous government announced would happen, you are cutting something the public expected to happen, and so the media is quite right to treat it as a spending cut.

[2] Scrapping public investment because it was bad value for money (or even harmful) is fine, but that is not the justification Reeves made. Scrapping public investment to fill a gap in the public finances is just terrible macroeconomic policy.

[3] Why cannot public sector pay be increased without higher taxes or spending cuts? That would represent an expansionary fiscal policy, putting upward pressure on interest rates. As I want to see large increases in public investment, which will do the same, I would rather see higher current spending matched by higher taxes.

[4] Keynes was more correct in saying "anything we can actually do, we can afford”, although the truth is a little more complicated than that. 

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More power to the OBR?

The new bill to ensure that a UK government obtains the OBR’s analysis for any fiscal event is largely symbolic, because the reaction to the Truss fiscal event will be enough to ensure that happens anyway. However there does seem to be a more general concern that the OBR’s analysis has come to dominate fiscal policy making. In this post I want to explore this concern in more detail.

Before the OBR was established, the Treasury published its own forecasts of what the consequences of any budget would be for the public finances and the UK economy as a whole. The obvious problem with that arrangement was that politicians may lean on Treasury forecasters, and secrecy ensures we will probably not know if this has happened. It clearly makes sense that fiscal decisions are made on the basis of an independent forecast rather than the forecast politicians would like to see.

Why does it often appear as if the OBR’s forecast is determining fiscal decisions? The reason is the fiscal rules chosen by politicians to constrain what they can do. If, for example, a Chancellor wants to cut taxes by as much as possible while staying within their own fiscal rules, then the OBR forecast will determine by how much taxes can be cut. Exactly the same would happen if the Treasury rather than the OBR did the forecast, with the only difference being that politicians could lean on the Treasury to produce a biased forecast.

Is some of the concern about the OBR’s role really a concern about fiscal rules? I have written a great deal about fiscal rules, but I think it is important to remember the underlying principle behind them. The principle is that fiscal decisions should be sustainable, by which we mean that tax or spending decisions described as permanent today do not have to be reversed at some point because the path of the public finances or the economy is unsustainable, and that this lack of sustainability is clear given the information we have today.

Fiscal rules, like an independent budget forecast, are designed to protect the public from being misled by politicians trying to gain political advantage. Fiscal rules make it harder for politicians to cut taxes or raise public spending just before an election, only for whoever wins that election to have to raise taxes or cut spending to restore sustainability.

When some talk about the OBR having a veto on fiscal decisions, in reality they may simply have a complaint about how well fiscal rules capture the idea of sustainability. Suppose, for example, that you thought tax cuts would, over a decade, generate sufficient extra growth to help pay for themselves. These tax cuts would be sustainable in terms of the public finances, but fiscal rules that only looked five years ahead might suggest that they were not sustainable. The same argument could be used for some public investment projects, for example. In both cases the problem is not the OBR, but the fiscal rules that governments have chosen.

A more interesting case is where politicians have a particular view about how the economy works, which is not shared by the OBR. For example politicians might believe in a Laffer curve where tax cuts pay for themselves because they incentivise people to work more (generating higher tax receipts). The OBR, drawing on the evidence and the consensus view of economists, might think these incentive effects are much weaker, and so in their forecast tax cuts would not pay for themselves.

Does the OBR have a veto in that case? No, because it is open to the politicians to ignore the OBR’s forecast and go ahead with their tax cuts. All the OBR forecast forces them to do is be explicit about why they are ignoring that forecast. This is surely a good thing, because it allows voters to eventually judge who was correct. Of course politicians might not be prepared to put their beliefs on the line, which is why this option has never been used since the OBR was established.

For these reasons, saying that the OBR has a veto on fiscal decisions, or that the OBR reduces democracy, is just wrong. Indeed the opposite is the case, because by making judgements more transparent the OBR increases democratic accountability.

However I do think there is a legitimate concern that recent budgets have become rather mechanical, and that this has over-emphasised the role of the OBR’s forecast. Here I think the fault is with the politicians and to some extent the media rather than the OBR. The biggest and most important fiscal issues involve the structure of taxation and spending. Have we got the right balance between direct (e.g. income tax) and indirect (e.g. VAT) taxation? Are we right to exempt so many goods from paying VAT? How does the income tax schedule influence incentives, and is it fair? Should the rich be paying more tax? How do cuts in some areas of public spending increase public spending elsewhere? How much should the biggest area of welfare spending, pensions, be provided by the state? The list of such issues is endless, and these questions are usually much more interesting than a discussion of how much room the latest OBR forecast leaves for tax cuts.

Unfortunately in recent years such questions have played a rather minor role in budget analysis. In part this is because politicians have focused on the distributional aspects of fiscal measures, and whether these might win them votes among those groups they want to attract. This can lead to an overall tax system which is badly distorted, with costs to society as a whole.

The second most important issue in fiscal policy involves the size of the state. How much more spending do we need on the NHS, education, defence etc, and what taxes need to be raised as a consequence. The idea that the OBR forecast determines the scope for tax cuts is only true if you treat spending as given, and similarly the notion that the OBR forecast tells you how much more can be given to the NHS is only true if you think you cannot raise taxes. In recent budgets there has been little discussion of this because the Conservatives adopted spending projections which were already implausibly low, so tax cuts depended entirely on the OBR forecast.

The media may also be partly responsible for the focus on the arithmetic of budget decisions (and therefore the OBR forecasts), rather than these other issues. Any journalist can ask whether a budget adds up in terms of meeting fiscal rules, while it requires a bit of knowledge or prior research to ask about some of these more interesting questions. It means that all too often IFS and other expertise is underused by the media.

All this suggests that the OBR as it currently stands has very little influence over the budget beyond providing an independent forecast, and certainly has no veto power over politicians. The new bill ensures that the OBR, rather than the government, decides whether a new OBR forecast is warranted after a big fiscal event, which also makes sense.

Going beyond this new legislation, there remain areas where the independence of the OBR’s forecast could be improved by allowing them not to take government projections of their spending totals or policy decisions as given when past evidence suggests they are highly unrealistic.

The most obvious example of this for the last government was their repeated freezing of fuel duty, while continuing to pretend that in the future they would raise fuel duty. The legislation setting up the OBR forced it to take the last government’s word on future fuel duty, even though it broke its word continuously. This could easily be changed, and it should be.

I would go further, and give the OBR discretion to look at scenarios based on alternative projections for government spending and taxes. The latest review of the Bank of England’s forecast said it should look at more scenarios, but at present the OBR is not allowed in its budget forecast to look at any scenario that involves an alternative path for government spending and taxes (‘policy simulations’).

Ending this restriction would allow the OBR to avoid being saddled with unrealistic assumptions about government spending, like those bequeathed by the last government. But more generally doing policy simulations alongside its forecast would give the OBR the opportunity to enrich the fiscal debate. The most obvious example was the Coalition’s austerity policy. Indeed I suspect the reason the OBR is not allowed to do policy simulations alongside its forecast is because Osborne did not want the impact of austerity on output exposed in this way.

Such a change to the legislation governing the OBR would give it a tiny bit of political power, because it could choose whether to do policy simulations and what these simulations would be. Experience suggests that it would use that power responsibly, generally reflecting the policy debates in parliament. It could help make the OBR a tool for parliament as a whole, rather than just an instrument of government. The OBR would still have a lot less power than some other fiscal councils around the world, which operate more as fiscal watchdogs directly criticising government policy.

More generally, I normally find complaints by politicians and others about ‘rule by technocrats’ unconvincing and often self-serving. If the choice is between on the one hand having technical work done by civil servants under the direction of politicians, work that may or may not become public, or on the other hand having this work done by independent institutions that always publish their analysis, I prefer the latter. The key is to ensure that these independent institutions are accountable to parliament, as the OBR is to the Treasury Select Committee.