False economy

The Coalition government has announced a major rethinking of the role of the state, spurred on by its decision to make a more rapid reduction in the budget deficit its priority. It has launched a comprehensive spending review instructing all departments to submit plans for reductions in their spending of 25 and 40 per cent over four years. Health and foreign aid are exempt from this, while defence and education must plan for 10 and 20 per cent cuts.

Cuts of this magnitude appear to signal the most dramatic reshaping of the state to have taken place since 1945. The government is encouraging such a view. It has announced that it wants to use the opportunity presented by the cuts to encourage a complete re-evaluation of the government’s role in providing public services. This is not intended to be the kind of exercise to which Whitehall is long familiar, of trimming a little here and a little there and waiting for the next surge forward in public spending. The Coalition wants to examine not just the cost of existing public services, but how many of them government should continue to provide.   

The state has grown inexorably since the last decades of the 19th century when it accounted for less than ten per cent of GDP. The responsibilities of the state were at that time few and its scope was limited. A.J.P. Taylor remarked that until August 1914 ‘a sensible, law-abiding Englishman could pass through life and hardly notice the existence of the state, beyond the post office and the policeman.’ The role of the state was changed by the two world wars, by the growing complexity and interdependence of modern industrial societies as well as the pressures of mass democracy.

The two world wars accustomed British citizens to pay much higher levels of taxation, and a large range of new responsibilities were recognised for the state. In the period since 1945 the share of public spending and taxation in national income has generally fluctuated between 37 and 42 per cent, rising towards 50 per cent in 1974-82 — and also since 2007  as  a  result of the financial crisis. The Coalition plans to reduce the share back to below 40 per cent by 2015, implying still further falls thereafter, thus returning the size of the state to where it was in the 1990s and the 1950s.

Some think the size of the state is irrelevant to what it does. Nick Clegg argued in a speech in July 2010 that what the state spends gives no clue to its policies. The absolute size of the state does not indicate whether the state is active or passive in shaping society, or how it conceives its responsibilities. But size remains an important indicator of capacity.

One of the major constraints on what states can do is their ability to raise taxes. Nordic states that have tax levels above 50 per cent have more options than Anglo-Saxon states where 35 or 40 per cent is seen as the ceiling. The ability to deploy and transfer resources between generations, between social groups, between regions and between interests has been one of the most important characteristics of the modern state. It does make a difference whether the state has ten or 50 per cent of national income to play with.

There is no necessary link between support for a particular size of state and position on the ideological spectrum. There are small-state Liberals and small-state Socialists as well as small-state Conservatives. In party rhetoric however there is a tendency for the parties to divide on whether they want more government spending or less, even if in practice the argument has been within a fairly narrow range since, as noted above, government spending has not fallen below 35 per cent of GDP in any year since 1945 and, except in years of economic crisis, has tended to be within the range 37-42 per cent.

The floor is set by the public services the electorate has come to expect governments to provide, and the ceiling by the amount of taxes it is prepared to pay. This implicit consensus on the upper and lower limits of public spending and taxation has always had its critics. Some favour significantly higher levels of spending, similar to the Nordic countries, while others want much lower levels, returning to a situation where the state only spends 25 per cent of the national income. In the United States some advocate much lower levels still — 12 per cent is popular with some in the Tea Party movement because of its apparent sanction in the Bible.

Apart, however, from how much the state should spend, there is the issue of who should spend it. A large part of state spending is transfer payments, such as pensions and tax credits, which provide incomes for individual citizens to spend as they choose. Other parts of state spending provide services, but these can be delivered in a variety of ways and by a variety of agents. In Britain, in contrast to most other democracies, most of the funding for public services is provided centrally. Local taxes contribute a very small proportion.

This has led to the priorities for much of this spending being decided centrally. All parties profess localism, but when in government parties have been very reluctant to sanction the transfer of real powers over taxation and spending to local jurisdictions. The preferred alternative by the Thatcher and Blair governments, and now the Coalition, is to bypass local authorities by giving budgets directly to the deliverers of services, such as GP consortia in the health service or state school academies.  

If pursued vigorously enough this will reshape the way in which public services are delivered, cutting out local authorities and primary care trusts, and giving much greater autonomy to those actually delivering the services. The dilemma for central government is that they will nevertheless be held responsible by the public for the quality and consistency of services, and therefore are highly vulnerable when things go wrong.  This situation may then well lead to the reimposition of central control.

The radical alternative suggested in the past by Thatcherites such as Keith Joseph and Blairites such as Alan Milburn — now back working for the Coalition — has been to decentralise budgets not to local authorities or to service deliverers but to citizens. Individual citizens would be given a budget for their health care or education, and service deliverers would be forced to compete for their custom. Central and local government would have only a regulatory role in ensuring standards and providing information on which citizens could base their choices.

Such a radical decentralisation could involve state funding similar to the present level to ensure fairness and comprehensiveness, or it could be accompanied by the gradual withdrawal of the state from funding major services for the majority of the population, who would become responsible for their own health and education, in return for lower taxation. Similar reshaping of the welfare budget could be envisaged, along the lines currently being explored by Iain Duncan Smith and Frank Field.

The huge welfare bill would be permanently reduced by denying benefits to many who now receive them, obliging them to find work or rely for support on their families. Similar ideas are being explored for transferring the cost of pensions from the state to the individual.

Such plans for reshaping the state are not new. What has always defeated them in the past has been the reluctance of ministers and civil servants at the centre to relinquish control of budgets and spending priorities, along with the costs of transition.

Doing something serious about the poverty trap which makes work an unattractive option for so many people on benefit would cost many billions in the short term. The savings would only come through in the long term.  This has always made such schemes very unattractive to the Treasury. The same is true for pensions, or university finance.

This creates a paradox. Many politicians believe that salami-style cuts are a bad solution to the deficit, and that a much more radical reshaping of the state should be attempted, permanently changing what the state does; for instance no longer financing higher education. But salami slicing produces instant savings while, in almost every case, radical reshaping costs money in the short run and therefore potentially adds to the deficit.

In the past when faced with this conundrum governments have tended to retreat from radical plans, and settle for incremental changes in spending and greater reliance on tax rises — even in good times. In the cuts implemented by the Conservatives in the early 1990s the ratio of public expenditure cuts to tax rises ended up as one to one. George Osborne is aiming at four to one, a very ambitious target. To achieve it he may need to back some of the radical ideas being championed by some ministers, and find the short-term funding for them.

That might produce a truly radical reshaping of the state, but at the cost of postponing the correction of the deficit.