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Paying for public goods

Patrick Diamond argues people will support higher taxes if linked to public service improvement.

More than ever, Labour needs to have an honest debate about tax. The question of the delivery of public services cannot be separated from the future financing of state provision and levels of taxation. The Conservative-dominated coalition is determined to reduce the size of the state, announcing cuts of at least 25 per cent in departmental budgets, bringing down the public sector deficit through a combination of 73 per cent spending cuts (£74 billion) and 27 per cent tax rises (£24 billion) over the next five years (link).

The financial crisis is estimated to have permanently weakened the UK public finances by roughly 6.5 per cent of national income, or £90 billion. The need for fiscal retrenchment to shrink the structural deficit is generally accepted across the ideological spectrum, despite disagreement about the timing of cuts. However, social democrats need to fundamentally re-cast the terms of debate about taxation and public spending.

The Conservatives have sought to reduce the deficit, but there has be no accompanying analysis of what level and quality of public services Britain needs for the future. Ministers have not faced up to the fundamental challenges and pressures on the state: from changing demography and the ageing population to the impact of new technology in fields such as medicine. The government insist that improved services can be delivered through efficiency savings, but this is an illusion. The table below illustrates that spending is likely to keep rising as the result of long-term fiscal trends.

Nonetheless, these estimates may be relatively conservative: research has shown that an additional six per cent of GDP will be needed to meet the social costs of ageing by 2030 alone . In the coming decades, the proportion of elderly people is likely to increase substantially as shown below. This trend results from a combination of factors, including increasing life expectancy, and the aging of two large cohorts born in the 1940s and 1960s. This will have a direct impact on age-related expenditure such as state pensions and healthcare, increasing the share of national income allocated by governments to 47 or 48 per cent of GDP within the next twenty years. The challenge will only be met by facing up to hard choices about funding and the composition of the UK tax base.

The centre-left should cultivate a more open and honest debate about the future of public services, emphasising the relationship between taxation, public spending and well-being. Social democrats fundamentally believe that individuals are part of a strong civic community where public goods contribute significantly to quality of life. There is a legitimate debate about the size of the state in any democratic society, but proposing that civic 'platoons' fill the void vacated by public sector retrenchment is misguided. Paying taxes is integral to enjoying the rights and claims of citizenship.

The debate about public services too often separates funding and provision, as the Plant Commission on A New Tax for Public Spending (Fabian Society, 1999) acknowledged over a decade ago. But research on the tax system and public provision exposes a deep, underlying 'disconnection' between the taxes citizens pay, and the services they receive. This reflects not only the incomprehensibility of the UK tax system, but uncertainty as to where taxes are going and whether government uses the money well. The paradox is that the public do not perceive that services have improved, even where their own experience was far better than anticipated. Not only does the state have to deliver improved services, it must also convince the public this is the case .

The most intriguing finding of the Plant Commission was that if citizens are relatively certain that additional money will improve services, they are prepared to countenance additional taxes. The priority for the Left is to ensure people feel better 'connected' to the taxes they pay. The legitimacy of taxation and sustained support for additional spending will only be achieved when the public better understand how their taxes are spent, and feel confident they are being used well. As well as improved public information and an effort by politicians to seek to influence public opinion, this can be achieved by earmarking taxes more directly for specific purposes. Examples include:

  • An hypothecated NHS and social care insurance fund which merges income tax with national insurance, renewing the contributory principle. Transparency may help to loosen 'tax resistance', guaranteeing that higher sums are focused on citizens' priorities. Both health and social care are universal needs which are inefficiently allocated by markets, as well as 'superior goods' for which demand rises as incomes increase.
  • The use of time-limited levies for special capital expenditures such as investment in transport infrastructure, especially at the local level. These are removed when sufficient funds had been raised.
  • The use of 'tax and public service' pledges where governments set principal rates of tax such as income tax. Ministers must set out what additional revenues are designed to achieve, and where possible, the auditable improvements that will be delivered.
  • The earmarking of environmental taxes for designated tasks such as improvements to public transport infrastructure, as well as incentive-based taxation that seeks to reduce adverse social and environmental impacts.
  • Grant the power to vary basic and higher rates of income tax by a maximum of three pence in the pound to local authorities in England, subject to a popular mandate through a local referendum; enable local councils to levy a supplementary business rate to fund specific infrastructure improvements in consultation with communities.
  • Reform council tax which remains highly regressive and penalises the poorest households hardest. There is a case for introducing a new set of property value bands in order to achieve a fairer, more progressive local taxation system.

These measures are intended to make the tax system more transparent, irrespective of overall levels of taxation. While public services must be effective, they must also be seen to be effective. This should include giving every household an annual citizen's statement which sets out clearly how the tax system works, and how public spending is allocated. It should also include an audit of government performance, undertaken by an independent fiscal authority accountable to Parliament which advises on tax and spending decisions, providing transparent information to citizens.

The notion of public investment underwent a modest rehabilitation after 1997, but the public's confidence and willingness to pay taxes should never be taken for granted. This reflects a wider debate about the civic contract between citizens and government. The Conservatives have a political strategy as well as an economic one: to secure a landslide victory at the next election with little over 40 per cent of the vote, adopting a tax-cutting agenda. Labour must confront this, not least by reminding voters that indiscriminate tax cuts will recreate the decrepit and underfunded public services of the 1990s.

Greater intellectual and political self-confidence will have to be displayed than in the New Labour years. All UK governments since the 1980s have conspired in the belief that Britain can enjoy European-quality public services with American rates of taxation. This is illusory. Indeed, the primary cause of the structural deficit is not Labour's 'profligacy', but the mismatch between declining tax revenues and increasing demands on public spending. The challenge for social democrats is to show how the state can be made more accountable and responsive, while promoting a more mature debate about the future of taxation.

www.hmtreasury.gov.uk/2011budget