Wholesale redistribution

February 28, 1997

Andrew Dilnoton the taxing choice we have to make.

Something for nothing. It sounds exciting. The Conservatives and Labour both seem to think we can have better public services without more tax. But those are the kind of stories we tell small children. We pay taxes to fund public spending. There is scope to improve the efficiency of that spending, but if we want better schools, health care and social security we will have to pay for them. If we do not pay higher taxes, we will spend more privately. The sooner we face these choices the better.

The reality of taxing and spending is dramatic. Kenneth Clarke takes an average of Pounds 15,000 a year in tax from each household in Britain, and then he gives it back again. But while every household both pays taxes and receives some benefit from public spending, for most there is a large imbalance, with the better-off substantial net contributors, and the less well-off substantial gainers.

Only a quarter of total taxation is income tax; value-added tax and National Insurance contributions are another 16 per cent each; excise duties 14 per cent; company taxes 14 per cent. Ingenious politicians have found many ways of taxing us with as little fuss as possible. Since 1979 the aggregate tax has fluctuated with the economic cycle, and is now close to where it stood at the beginning. Income tax rates have been cut, from a top rate of 83 per cent to 40 per cent, and a basic rate of 33 per cent to 23 per cent - paid for by cuts to allowances such as mortgage interest relief and the married couples allowance, a trebling in the number of higher-rate tax payers, approximately doubling VAT and increases in NI contributions and some excise duties.

Most tax funds the welfare state of social security, health and education, costing respectively around Pounds 4,500, Pounds 2,500 and Pounds 2,000 a household each year. These three items absorb all the income tax, national insurance contributions, VAT and corporation tax we pay, over 60 per cent of public spending.

Why do we do this? There is a sense in the political debate that all this public spending is somehow in our individual self-interest. Certainly there are arguments to be made about economic efficiency, but none comes close to explaining the level of activity in welfare provision in Britain today.

It is tempting for economists to try to explain all economic life without appealing to ethical and political principles. But any such attempt is absurd. Tax-financed public spending is about political and ethical values.

These are difficult issues, not least because people can disagree about how to respond. That poverty is bad, both for those affected and their society, is clear. But there is a coherent debate about the right balance between supporting people and expecting them to support themselves. When we think of health and education, problems persist. Some equality of value must be reflected in our health and education systems, but there is room for debate about what sort of equality, and how. And these choices become harder when money is short.

In recent times, unsettled economic performance and suggestions that high taxes can damage incentives, may have helped create a climate in which politicians seem loath to offer higher taxes, and voters are reluctant to pay them.

Yet there is continued pressure on spending. Maintaining the current level of all welfare services relative to general living standards, so that benefit levels keep up with growth in the net incomes of those in work and the earnings of health and education workers grow in line with those elsewhere, will require an increase in spending and tax of around 5 per cent of national income over the next 50 years. To match increased demands, rises might need to be 10 per cent.

By historical standards, 5 per cent of national income, or even 10 per cent, is not an unthinkably large amount. But this is equivalent to between 17p and 35p on the basic rate of income tax.

All sides argue that such tax increases cannot be afforded. But "afford" is the wrong word. Few would suggest the proportion of gross domestic product absorbed by activities now covered by the welfare state will do anything other than continue to rise.

Either taxes or private spending must rise. The question is not "can we afford to pay for welfare", but whether we pay more tax to provide better services through the state or choose a more individualised system, relying more heavily on self-provision. Either way, spending will rise. This is the reality politicians seem to want to ignore.

Higher taxes are possible. In Britain we pay less tax than in any European Union member state other than Luxembourg. If the UK chose a tax burden as high as that in France, we could double spending on health and education. Such a massive increase might find little political support, but there is no correlation between economic performance and the burden of taxation. Putting the top rate of income tax back up to 83 per cent would be silly, but a basic rate of 30 per cent would certainly be possible. We cannot raise much more by trying to tax capital or highly mobile individuals, because both can move. But most potential revenue sources are not highly mobile. Raising taxes might be unpopular, or even wrong, but it is economically feasible. We cannot use possible damage to the economy as a reason for not choosing higher taxes, nor use it as a powerful argument for choosing lower taxation.

We must be clear about what can and cannot be done by public and private sectors. The main characteristic of public sector provision is systematic redistribution from better-off to worse-off. This is very hard to achieve, and impossible to enforce, in the private sector. By shifting responsibility to private provision we leave public provision with a role that is ever more redistributive. We may be able to avoid raising taxes by making the better-off responsible for their own pensions, but if they get less in return for the tax they pay, they may be even less happy.

Over the past century we have seen a massive growth in communal tax-funded state provision in health care and education. In the past two decades, this approach has been challenged, with confidence in the state's effectiveness declining, and acceptance of large-scale redistribution questioned.

It is possible to protect the disadvantaged without higher taxes, by targeting spending more closely on those in need, and leaving the better-off to pay directly. That raises many thorny issues, but the bigger question is what our redistributional objectives should be. We can afford to allocate more or less of our national income to tax-funded health, education and transfers to the retired, unemployed, sick or those on low incomes. But we have to make a choice, and in making that choice economics is of secondary importance to our political and ethical values. Economics can help us achieve goals in the most effective way, but it should not be expected to set them.

The tired battle between the major parties to promise that "no-one will pay more if we win" completely misses the point.

Andrew Dilnot is director of the Institute of Fiscal Studies.

Tax shares of GDP in selected EU countries 1995 (%)

UK 38 Belgium 51 Denmark 59 France 49 Germany 46 Ireland 39 Netherlands 48 Spain 38 OECD Economic Outlook (Dec 1996)

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