How 14 Years Have Shown The Impossibility Of Shrinking The UK State

By Simon Wren-Lewis, March 7, 2024

Simon Wren-Lewis is Emeritus Professor of Economics and Fellow of Merton College, University of Oxford.

The Budget was predictable, and predictably boring. Hunt cut taxes, but the tax burden is still rising because of the tax increases already programmed in. Furthermore, he was only able to make the tax cuts he did (i.e. reduce the extent of tax increases) because he had previously pencilled in assumptions about public spending that were fantastically low. You can either portray those assumptions as Austerity 2.0 or just silly - I did the latter here.

However, with (I hope) the not silly assumption that this will be the last Conservative budget [1] for a while, I thought it might be useful to look back on the previous 14+ such events since 2010 to see if there are any general lessons we can draw from them all. One in particular runs through most of them and really sticks out. From 2010 onwards Conservative Chancellors have attempted to cut what they like to call the 'tax burden' by reducing the size of the state without any major changes in what the state is meant to do, and as the chart below shows (which includes the impact of yesterday's Budget) they have completely failed to achieve this objective. 

The professed aim of Austerity 1.0 from 2010 onwards was to reduce the budget deficit, but it quickly became clear that was not the only aim, because Osborne started cutting taxes in his budgets as well as reducing spending. (The initial VAT increase was deliberately designed to give the impression it was all about the deficit.) Yet despite cuts to corporation tax and personal tax thresholds, all Osborne could do was to keep the tax share stable at around 33% of GDP.

Then came Brexit and Boris Johnson. Johnson understood that trying to make Brexit work while continuing to shrink the state was politically impossible, so he undertook a partial and limited (in scope) reversal of Austerity 1.0 by raising spending on the NHS, schools and the police. This would inevitably mean a large increase in taxes, undertaken by then Chancellor Sunak for reasons he clearly set out here. Even without the intervention of Covid it is unlikely the additional spending would have been enough to start bringing NHS waiting lists down, so the government got the worst of all worlds in political terms: public services were inadequately funded yet the tax share was going up significantly.

When Johnson was thrown out of office, what little political sense he had brought on the size of the state left too. It was replaced by fantasy and deception, in that order. The fantasy was of course Truss, who had bought the Laffer curve idea that all you needed to do to get more revenue was to cut taxes because strong economic growth would surely follow. Very few people believe this, in large part because it’s not true. The deception is Jeremy Hunt, who is pretending he can cut taxes by using make-believe numbers for future public spending (Austerity 2.0).

Almost 15 years of trying to reduce taxes, and complete failure. There are many reasons why, but one for me stands out because it doomed the project to shrink the state from the start. The chart below shows health spending as a share of GDP in the UK, France, Germany and Italy since 1980.

Don’t worry about the details, just note that all four series are trending upwards by substantial amounts. There are many reasons for this trend, like people living longer or discovering new ways to help them live longer, but as yet we have not found anything to counteract health absorbing a steadily increasing share of national income.

If governments try to keep the health share constant (aka 'protecting it'), as the chart clearly shows the UK government did from 2010 until just before the pandemic, then the quality of healthcare provided for most of the population will steadily deteriorate. To avoid that deterioration, which is not sustainable politically, you have to pay more of national income into healthcare. If you have the NHS, that means a rising share of taxes in GDP.

Decades ago this trend rise in health spending as a share of GDP was offset by the ‘peace dividend’, with defence spending falling because of the end of the cold war. Those days have long gone, with no obvious replacement in terms of a major area of public spending where less and less money is needed.

None of this was unknown in 2010. The shrinking the state project was doomed from the start, and anyone familiar with these numbers knew it was doomed from the start. So why didn’t Conservative politicians realise this, and why are they still in denial about it? I think in 2010 at least there was a view among Conservatives that everything in the public sector was inefficient, and the way to improve efficiency was to squeeze resources or introduce market mechanisms. [2] Again there were international comparisons that suggested this wasn’t true, for the NHS at least, but the story fitted too easily with a neoliberal viewpoint.

However you have to ask if any Conservative who had realised the futility of trying to shrink the state would have been successful as politicians? It was and continues to be a message that Conservative members, press barons or donors don't want to hear. Look at how Sunak’s position has changed from one recognising realities as Chancellor to a Prime Minister who has to pretend he can get something for nothing. The way politics is done in the media doesn’t help either, where basic numerical facts like an international trend rise in the share of health spending in GDP seems too much for many political journalists to remember.

So the chances of the Conservatives giving up their obsession with tax cuts is close to zero. In addition the media will remain constantly surprised that UK tax shares are steadily rising. This is unfortunate, because in trying to do the impossible (reduce the tax share) the Conservative party has done a great deal of harm. Obvious harm to the public services, but also to the economy. 

Austerity 1.0 is a key reason why the UK’s recovery from the Global Financial Crisis recession was so weak, and austerity also played an important part in influencing the Brexit referendum result. The damage caused by Truss we all know, while the game played by Hunt/Sunak is in danger of preventing Labour doing enough when they gain power. The dire state of the NHS is also directly influencing the economy. As the OBR notes, the number of inactive working age adults has increased substantially since the pandemic, with many citing long-term illness. The OBR now expects no recovery in labour force participation over the next five years, making the UK quite different from other countries where post-pandemic participation rates have recovered. This seems quite consistent with the continuing squeeze on public sector spending. For more details on how poor health has a negative influence on the economy as well as wellbeing, see the reports from the IPPR's Commission on Health and Prosperity, and Bob Hawkings here.

While there will always be a debate about whether high or low tax countries grow faster, the UK's experience over the last 14 years show that trying to cut taxes by shrinking the state when it is impossible to do so is very damaging indeed. Unfortunately neither the Conservative party nor many political commentators in the media appear willing to recognise the damage these attempts have done to both social wellbeing and the UK economy.

Footnotes 

[1] I fear there will be one more Autumn Statement before the election, and because that will involve another year of nonsense public spending assumptions, it will give the government room within its fiscal rules for further tax cuts.

[2] What they also did was starve the NHS of investment, which was bound to decrease efficiency, and privatize increasing amounts of its provision, which reduced the quality of provision.