The recent general election offered the electorate a big fiscal choice over the speed and extent to which the deficit, and public spending, should be cut. The electorate plumped for the bigger, swifter cuts on offer. But we weren’t offered much choice on the shape of the cuts. There was, for example, complete unanimity on the need to protect spending on health and pensions at the expense of most other spending. And we certainly weren’t faced with the big, longer term, choices that we will have to make in response to growing pressures created by an ageing population.
Those pressures were set out on June 11, when the Office for Budget Responsibility (OBR) published its annual fiscal sustainability report. The main thrust of the report was to say that because of an ageing population, increased spending on health and pensions would, in the absence of tax rises or spending cuts, lead to fiscal policy becoming unsustainable. Even after imposing another £40 billion worth of spending cuts and reaching budget balance 2019, without further policy action a large deficit would open up again over the following decades.
The OBR’s supposedly central, but probably rather optimistic, scenario sees spending rising by more than 4% of national income in the three decades after 2019 purely as a result of the ageing of the population. That’s well over £60 billion a year of extra spending in today’s terms. With unchanged policy, tax revenues would barely change. Result? A big deficit, and the conclusion that current policy is “unsustainable”.
Shaping the state
That’s one way of viewing their analysis. There is a more interesting lens through which to look at this though. That is to consider not so much the potential lack of fiscal sustainability – we have plenty of time to make the choices to put ourselves on a sustainable path – but rather to ask what these trends mean for the changing role of the state. The answer must be that public spending will become increasingly dominated by spending on health, pensions and social care.
The OBR’s analysis suggests that even if total spending rises to accommodate the pressures on these three programmes, then by the middle of this century they would account for more than half of all public spending. That would require a state about 4% of national income bigger than we are heading for on current plans in 2019, and hence taxes that much higher. If we want to avoid such tax increases by constraining the size of the state to remain at around its projected level in 2020 then the proportion of state spending going on health and pensions would rise towards 60%.
That would leave an awful lot less for everything else the state currently does – from building and maintaining roads to providing education and paying working age benefits and tax credits. Coming on top of the cuts in these areas already in place and planned for the rest of this decade it is hard to see how such a change in the shape of the state could be attainable without some radical shifts in policy.
Before progressing to look at that, though, it is worth saying that all the figures above are more likely than not significant underestimates of the likely scale of change. That’s because of the way the OBR treats public spending on health in its main estimates. It does not account for the fact that health spending is likely to rise more quickly than other spending over the next five years.
More importantly their health spending estimate effectively assumes that productivity in the health service rises as quickly as that in the rest of the economy. That has never happened before over a sustained period: spending on health over long periods has risen more quickly than can be accounted for simply by the ageing of the population. So they present an alternative scenario in which trends since 1979 are rolled forward.
Under this scenario spending on health rises not to 8% but to 13% of national income by the mid 2060s. In that case a state the same size as projected in 2019 would by the middle of the century be over 70% focused on just health, social care and pensioner benefits.
Are these numbers not just fanciful? When you look 40 years ahead and come up with such big changes are you not just exposing something inappropriate about your assumptions? One way to think about that is to ask what has happened over the past 40 or 50 years. The answer is that we have already seen changes on this sort of scale.
Public spending on health stood at 3% of national income in the early 1960s, had risen to 5% by the mid 1990s and had hit 7% by the mid 2000s. Its share of government spending rose from just over 8% to 18%, while state pension spending accounted for 7% of public spending in the early 1960s and 12% by 2013.
How was this accommodated? In part through a very sharp fall in defence spending as we reaped the reward from the end of the cold war, but also by reductions in spending on housing and other economic support – particularly that associated with the nationalised industries.
We are going through a period right now which is generally characterised as one of fiscal austerity. One could equally well characterise it as a period of continued, indeed accelerating, transition towards a state focused on the needs of the older population.
Overall spending is being cut back significantly as a share of national income, working age welfare is being cut, and spending on “unprotected” departments could average one third lower in 2019 than it was in 2010.
But spending on health and pensions, is continuing to grow apace. This is one thing on which there appeared to be no significant disagreement at all between the main political parties at the general election. The main parties were committed to protecting and increasing these areas of spending. What they were less explicit about were the obvious consequences for other bits of public spending.
By 2020 public spending will most likely not take a very different share of national income to that which it took in the year 2000. But it will be much more focused on health and pensions. What the OBR is telling us is that this is a trend which will continue in the coming decades. It would be tough to accommodate that without raising overall spending, and therefore taxes. It would be tough to raise taxes. It would be tough to cut spending on health and pensions. We’ll have to do some combination of those. Let’s at least make the choice consciously.