Spending Review 2015: Osborne’s third way? Changing how we pay for the state

The Chancellor will announce during his Autumn Statement this week the details of the deals he has struck with government departments – his own included – on cuts to be achieved across this Spending Review. But SMF Director Emran Mian argues that just to focus on cuts is to miss the possibility that the Chancellor may decide that we will pay for services differently.

There is a ‘third way’ to balance the books, on top of cuts or higher taxes. And we estimate that it could deliver up to £2.5 billion towards the Chancellor’s fiscal objectives.

The apprenticeships levy – essentially a payroll tax on large employers to pay for training – is one example of this third way that the Chancellor has already announced. There are a couple of reasons why as a matter of political economy too this will be a salient approach.

The first is the roll call of positive economic developments across the private sector. Sales, employment, pay – they’re all rising, so it’s much easier for policy makers to look across and decide that someone else can take on the obligations currently held by government. The National Living Wage, for example, is plausible now in a way that it wasn’t in 2010.

Secondly, it’s not only policy makers who are more likely to reach that conclusion in the present economic conditions – voters are more likely to support it. Businesses have recovered from the crisis, or so it seems to many. Households are only starting to. Government has a deficit. So it’s compelling for voters to stick the cost of achieving policy objectives on others rather than pay for it themselves through taxation; or delay deficit reduction.

What might be on the cards? We’ve been looking at the options. One proposal, already floated by Justice Secretary Michael Gove, is to levy law firms to help pay for legal aid. This draws on the social obligation that most lawyers already feel to provide access to justice – which they currently do for example by providing more than £500m worth of free legal advice every year. Gove has suggested this is too little, in the context of the huge success of law firms.

What would it take to raise some serious money by this route? I calculate that raising roughly £1 billion in 2018 would require a levy of 4% on the revenues of the 200 largest law firms or 3% on the sector as a whole. That’s a hefty new tax, though Ministers may prefer putting that burden on law firms rather than dealing with the fallout from further legal aid cuts unsweetened by any other funding.

The Business Secretary Sajid Javid, on a similar theme, has been reported to be considering changes to business support. Innovate UK disbursed almost £600 million of grants to businesses in the last financial year. BIS provides roughly another £300 million. Changing these grants to loans would mean that Government would get a proportion of the money back in future years; and the immediate impact on reducing the deficit would be significant. Even if we assume that 40% of the loans will go bad the saving should be around £500 million per year.

There’s another £1 billion to be saved – or refinanced – through cutting the government’s Industrial Injuries Compensation Scheme and moving these costs on to employers. They ought to have insurance for workplace injuries anyway and a previous report commissioned by the Health and Safety Executive suggested that increasing the financial liability of employers would have the positive benefit of giving them stronger incentives to improve workplace safety, to prevent accidents happening in the first place; and fund rehabilitation for workers who have suffered injuries, so that they come back to work more quickly and stop needing the compensation. Leaked material from DWP that surfaced before the election suggested this change was under consideration.

That’s somewhere in the region of £2.5 billion, obtainable from business, that may either mean smaller cuts to some departments – or give the Chancellor more fiscal room to delay, for example, tax credit changes. These are hard choices, of course. But straight cuts may be even harder. Refinancing the state rather than reshaping it is an option that the Chancellor is likely to pursue. We’ll find out in a couple of days.


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