This is the first in a series of blogs that we will write in anticipation of the Government’s spending review.
This one looks at the broad issue of whether the spending review might include measures to refinance the state rather than reshape it.
The spending review will conclude on 25 November. So far departments have provided their initial plans to the Treasury. The Chancellor wanted to examine savings of 25% and 40% from each of the unprotected departments. And there were hard questions asked of the protected ones too. For example, the NHS, by its own calculations, and despite the promise of an additional £8bn of funding, needs to save more than £20 billion from forecast costs by 2020. We have produced previous research that puts the spending review in the broader context of the public finances and forecasts for economic growth.
The most obvious element of the discussions going on between departments and the Treasury over the next two months will be how to reduce services or deliver them at lower cost. There will be scope for this, especially in areas that have been relatively untouched by reform since 2010; or where private sector firms and voluntary organisations can offer a new approach. Future blogs will examine some of the options.
However, across most of the government, large efficiency savings have already been spied and taken. So the other big option to consider in this spending review will be how to pay for services differently. Refinancing the state rather than reshaping it. There are a couple of reasons why as a matter of political economy too this will be a salient approach.
“Refinancing the state rather than reshaping it. There are a couple of reasons why as a matter of political economy…this will be a salient approach.”
The first is the roll call of positive economic developments across the private sector. Sales, employment, pay – when they’re all rising, it’s so much easier for policy makers to look across and decide that private actors can take on more of the social 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. 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 through taxation or delay deficit reduction.
But what does refinancing the state look like in practice if it isn’t achieved through higher taxation? There are four possibilities:
- switching from grants to loans, as the Financial Times has reported the Department for Business, Innovation and Skills (BIS) is considering for various elements of business support;
- charging, for example through a levy, such as that announced in the Summer Budget to pay for apprenticeships;
- increasing regulation, which moves the cost of achieving the same or a similar outcome from government to private firms; and, finally,
- social investment, where the upfront cost of trying to achieve the common good is provided by private investors and government pays later when the benefits are realised.
Where can we expect these techniques to be used? The first has probably given most of what it can. During the last Parliament, university funding was switched from grants to loans; and the Summer Budget already announced that the same switch will now take place for student maintenance support. There may be a small number of further applications, e.g. grants to business for innovation could become loans. But these are small budgets. The much bigger item in BIS’s budget is research funding. It is much harder to see how support for fundamental research in science could be provided as a loan. This work is driven by curiosity rather than the prospect of the future revenues which would be needed to pay off a loan.
The second way of refinancing the state is charging. The government is consulting on an apprenticeships levy; and Michael Gove, the Justice Secretary, has raised the possibility of a levy to raise money for legal aid. A levy would mean that clients who can afford legal services are providing assistance to those who cannot. As with all instances of charging by government, it’s legitimate to ask whether taxation might be fairer. But there’s probably no doubt that sticking a levy on law firms is politically more feasible than higher taxes. And the social obligation of providing access to justice, to which the levy gives form, is one that most lawyers recognise.
I calculate that raising roughly £1bn 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. While those rates look unrealistically high, even a gentler levy on either revenues – or, alternatively, client deposits – would provide significant help to the Ministry of Justice in identifying the savings that it needs for the Spending Review.
“Why, for example, pay a winter fuel allowance to pensioners from the Treasury when it could be a condition of operating in the market that energy firms provide discounted tariffs or rebates…”
Thirdly, regulation can in some instances do the work of government. Why, for example, pay a winter fuel allowance to pensioners from the Treasury when it could be a condition of operating in the market that energy firms provide discounted tariffs or rebates to older people who are struggling to pay their bills? Regulation of this type is already commonly used to share social obligations between the state and private firms. In the energy market, there is the Warm Home Discount, funded by suppliers. Royal Mail, while it has been privatised, is still required to provide a universal service at a uniform price and doesn’t receive taxpayer money to do so. The added advantage of regulation over government provision can be that private actors will find diverse and innovative ways to discharge their obligations, e.g. improving energy efficiency in the older person’s home and thus reducing the cost of heating their home over the winter rather than handing over cash.
The fourth mode is social investment. The potential, if you listen to some people, is that, by drawing social investment into public services, government can offload risk as well as shift its payments out to the right – for instance, to when the deficit has been eliminated. When the benefits of social investment are described like that, they are too good to be true (i.e. moving risk and time costs money). But social investment can be part of wider reform. Recently we published a report on how more pension savings might be used for social investment. And we will look at the scope for social investment as part of the spending review in more detail in a future blog.
Finally, while this overview suggests some of the ways in which the state can be refinanced rather than reshaped, it’s worth adding that there are a couple of major reasons why the government may not go down this route.
“…involving private actors in implementing social outcomes requires careful design, consultation and therefore time.”
The first is that involving private actors in implementing social outcomes requires careful design, consultation and therefore time. But then, so do straight cuts. Ultimately, I doubt whether the pace of deficit reduction will itself militate against these options. Secondly, it may be that a Conservative government in particular will hesitate from interfering so much with the actions and choices of private actors. Though the road may be harder, cutting back the state outright may be preferred to keeping the state’s objectives and meeting them differently. Let’s see. Though my hunch – based on, for example, the Big Society agenda or the National Living Wage surprise – is that meeting social obligations differently rather than not meeting them at all is more of the essence of the present government. In any case, the charge of interfering with the private sector through levies or regulation will be relatively easy to shuck off for the government when the main opposition is likely to be considering renationalisation or the exclusion of private firms from the many public services they help to provide now.
“…my hunch – based on, for example, the Big Society agenda or the National Living Wage surprise – is that meeting social obligations differently rather than not meeting them at all is more of the essence of the present Conservative government.”
This spending review will be hard, there’s no doubt, but there’s a lot of policy space for the government to play into.