Tough choices, and not just about Viagra

We cannot have everything we want from the public sector and stable taxes

WHAT IS the point of public spending? Viagra has grabbed our attention over the last week, as Frank Dobson struggles to work out whether the NHS should provide it, but there are many other difficult questions around. Should beta interferon be available from the NHS to all MS sufferers who might benefit from it? How much more should we pay teachers? How much more do we need to spend to provide enough nurses? Where can we find the money to help poor pensioners? Although we had a Comprehensive Spending Review this year, and a Fundamental Spending Review in 1993/4 from the last government, there is still uncertainty about the answers to all these questions.

How did we get to where we are now, with government taking about 40 per cent of national income in tax, and then spending it? The chart shows the history of public spending since late in the last century. In the 19th century, defence spending was the principal component of government activity. But as the 20th century dawned, government began to take on new responsibilities in social security, education and health.

The two world wars saw remarkable increases in spending, and although the scale of government fell back after each war, it remained well above its pre-war level, as expectations of the role and competence of government were enhanced by the activity of war.

Welfare state-driven growth continued spectacularly after the Second World War, with all three major components of the welfare state, social security, health and education, reformed and extended. The expansion of provision meant more spending, as shown by the chart, and that spending meant correspondingly more taxation, both in real terms and as a share of national income. The tax rises seen for the first three-quarters of the century were so great that it is hard to imagine any politician claiming that taxes were not going up.

How was this possible? First, incomes were rising. National income was nearly four and a half times higher, after adjusting for inflation, in 1975 as in 1900, and by the end of the century will have increased sevenfold. As incomes rose it was possible both to increase the burden of taxation and leave households with increases in their disposable income. Second, many of the tax increases were relatively disguised, through higher national insurance contributions, or the erosion of the value of the allowances for inflation, for example. And third, for much of the century there was a belief that governments were powerful and effective.

The party came to end in the UK in the 1970s. The economy stagnated, meaning that tax increases required reductions in disposable income, and confidence in governments declined. Denis Healey, the then Labour Chancellor of the Exchequer, called a halt to higher public spending and taxation, which his Conservative and now Labour successors have continued with.

Although the economy has recovered from the 1970s, and has grown more rapidly during the 1980s and the 1990s, there seems little political desire to attempt a return to the years of government increasing its share of the economy. During the 1980s, many of our western European competitors continued to raise the tax burden, so that we now find ourselves one of the lowest taxed countries in Europe. But in the 1990s, the rest of Europe also seems to have decided the time has come to call a halt to growing government.

So what's the problem? Simply that we want to spend more on many of the activities governments provide. As we grow richer, individually and as a society, there are some things we seem to want to allocate a larger share of our income to, and others which decline. Healthcare, education and incomes in retirement figure high on the list of things we want to allocate more to as we grow richer. This seems true across all countries, and at all periods, and is hardly surprising.

How did the Conservatives tackle this over their 18 years in government? They did increase spending on health, quite substantially, by over 70 per cent in real terms, which meant a rise as a share of national income. The same was true of social security, while in education the real increase was not quite enough to increase spending as a share of national income. And yet the tax burden barely rose - the last government funded increased welfare state spending by cutting everything else.

That road is no longer really open, there simply is not much left to cut, as the ill-fated Comprehensive Spending Review discovered. The initial idea was to cut spending in some areas to fund higher spending in others. The cuts have not materialised, which doesn't seem too surprising after four Conservative governments seeking to do just the same.

So the problem is still there, and attracting more attention by the week. We will spend a growing share of national income on providing income in retirement, sickness and unemployment, on healthcare, on education. If public spending and taxation is not to rise, that implies a shift to private spending. In all areas of the welfare state that is under way. Most dramatically, private pension provision is already very substantial, and continuing to grow. The new Government has introduced top-up fees for universities, to be added to substantial private spending on pre-school education and private schooling. Private spending on healthcare doubled as a share of total health spending under the last government, and Viagra is just one example of an area where private spending will rise if the public system does not provide.

We are a very low taxed nation by international standards, especially given the age structure of our population. That puts inevitable constraints on the level of public provision. We are making choices about who pays for what all the time, but as yet, the political debate has been vague. We could have more of what we want for everyone and higher taxes. We could have more of what we want for some people, paid for by giving less to others, and if we were radical that could even allow tax cuts. What we cannot have, however much we would like it, is everything we want from the public sector and stable taxes.

Andrew Dilnot is director of the Institute for Fiscal Studies (IFS). This article was co-authored by Carl Emmerson, IFS research economist.