Ruinous public service cuts or toxic tax rises? Our economic prospects look bleak – John McLaren

Wealthy countries like Denmark, Belgium and Austria demonstrate that high taxes are not necessarily bad for the economy

The Chancellor’s recent autumn statement was a dispiriting read in terms of what it suggested for both the UK’s and Scotland’s economic and fiscal prospects. On the economic side, Jeremy Hunt did everything he could think of to try and raise the growth rate, but to little avail as his 110 measures are expected to result in a desultory 0.3 per cent of extra GDP by 2028-29. So why so glum?

First of all, it’s worth highlighting what the Office for Budget Responsibility’s chair, Richard Hughes, had to say about this: “0.3 per cent doesn’t sound very much but it is one of the biggest growth upgrades we have ever done for policy in our forecasts. That is because it is really hard to accelerate the growth rate of this country. You are dealing with a capital stock of £4 trillion and a labour force of 34 million, so £14 billion of investment and an extra 100,000 people does make a difference. But it is a few drops in a big ocean and you have got to keep dropping it in if you want to make a difference.” Thanks Rich, it’s only the hope that keeps us going.

Unfortunately, the OBR also foresees stronger, negative, currents coursing through the forecasts, due to their reassessment of other factors. Hence, the medium-term potential annual growth rate of the economy fell from 1.8 to 1.6 per cent, reflecting demographic shifts in the composition of the working population toward younger and older age groups, who work shorter hours; a rising retirement rate for capital; and a weaker near-term outlook for total-factor productivity growth. The impact of these downward revisions is only partly offset by higher migration, lower energy prices and the measures announced to boost labour supply and business investment. A fall of 0.2 per cent a year may not seem like much but I refer you back to Richard Hughes’ statement to get a feeling for how much it takes to move the dial on this.

Chancellor Jeremy Hunt leaves Downing Street on his way to present the autumn statement to the Commons (Picture: Dan Kitwood/Getty Images)

Positive effect of economic migrants

Furthermore, we’re only where we are thanks to the positive effect of many more economic migrants than was expected. But such an influx is unsustainable, first in political terms, as all UK parties agree, and second because the UK cannot assimilate numbers like this – net immigration was well over a million people in the last two years alone – on an ongoing basis.

The politics might alter, as the students and their dependents bring in money and either leave again or make a positive economic contribution, and as health and social care is the end destination for 40 per cent of all work visa arrivals – without actually ending staff shortages in this sector. However, to allow for such a change in attitude would necessitate the expansion of public services to accommodate a rapidly growing population. This would be expensive, given that, on housing alone, the cumulative shortfall, over the past decade and just in England, is 1.3 million homes, according to the Centre for Policy Studies.

Which brings us to the fiscal side. At present, the spending envelope available after the next UK election implies another period of austerity as pronounced as that overseen by George Osborne, except that this time the ‘fat’ that may be available to be cut is much closer to the bone than it was in 2010. The Institute for Fiscal Studies calculates that, excluding flat or improving settlements for the NHS, schools, defence, overseas aid and childcare, all other departmental day-to-day spending budgets will be declining by an annual average of 3.4 per cent, after adjusting for inflation, between 2024-25 and 2028-29. In other words, a cumulative decline in spending power of over 14 per cent for areas like local government, justice, housing, transport etc.

Core public services in dire straits

Next year’s Spending Review might be expected to top up these sums, as has been typical in past exercises, except that, first, there are no obvious sources from which to procure any such top-up and, second, even if there were, Jeremy Hunt seems determined to make a cut in income tax his first port of call for any spare cash. On top of that, there are pledges on defence and overseas aid spending to meet and the inevitable pushing forward of the freeze on fuel duty to factor in, potentially making things even worse.

Core public services like courts, hospitals, schools and public transport are already in dire straits, especially post-Covid, such that further ongoing cuts seem untenable and politically ruinous. The only trouble being that the flip side is even higher taxes, across the board, which might be just as toxic.

All of this is pretty much in plain view in the OBR’s Economic and Fiscal Report that accompanied the autumn statement. There is not much conjecture involved – that IS a large train emerging from the tunnel. Unless economic growth fortuitously resurrects itself, then something has to give. With a Tory government having led the UK to the highest tax burden in 80 years, despite its ideological opposition to this, the direction of travel seems pretty clear, more tax increases, either directly or indirectly.

As high-tax countries like Denmark, Sweden, Finland, the Netherlands, Belgium and Austria demonstrate, this need not be economically damaging, since they also happen to be more prosperous than the UK – contradicting the Chancellor’s claim on this matter. However, any such shift will involve significant changes to how public services are organised and delivered, which in itself will be a huge task, rebuilding the UK in a more central European style.

Scotland will inevitably follow in the UK’s wake, but starting from a higher tax position and lacking a proper Treasury department to help plan a way forward puts it in an even more awkward spot.

John McLaren is a political economist who has worked in the Treasury, the Scottish Office and for a variety of economic think tanks