Debt is the curse of our age. Public debt, private debt, personal debt – in every case we have, as a country, borrowed too much and too fast. In doing so we have distorted and destabilised the economy, not only harming our own future, but those of our children and grandchildren.
Debt undermines homeownership, job creation and the savings culture
Our national over-indebtedness does particular damage to the foundations of the mass middle class. By pumping money into the property market it causes house price inflation – pushing home ownership out of the reach of ordinary working people. Asset bubbles also suck talent and investment out of genuinely productive enterprises – damaging job creation and suppressing wage levels. And even more damage is done to the whole economy when those bubbles burst – as they inevitably do.
Above all, a debt culture is the antithesis of the savings culture. Ordinary working people are impoverished by the accumulation of liabilities, while the rich – who own wealth beyond a home and basic savings – get richer as the rising tide of cheap money lifts the value of property investments and other fixed assets. The unfairness is further exacerbated by government bail-outs and financial repression (see chapter 3).
In the previous chapter we set out a programme to restore the savings culture. But bearing down on personal and private debt is not enough. We also need to deal with public debt – because as long as the state is deep in the red, governments will be under overwhelming pressure to pursue the cheap money and easy credit policies that got us into this mess in the first place.
Living within our means
Ultimately, the only way for both households and governments to free themselves from debt is to live within their means. Keynesian economic theory has long been used as an excuse by governments to run budget deficits. But for too long, government policy has only been ‘semi- Keynesian’ – running deficits in bad times, but failing to balance this with surpluses in good times.
Running deficits in both good times and bad is unsustainable and ensures there will be more bad times than good in the future.
Though the cuts we’ve seen as part of the current austerity have been painful – they don’t deal with the structural causes of our national indebtedness.
- Fiscal rules in this country are weak.
- The process of setting budgets is inflexible.
- Incentives to drive down costs in the public sector are limited.
- And, in the long-term, politicians face no accountability for the effect that their decisions have on our national solvency.
Therefore, while the current Government is absolutely right to pursue a programme of deficit elimination, we also need much deeper reforms that embed financial responsibility into the very fabric of our system of government.
Fiscal rules that stand the test of time
It’s very easy for governments to set financial rules for themselves. It’s even easier for them to break those rules.
Currently, the government is on course to eliminate the deficit by 2019. However, that will still leave an enormous outstanding level of net debt – peaking in the next few years at more than 80 per cent of GDP. The responsible thing to do next would be to get this down to a lower level – because while we’ve been able to finance our debts at a comparatively low rate of interest and with a comparatively long repayment period, there’s no guarantee that we’ll be able to refinance as cheaply in the future.
In short, it would be wrong for us to bequeath an unexploded debt bomb to future generations. However, in defusing this debt bomb, governments now face an acute moral dilemma. If one government exercises the fiscal and political discipline necessary to get debt down to a lower level, what’s to stop the next government from pushing it back up to the previous level – and claiming credit for the ‘generosity’ of its spending policies?
The British constitution does not allow one government to bind the hands of another, but it can embed fiscal responsibility within a legal and institution framework that a future government would not be able to dismantle without paying a political price.
Therefore, we propose:
- A Balanced Budget Plus rule – requiring budgets to be balanced over each economic cycle, with an additional sum equal to at least one per cent of GDP in that period used to pay down Britain’s national debt.
- The Office of Budget Responsibility would be given the right and duty to block any budget that failed to meet the Balanced Budget Plus rule.
- In addition, a debt ceiling would be defined in law, which public borrowing would not be allowed to exceed – furthermore the ceiling would come down in line with diminishing public debt.
- To provide a third line of defence against fiscal irresponsibility there should be a permanent cap on public sector headcount and payrolls.
- As a result of Quantitative Easing, the Bank of England owns about a third of the national debt: to stop a future government from taking advantage of this situation by ‘retiring’ (i.e. cancelling) this debt, the bonds currently held by the Bank should be transferred to the UK Sovereign Wealth Fund (see chapter 3).
Near-range and long-range zero-based budgeting
To stick within spending limits, governments need to control public spending with much greater success than they have done so far. Part of the problem is a budgeting process in which spending on particular items in one period sets a precedent for spending on the same items in future. While new items might get added, old items stay in place with no more than a small variation (usually upwards) in the money allocated to them.
This has three serious consequences: Firstly, a ratchet effect on the overall level of spending. Secondly, a culture of complacency and entitlement, in which the continuation of various programmes is taken for granted. And, thirdly, the inability to free up resources for innovative policies that might actually solve social problems instead of merely managing them.
It is vital that we free ourselves from the inflexibility and short-termism of the current approach.
Therefore, we propose:
- A system of zero-base budgeting in which, regardless of any level of spending in previous budgets, the default option for any item in the next budget is zero unless a case for doing otherwise can be actively made and agreed.
- We will extend the zero-base principle into financial planning for future decades (as well as the next few years), setting, where judged appropriate, long-range goals for the phased withdrawal of government intervention from non-priority areas.
- The long-range approach has already been applied to the official age of retirement, but it could and should be applied to other policy areas – serving notice on all concerned that government support is on the way out and that alternative approaches must be developed in preparation.
- As with the rising retirement age, there will be nothing to stop future governments from reversing particular phase-out decisions – but they would have to make a point of doing so – prompting questions as to how they plan on funding each disinterred long-term spending commitment.
Successive governments have tried and failed to reduce the supply of government. The only way in which we can permanently ensure the sustainability of our finances is to reduce the demand for government – and this requires social innovation.
The financial flexibility of zero-based budgeting will remove one of the biggest of impediments to such innovation, but we also need to incentivise it. Even within a decentralised public sector, where various players at all levels of government are able to identify ways of saving money, the motivation for doing so will be missing if only one player – the Treasury – hogs the financial benefit.
Therefore, we propose:
- The fiscal decentralisation of our entire system of government – so that the greater part of any saving is retained where it is made.
- Note that this does not mean that higher levels of government are not allowed to reduce central funding to lower levels of government – but it would have to be done across-the-board in accordance with pre-agreed general funding formulae and not by clawing-back individual savings.
- In addition there should be a savings-bounty system in which individuals and teams working within or in partnership with government are directly rewarded for ideas and actions that save money.
- Fiscal decentralisation should be supported by further efforts on fiscal transparency – in particular, a common accounting standard for all spending in the public sector should be implemented.
- It should be possible for anyone to follow the progress of each stream of public funding from initial budgetary allocation down to individual receipts and supply contracts – with quantitative information displayed in a clear and consistent graphical format.
So far we’ve only mentioned the debts that appear on our national balance sheet. Unfortunately there are many more ‘off-sheet’ liabilities that don’t appear in the headline figures. For instance, public sector pension liabilities, the long-term costs of decommissioning Britain’s nuclear power stations, and the sums owed under the terms of various PFI deals.
All of these incredibly complex arrangements have allowed successive governments to run up enormous debts on behalf of the nation, without being held accountable for them. In fact, it is a key weakness of our system of government that senior politicians and officials can make the most irresponsible decisions and yet face no personal comeback because the consequences aren’t felt until long after they’ve left office.
This cannot be allowed to carry on.
Therefore, we propose:
- An independently audited register of all long-term public liabilities (and assets) – with each annual update subject to a full debate and vote of both Houses of Parliament.
- The introduction of a legal duty of care to taxpayers on the part of all signatories to new PFI deals and similar agreements.
- A squeeze should be placed on existing PFI deals through a systematic investigation of compliance with the original terms of the contract and the law – where breaches are found compensation must be sought and terms renegotiated in the taxpayer interest.
- Pensions for ministers, MPs and senior public sector officials should be invested in securities that are directly linked to the solvency of our public finances – so that any future default on Britain’s national debt would automatically result in a default on pension payments to those responsible for our national bankruptcy.
Priorities for tax reform
Budgetary policy is too often presented as a simple trade-off between spending (which left-wingers want to maximise) and taxation (which right-wingers want to minimise). It has taken the financial crisis of the last few years to remind us of the third basic element in any budget, which is borrowing.
Therefore, as well as the choice between lower taxation and higher spending there is another balance to be struck – between lower taxation and lower borrowing. The old excuses for not making this choice no longer wash. For the most part, tax cuts do not pay for themselves – nor is it the case that tax cuts ‘starve the beast’ i.e. force governments to curb their spending.
At a time when income tax rates are still a long way from the punitive levels of the 1970s, and borrowing levels are dangerously high, a new order of priorities is required.
Therefore, we propose:
- That, for all the reasons set out in this chapter, reducing the burden of debt we have placed on future generations must take precedence over tax cuts in the present.
- Any money that is available for tax cuts must be focused on those taxes that do most to ‘gum up the works’ of the economy – especially those that get in the way of homes, jobs and savings for ordinary working people such as Stamp Duty (see chapter 1) and employees’ and employers’ National Insurance Contributions (see chapter 2).
- Within the tax system, reliefs should be redistributed to provide greater benefits for ordinary working people and all remaining loopholes must be closed for the rich.
- McKinsey Global Institute, ‘Debt and deleveraging: Uneven progress on the path to growth’, January 2012, pages 13 and 23
- Jonathan Jones, The Spectator, ‘Ed Balls tells porkies about the deficit’, 25 October 2012
- BBC News, ‘UK debt and deficit: All you need to know’, 21 February 2014
- For instance, see Ben Gummer, Financial Times, ‘Struggle against public debt must go on’, 4 December 2012
- Emran Mian, Prospect, ‘HS3: Does a high speed rail project mean austerity’s over?’, 24 June 2014
- For how debt retirement might take place see Jo Owen, The Financial Times, ‘Bank of England should retire QE
debt’, 11 March 2012
- The Economist, ‘Zero-base budgeting’, 26 January 2009
- For a comprehensive reform programme see Jesse Norman, Centre for Policy Studies, ‘After PFI’, May 2012
- See Pete Hoskin, ConservativeHome, ‘Margaret Thatcher and Ronald Reagan didn’t tame the state’, 21 November 2012