Austerity – or Catastrophe…?

15 mins. to read
Austerity – or Catastrophe…?

The minority UK Conservative government is under pressure to loosen the fiscal purse strings. Does that mean the dream of balancing the budget remains no more than a dream? Who would benefit? Will taxes have to rise? And what are the risks? Cardiac arrest in the Gilts market is a real possibility.

Under pressure

Boris Johnson opines that the public sector pay cap of one percent per annum should be scrapped. Michael Gove believes that the British people need a break. Numerous other Tory luminaries have also recently told Chancellor of the Exchequer Hammond that he should ease up on closing the deficit and cut the nation some slack. In other words – borrow more than he is borrowing already and bung some dosh in the direction of local government, the NHS, and any other spending department with a sob story to tell.

Since the election, the Tories, still in government but clinging on for dear life, are running scared. Some think that they might buy popularity – and time – by easing up on the aim of balancing the books by 2025. This objective, and the cheese-paring of spending commitments associated with it, generally goes by the name of austerity.

In the current climate, every tower block that goes up in flames, every tardy ambulance, every bungled criminal investigation by the plods and every delayed and overcrowded train are blamed on austerity. Almost any imaginable administrative cock-up has the same cause.

In signalling an end to austerity Boris & Co. are stealing the Opposition’s clothes. Labour and their Green side-kicks loathe austerity, full stop. The Scottish Nationalists, with Presbyterian righteous indignation, regard austerity as a moral abomination. The Lib Dems think it would be jolly nice if there wasn’t quite so much of it.

How did we get here?

Mr Brown’s unhappy legacy

When the Coalition Government came to power in 2010 in the aftermath of the Credit Crunch and the recession which ensued, the UK budget deficit – the gap between government spending and tax revenues – was running at nearly ten percent of GDP. To their credit, Messrs Cameron and Osborne, supported by Mr Clegg and his crew, made the elimination of that deficit their principal mantra. The deficit was supposed to be closed by the end of the parliament (2015). Of course, that never happened; but it was reduced to around four percent of GDP which was progress of a kind.

The majority Conservative government of 2015, until, Titanic-style, it hit the Brexit iceberg on 24 June last year and sank, reset the target date for deficit elimination to 2020. When Mr Hammond became Chancellor last year, our arrival in the Promised Land of fiscal equilibrium was postponed until 2025. Now Borisites want to postpone that further.

Well before the financial crisis of 2008, Mr Brown, as Chancellor, had increased spending on the NHS by 60 percent. Wages in that hallowed institution rose by even more than that. OK, you can argue that nurses had been underpaid; but thanks to Labour, we ended up with the highest paid doctors in Europe, even though our health outcomes (e.g. cancer survival rates) compare unfavourably with those of France and Germany.

Thanks to Labour, we ended up with the highest paid doctors in Europe, even though our health outcomes (e.g. cancer survival rates) compare unfavourably with those of France and Germany.

Let us just rehearse the reality of our current fiscal situation. Official projections are for a budget deficit of nearly £60 billion this year – so the deficit is still running at around 2.5 percent of GDP. Total government debt outstanding (all those Gilts and bills in circulation) amounts to just under £1.75 trillion – up from about £700 billion in 2010 when Mr Brown left office. That yields a debt-to-GDP ratio of just under 90 percent – and rising. When we went into the financial crisis back in 2007-08, the debt-to-GDP ratio was around 30-35 percent.

Public spending is still running at around 40 percent of GDP – well below France and Sweden I grant you, but well above Switzerland’s 35 percent. At least it is well below the 47 percent of GDP achieved by Labour’s Denis Healey in 1976 (on which more later). But, roughly speaking, in order to balance the books and to check the further rise of the national debt, it would have to be reduced to about 37 percent – or growth would have to tick up to three percent. Both of those eventualities are improbable.

Spend – then tax

The impact of rising expenditure on the deficit could of course be mitigated by raising taxes. Tories dislike raising taxes for two reasons.

First of all they believe that there are moral limits on how much other people’s money you can filch for your own ends – even if you invoke the public good. To most of us any tax rate of 50 percent or more looks suspiciously like theft. In any case, on a practical level, the better off can vote with their feet and leave. High taxes can also be legally avoided by clever tax structures which only the rich can afford (offshore trusts, buying homes using offshore companies and so on).

Secondly, Tory-inclined economists argue that higher taxes impede economic growth. Low tax economies do seem to have higher growth rates than high tax ones; though some economists would argue that this is a question of economic development: young, dynamic Wild West economies typically have low tax and minimal public services; as economies mature they develop welfare states and tax accordingly.

The idea of the social contract, first articulated by Rousseau in the late 18th century[i], implies that most people are prepared to pay reasonable taxes for an acceptable level of public services. But that social contract is disrupted if taxes are seen as unfair or the quality of social services is impacted by exogenous factors (such as mass immigration or a huge spike in the incidence of diabetes resulting from excessive sugar intake – both things that governments allowed to happen).

It is pretty obvious that high taxes impede capital formation and encourage individuals and corporations to transfer assets and businesses to lower tax jurisdictions. High taxes dis-incentivise enterprise.

The Laffer curve conundrum

Non-economists assume that the more governments increase taxes, the more tax revenues they receive. But you only have to think about this for a moment to realise that this is false.

If national income were zero, even a tax rate of 100 percent would yield zero tax revenue. And if the tax rate were 100 percent, nobody would bother to work at all (at least in the official economy) so the tax revenues would also be zero. Now the Laffer curve plots the level of the tax-take (as a percentage of national income) against tax rates and assumes that there is some kind of parabolic curve connecting these two zero values. The only problem is that nobody agrees the exact shape of that curve; and that therefore, nobody agrees what the optimal level of taxation should be.

Most people (and economists) agree that taxes should be progressive – not in the current Lefty sense of the word (meaning right-on) but in the sense that the more money you earn, the more tax you should pay. People on low incomes should pay zero or very little tax while people on high incomes should pay much more (as a percentage of their total income).

In the era of so-called austerity, spending on the NHS and welfare has continued to rise.

But where you set the threshold for those who pay tax at all, and where you set the trigger points for higher rates of income tax, is an inexact science. (Mr McDonnell believes that the very rich are those earning above £70,000 – and he is entitled to his opinion, as it is no more than that.)

I personally believe that people should only pay income tax if they earn above the minimum wage. The Coalition government of 2010-15 and its Tory successors succeeded in raising the Personal Allowance[ii] from £6,475 in 2009-10 to £11,500 in the current fiscal year. That has taken many low-paid out people of tax altogether (though they may have to pay some NICs). But if you work full time on the Living Wage of £8.45 an hour you will still end up paying about £1,000 in income tax[iii]. Though you will then be able to claim in-work benefits (Tax Credits) of more than that. What a crazy system!

Anyway, the Laffer curve teaches us that even the Corbyn-McDonnell tax plans could actually yield less tax revenue than the current regime under the Tories. Moreover, in the era of so-called austerity, spending on the NHS and welfare has continued to rise…


The NHS will cost £147 billion to run this year. Pay rises for NHS employees could be more easily justified if they were linked to productivity. Where I live in Kent, if you want a same-day doctor’s appointment you have to ring the surgery between 08:00 and 08:30 hours. Of course, the line is continuously busy, so there are hundreds of people in the locality wasting their time. Why couldn’t that be accomplished online – fewer receptionists, a lower telephone bills – happier “clients”?

Or again, why can’t we consult robot doctors before we book an appointment? A lot of personal medical information could be transmitted to the robot by smartphone. Regular readers will know that I’ve written a lot on this theme – but few in government are paying attention.

According to the IFS, employees in the public sector still enjoy higher levels of compensation than people in the private sector with equivalent qualifications, despite the pay cap of one percent imposed since 2012. (During 2010-12 public sector pay was frozen). This is because real incomes have actually been falling in the private sector. Moreover, public sector workers get better pensions and longer paid holidays.

I have long thought that the problems of the NHS are more about appalling management than funding. Younger doctors are finding ways around this. They are circumventing the NHS computer architecture (run on Windows XP (2001)) by sending scans and x-ray images to one another on Snapchat[iv]. And at no cost to the taxpayer. Give that man a bonus!

Welfare reform

Despite Mr Duncan Smith’s much heralded roll-out of Universal Credit, welfare spending is still on an upward trend. Pensions will cost the state nearly £160 billion this year and other transfer payments another £57 billion. Mr Corbyn reminded us again at PMQs this week that, not only are there more food banks than ever, but that even public sector workers such as nurses use them. This is adduced as hard evidence for unfair welfare cuts.

I was talking to a sensible lady vicar from the West Country who runs a food bank in her parish. She said that she was shocked to find that many of the beneficiaries of local generosity were heavy smokers. We worked out that someone who smokes 20 fags a day now spends about £220 a month – more than enough for the weekly shop at Waitrose for a family of five (especially if their excellent claret is on discount). She also said that many of her “clients” are grossly overweight.

Whatever happened to the Blair-Cameron social engineering agenda “to nudge” the more feckless amongst us into some semblance of social responsibility? I never hid my discomfort with Mr Cameron – a toff who draped himself in Mr Blair’s discarded robes – but he started off with the notion that behaviour must change in a “Big Society”. Somewhere along the line the Tories dropped their visionary aspirations for a better society – and opted for the quiet life of the managerial state. And now they want to abandon the one thing that they have got right in difficult circumstances – fiscal rectitude.

Somewhere along the line the Tories dropped their visionary aspirations for a better society – and opted for the quiet life of the managerial state.

Tories should reflect that the best form of welfare is a job – the wages from which are not excessively taxed; and rejoice that unemployment is at its lowest since the 1970s.

There are a million and one things the state could spend money on in the general cause of welfare. Jamie Oliver think schools should provide breakfast and lunch free to all kids. Call me old-fashioned, but isn’t it one of the duties of parenthood to feed one’s children? Towards which end parents already receive transfer payments from the state. And it’s clear that many people don’t watch Mr Oliver’s TV programmes since they don’t cook at all: instead they send their kids down to the kebab shop or the Chinese take-away. Should the state provide vouchers for this? (And then introduce extraordinary measures to tackle childhood obesity?)

2018-19: A catastrophe scenario

The Government has left the country very vulnerable to an economic downturn even at a time when a cyclical recession is overdue. This could arise from a general downturn in the global economy or from UK-specific factors such as a major banking failure resulting from a spike in consumer loan defaults. Or it could be triggered by a geopolitical event such as the outbreak of nuclear war with North Korea…

There is indeed much that could go wrong for UK PLC right now. Supposing that the downturn coincided with a material increase in interest rates (which even Mr Carney now thinks likely). This might easily double interest costs on the national debt. So interest costs, which are already greater than the defence budget, could exceed the education budget (about £100 billion).

By that stage the UK will already have been downgraded by the major rating agencies. (S&P has already signalled that this is highly likely). And suppose further that all this coincided with a Crash Brexit in which WTO tariffs were imposed on British exports to the EU as I recently speculated. I accept that tariffs imposed on imported German cars would accrue to the Treasury – but this outturn would almost certainly have a seriously negative impact on the Pound, which would further weaken the UK’s balance of payments.

At this conjuncture institutional investors who purchase Gilts in massive quantities each year would want to know that the Government has some credible medium-term plan to close the budget deficit in a proximate timeframe. If that is not the case, they may well determine that the yields on Gilts are not commensurate with the risks incurred.

A rating of AA- maps, in standard bank risk management models, to a one-year Probability of Default (PD) of less than one percent. But, with my risk management hat on, I would put the PD in this scenario very significantly higher than that. In plain, non-technical English: British government bonds could be reduced to junk status overnight – just as Greek bonds were in 2010.

I am not a doomsayer, but it is possible to imagine that the entire Gilt market could go into cardiac arrest. The Government would then run out of money – virtually overnight – and, like in Venezuela, hospitals would have to close their doors to new patients. Teachers would go unpaid. Lights would go out. Now that’s what I call austerity.

If you think this is fanciful – it actually happened to us back in 1976. After two years of Chancellor Denis Healey’s spending like crazy to get the UK out of recession (spending increased by 31 percent in 1974-75 and by 28 percent by 1975-76[v] – much of it on public sector pay) the country went broke and had to be bailed out by the IMF. Not our finest hour.

Modern Western governments are required to play a constant game of liar’s poker with the international money men: so long as they think you’re solvent, you’ll remain so; but if they think for a moment you are bust – your flush is already busted.

What is the point of the Tories?

If the Tories really want to become the Tax-and-Spend Party – why do they exist? One may as well vote for Tax-and-Spend-Lite (Lib Dems), Tax-and-Spend-Max (Labour) or their funny friends, Tax-and-Spend-Organic (the Greens).

Unfortunately, the Tory elite have become detached from their grass roots – which is why they ballsed up the election. They have allowed the party to be portrayed as nasty and the Tory brand to be trashed. The writer, Caitlin Moran, was allowed to say that anyone who voted Tory was a s**t. And that was mild compared with what the Corbynistas said about Tories on social media. (They have learnt much from Trumpery). As Scottish Tory Leader Ruth Davidson pointed out, north of the Border, the Tories have had to put up with vile invective for years: English Tories had better toughen up.

English Tories had better toughen up.

The last thing the Tory party and the nation need right now is a leadership election. Mrs May has no serious rivals. Mr Davis should remain at the Western Front, grappling with the Hun (even though he already looks out of his depth). Boris, while I admit he is a talented writer with an encyclopaedic knowledge of the Ancient World, seems to have an incomplete understanding of the modern one. The Maybot must stay – even if she must be re-booted. She’s the only bot they’ve got.

What the Tories really need is not a new leader – but to re-connect with their core precepts, which are Protestant-Christian in origin but pragmatic in application; and which run deep in all parts of British soil. In case Mr Johnson and Ms Moran might not know what they are: patriotism, self-reliance, enterprise, civility, concern for the under-dog, vigilance, manners (even when provoked); hard work, low taxes; and – most important of all – hope: the idea that anyone can succeed, regardless of background. Pride in the past has to be balanced with excitement about the future.

This is the only recipe, long-term, for prosperity and social happiness: not endlessly borrowing more money to pay for bread and circuses, thus imperilling us all.

[i] Jean-Jacques Rousseau (1712-1778), The Social Contract (1762).

[ii] The level of income below which no income is paid in the UK.

[iii] Assuming you work 37.5 hours a week for 52 weeks your gross income will be £16,447.50.

[iv] Daily Telegraph, 05 July 2017, page 7.

[v] In nominal terms. Inflation was running at 16-20 percent.

Comments (13)

  • workchamp says:

    you are wrong on tax. it’s 2000 pounds p.a. on minimum wage. so-called ‘national insurance’ is just income tax by pseudonym.

    • Victor Hill says:

      Workchamp – you are absolutely right. In the example I gave income tax would be £995.50 and Employee NIC would be £997.62 – making a total of £1,993.12 – an effective tax rate of 12%. So for every hour that the “Living Wage” worker works he/she is paying over £1 in tax! I wonder how many politicians know that! I should have made that clearer – thanks for pointing that out.

  • Concise summary says:

    The UK is f****d no matter what. Cut spending, no hope. Increasing spending, bankrupt.

  • Jon says:

    This was another great piece from the resident Wordsmith.

    I even sent it to a female friend to explain the facts of life. Cheers.

  • Craig says:

    This is a brilliant article, very interesting and I generally agree with the points you’ve made. My own feeling is that Corbyn will be the next PM (unfortunately), and will be voted in by reams of millennials who know nothing of the dire straits hard-left Labour left us in during the 70’s. In a few years time those millennials will know what real austerity is.

    • Peter says:

      I agree you are correct that millennial do not realise the dangers of the hard left. But they Millennials will not suffer as they don’t have a stake in society (houses)and can simply move to other countries. People are more mobile now as opposed to the 70s. The pensioners who rely on the state are the most vulnerable.

  • Mark Richardson says:

    You’ll never balance the budget by cutting public spending, because you’re destroying wage growth and creating an economy where wages can never go up. Combined with all the tax cuts, you’re ensuring tax receipts will keep declining and ensuring that we’ll never be able to afford public services.

    In short, you’re creating neo-feudalism and slavery, and at the end of it all you’ll have done is cut the budget deficit 3 times more slowly than you would have if you’d just borrowed and invested in high skill public sector jobs.

  • Mark Richardson says:

    I just cannot believe the amount of delusion in this article. You’re not a kindly, unappreciated sensible economist doing what’s ultimately for the best, even though it might be cruel.

    You’re COMPLETELY DESTROYING the whole economy because you haven’t a clue what you’re doing.

    The number of arguments I have had with Tories on this subject and it all boils down to one thing. You WANT spending cuts to work because you don’t like benefit claimants. Unfortunately, a strong welfare state is necessary for a thriving middle class. No welfare state = no bargaining power for workers = no thriving middle class. You can’t have a middle class if workers are victim to coercion through desperation.

    Stop with your childish whining, stop saying “everything I don’t like is bad for the economy” – suck it up, and spend some money! This country is DESPERATE for investment.

    • matchmade says:

      Where is the money going to come from for your public sector “investment”, a.k.a. pay splurge, when the country is already on a terrifyingly high debt-to-GDP ratio of almost 90%? You’ve completely failed to engage with Victor Hill’s arguments: for example, “capped” public sector pay (which it isn’t, because most workers – like my wife, an NHS Band 7 specialist professional – are also on a pay scale with guaranteed annual increments) and work-related benefits like pensions have actually held up very well and are still more generous than equivalent roles in the private sector; so-called austerity has been mild so far, with many departments of state operating on protected budgets; and what happens if overseas investors decide to stop buying our never-ending issuance of gilts to fund our excessive expenditure?

      Ultra-low interest rates are not some inevitable, guaranteed off-shoot of Labour’s Money Tree: they have only been permitted because the money markets trust the government to keep bearing down on the UK’s huge fiscal deficit. This is very, very basic economics, and describing as “cruel” anyone who says the UK should aim to live within its means and ultimately reduce its National Debt is just the politics of the playground. And I’ve no idea what you mean by “all the tax cuts”: taxes overall have *risen* as a percentage of national income since 2010; the cut in highest-rate income tax has raised more revenue, not less; and are you opposing the introduction of the National Minimum Wage and the increase in tax-free allowances, which have so benefited the low-paid?

  • Rocky says:

    Quite the best summing up I have read anywhere of the mess we have got ourselves into. That “living within your means” has surreptitiously morphed into “austerity” is a national disgrace, and shows the pitiful level to which our once respected national media have sunk. The most mediocre bunch of politicians (on all sides) for several generations, who generally believe that any problem can be solved without much thought by throwing money at it, are leading us all over the edge of the cliff like lemmings.

  • Peter says:

    This is a very good article – probably more likely to happen than people realise. The off balance sheet debt which is never talked about (future entitlements to pensions) will never get paid. When the government runs out of money they tax the citizens heavily – this is the biggest threat to peoples wealth (government). Bubbles burst!

    Can house prices keep rising given this backdrop?

  • John Davis says:

    Anything that goes wrong is caused by Austerity. Or Brexit. Or Global Warming. Or a Global Elite conspiracy. Or ….. take your pick. People get smart only for relatively brief periods following events within their memory, and memories are short. How else could Labour policies now be seen as having some validity? But we are unlikely to end up like Greece for one very good reason: we can print our own currency. Not so much Greece then, more like Zimbabwe.

  • roger bennett says:

    Very encouraging to read truth and common sense, most public sector pay offers a low financial return to the economy and the economy has to make a return to grow. Paying interest on the national debt makes this more difficult.

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