18 June 2018

Gemma Tetlow argues that separating news of spending largesse from any serious attempt to explain where the money will come from makes it harder to make the case for necessary tax rises – or looser fiscal targets.

Theresa May’s announcement of extra money for the NHS answered half of the easiest of the three important questions facing politicians to ensure a sustainable funding settlement for health and social care in the UK: what scope and quality of services the public sector should fund and how much that will cost, where that money will come from, and how it can be sustained in the longer-run.

By separating the firm announcement of the spending goodies from any serious discussion of where the money will come from, the PM has made the job of persuading the public that corresponding tax rises will be needed much more difficult. Her claim that much of the money will come from a “Brexit dividend” wrongly suggests the money will be easy to find.

May announced that spending on the NHS would be increased by 3.4% in real terms on average over each of the next five years, leaving the NHS’s budget £20bn higher by 2023-24 than it is now. This goes some way towards meeting the spending pressures that the NHS faces, though it does nothing to address similar pressure on social care services.

Brexit will reduce tax revenues

The PM said that part of the money for the NHS will come from a “Brexit dividend” – money that would have been sent to the EU if the UK had remained a member. But this dividend is illusory. The weight of economic evidence, including the judgment of the official fiscal forecaster – the Office for Budget Responsibility (OBR) – is that Brexit will reduce tax revenues by more than the reduction in net payments to the EU.

Following the referendum, the OBR estimated that public borrowing would be £15bn/year higher as a result of Brexit, exceeding the UK’s net annual contributions to the EU of around £9bn. Even after the UK officially leaves the EU next March, the Exchequer will continue to make payments to the EU as part of the divorce settlement reached last December. This means most of that £9bn will continue to go to the EU over the next five years.

Where will the money come from?

In the absence of any Brexit dividend, the money for the NHS must come from higher taxes, higher borrowing or cuts to other areas of public spending.

Even before the new money for the NHS was announced, the Government’s latest fiscal plans imply that day-to-day spending on public services as a whole will fall by nearly £3bn over the next four years. No plans have yet been published for 2023-24.

That – together with further cuts to working age benefits and rising tax receipts as the economy grows – will help to reduce borrowing from 1.8% of national income this year to 0.9% by 2022-23. But this would still leave work to do to achieve chancellor Philip Hammond’s target of eliminating borrowing by “the mid-2020s”.

In the past, spending increases for the NHS have been found from cuts to other public services or welfare benefits. But after eight years of spending cuts and with growing calls for more spending elsewhere – from prisons and police to defence, housing, schools and social care – there appears to be a lot less left to cut.

The extra £20bn promised to the NHS equates to a little under 1% of national income. The Government could simply borrow the money. Adding this to the latest forecasts for public borrowing would leave total borrowing at around 2% of national income - below the levels sustained before the financial crisis. But it would leave the Chancellor well-adrift of achieving his balanced budget target – and moving in the wrong direction.

Raising the money from taxes would require something equivalent to raising rates of income tax or VAT by around 3 percentage points.

Public support for higher taxes to pay for more spending on public services has been growing over the past few years. Members of the public are particularly keen on tax rises that they believe will be used directly to fund the NHS, though a directly hypothecated tax would have many problems.

But recent experience – from the reversal of planned increases in National Insurance for the self-employed, to the U-turn on social care – suggests tax rises are still a difficult sell and will need careful handling.

By separating the firm announcement of spending largesse from any serious attempt to address the thorny question of exactly who will pay, May is likely to have made sensible tax rises harder to achieve. She has said that Hammond would announce the details of where the money will come from “in due course” – but by then the Government’s generosity may be a fading memory.

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