David Willetts: The cost of living crisis. We need greater mobility to achieve higher growth, and higher growth to fund higher wages.
Lord Willetts is Chairman of the Resolution Foundation. He is a former Minister of Universities and Sciences.
The debate over the Spring Declaration is roaring because it encompasses so many important issues on which the Conservative Party has yet to make up its mind. These are clearly revealed because the problems facing Rishi Sunak are so acute – yet another once-in-a-lifetime crisis, with the shocking rise in energy prices and wider inflation hitting living standards hard. Typical household incomes are expected to fall 4% in 2022-23 — the biggest hit to family budgets since the mid-1970s — as inflation far outpaces wage and benefit increases.
I think the Chancellor is right to be a fiscal conservative, relying on borrowing and debt. One of the most striking figures from his statement last week is that government borrowing falls from 14.8% of GDP in 2020-21 to just 1.3% in 2024-25. With the cost of debt rising – partly due to inflation-linked debt – it makes sense to cut back on borrowing.
Many Conservatives would rather he achieve this by cutting spending than by raising taxes. But the forces underlying the increase in public spending are very strong. Health care spending has increased and will continue to increase faster than inflation. And demographics will continue to put pressure on public spending.
When there were lots of baby boomers, that meant lots of workers. Now baby boomers are getting older, which means they are using the NHS more and claiming pensions. The conservative overhaul of the state over the past decade has made it a state providing health care services and benefits primarily to the elderly – and there will be more of them. They also tend to vote Conservative, which means even reducing the triple lockdown is difficult.
The tax burden increases accordingly. The Conservative Party does not like to raise taxes, but that should not preclude the necessary debate on the best design of the tax system. Regardless of the exact amount of the tax, there are still important decisions to be made about how to collect it.
A key choice is between rates and thresholds. To what extent should the government broaden the base – make more people pay taxes – and, if it had the means, reduce the rates? Or is it better to raise the thresholds, even if the rates remain high.
It may not be a happy precedent, but it was the argument that gave us the poll tax – Margaret Thatcher feared that high-spending councils could be elected by coalitions of voters who paid no local tax.
Does it matter that the income tax threshold is so high that only three quarters of households pay the tax? While raising the threshold is usually portrayed in the media as helping the less well-off, it actually helps all taxpayers, so it’s an expensive way to help low earners.
If the Treasury then tries to claw the money back from the highest paid, it makes the system at the top more complex with higher marginal rates as tax breaks are taken away. The Chancellor likely feels the threshold-raising strategy has gone too far, and his announcement of the future income tax cut could signal that he is cutting rates, even if tax is next paid for by a broader base of taxpayers.
The big omission in the budget was all to help the less wealthy half of the population. The obvious way to achieve this is, to some extent, on benefits. There was a very enlightening comment from a Conservative MP: “Helping the working poor saves Conservative votes. It is not the case to help those who only receive benefits. »
This reflects the widely held belief that most benefit-receiving families do not work. But this is no longer the case. We have a flexible labor market with very high employment rates, but wages are still quite low, so there is a big problem of the working poor and they are receiving benefits: 40% of Universal Credit claimants are working.
The Treasury, in its neat way, thinks it has already tackled the springtime energy price cap hike. The next decision moment will be the cap increase in the fall and they can tackle that later. The Chancellor could announce tax cuts in advance, but he has not announced in advance what help might be available at that time.
However, it seems that he plans to repeat the council tax refund. But more than one in ten households in the bottom half of the income distribution will not be eligible for council tax rebates to pay their bills. Instead, the Treasury could have brought forward next year’s benefit increase, offering more substantial support to ease pressures on the living standards of low-income households.
Behind all this lies the problem of an underperforming, low-growth economy. This is the underlying reason why the standard of living has remained stuck. By 2027, real wages are projected to have increased by just £18 a week since the financial crisis, compared to £240 a week if they had increased in line with the pre-financial crisis trend. In a low-growth economy, tax cuts are more important because they seem to be the only way to increase income.
The most effective way to tackle this shockingly poor long-term performance is to increase the growth rate. Britain appears to be operating with a much lower rate of economic mobility than in the 1980s: lower rates of workers changing jobs – especially lower rates of changing sectors, higher rates of geographic mobility low and lower business opening and closing rates across sectors.
In 2021, the reallocation of labor in 21 industrial sectors, compared to ten years ago, was equivalent to 7% of total employment. This is a reallocation rate three times higher than the peak of the 1980s, when we were a much more mobile economy.
Margaret Thatcher had a strategy to boost our economic performance. It was privatization – but now many of these companies are heavily regulated and it is the regulatory state that needs to be reformed. We had labor market reform.
Back then that meant attacking the power of unions, but now the problem is weak incentives for workers to leave and retrain. And the single market has exposed companies to increased competition in a larger market, giving them an incentive to improve their performance. Today the openness of the economy is down: latest figures show UK export volumes fell 14% between the three months to January and the same period before the pandemic, compared average for advanced countries, which increased by 5%.
Perhaps one of the reasons Treasury is wary of the upgrade program is that the white paper on it includes a celebration of staying where you are. It is a key element of conservatism. But it’s not clear that this is the way to tackle the growth crisis, which is a mobility crisis – and the underlying cause of the cost of living crisis.