Big Steps to a Smaller State

17/07/2011 15:20 | Updated 12 September 2011
  • Philip Booth Editorial and Programme Director at the Institute of Economic Affairs and Professor of Insurance and Risk Management at Cass Business School, City University.

If you google the phrase 'vicious public spending cuts' you get 64,000 results from websites in the United Kingdom. Even if 32,000 of those are references to articles written by Polly Toynbee, that statistic still suggests a lot of widespread public ignorance.

The government has reviewed public spending over the period to 2015 and has decided that nominal government spending will rise by about 7% and real spending will be cut by 0.7% per annum. Of course, some areas of public spending have been ring-fenced and debt interest costs will be trebling, but this is the result of deliberately chosen political priorities over the last few years. By 2015 the government will still be spending 40% of national income.

The government's Comprehensive Spending Review has been anything but comprehensive. The government spending cuts are not just small in total, the whole approach to spending reductions was piecemeal. It smacked of the approach of the not-very-accomplished gardener who randomly prunes an overgrown flower bed not distinguishing between the weeds and the flowers. If you do that, of course, you end up with an even more overgrown bed in a couple of years' time.

We wanted the authors of Sharper Axes, Lower Taxes - Big Steps to a Smaller State to go back to basics, to decide what governments should do and how they should do it. The agenda in each main area of government activity was to be backed up by sound economic reasoning and analysis, so that government would do those things it seeks to do -- such as assisting people to have access to health care, defending the country, topping up the incomes of the less well off, and so on -- most effectively and efficiently.

For example, if the government is to help ensure that all have access to healthcare, it is not necessary for it to abolish competition, nationalise finance and provision and control all health services from a government department. Instead, our author suggests, the government can assist those people who cannot afford healthcare to save for routine health needs and insure for the big events: the better off can finance themselves out of much bigger post-tax incomes. We would then get competition; the system would be responsive to the needs of the patient; and people would have incentives to take health promotion measures: this is clear from the experience of other countries. Similarly, if the government is going to help the poor, it does not have to put them in a situation where they have marginal tax and benefit withdrawal rates of between 70 pence and 100 pence in the pound and penalise them if they marry when they have children. Instead, we can have a negative income tax based on a household unit of assessment with individuals who are not in employment being required to work in order to receive benefits. Again, the evidence suggests that the British approach of huge benefit withdrawal rates and penalties on family formation just does not work. The poor respond to incentives too!

As it happens, large-scale government intervention in health and education does not help the poor. The gap between life expectancy for men in the highest social class and that in the lowest social class has widened from about five years to about seven years between 1972 and 2002 despite per capita budgets that are 42% higher in areas containing the poorest 10% of people than in areas containing the richest 10% of people. We know from the evidence that when governments liberalise education it is the poor who benefit most.

It appears from the polling that the IEA has undertaken that the British people agree with the IEA authors. Asked whether people would like government spending cut by 25% and a tax cut equivalent to an average of £7,500 per household, the overwhelming majority wanted the tax cut. Asked at what level government spending should be set, over half wanted another £100bn of cuts in addition to the government programme.

A side effect of our authors' proposals is that the much reduced level of taxes would lead to economic growth increasing by an extra 0.75% per annum. In other words, every 25 years we would be 20% better off.

We can have much smaller government. The government should reconsider all its functions and radically reform every area of government finance and provision. IEA authors have shown how, as a first step, government spending can be returned to below 30% of national income. I encourage you to read on...