Our welfare state is unsustainable – huge changes are surely inevitable

Ryan Bourne
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I RECENTLY took part in a debate at the Cambridge Union, arguing in favour of the motion that “this House believes the modern welfare state is unsustainable”. Cambridge voted against me and, being a sore loser, I thought I’d put my case to the readers of City A.M. This is, after all, likely to be the defining political debate of the next 40 to 50 years.

State spending on the welfare state (education, health, pensions, benefits) was 11 per cent of GDP in 1935. It’s now around 33 per cent. We have a universal health service, universal education, universal state pensions, a benefits system in which 44 per cent of non-retired households get benefits other than child benefit, pensioner-age benefits, and social housing provision. Can we continue on the path we have travelled for 70 years? Surely not.

Our deficit is still £120bn, and we’re relying on growth recovering to trend to eliminate a large chunk of it. But every year that passes without a proper recovery suggests our trend growth potential has diminished. And to see how entrenched the deficit is, consider this: the proportion of households that receive more in health, education and benefit spending than they pay in taxes rose from 43 per cent to 53 per cent in the last 10 years (an extra 3m households). The median household made net contributions of around £1,700 in 1990, but received £4,600 more than it paid in taxes in 2010. In the absence of a return to growth, it’s unlikely the welfare state can be spared the axe.

Even with a balanced budget now, sustainability would still be in question given our ageing population. This will mean more resources spent on pensions and healthcare, paid for by a shrinking working population. Office for Budget Responsibility figures (which are optimistic on healthcare productivity) suggest healthcare spending will double from 8 per cent of GDP to over 16 per cent of GDP by 2060. Alongside the cost of pay-as-you-go state pensions, rising health costs will mean taxes or borrowing must stay at such high levels that an adverse effect on growth is inevitable.

On the revenue side, globalisation-induced tax competition has lowered corporate income taxes and put pressure on VAT revenues. Mobility of individuals will prevent governments from substantially increasing income or wealth taxes, particularly at the upper end of the income scale. Technology and the increasing importance of intellectual property will squeeze government income further. This, in part, explains why UK governments find it so difficult to tax more than 40 per cent of GDP.

With these pressures, how can we provide a safety net for the poorest while not killing the economy with incentive-destroying taxes (which could worsen absolute conditions)? It seems inevitable that we’ll move from a cradle-to-grave welfare state towards a more liberal concept, with the state providing genuine public goods and a limited safety-net. This will entail one generation paying twice: for their parents’ pay-as-you-go benefits, while being encouraged to save more for themselves. Funnily enough, it’s the vision that William Beveridge had in mind – a safety net creating a platform for more personal responsibility and civil society institutions.

Ryan Bourne is head of economic research at the Centre for Policy Studies.