Wednesday 15 September 2021 11:00 am

Hikes to national insurance funds a level of public services we can't afford

Paul Ormerod is an economist at Volterra Partners LLP, a Visiting Professor in the Department of Computer Science at UCL, and author of Against the Grain: Insights of an Economic Contrarian, published by the IEA in conjunction with City A.M.

The government’s plan to increase National Insurance has sparked the predictable furore. 

The pressures to raise taxes to pay for the level of public services the electorate have come to expect is hardly new. 

The welfare state was created immediately after the Second World War. For a time, the financial demands were held in check. Over the period from 1946 to 1958, for example, the cumulative amount of net borrowing by the government was zero.

Since then, even in normal years, the government has routinely spent far more than it has raised in taxes. The annual average is roughly 3 per cent of GDP. This may not seem much, but even a small percentage of GDP is a huge number. In fact, at today’s prices, this works out to be around £60bn. 

But for a long period, the value of the outstanding stock of government debt relative to the size of the economy – GDP – remained low. Between the late 1970s and the late 2000s – when the financial crisis hit – this ratio stayed under 50 per cent. 

This was despite the fact that a lot of new debt was being issued every year to finance the deficit.

The key to this apparent puzzle is two-fold. After allowing for inflation, the amount of goods and services produced expanded on average by 2.5 per cent a year. Over these three decades, the economy more than doubled in size. Further, inflation in the 1980s was high and prices effectively doubled.

With GDP growing rapidly, through a combination of real expansion and inflation, new debt could be issued without increasing the ratio of the total debt issued, relative to the size of the economy.

Looking ahead, it is hard to believe that the economy will grow at 2.5 per cent a year over a sustained period. Historically, this is a high figure. Inflation is very unlikely to return to the 7 per cent average of the 1980s. This means it will be nigh on impossible to keep the amount of debt relative to GDP in check. 

With the current demand for public services, debt will never be controlled. The Government may find unlikely inspiration in council tax. This is a highly visible tax. People see the money disappearing from their personal bank accounts into that of the council. They wonder how the money is being spent. As a result, it is a very unpopular tax.  

At the moment, only a minority of income tax payers have to fill in a return and transfer money directly to HMRC. For most people, the money is deducted through PAYE and they never see it.

Getting all income taxpayers to file a return and hand the cash over would concentrate their minds. It would act as a political restraint on government spending in the way in which council tax keeps local authorities in check already.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

Share