We have forgotten what budgets are for

{"text":[[{"start":null,"text":""}],[{"start":5.8,"text":"Here, at last, is a Brexit benefit of sorts: UK chancellor of the exchequer John Healey’s in-tray contains only one impossible budgeting task rather than two. EU governments have not only their national budgets to worry about but face pressure to make progress on the next seven-year common budget for the bloc as a whole. This week I want to highlight a parallel between the two challenges."}],[{"start":28.150000000000002,"text":"The parallel is that both the UK and the EU budgets are failing badly to deliver what they are supposed to. To be sure, both public finance arrangements sustain long-established patterns of redistribution. But neither does a good job of newer and more urgent needs: in the UK, to promote higher and more productive private investment and growth, and across the EU, to fund agreed new priorities on defence, energy, industrial policy and digital technology. "}],[{"start":54.7,"text":"The ultimate reasons for this are also similar: a set of political constraints that together make any significant change to the allocation of resources seem out of reach. In the UK, the constraints combine stultifying fiscal rules (here is my longer take on that) and a government that thought, to be elected, it had to promise not to raise income tax, national insurance and VAT. It is therefore reduced to tweaking along the edges (and yes, I count the decision to slightly weaken the “triple lock” on state pension as no more than that). "}],[{"start":86,"text":"In the EU case, the constraint takes the form of a political war of attrition. States that receive more out of the budget than they put in want to maintain the programmes that secure this. Net contributors, meanwhile, want a larger relative share to fund new priorities such as defence and energy, without increasing the overall size. Every time in the past, the result has been stalemate, last-minute brinkmanship and an outcome that only marginally changes the status quo ante. For example, researchers from Bruegel have just found that the budget currently being negotiated will only fill a small fraction of the widely recognised investment gap for European public goods. "}],[{"start":128.75,"text":"What I think the two situations (and no doubt budgeting in many other polities) have in common is that they largely undermine the ability to use budgets as tools of governance. When politics locks public finances into at most marginal departures from the status quo, budgets cease to be tools of governance. Yet the time has long since passed when public policy could largely be left to autopilot and market equilibria."}],[{"start":153.85,"text":"Something has to give, and if it’s not the budgeting process, it’s most likely a crisis that ultimately forces politicians’ hands. The much better alternative is to find a way to deliberately unlock the political economy of budgeting. That is easy to say, of course, and harder to figure out how to do. But if we know that moving incrementally means hardly moving at all, then it’s at least clear that much bigger steps are needed: these are chasms that cannot be crossed in many small leaps. So what might this entail for the two cases I have mentioned?"}],[{"start":188.35,"text":"In the UK, it is surely a comprehensive reform of the entire tax system. My colleague Martin Wolf wrote this week that: “The important challenge is to improve the efficiency of the fiscal system . . . [D]o not look at a single tax on its own but relative to the rest. The time now is ripe for such reform.” What sort of reform? He rightly points out that a comprehensive overhaul needs to be done with deliberation and care, and mentions the 2011 Mirrlees Review, which remains as good a place as any to start. "}],[{"start":220.6,"text":"But it is possible to state straightforwardly what one thinks should be the main steps of a good reform. As I have written before, I think a lot would be gained from fully harmonising the taxation of income, replacing the current income tax and employers’ national insurance, as well as capital income taxation, with a single new tax that would cover all sources at the same rates for the same levels of income. This would have some obvious losers: those with non-labour income, where national insurance is not paid today, and those with capital gains, who would no longer pay lower tax than wage earners. But that could in return pay for noticeably lower rates."}],[{"start":257.4,"text":"For example: based on Resolution Foundation research, shifting 2 percentage points from employee national insurance (which is not paid on pensions and investment incomes) to income tax (which is) would raise £6bn. So a rough estimate is that folding the entire 8 per cent national insurance into income tax would give the government roughly £25bn to play with. New research from CenTax, meanwhile, finds that taxing capital gains like other sources of income would raise an additional £20bn. Add in other, smaller effects, and the amounts raised easily surpass £50bn a year. And that is before even contemplating similar simplifying reforms to VAT or property taxation."}],[{"start":300.5,"text":"The point is not that taxes should rise by that amount, but to underline just how much political room for manoeuvre comprehensive reform buys you. With these sorts of resources, a lot of taxes can be cut. For about £10bn a year, the threshold for paying tax on income at all could be unfrozen, along with that for the higher rate. For about the same amount, you could cut all income tax rates or VAT by 1 percentage point, or corporation tax by 2.5 percentage points. (All of which should be good for growth.) It would be a poor politician who could not marshal that kind of largesse into political support. As an added benefit, if income tax and national insurance no longer existed in their previous forms, it’s not clear how Labour’s manifesto pledge not to raise their rates would continue to bind."}],[{"start":347.55,"text":"One could mount all kinds of objections. But the question really is: who can honestly say the current marginalist approach to budgeting is delivering?"}],[{"start":356.85,"text":"What about the EU? There, the political economy deadlock may seem deeper than in the UK. It is caused not by the self-imposed strictures of an otherwise all-powerful one-party government, but by the irreconcilable policy positions of many veto players. Not literally irreconcilable — every seven years, EU leaders somehow hammer out a compromise and pass a budget, but always involving very small changes. Irreconcilable, then, in that it seems impossible to get much past the status quo ante."}],[{"start":388.8,"text":"Here too, it is useful to think about how root-and-branch reform could change the political economy of budgeting. How, when unanimity is so hard to get to? But this objection assumes that a budget must be agreed. That is not true. EU law provides that without a budget agreement, previous spending decisions are carried on. The nominal spending limits follow a fixed 2 per cent inflation adjustment — so as long as nominal growth exceeds that, the share of the budget to GDP will keep shrinking."}],[{"start":418.2,"text":"So consider a radical rupture with current procedures, in which EU leaders simply decided not to agree a new budget. (Unanimity means it only takes one brave leader to impose this on the rest . . . ) The status quo ante would prevail, but be eroded by inflation and growth over time. That erosion is sizeable. (For illustration: in the soon-to-be finished seven-year budgetary period, EU nominal GDP has gone up by about 40 per cent. Against a 2 per cent per year inflation adjustment, that sort of increase would shrink the budget as a share of GDP by more than one-fifth.) In isolation, this is a double win for the net contributors, who would contribute less and less overall, and in particular cut the size of the traditional transfers they most object to. That alone should concentrate the minds of net recipients."}],[{"start":473.15,"text":"Another consequence, however, would be resources falling even more glaringly short of what is required for new, geopolitically important spending. So in this hypothetical world where budget talks both consumed a lot less political attention and evidently did not address agreed priorities, the pressure would rise to come up with other solutions — parallel budgets, as it were. "}],[{"start":493.9,"text":"The EU has a good record of coming up with these quickly when needed. Most notable is NextGenerationEU, agreed within months during the Covid-19 pandemic and largely matching the normal seven-year budget for size. Sure, an unemployment reinsurance scheme, Safe, a fund for joint defence procurement, and the Ukraine Support Loan as well as earlier facilities to fund Kyiv through joint debt, together committed nearly another seven-year budget’s worth of resources. The USL even pioneered a way to borrow jointly against the EU’s creditworthiness while leaving some unwilling countries off the hook through side payments."}],[{"start":531.35,"text":"This is beginning to look like a political economy to produce a shrinking traditional budget coupled with more — and more debt-funded — new budgets for specific purposes. Does anyone think the current model — which wastes enormous amounts of time and effort and by common consent fails to address the most urgent priorities — is preferable? "}],[{"start":551.2,"text":"Other readables"}],[{"start":553.75,"text":"● My colleague Soumaya Keynes has a very thoughtful conversation with Jenny Bates, a senior British civil servant who has reflected hard on how the UK must change its way of doing things in the new era of geoeconomic rivalry."}],[{"start":567.9,"text":"● The return on East German industrial espionage in the west was astonishingly high, new research finds."}],[{"start":574.65,"text":"● Is quantum computing becoming reality? "}],[{"start":577.6,"text":"● The Syrian government has unleashed a free-market experiment on the previously closed and protected economy cultivated by the Assad regime."}],[{"start":null,"text":""}],[{"start":593.1,"text":""}]],"url":"https://audio.ftcn.net.cn/album/a_1790850792_9148.mp3"}