The frightening maths that shows Britain's austerity future

Do you dare gaze into the future? Matthew Paulson, CC BY-NC-ND

There was much to digest from last week’s budget. Some commentators focused on George Osborne’s bid to undercut the Labour Party’s general election campaign; others focused on Tory rumblings that the Chancellor of the Exchequer had missed a chance to offer some pre-vote sweeteners. We thought it was a good moment to draw attention to some important fiscal forecasts that shed a painful light on the growing cross-party acceptance of austerity.

We are referring to the UK fiscal imbalance: the difference between the present value of the government’s commitments to pay future benefits (such as state pensions and NHS outlays) and the present value of its tax revenues. According to a set of independent estimates by Cesifo, the UK fiscal imbalance is equivalent to a whopping 510% of GDP. It is a reflection of the public spending pressures that we face as the baby boom generation reaches retirement age and life expectancy continues its upward trend. Add in the government’s official debt on top of that and you get a number close to six times our national income.

Compare and contrast

To put this figure in context, a related study by the Institute of Economic Affairs (IEA) recently calculated that total spending would have to be cut by more than a quarter as compared with the level implied by current policy if the UK is to avoid tax increases and all spending is to be met out of tax revenue in the long run. By comparison, the US has a much lower fiscal imbalance as a proportion of national income (due to the relatively small size of its social security programmes), while other leading European economies also fare better (see Table).

Cesifo DICE report, Author provided

The scale of the UK fiscal imbalance is staggering and helps to explain shadow Chancellor Ed Balls' admission that he would not reverse his opposite number’s pledges. And, of course, it also raises the question of how on earth we should deal with it.

There are several options available, including an increase in income taxes, National Insurance contributions or consumption taxes such as VAT and fuel duty. We could raise the mandatory retirement and state pension ages, or reduce unemployment and other welfare benefits. Or we could increase the share of young immigrants in the population to rebalance the age distribution.

Taking the hit

This list makes us think about which groups in society should bear most of the burden of this adjustment in our economy – workers, retirees or the unemployed. But it is also about the trade-off between current and future generations. On the one hand, a relatively fast fiscal adjustment would spread increases in taxes and reductions in spending over a much smaller population – primarily those generations currently living. As a result, the burden per person would be much larger, and the economic pain for individuals correspondingly greater.

Taking the load. Darren and Sandy Van Soye, CC BY-NC-SA

On the other hand, it is difficult to justify shifting most of the burden onto unborn future generations, because the latter have not benefited directly from the spending surge of recent decades and so cannot be expected to foot the bill. Recent policies (for example, relatively generous public sector pensions; the delayed and insufficient proposed rise in the state pension age) are not striking a fair balance here, with unborn generations and the current young poised to bear almost the entire burden of the fiscal imbalance.

So, what should be done? For one thing, we can say that any workable solution is likely to require a combination of the measures listed above, so that no one group is singled out to bear the brunt. That way, the burden could be rebalanced toward current generations but the economic pain on individual groups would remain bearable – a necessary condition for any economically and politically viable solution.

The fiscal imbalance presents an important set of choices for the UK economy, and it therefore deserves a public debate. The first step in the debate is to appreciate the scale of the problem: the frightening fiscal arithmetic. The difficult part is to find a solution and then stick with it.

Michael Hatcher, University of Southampton

Alessandro Mennuni, University of Southampton