Tony Blair and the taxation question / Michael Jacobs - [Electronic ed.] - London, 2001 - 7 Bl. = 36 Kb, Text . - (Working papers / Friedrich-Ebert-Stiftung, London Office ; 2001,2)
Electronic ed.: Bonn : FES Library, 2001

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Politics in the UK is now well into the pre-election campaign. Unless events intervene, Tony Blair is expected to call a general election in May or June 2001. And the central issue is already clear. It is taxation and public spending.

As Labour and the Conservatives draw up their election manifestos there has been some convergence between them on this issue over recent months. Labour is committed to a major programme of public spending increases, but at the same time its March Budget implemented a series of tax cuts to families with children, pensioners and others. (The UK's public accounts are in substantial surplus at the moment.) The Conservatives have promised further tax cuts of £8 billion over five years, but have also committed themselves to keeping to Labour's spending plans in almost all the major areas of public spending – education, health, crime and transport. (They claim to be able to fund their tax cuts from savings in administration and social security spending.)

Such convergence is perhaps inevitable in advance of a general election, when political parties cannot resist appealing to the public's apparent desire to have both higher public spending and reductions in tax. But underlying this debate there are deep divides about taxation and public spending in a modern society.

For the Conservative agenda is not really to defend public spending, but to reduce it. In the long term the Tories seek to introduce a greater degree of private insurance into the health and welfare systems, and to encourage the growth of private and semi-private education. Labour remains committed to more or less universal public services, free at the point of use, but is desperately concerned to improve their quality. It believes that the poor standard of public services in the UK is the most serious threat to the long-term prospects for centre-left government. Labour is expected to win the forthcoming general election, but, unless it can dramatically improve the quality of Britain's education, health and transport services, the party fears that it could lose the following one in 2005-6. If the Tories return to government then, it could mean the end of Britain's welfare state altogether.

The problem for Labour, however, is tax. The UK takes only 37.5% of its GDP in taxation, 4% less than the European Union average. It will be extremely difficult to improve public services without more money, but Labour has been frightened of seeking tax rises openly. Following eighteen years of Conservative government preaching the virtue of low taxation, the party believes that British voters are not prepared to see taxes rise – despite their widespread dissatisfaction with the state of public services.

It was to explore these questions that in November 2000 the Fabian Society published a major book, Paying for Progress: A New Politics of Tax for Public Spending, the report of its Commission on Taxation and Citizenship. This paper will discuss the debates it has raised.

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Public attitudes towards tax

Social democrats have traditionally regarded taxes as a good thing. As Keynes put it, taxes are the membership fee we pay for living in a civilised society. Taxes pay for the things we value: universal education and health services free at the point of use, social services which care for the weakest members of society, welfare benefits, public transport, overseas aid.

Unfortunately, this is not how the majority of British people think about taxation at all. The Fabian Society's Commission on Taxation and Citizenship ran a series of discussion (focus) groups exploring public attitudes towards tax and public spending. The most striking and widespread response came out right at the beginning of every session: the extraordinary sense of alienation with which most people view the whole subject of taxation. Taxes invoked deeply negative feelings – not just political antipathy but a highly emotional aversion.

This is not just a dislike of paying taxes, which would hardly count as news. It is that people seem to make almost no connection between the taxes they pay and the public services which these finance. Taxes are perceived almost entirely as a burden, a drain on the individual and family budget from which no tangible gain is seen at all. Of course, people know that taxes pay for public services. But what they have experienced over the last ten years is that taxes have been rising while public services have been getting worse. So the link between changes in taxation and changes in public expenditure – which is what matters at a political level – seems to have more or less collapsed. Higher taxes have not led to better public services, so there seems no reason to think that lower taxes would lead to worse services either. As one respondent put it: "you pay your taxes but where's it going? Where's the money going?"

This 'disconnection' between the public and the taxes they pay is a serious phenomenon. And it is compounded by the view of government and politicians which emerges from our own and others' research. This will not come as much of a surprise either, but the view that governments are almost universally incompetent and politicians untrustworthy has important implications for tax policy. For why should people pay more in tax – or even what they are paying now – if governments will just waste it? And even if governments did manage to spend money well, how could the public believe them through the fog of 'spin' and manipulation of statistics with which politicians try and fool the public?

It is not just income tax that this is about, either. Until recently it was received wisdom in political circles that, while income tax might have become untouchable, indirect taxes could always be put up because the public could not see them. No longer: now the public are highly conscious of, and indignant about, so-called 'hidden' taxes too – on fuel, tobacco, alcohol, insurance, air travel, and so on. Indeed many people in our focus groups regarded increases in indirect taxes as even worse than rises in income tax: at least the latter are visible, they pointed out, whereas with indirect taxes one has no idea how much one is paying. Chancellors can simply use them to extract money from the public without anyone noticing.

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New Labour and tax

Tax has played a central role in the Blairite worldview. Almost more than any other issue it was high taxes that symbolised 'Old Labour'. It was the image of Labour as a party of profligate 'tax and spend' which made its own target voters so hostile to it. It was, therefore, high taxes from which New Labour had to distance itself. It did so by pledging before the last election that Labour would not raise income tax rates during the lifetime of its first Parliament. This was never, deliberately, a promise that Labour would not raise taxes overall; but it was clearly intended to sound like it. And indeed, as our research respondents made clear, this was how it was heard.

But it went deeper than this. The pledge on income tax was not just a tactic or even a policy. The belief that taxes actually were a bad thing, and that reducing them was a genuine goal, entered the New Labour soul. In several press interviews in the first two years of the government the Prime Minister went out of his way to say that he hoped to cut taxes. In June 1999 he published a paper on the Third Way with Gerhard Schröder which explicitly argued that the share of taxation in national income had reached its peak in a modern economy and should be brought down.

The attack was not just on taxes either. It was on 'tax and spend' together: the evil twins of 'Old Labour' mythology. Labour in 1997, after all, did not just pledge not to raise income tax rates. It promised to keep to the Tories' tight-fisted spending plans. And the first line of the 1997 manifesto made it clear why. Problems of public services are not solved, it argued, by throwing money at them. Some New Labour people genuinely believed this: that 'modernisation' – reforms to structures and priorities – could achieve significant improvement in public services without extra cash. Taxes really were bad: they were not just saying it.

There was only one small problem. The new Government had to raise taxes overall. Labour inherited a huge budget deficit from the Tories which it was committed to reducing, and it had set itself strict borrowing rules. There was only one way to square this circle. The share of taxation in national income had to grow. But prudent fiscal policy came right up against the symbolic importance of taxation to New Labour's identity. The result was the extraordinary – but emblematic – spectacle in the winter of 1999-2000 of the Government trying desperately not to acknowledge what its own Treasury statistics were by now showing: that taxes had indeed risen. There were absurd exchanges in the Commons in which Tory spokespeople pointed out the figures showing the tax share had risen in the previous two years, and ministers answered that taxes were due to fall in the next two. However important and necessary the fiscal policy had been, not least for its economic credibility, acknowledgement that taxes had risen just could not pass the Government's lips. The charade was brought to an end, it may be recalled, not by an official statement but by an Alastair Campbell press briefing in March, in which the 'admission' (note the word) that taxes had indeed risen was slipped out.

Yet since then Labour has performed something of a U-turn in this field. First, after freezing public spending for its first two years, it committed itself from 1999 to much higher levels. Committing the Government to meet the demanding, not to say uncosted, 'aspiration' of the European average for health care expenditure, the Prime Minister finally acknowledged that reform was not enough. Money, sheer cash, counted too. With tax receipts strong, the Budget in March 2000 and then the Comprehensive Spending Review in July 2000 confirmed Labour's re-conversion to a faith in public spending.

It was the fuel tax protests in the summer of 2000, however, which sealed the transformation. With the strategy of 'hidden' taxation shattered, the Government frankly had nowhere to hide. The key moment came in an article by the Prime Minister in the News of the World during the height of the summer. High fuel duty, he wrote, was necessary to pay for schools and hospitals. For the first time, Blair was defending high taxes on the basis of the good they do. For the first time, he was telling the British public the uncomfortable but self-evident truth that they could not have good public services without paying taxes, and if indirect taxes were high this was because income tax was low. There is no free lunch. By the Labour Party Conference in September 2000 the strategy had turned on the offensive, with both Blair and Brown explicitly defending the combined 'tax and spend' policy, and the Chancellor calling for a national debate on the subject. The Chancellor's targeted tax cuts in his March Budget have not altered – though they have inevitably partly compromised – this fundamentally more social democratic approach.

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The sociology of 'disconnection'

But it would be a fatal error if the Government's new strategy were to become simply a return to the 'Old Labour' position. For the world has changed. Put simply: the public can no longer be taken for granted.

Thirty years ago, when Labour last sought to tax and spend its way to political success, the majority of voters had limited private spending power. Most were dependent on the state in significant areas of their lives: for the housing in which they lived, for the bulk of their pension, for the transport they used, for the social security benefits which gave them daily security against unemployment and illness. Compare the far more limited role which the state plays today for most people – particularly for those on average incomes and above, who constitute the parties' 'target' voters. Such people's self-interest in taxation has declined exactly as the proportion they pay in tax has increased.

But the sociological changes go further than this. As earnings have risen, private consumption has come to play a much larger role in people's lives. People have more money to spend, and consumer choices have become more important in shaping people's identities and lifestyles. Considerable efforts have been made by the private sector to respond to these trends (as well as to shape them). Much more emphasis is given to customer service and convenience. Product standards have almost universally risen. Unsurprisingly, consumer expectations have followed suit.

This has left the public sector struggling to catch up. It is not, in fact, true that public sector services are worse than they used to be: in many areas, including the National Health Service (NHS) and schools, there is considerable evidence of improvement. The NHS treats many more diseases than it used to, and more successfully. The number of pupils passing GSCEs and A-levels and entering higher education has risen. In many cases, greater demands on services mean that improvements are required even to stand still: this is true, for example, in transport (given greater mobility), and in the care of the elderly (given an ageing population). For most of the last two decades public spending has risen more slowly than average private earnings. But public attitudes rarely take such factors into account. People's perceptions are based not on actual performance, but on the gap between their expectations and reality. And the comparison with the private sector has now raised expectations high. So what people notice – as was widely observed in our focus groups – is that public sector services are in general not as flexible or efficient, and certainly not as consumer-focused, as the private services people pay for directly.

At the same time, public confidence in the political system as a whole has also been in decline. This is crucial, because – as the members of our groups pointed out – taxes are not paid direct to public services. They go first to the government, and the government is controlled by politicians. As social surveys have shown, trust in politicians and parties has fallen considerably since the 1970s. Turnouts in elections over the last five years have been at record lows. In the regular British Social Attitudes opinion surveys the number of people saying that "the system of governing Britain works extremely well" or "could be improved in small ways but mainly works well" has fallen from just under a half in 1973 to around a third in 1996.

The reasons for these trends are complex, but what seems to have happened is that as people have become more active consumers, and their outlook on the world in general has become more individualistic, they have become more sceptical and less deferential about politics. Higher standards for their own consumption have been accompanied by an increasing unwillingness to take governments on trust. Overall, Britain seems to have developed a more critical citizenry – in both senses of the word.

These trends have profound implications for the Government's new approach. 'Tax and spend' on the old model is no longer good enough. The public need to be actively convinced that the taxes are worth paying and the spending is doing good. And they need to believe what they hear. The public, in other words, need to be 'reconnected' to the taxes they pay and to the public spending which these finance.

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'Reconnecting' the public to their taxes

There can be little doubt of the most important task in this process of reconnection. It is to improve public services. The Government has embarked on a whole series of programmes aimed at improving the administration and efficiency of the public sector.

But the report of the Fabian Commission on Taxation and Citizenship goes much further than this. It argues that taxes themselves need to be 'connected' to the services they pay for. It makes three principal recommendations.

First, the Commission argues that the public need to be much better informed. Local authorities are required by law to provide a leaflet to all council tax payers setting out what they do with the revenues. But central government does not do this. We found huge ignorance in the focus groups about how much was spent on different areas of government – with many people being aware of how little they knew. A major programme of accessible information is needed, setting out in simply understood terms how much people pay in tax, where it goes and the difference it makes. It cannot be assumed that people know this already. The Commission recommends that every citizen be sent a 'Citizen's Contract' every year setting out the taxes that have been paid, how they have been spent, and the improvements in public services that have been achieved. (With commendable speed, the Liberal Democrats have already adopted this idea.)

But such information, second, needs to be credible. Loss of trust in politicians, and the perceived prevalence of 'spin', has badly undermined any information provided direct by government. It simply is not believed. An independent source of information about government spending and performance is therefore needed. The Commission recommends a new and independent 'Office for Public Accountability' to audit public spending and government performance for this purpose.

Third, the report recommends an increase in the use of earmarking or 'hypothecation' of taxes: tying certain taxes to specific forms of expenditure.

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Earmarked taxes

The attraction of earmarking is simple. If people knew exactly where their taxes were going, they would be more willing to pay them, possibly to pay even more. Rather than the present 'black box' system, in which all tax revenues go into the Treasury and are then allocated to different areas of spending by invisible processes inside government, the whole system would become much more transparent. Indeed, in an interesting kind of way, earmarking makes the public, not just the government, more accountable. If voters want more spending on a public service, an earmarked tax makes it clear to them what they will have to pay to get it.

But, as the Fabian report notes, there are good arguments against earmarking too. Earmarking reduces the efficiency of the Treasury in allocating public revenues to where they are most needed. Unless the tax rate is constantly (and inefficiently) changed, a fully earmarked tax will almost certainly bring in either more revenue than is needed for the spending programme, or less. (There is no reason, for example, why the revenues from the vehicle licence fee should match government spending on road building – indeed they ceased to do so fifty years ago, and since then no-one has pretended the fee is earmarked.)

It would be possible to get round this objection by making earmarking less strict. Governments could be allowed to spend more in the designated area than the specific tax yielded, or to spend some of the revenues elsewhere. But this then risks the whole exercise becoming a sham. The public will be told that the tax is going to the specified spending area – but in fact it might not be. The public might want more to be spent – but this would not in fact require them to pay a higher level of tax.

There is a particular risk of dishonesty when an earmarked tax is presented as a way of increasing public spending, as for example with the Government's proposed Congestion Charges, which local authorities are required to spend on improving local transport. Councils, after all, already spend money on transport: how do we know how much they would have spent in the absence of the new congestion revenue? Such revenue might prove more than they really want to spend: it will surely then be tempting to reduce their original allocation and redirect it to some other need, such as schools. But if this occurs then Congestion Charges will not, in fact, be a way of getting more money into transport: it will go into education instead. Is this what the public will be told?

The Fabian report considers these arguments very carefully. It comes to four conclusions.

First, earmarking cannot be a general principle of government accounting. For most of its revenues – at least 80% – the Treasury needs the efficiency guaranteed by a flexible system.

Second, however, earmarking is appropriate for incentive-based taxes which seek to change behaviour, such as environmental and transport taxes. Earmarking in these cases can be flexible, but only in one direction. The designated spending area need not be fully funded from the tax: but all the tax revenues (or all of a fixed percentage of them) must be spent on that area.

Most environmental taxes in the UK already in fact operate in this way. A specified 20% of the revenues from the Landfill Levy, for example, have been earmarked since its inception for environmental spending. Similarly, around 15% of the revenues from the new Climate Change Levy (to be introduced in April 2001) will be going to energy efficiency programmes. Congestion charges are also to be earmarked, as we have seen.

Earmarking here has an important environmental purpose. Many environmentally damaging activities are 'inelastic' in form: that is, they are not very responsive to price. (Driving is an example, energy use another.) The tax will therefore have some impact on behaviour, but not as much as we might like. Allocating the revenues from the tax to the problem can then help to increase the elasticity of response: improving public transport, for example, makes it easier for people to drive less, while providing energy efficiency grants helps firms cut their energy usage. At the same time, earmarking can increase the public acceptability of the tax. Most people now accept that environmental damage has to be dealt with, but will be much happier about paying higher environmental taxes if the revenues are being used to tackle the problem than if they are simply going into the general Treasury coffers.

The report's third conclusion, however, is that the relationship between existing and newly earmarked spending must be transparent. To avoid any hint of political dishonesty, a 'baseline' of existing spending must be established, to which the new revenues must be clearly additional. Such a baseline needs to extend at least five years into the future, so that the public can be sure that the earmarked tax revenues are genuinely going to increase expenditure in the designated area. This will be particularly important for Congestion Charges.

Fourth, and most radically, the Fabian report recommends that a fully hypothecated tax for the National Health Service be introduced. Simply explained, the proposal is for income tax to be split into two. Half would become a fully hypothecated health tax, from which all NHS spending would come. The other half would become General Income Tax, allocated as normal between other areas of government expenditure along with the revenues from other taxes. Since tax revenues fluctuate with the economic cycle, while NHS spending clearly should not, the revenues would go into an 'NHS Fund' to smooth the path of spending. The tax rate would be set at a level sufficient to finance planned NHS spending over the economic cycle: in boom years the Fund would build up a surplus, which could then be spent in leaner times.

The arguments in favour of an NHS tax are the same as those for earmarked taxes in general. It would increase the transparency of the tax system, thereby making it clear to the public what they were paying for. In turn, this would make it easier to raise the health tax to pay for higher health spending. At present, health spending is rising quite quickly, but because there is a general constraint on tax increases – since it is believed the public will not put up with them – other areas of spending are inevitably being squeezed. An earmarked NHS tax, it is argued, would release the constraint, allowing higher spending not only in health but on other areas too.

The Fabian report provides some evidence for this. The Fabian Society commissioned a special opinion poll. We asked people if they would pay an extra 1p in the pound on income tax for general public spending. Forty per cent of respondents said yes. But when they were asked if they would pay this if the money were specifically going to the NHS, this figure doubled to 80%. (In each case respondents were told how much extra tax this would mean for them.) Earmarking, it seems, could solve the tax conundrum: by convincing people that the money was really going to the service they care about, it would make people willing to pay more.

But equally, the report sets out the objections to an earmarked NHS tax. First of these is the risk that earmarking would prove the thin end of the wedge to a 'pick and choose' approach to taxation and public spending which actually reduced the overall willingness to pay. Of course, critics argue, the public will happily pay more tax for 'deserving' areas such as the NHS. But they will then seek lower spending and taxation for 'undeserving' or otherwise unpopular areas – for mental health services, say, or asylum seekers, or defence, etc. Indeed, reaction might go even further than this, leading to a 'benefit principle' approach to taxation. An earmarked NHS tax may encourage people to believe that taxes are just payments for services they benefit from individually, rather than contributions to the general good. Those paying private health insurance, for example, may seek an NHS tax rebate: under this principle, the legitimacy of the whole system of general taxation – and the proper funding of public services – could begin to unravel.

The report also notes that the proposed 'NHS Fund' makes the health tax rather less transparent than it looks at first sight. It would not be true that whatever was paid in tax in any year was spent on the NHS: in some years the Fund would build up surpluses, which might be difficult for the public to accept, while in other years it would have to pay back debts. Critics fear that such debts would never in fact be paid: frightened of putting up the tax, politicians would just let them accumulate until (like the debts of the old nationalised industries) they were eventually written off, thereby destroying the earmarking relationship.

Amidst the noise of inter-party conflict we are unlikely to hear very much about earmarked taxes in the coming general election. But the subject may well return during the next Parliament. Few people in the National Health Service – or indeed in many other areas of spending, such as education or social services – believe that the Governments' increased spending plans, significant though they are, will end the crisis of funding in the main public services. Some time in the next Parliament this will become clear. We may expect a return to this proposal then.

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Can the British public be 'reconnected' to their taxes sufficiently to get them to vote to pay more in tax? The Commission on Taxation and Citizenship found enough evidence to suggest that they might. For however deep their alienation, the people we met had not given up on taxation and spending altogether. If they could be convinced that the money really was being well spent on the services they most cared about – health and education – a significant majority of our respondents, in both qualitative and quantitative surveys, said they would be prepared to pay more in tax. It was a big "if", but that is the point. Tax and spend is not enough. Today it must be 'tax, spend, improve and connect'. If all four elements are included, Labour can take this oldest of political arguments on to new and potentially vote-winning territory.

The potential prize here is substantial. For twenty years the Conservative Party fostered a lie: that Britain could have good public services at the same time as taxes were kept low. As the British public look around at broken railways, decrepit hospitals and failing schools the consequences are plain to see. After six years acquiescing in the same illusion, the Labour Government has now begun – cautiously – to face the electorate with the truth. It is not a moment too soon, but the task has hardly begun.

Michael Jacobs is General Secretary of the Fabian Society, London

The Commission on Taxation and Citizenship's report, Paying for Progress: A New Politics of Tax for Public Spending, is published by the Fabian Society. It is available direct from the Fabian Society at 11 Dartmouth St, London SW1H 9BN, UK, priced £9.95 plus £4 p&p (Europe).
Tel: +44 (0)20 7227 4900. Fax: +44 (0)20 7976 7153. Email: info@fabian-society.org.uk

The opinions expressed in publications of the Friedrich-Ebert-Stiftung London Office are those of the author(s) and do not necessarily represent the views of the Foundation.


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