Election '97: Welfare state caught in tax tug-of-war

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Taxes will have to rise or the welfare state will shrink, no matter which party wins the election, according to the Institute for Fiscal Studies, an independent think-tank.

In a report published yesterday, the IFS predicts that the Government's borrowing requirement would fall this year - thanks to the booming economy. But if the two main parties stick to their pledges to keep borrowing low over the longer term, either spending must be lower than planned or taxes higher.

"Either the current shape of the welfare state will be maintained and the next government will have to spend - and tax - more than planned, or the welfare state will shrink and provide fewer services to fewer people," it concludes.

The IFS calculates that, despite the prospect of a rapid reduction in the gap between government revenues and spending, either party would have to deliver a tough budget reducing borrowing by some pounds 10bn in order to satisfy manifesto pledges.

It also cast serious doubt on the possibility of any government hitting the current spending targets. The report calls the plans "very ambitious indeed", noting that the 0.4 per cent a year real growth in expenditure pencilled in for the next five years would be the lowest in any parliament for the past 80 years.

The IFS identifies the National Health Service budget and public-sector pay as the pressure points. Current plans have a rise in health-spending this year followed by two years of zero real growth. Not only is this far tougher than any previous plans, but health-spending has also overshot its target by far in every year except 1991.

Unless taxes rise, the result will be a steady increase in private spending on services such as health and education. The report notes that Britain is a low-tax country by international standards, and virtually the only industrialised economy where the tax burden had not increased by very much since 1979.

"These are things that nobody is talking about in this campaign," said Paul Johnson, deputy director of the IFS.

He said the Tories' planned pension reform, involving privatisation of the basic pension and creation of new personal pension funds, was particularly radical and could form the model for further shrinkage of the welfare state.

The document offers some shreds of comfort to both Conservatives and Labour by confirming that we are better off than at the time of the last election, but are also paying an average of pounds 7 a week more in taxes. Each pounced on the finding that best suited them.

However, it criticised both of the main parties' income-tax proposals as expensive measures that would not help the poor. "You can't help people on low incomes by cutting a tax they don't pay," said researcher Julian McRae. The IFS also found fault with Labour's plans for a minimum wage and a windfall tax, and with the Conservatives' transferable tax allowance.

The minimum wage would be of most benefit to households in the top half of the income distribution. The Tory plan to allow the non-working partner in a married couple to transfer their tax allowance to their spouse would undermine the principle of independent taxation, create a big disincentive to work, and be complex to administer.

Business comment, page 23