The NHS makes Britain a high-tax nation. Tories need to get over it

The most significant political development here in Britain in the last week was the government’s announcement that it is going to raise National Insurance by 3% of income (1.5% each to be paid by employer and employee) to pay for additional short-term costs in the NHS and longer term costs of social care. Alongside it were announced a sketch for the future public funding of social care. This is a reversal for the Conservatives, who had promised not to raise rates of Income Tax, NI or VAT, which has caused consternation among many Tories. They see their dreams of Britain being a lower-tax country ebbing away.

With this new tax the proportion of national income taken as tax will be historically high – though I read differing stories of just how much. When I first started to work calculating PAYE and such in a small accountant’s office in 1976, the basic rate of income tax was 35%, and the top rate was 83%. On top of that “unearned income” was subject to a 15% surcharge, which could take the top rate up to 98%. Then there was National Insurance – admittedly at a much lower rate and capped so that it did not apply to higher levels of income. Corporation Tax was 52%. VAT was only 10% (or 8% on some goods I can’t quite remember), compared to 20% now – but I find it very hard to believe that the country is even close to raising as much tax relative to income as it was then. Maybe I’m missing something. It was a signal achievement of Margaret Thatcher’s government (1979 to 1990) that it cut these rates drastically without destroying the nation’s finances.

That achievement seems to have fostered an illusion amongst many Conservatives – that lower tax rates pay for themselves by creating economic growth – and the effect would be doubly beneficial if wasteful public spending could be cut too. They could point to successful countries with lower rates of tax: such as the USA and Japan – whereas many European countries were regarded as basket cases, suffering from excessive tax. Such people, often styled as “economic liberals”, dominated the Conservative/Lib Dem coalition of 2010 to 2015, and David Cameron’s majority Conservative government that briefly succeeded it. These governments drove forward a period of austerity, in which many areas of public spending were cut drastically, and spending on other areas, such as the NHS, failed to keep up with increased demand. Taxes did not fall so much, though. Personal tax allowances were raised – but tax collection was tightened up. This period should have awakened Tories to the fact that big tax cuts are off the political agenda in the UK. It required huge amounts of political capital just to stand still on the tax and spend equation.

At the heart of this reality is the National Health Service. Unlike most developed countries, the bulk of Britain’s health care is supplied for free through this nationalised utility. This must be funded by taxes (or if you are a follower of Modern Monetary Theory, taxes are required to ensure that the spending is not inflationary). Private health services exist alongside the NHS, but in most cases a wall is placed between the two. You cannot top up your NHS care with private money. Such are the egalitarian principles behind the NHS.

When the NHS was set up in 1949 it was widely thought that health services were like any other utility – such as the drains. Demand would be contained at a particular level when health needs were met – few people become intentionally ill after all. This has never happened. Health care has extended its reach as new conditions come within its scope, and new treatments become available.

All this is generally understood. But what economic liberals often fail to grasp is that if some perfect market mechanism could be found to supply medical services, backed by a perfect social insurance system, then the overall demand for medical care would be very high. In other words people would choose to spend on health services over and above other sorts of consumption. The consumer appeal of reducing pain and extending life has a strong competitive appeal. It is unknowable how much this hypothetical level of demand is – but to get some idea of how high it could be, look at the USA – where healthcare costs 18% of national income, notwithstanding high levels of unmet demand. In Britain the ratio is about 10%, with a lower income per head. So Britons get to spend 8% more of their income than Americans on other things. But other things they probably don’t want as much as better healthcare. They just have no good way of using their income to achieve this because of the way the NHS is structured, and because their political leaders have imposed such a draconian cap on costs. The NHS tops international league tables for value for money – but not for health outcomes. That is not the right way round. In one view the design of the NHS means that demand for health care is exaggerated, because it is free at the point of delivery. In practice the NHS acts as a constraint on demand, because it makes it hard for consumers to use their own money to get what they want.

Other health systems are better at drawing in private money to supplement taxpayer funding. This is done by not imposing a segregation between public and private systems – typically by using an insurance system underwritten by the state. Well-working examples include Australia and the Netherlands (America, on the other hand, is a horrible mess). Alas this not an option for the United Kingdom. The NHS and its egalitarian principles are a national religion that no politician dare touch. Since all health systems have serious drawbacks alongside their advantages, it surely makes sense to try and make the NHS system work better, rather than replace it with something new.

But making the NHS work properly means ramping up the level of funding so that it is closer to the level of “natural” demand, alongside taxes and fees that distribute costs fairly, reflecting that it is a form of insurance. To his credit Labour Prime Minister Tony Blair understood this when, in the early 2000s, he decided to just that, reversing many years of constrained spending. To balance this he and his Chancellor, Gordon Brown, raised National Insurance. At one level this makes sense. This tax is the closest we get to an insurance premium, paid while people are in work, and drawn down in retirement – alongside taxes on tobacco and alcohol, two big drivers of healthcare demand. However the Treasury hates the idea of hypothecated taxes, and there has been no attempt to fund the NHS actuarially. National Insurance is lost in general taxation. Alas Messrs Blair and Brown fatally misread the economy and cut income tax at the same time, all the way down to 20% for the basic rate. That was because of buoyant capital receipts from Britain’s booming capital markets. That income evaporated in the financial crisis of 2007 to 2009. Beyond a little tinkering with top rates, it has been considered toxic to raise income tax rates since Mr Blair promised not to do so before he was first elected in 1997. That is unfortunate because it is clear this tax that should be raised, rather than NI, as it would take money from better-off pensioners (people like me, in fact) who have not done so badly from the austerity years, but who can expect to be using NHS services more.

This problem will come back to haunt this government, or, more likely, its successor. The extra 3% on NI may be enough to keep the NHS going for now, but it surely cannot do the job on social care as well. The wider economy may give governments more time, through growth and with greater scope for budget deficits than the Treasury is assuming. In the long run though, the NHS means that the UK will be pushing its way up the league table of higher tax countries. Conservatives need to get used to that fact.

20 years after 9/11, the terrorists have failed

Pessimism is the prevailing wisdom of the times. So it is for most commentators looking back at the terrible events of 11 September 2001. In The Times Gerard Baker’s article is headed “Awful truth about 9/11: the terrorists won“, which the editor says “has the ring of truth”. The veteran BBC correspondent John Simpson has been saying much the same thing. This is what the public wants to hear: the glass must always be half empty. But the half full case needs to be made.

The muddle starts with what you think the terrorists were trying to achieve. Messrs Simpson and Baker assume that it was really rather limited: to promote their ideology, and to take America down a peg or two in its world standing. This framing perhaps comes from America’s “War on Terror”. I would accept that this was meant to stamp out jihadism and to maintain America’s world standing. And I have no difficulty in accepting that it has failed. Jihadism rumbles on; America’s standing has taken a knock in the last couple of decades. But wouldn’t his have happened without 9/11? America’s power, or rather its power relative to the rest of the world, has clearly diminished. This is mainly because of China’s rise. That is a product of successful policy in China itself, rather than anything America did or did not do. China’s resources are massive; the curious thing is why its global standing had been so low for so long. It is slowly moving towards its rightful place. Inasmuch as this has meant many millions being lifted out of poverty, that is something to celebrate.

Jihadism also persists. But this is not as the international network whose aim is to bring down western civilisation – but more localised rebellions, building on the resentment of the left-behind against corrupt elites. This is on the rise in parts of Africa and the Middle East. It was present before 9/11, and did not need Al-Qaida to to push itself forward. and I don’t see its rise as a failure of Western policy – but the result of poor governance in many less well-off countries. It would surely have happened anyway.

But the aims of Osama bin-Laden, Al-Qaeda, and Islamic State who followed them, were and are much broader. They wanted to destroy the West by provoking a global clash of civilisations, in which force the oppressed Muslims to take sides, and would eventually bring down the decadent, materialist West, who lack of moral fibre would do for them in the end – and doubtless the decadent, materialist Russia and China too. At first things went well for them. America’s “War on Terror” played straight into their hands, especially when they decided to extend it to an attack on Iraq. This indeed provoked anger, and America and its allies found it hard to sustain their early victories. Meanwhile jihadism attracted a following among people in Western countries who felt powerless and marginalised. Their biggest success occurred more than a decade after 9/11, when the Syrian civil war created space for jihadists to become established. This was because the Syrian regime pushed anti-government forces into their arms, while the West stood back. But when they tried to exploit this space to fuel terrorism in Europe, this time by IS, the West acted and caused their collapse. But Western leaders had become cannier. Once IS has been destroyed they pulled back. They were happy to leave the jihadists to their fate in a messy but localised civil war, with Iran, Russia and the Gulf Arabs jockeying for advantage.

Meanwhile in Western countries jihadi terrorism has dropped off to a low level, with little serious organisation. It has clearly lost its cachet amongst the discontented. Security types worry that the Taliban victory in Afghanistan will change that; it’s their job to worry about that sort of thing. But jihadism does not look like a path to global victory, but an exercise in futility. Afghanistan is an exception. In North Africa, the Middle East (and not least in Palestine) and the rest of Asia Sunni Muslim militants look further than ever away from achieving their goals. And Afghanistan will doubtless start to look messy in its turn. For jihadism to maintain momentum they needed Western armies to go into Muslim countries and provoke retaliation. Now they are gone. It took time but Western leaders have finally understood what this war is all about and how to win it.

And that, rather paradoxically requires a dose of humility. It requires accepting that not everything that goes wrong in the world is a matter of policy failure in the West. Others have agency too. There can be no crusade (a word that means much the same as jihad) to promote Western values. If these values win out, it will be because of their inherent virtues, as the alternatives break down. And their the picture looks much more hopeful.

The developed world’s business model unravels. Is that a good thing?

Free trade and globalisation; just-in-time supply chains; the supply of cheap labour (such as lorry drivers or fruit pickers); each of these has been a critical aspect of economic development in the last twenty or more years in developed countries. And almost every day I read an article about each of these is unravelling. This feels like a profound reversal – but what will it mean?

I can’t help thinking back to my management training in the late 1990s. There was one segment called “The Power of One”. The idea was that if you improved each aspect of your business by a small amount (“one”, which could be 1%), the overall effect on profitability could be profound. Profit is the difference between two large numbers – so improving each of those numbers by a small proportion has a disproportionate effect. If your revenue is 100 units, and cost is 98, your profit is 2. If you increase revenue by one to 101, and cut costs by one, to 97, your profit is 4 – double. This was part of an era of tight micromanagement and of continuous, incremental improvement. Alongside this came a trend to break up business processes amongst specialists by outsourcing – and often this was to businesses based in places where labour was cheap. Or sometimes to agencies that could procure cheap labour, often by using immigrant labour. This gave managers more ways to exert the Power of One, often using the oldest management technique of all: bullying. The changes might be incremental each year, but over time the effect was profound. Complex supply chains and cheap labour became embedded in rich world economies. Some big businesses, such as supermarkets, became very powerful; others, such as farmers and haulage businesses were squeezed dry.

By and large economists applauded this process. Prominent liberal economist and Nobel laureate Paul Krugman once said “Productivity isn’t everything, but in the long run it is almost everything”. Human wellbeing is measured by the amount people consume (well it isn’t, economists admit – and then fail entirely to to act on this insight); in the long run to consume more per person people must produce more per person; that is the definition of improving productivity. Add to the mix gains from trade, a favourite concept of economists, and the gains made in the 1990s and 2000s through tighter management would be bound to lead to gains for everybody in the long run. Economists deal in aggregate numbers and sweeping generalities – their’s is not ask what is really happening beneath the numbers; that’s mere logistics that the little people like accountants are there to manage. But non-economists were not so sure that all was well. They pointed to a number of problems: inequality, exploitation, sustainability and resilience.

To many the rewards of all this productivity improvement were skewed. True, many things became cheaper and inflation was reduced to a small number – but the lives of many workers and small business owners were squeezed by the culture of continuous management bullying, and their livelihoods became less secure as work became here today and gone tomorrow. The big, powerful businesses controlling it all were not necessarily all that profitable, as they often competed intensely with each other, but they were controlled by small elites who were able to corner good incomes for themselves – a reward as they saw it, of making their business more efficient. And there was a strange shadow world of highly-paid professionals designing these complex systems and keeping them in being, in finance and consultancy.

But the inequality problem went deeper than that. Many of these techniques are about the use of cheaper labour (not all – just-in-time management is about inventories) , either by outsourcing to places where labour costs are low, or by importing workers from such countries. Economists are relaxed about this. Wages are low in less developed countries because productivity is low there. Trading with them helps the raise productivity and wages, so both sides gain. This is more of a stretch if the workers themselves are imported – but there is evidence of benefits to the exporting country in that case too. There are a couple of problems though. Labour standards are often lower and this is often exploitative and unethical. More fundamentally, it can only be a temporary fix. Living standards and wages rise in cheap labour countries (look at the succession of countries where this has happened – Japan, South Korea and now China) , and immigrant workers integrate into their new home.

There was also a hidden cost: to sustainability and resilience. Farmers were forced into methods that sucked the land dry (figuratively – depriving the soil of nutrients rather than water), and culled biodiversity. Few people want to be lorry drivers, and their average age is rising. And when there is disruption, such as an earthquake in Japan or a container ship grounding in the Suez Canal, chaos ensues right around the world. Never mind a global pandemic. Suddenly, the world is full of production and transport bottlenecks.

And so it has all started to unravel; the gains are being unpicked and reversed. The changes have been happening for a decade or more, but the first conspicuous reversal came with a political backlash that economists are prone to dismiss as “populism”. In 2016 Donald Trump railed against outsourcing, immigration and foreign trade deals. And in power he did his best to put the clock back, most successfully in trade. In the same year Brexit campaigners also exploited discomfort with free trade and immigration. The outcome has been a profound disruption to many businesses, as buying things from the European Union has become harder (and selling things there), while the pool of flexible European labour has diminished.

Brexit means that the shift has been particularly acute here in Britain – but Brexit has merely accelerated trends that can be seen right across the developed world, and which the Covid-19 pandemic has also accelerated. This has created a very challenging environment for many businesses, and it will surely mean that the prices of many goods will increase, and living standards, as measured by economists, will fall. But before we get too gloomy about this we need see it all in a broader perspective.

Firstly, most of this is about “stuff”: things that need to be moved around by ship, train or lorry. Productivity levels for stuff are already very high, to the extent that it plays a much smaller role in the economy as a whole than it used to. Manufacturing and agriculture account for less than 20% of British national income, compared to over 70% for services. Furthermore there is a lot of over consumption. Most clothes that are bought are only worn rarely. Who really needs an SUV with a max speed over 100mph to do the weekly shopping? Vast amounts of refuse is generated. Consumption of yet more stuff is not going to be the route to improved wellbeing. We can adapt to consuming less across our society without an adverse impact – even recognising that a significant minority of people would benefit from an increase in consumption.

Secondly, it is good thing if many people in lower-paid jobs (which I will not call “low-skilled” as the Home Office does) have more bargaining power. We are long overdue for a reversal of the balance of power between workers and capital, which has tilted towards the latter from the 1980s. This is why incomes have been skewing towards the better off. Whether what we are witnessing is enough to be such a reversal is another matter – but it is surely a step in the right direction.

And thirdly there are other ways to improve productivity. Automation may destroy jobs, but, as economists don’t tire to point out, it leads to the creation of others. Good process management, another 1990s idea, but one that failed to catch on as much as it should, could improve many industries, especially in services such as health care. It failed to catch on because it involves delegating more power and responsibility to lower levels of the organisation – something that senior managers and regulators like are uncomfortable with. Many observers suggest that the shock of lockdowns has spurred innovation and productivity improvement.

So it may not be a bad thing that the world is changing, but all change is disruptive, and the main victims of disruption, in the short run, are usually the less well off. But in the short term most of will find it harder to get many of the things that we want. there will be more self-service. But it may a step towards making the world a better place.