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.

7 thoughts on “The NHS makes Britain a high-tax nation. Tories need to get over it”

  1. “That achievement seems to have fostered an illusion amongst many Conservatives – that lower tax rates pay for themselves by creating economic growth …”

    They have it partially right. The problem for the left is that they are wedded to the concept of tax and spend which means that when they do back of envelope calculations on the amount they’ll need “to pay for it” they frighten off their potential electoral support. So they have it more partially wrong that partially right. The Lib Dems are worse than any other with their ‘put a penny on income tax’ for this and another for that mentality.

    The Tories, and the right in the US too, only have it partially right so end up doing some of the right things for all the wrong reasons. We first saw this with President Reagan who somehow convinced himself that the Laffer effect was genuine, when all he was doing was providing a fiscal stimulus to the economy by reducing taxes.

    A reduction in taxes doesn’t necessarily reduce the tax take just as an increase in taxes doesn’t necessarily increase it. Government spending will always come back as taxes sooner or later. Sooner if everyone else saves less, later if they save more. So an increase in spending or reduction in taxes is likely to produce more growth and an unchanged fiscal deficit over the longer term unless saving patterns change as a consequence.

    The limitation to a reduction in taxation and an increase in spending is of course is inflation. The question of NHS and social spending has to be about the available resources in the economy.

    It could be that there are aren’t enough. In which case it may be necessary to consider whether to get them from elsewhere else. Some elderly people might wish to spend their retirement on the Med in Greece, for example, so it could make sense to ship out our elderly! Only with their consent of course. The same with NHS routine operations which may be cheaper elsewhere.

    The alternative, as you suggest, is much higher taxes. But no-one is going to get elected on being honest about that so some lateral thinking is needed to avoid a collapse of the system with the Tories permanently in government.

    1. I think you have it the wrong way around about the left’s tax-and-spend. The right paints scare stories about the profligate left, whose answer to all problems involves spending public money, and how this will lead to eye-watering tax rises. The left feels it has to show it has properly thought it through – and show that it will all take less tax than the other side says. Economically sophisticated arguments don’t cut it. Still, whether you are right or I am it adds up to a very big problem for the left. My belief is that very high taxes are needed to deliver the sort of health service the public wants, alongside other public services. But I agree that the lot saying so could lead to perpetual Tory government. A hypothecated tax is probably the best way through (and why the “penny on income tax” imight a step in the right direction though of itself inadequate). Some Tories are genuinely worried about naming the new tax a health and care levy, as the only way it can go is up. If the Tories start it then maybe others can build on it.

      Incidentally I do think that Britain can do the bulk of healthcare itself even at double the volume and a demographic squeeze, with a bit of strategic thinking from government. It is mainly a people and property business and the UK even does a lot of pharma manufacturing. It means developing a proper pipeline of trained people. Still outsourcing abroad could be part of the mix. To be sustainable though some other forms of consumption will have to be contrained – I am less sanguine than you are about current account deficits in the long term – though I accept that some level of deficit my well be sustainable. And that’s why I think this points to more tax

  2. This post seems right in accepting that , left to themselves, people would want to spend more on their healthcare than is currently the case. This is demonstrated by experience in Switzerland, which offers its citizens two health insurance schemes, one involved more expensive levies and better service than the other; the majority of Swiss citizens choose the more expensive option. So, in political terms, it ought to be possible to get more money into our health service, provided it is genuinely universal. But the wealthier segment of UK citizens are increasingly turning to private health care, thus threatening to cut off public support for increased state spend/

    And the solution? I would say that hypothecated taxation needs to be part of it, as that populist Johnson seems to realise. But on this principle high income pensioners (in which I am fortunate enough to include myself) do need to pay more than under the Johnson approach. Under the radar ‘topping up’ is rife, when people turn to the private sector to avoid long waiting lists, while using the basic NHS system where it still functions well. O for a more rational world!

  3. There is a general argument that if we want better government services that we have to pay more for them, which is of course true, but how much more do we have to pay? It is often pointed out that the GDP share taken by Govt in the UK around 38% whereas it is 45% for Germany and around 50% for Denmark.

    So do we simply need to divert another 10% or so of national resources from the Government to the private sector? It’s not quite as bad as that.

    If we look at the sectoral balance equation we have that:

    S=savings, I=Investment, M=Imports, X=Exports, T=Taxation Revenue, G= Government Spending

    Or T = (I-S) + (X-M) + G

    So the usual argument is that, if all else remains the same, (which is always a dangerous assumption to make in economics) then T must increase if we want G to increase too.

    But what about (I-S)? We can spend more if we push this term to be lower. In other words we encourage everyone to save more. This is what we saw happen during wartime with the sale of war bonds. Also rationing meant that there was less to spend money on in any case so encouraging the saving process.

    And the there is X-M. We need to make this lower too. In other words imports are good! This is where we do have a natural advantage over the export surplus junkies of Denmark, Sweden and Germany. We run a trade deficit which means we don’t have to raise taxes to their levels to be able to have the same levels of service. If we ran a £100 billion surplus in trade rather than a £100 billion deficit we’d have £200 billion more to raise in taxes.

    1. The accountant in me bristles. This is an argument built on flows of resources. Admittedly this is much more important in economics that in accountancy (where it is the profit and loss account). But how far can you go in ignoring the national balance sheet? Financing government through extra saving means selling lots of bonds, which in theory have to be repaid someday. WW2 was followed by a period of austerity. Using net imports means building up debts with foreigners, or selling off your own foreign assets. One answer to both problems is simply to create the money to settle the debts, as we control the currency, and the bulk of the debt is still denominated in pounds. But the underlying question is whether any change in flow is temporary and when will it go into reverse. In fact we have already been living of net imports for some time. This seems to be financed largely by capital inflows with foreigners buying up British real estate and businesses. That’s probably quite benign, but it does suggest that there are limits to this strategy.
      As for saving, the most effective way of increasing this seems to be letting inequality run riot – as the rich save more. This has been offered as an explanation of “secular stagnation”. If that’s the case then raising taxes on the rich won’t have much effect, but might make the balance sheet easier to manage.
      But, I suspect, the argument will be driven as much by feelings of equity and fairness as the raw economics. Nevertheless the Tory preference for fiscal discipline does look a tad irrational. The high levels of inequality that they favour mean that the government can be much more profligate, and so it is easier for them to stay in power. Boris seems to grasp this if nobody else does,,,

      1. I agree with some of what you say. However, it is a matter of simple accounting that exports are a real cost. If exports and imports don’t balance then someone has to pay the differences in the short term. Whether they will ever come to be repaid in the longer terms is a moot point.

        There are downsides to running both a large trade surplus and a large trade deficit. The first leads to higher taxes than are necessary. The second, as you say, creates long term international debt issues. It makes sense to take the matter of trade balances much more seriously than we do, in all countries including both the UK and Germany. The naïve neoliberal assumption that currency movements, and the operation of the market generally, will fix any problem just isn’t working. We all should consider how best we can move to a position of more balanced trade.

        1. Well I certainly agree with you there. A trade balance may not be right, but big imbalances don’t look sustainable. Germany is now dealing with a legacy of under-investment while Britain is selling any asset it can to foreigners…

Comments are closed.