188. How Politics is Bankrupting Britain

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1:20Hello and welcome to The Rest is Money with me, Steph McGovern. And with me, Robert Peston. Today, we are delighted to have a regular on this programme, Paul Johnson, who is head of the Institute for Fiscal Studies. And it's a big and emotional moment because we are recording on his very last day in the job, essentially as de facto policeman of the nation's finances and whether chancellors are behaving responsibly. and he's been doing this job since 2011. Yeah, and what a time we've had in that 14 years that he's been in charge of the IFS, as you say, keeping an eye on everything that the government's been telling us and deciding fiscally in that time.

2:08So because we've got so much to talk to him about, we're going to split this in two, aren't we? So today we're going to focus on what's happening right now. There's been some really interesting research that's come out from this annual report from another acronym, the OBR, Office for Budget Responsibility. So we want to talk to him a bit about that and where we're at. And then in a second episode, we're going to go back through his career and just look at, you know, what it was like when he came in and that Cameron Osborne years in 2011 to take over and, you know, where we've gone through in that time and what he'd do if he was Chancellor as well.

2:42But we're going to start, first of all, looking at the now. So here's our interview with Paul Johnson. So, Paul, we've just had the annual assessment by the Office for Budget Responsibility of the strength, or in this case, we should say weakness of the UK's public finances. I suppose the question where I wanted to start was, obviously, there's a lot of focus at the moment on the importance of the so-called fiscal rules. These are these rules which are supposed to limit how much the government borrows to pay for day-to-day spending and how much our national debt rises. Now, we've had these sorts of fiscal rules now for well over 25 years.

3:30And yet, over that time, debt and deficit has been rising at an extraordinary rate. Reconcile these two phenomena, as it were. On the one hand, we've got governments saying managing debt and deficit really matters, and we've got strict rules. And on the other hand, they've just not worked at all in limiting borrowing and the rise in debt. What's going on? Good question. And I mean, that OBR document in somewhat civil service-ish tones is really quite concerning. I mean, it refers to our fiscal situation as, quote, relatively concerning, and shows how our debt, our deficit have risen much faster than nearly all other countries over the last 25 years and how actually we're paying more interest, a higher rate of interest on our debt than any country in the OECD other than Iceland and New Zealand.

4:25This is quite concerning stuff. So how have we got there? Well, I think partly it's because our fiscal rules have always been forward-looking in the sense that they're aiming at something in five years' time and literally five years' time never arrives in the sense of the fiscal rules because it's always if we do this, that and the other, where would we be in five years time? It's partly, of course, because we have had a number of extraordinary shocks over this period. I mean, the financial crisis being still much the biggest and much the longest lasting of them. And then when we've had those shocks, we've kind of chucked everything away and started again in terms of fiscal rules.

5:03We did the same around Brexit. Obviously, we've had the big issue around COVID. And I think to some extent, governments have somewhat gained these rules in the sense of saying, well, if we commit to these really big spending cuts over the next period of time, then we'll get to a good position fiscally. It is worth saying, we did on one occasion meet just the aim of borrowing only for investment, which broadly speaking is what all of the governments over this time have done. When was that? Only once since 2010. That was in 2019. So just before COVID, we actually got there. And then, of course, COVID struck.

5:43But when you say about the financial shocks and things, everyone's had them. So why are we the worst? Giving you the starkest counter example, Germany's national debt has not risen since the financial crisis, or at least not significantly. And they are in a way stronger fiscal position. They've got other problems, industrial problems of a very significant sort. But why is it that Germany has been able to limit the rise in its national debt in a way that we just haven't? Well, I think there are several answers to that. One is that they're actually they've got much stronger constitutional rules about what they're able to do in terms of borrowing.

6:23They were hit much less hard by the financial crisis than we were. I mean, our financial sector is much more important to our economy than it is there. They started off in a better position as well. And you're right, they're now in a much stronger position, both in terms of the level of their debt and their, broadly speaking, the interest rate they're paying on is about a full two percentage points less than we are. And so they're going on a massive spending splurge to regenerate their economy in a way that we just can't afford to do. Well, exactly. If we were paying the same interest rate on our debt as they are, we'd be about 50 billion quid a year better off.

6:57I mean, it's that scale of magnitude of difference that we're seeing. And you're exactly right. They now have the financial firepower to do far more than we possibly could at the moment. And obviously one of the worries that we face is, given where we are now, if we had another crisis, how much firepower would we have to deal with it? One of the many warnings that the OBR makes is we do not have the financial cushion to absorb another shock without incredibly serious damage to the public finances. And as all of us know, there will be another shock. You know, the notion that we live in a world where there aren't financial crises is absurd.

7:45Absolutely. I mean, they seem to be coming along more frequently as we go through. And it's one of the reasons why it's so important for governments when we are in non-crisis times. And whilst today doesn't feel very easy, we are in a sort of non-crisis time. It's so important to really get these fiscal numbers, get the borrowing and so on under control. And as the OBR has shown, broadly speaking, we have failed to do that. There are sort of two issues, though, aren't there, or rather two time horizons. There are the short term horizons where the deficit and debt is pushed up because either we have a shock like COVID, where government spending went through the roof, or the financial crisis where government spending and borrowing goes through the roof.

8:38or politicians make short-term profits about fixing our schools, fixing our hospitals, all perfectly reasonable promises to make to the electorate. We all want decent schools and hospitals. And those two will inevitably constantly put the ratchet up, as it were, the national debt. But then there's another issue. And this is one of those things that the OBR has historically focused on to almost zero effect when it comes to influencing politicians, which is there are these massive long-term liabilities, whether it is the cost of an ageing population, which means the cost for the health service are rising exponentially, whether it is the cost of paying.

9:23One of the things that this report says is that the cost to the public purse of the so-called triple lock that is guaranteeing to pensioners that the state pension will go up by a minimum of inflation earnings or two and a half percent. They say that will cost, is it 15.5 billion? But it's three times over the next few years what it was originally forecast to cost. And then if you go decades out, the cost of maintaining living standards for older people relative to a shrinking workforce get even bigger. And politicians are incredibly bad at tackling these long term liabilities. Well, I think that's why we need to take, again, responsibility with the fiscal numbers really seriously, because we focus every budget, every year, you know, is the Chancellor going to meet her fiscal rules or whatever over the next four or five years?

10:19And you always get these calls from people saying, well, actually, it doesn't matter so much. Maybe we should loosen them. But everything gets harder, I'm afraid, as we go further through the next couple or three or four decades. It's not only the ageing population which you've referred to, and that will mean more money on pensions and health and so on. The Prime Minister, you know, just a month or so ago, promised another nearly£40 billion a year on defence. Now, that's completely unfunded. It may not happen. I mean, a lot of these international promises never actually amount to anything. But, you know, he's on the record of saying we will spend another£35 or£40 billion a year on defence by the mid-2030s.

11:02add that to the cost of health, add that to the cost of pensions, add that to the cost of climate change policies and so on. And we are looking at another really big increase in tax, presumably, over this period to pay for all of this following what is through the 2020s. The 2020s has been an astonishing decade or will be an astonishing decade because we will have seen a huge increase in the size of the state, a huge increase in tax over this period, whilst we've still got a really big borrowing problem but completely different from anything we've seen in the previous 50 years and it's really hard to see how that doesn't carry on into the 2030s and beyond.

11:41So I mean you mentioned there about the defence spending and you're saying you know that's unfunded it might never happen but then there are businesses that are changing their decisions based on that. I was at Harland and Wolfe in Northern Ireland a couple of weeks ago where You know, they've got this£1.6 billion contract to build these three ships over the next decade or so. You know, the ships that are going to support the Royal Navy and things. And this company is making huge decisions off the back of what is being told is going to be spent in the industry. You know, they're having to spend a fortune on training people up, getting the right skills, completely changing this old.

12:20You know, this business, Harland & Wolfe, has been going for a lot, you know, over 100 years. It's where they built the Titanic and, you know, they haven't built ships there since like 2002 or something. So they're having to completely modify everything and invest loads of money to do that. And isn't there a danger, you know, when you're saying something like this money might never come. And I'm not talking about that specific contract, but that money around defence. But how as a business are you meant to make any decisions if it feels so like fickle, I guess, and it might never happen? The initial increase in spending on defence is happening.

12:55I mean, that's in the numbers, and it is all going on building stuff. If you look at the numbers over this parliament, the additional defence spending, it's not going to pay for one more soldier or sailor. It's all going on equipment. Now, I've no idea whether that's the right thing to do, but that's the decision that's been made, and that is baked in. But the change that the Prime Minister has promised by the mid-2030s, by 2035, is on a different scale from the increase that we're seeing over this parliament. So, over this parliament, we're seeing an increase of, what is it, 0.2 % of national income or something.

13:30And then he's wanting to sort of triple or quadruple the scale of that over the first five years of the 2030s. Now, that's the commitment that was made at the international summit. That would be a huge problem for the public finances because that's a a really big increase in defence spending. That would mean, presumably, huge amounts of contracts for all of these defence industries. But if I was Harland and Wolf, I wouldn't be sort of at the moment banking on that bit of the increase happening. We've seen so many of these international agreements go by the wayside. I was in the Treasury. This is a different issue, but I think it's kind of telling.

14:08I was in the Treasury in the 2000s when there was this big conference at Glen Eagles where Gordon Brown helped push through this commitment for all of these nations that we get overseas aid to 0.7 % of national income. Now, the UK was one of very few countries that actually did that, despite everyone signing up to it. And now we've completely reneged on it. And no one kind of remembers those international commitments when other things, when other priorities arise. That's a sort of important and fascinating issue in its own, which we're definitely going to come back to. I also, though, wanted to talk about the vice that the current government is currently in.

14:48So we recently saw that Labour Party rebellion, backbench Labour MPs, rebelling against the welfare cuts, which were supposed to yield, I don't know, five and a half billion and are now yielding a big fat zero, because in the end, the government did not have the numbers, despite having this stonking majority, to push through changes to eligibility for disability benefits. Now, the markets have taken the view that this means that this is a government that is incapable now of serious welfare reform or indeed any kind of cut that would disadvantage those on lower incomes or vulnerable people. and therefore the markets have just taken the view that the only lever that the government has to pull is tax.

15:44And investors are not even confident that they'll be able to raise tax enough. So as I say, there are quite a lot of lenders to the UK who are just concerned that this issue of an unsustainable deficit and rising debt is not one that the UK will be able to manage. I suppose the questions here are, what is your view? I mean, I've got no doubt in my mind that Rachel Reeves is absolutely committed as chancellor to honouring her own fiscal rules. Can you envisage any spending cuts that this government could get past its backbenchers at the moment? Is it inevitable that in the autumn and probably subsequently that taxes will continue to rise, even though the overall take of taxation from the UK economy, the tax burden is, I think, at levels we haven't seen since, is it the 50s?

16:35Well, effectively ever in a consistent way. Yeah, I mean, usually governments have three levers. If they've got a problem with public finances, they can cut spending, they can increase borrowing or they can increase taxes. Well, we certainly can't increase borrowing. I mean, not just because we're up against this government's particular fiscal rules, but again, as the Office of Budget and Responsibility pointed out this week, these fiscal rules are about as loose a set of fiscal rules as it's possible to imagine. It's just that we're in such a bad position that even though they're very loose, we're barely meeting them.

17:09And we saw what happened last week when it looked like Rachel Reeves might be, her position might not be completely secure. The market's worried about changes to borrowing. An interest rate on our debt just zoomed up, you know, very, very fast before it came back down again. And that's because investors took the view that whoever replaced her would be, you know. The only reason for replacing her would be to have a looser fiscal policy. So I genuinely don't think there's space for more borrowing. And not just because of the very specifics of the fiscal rules, but because there just isn't more space for more borrowing.

17:41Spending, I mean, the public service spending numbers were set in the spending review about a month or so ago. And all experience tells you that what happens to numbers set in spending reviews is they never go down. They quite often go up later on. But, you know, the government's, the chance is not going to reopen negotiations with Yvette Cooper or Bridget Phillipson or something and say, actually, sorry, you're getting 5 % less. on welfare yeah if you can't if you can't do anything to disability benefits where we've seen a doubling a literal doubling in the number of people claiming these things coming forward and claiming each month and being awarded them and a vast increase in spending if you can't do anything with those then you might as well give up and go home in terms of welfare reform so that really does leave only taxes as the only thing the only the only space for adjustment now we don't know how much that adjustment might need to be in the autumn.

18:34I've seen all sorts of numbers floating around. The answer is we just don't know. This is very dependent on what the... But it's probably tens of billions of pounds. It's not going to be a few billions of pounds. It probably is. I mean, we don't know. It probably is, you're right, tens of billions. But again, it makes a big difference. If it's 10 or 20 billion, then that's the sort of amount that the chance they'll be able to find by some more freezes in income tax allowances and so on, and some other sort of relatively small, maybe not politically too damaging changes. If, as is quite plausible, it's more like 40 billion.

19:08Well, the National Institute said almost 60 billion recently. Well, as I say, I think these numbers are incredibly speculative, but it is possible it would be that scale. If it's in anything remotely that scale, I genuinely don't see how you do that without basically breaking some of their commitments on income tax, national insurance or VAT, because you just can't raise that scale of money without using those taxes. Paul, sit tight for a couple of minutes. Loads more we still want to ask. We'll do that after this break.

19:43So, I mean, the Chancellor's in this. It feels like this impossible situation, because if she loosens the fiscal rules or breaks them, then the markets will put up our borrowing costs and make it a lot more expensive for us to borrow money as a country and, you know, push up debt and everything else. If she doesn't loosen the rules or break them and instead makes these major cuts, the backbenchers vote against it if they're not happy with them and therefore it's impossible to get them through. And as you said, their manifesto was to not tax working people. But again, that feels like a rule which inevitably, sticking to it, is by proxy going to put up all of our taxes anyway and make life harder for us because life will just, the cost of living will feel a lot more expensive because there'll be lots of indirect ways that working people will be paying more.

20:37So do you think this is an impossible situation. And can I just add to that, Steph, if you don't mind, the sort of elephant in the room here, which is, this is an economy that has not grown for 15, 16 years. This is an economy in which living standards have not risen to any significant degree for 15, 16 years. Obviously, the great cliche is the way to solve our problems is to get productivity up and growth up, which if those two things happened, you would actually just automatically get more tax revenues because there'd be more transactions. And on those transactions, you know, and there'd be more income and on the income on the transactions, there would be more of a tax yield, right?

21:22But the problem with these fiscal rules is that they massively limit the ability for any government to stimulate the economy. So how do you reconcile? Because the government's position, Reeves's position is, there can be no sustainable growth if we don't meet our fiscal rules. But the history of the last 16 years is obsession with fiscal rules has delivered zero growth. So how do you reconcile getting the growth up with honouring the fiscal rules? Okay, I agreed with you until the end there, where I really disagree with you quite fundamentally. I'm not sure. I'm not sure. I think I'm using a question rather than expressing a point of view.

22:03And we can come back to my own view on this. But just tell me what you think. So you're obviously, I mean, you're right. What is the fundamental reason we're in this terribly difficult position at the moment? It is, as you say, that we've had very little growth over a very long period of time. Now, that makes the politics of everything really hard because everything becomes a zero-sum game. So if you're going to increase taxes and increase spending, you're making some people worse off in absolute terms because their incomes aren't growing. Actually, what the last government especially did was where have we got that extra revenue from?

22:35We've got it from companies. We're getting far more from corporation tax than we've ever had before, astonishingly. I mean, not something I would ever have projected. And they're getting it from people on very high incomes. We're getting far more tax from people on very high incomes than ever before. And over this period... It's a tiny proportion of people who are paying the most tax, isn't it? We've talked about this on the podcast before. Absolutely. It's such a tiny number. The top 1 % of income taxpayers are paying about 30 % of income tax. And that's up from about 25 % or 26 % in 2010. And not because their incomes have grown more than other people's, but because the tax system has got much more heavily weighted towards that group of people.

23:11So it makes it then harder to say, if you're going to get more tax, where are we going to get it from? Is it really going to be companies and high-income people again? I think that becomes more and more difficult over time. So going to Steph's question about does that mean if we're going to raise taxes, that's going to inevitably mean a break in the manifesto rules. Well, first thing I say is it's absolutely obvious to me the manifesto was broken in the first budget. The manifesto says very clearly we will not raise rates of national insurance contributions. It does not say we will not raise rates of employee national insurance contributions.

23:45It says we will not raise rates of national insurance contributions. In a sense, that pass has already gone. Although Labour, extraordinarily, this government, refuses to accept that. Absolutely. I know that. They probably get away with that because you don't actually see it in your pay packet directly. But if they really do keep to, we're not going to increase employee national insurance, we're not going to increase any rates of income tax, then they're going to have to do... Or VAT. Or VAT. Then you're going to have to do horrible things like really mess around with pension taxation or something.

24:15because if you're looking for where can you get serious money, that's where you could potentially get serious money. I'm not saying it's a good idea. I think it would be a terrible idea. But I think that is somewhere where you could look. Now, the role of the fiscal rules in all of this, I absolutely don't think that they are constraining our capacity to grow or manage the economy. And this government is investing, in terms of government investment, really big amounts of money, certainly relative to history and relative to the last government's plans. Although, again, some kudos to the last government, they also increased investment spending quite significantly.

24:53Now, I would slightly challenge you on that because it comes back to my political point earlier. It seems to me that if you had an infrastructure plan that was overwhelmingly weighted towards what are the investments we need to make to get the growth rate out. up, then I would agree with you. But actually, what you've got is an infrastructure plan that is much more about what they think are voters' priorities, fixing schools and hospitals. So that's not a problem with the fiscal rules. That's a problem with the priorities. And they talk a lot about big increases in investment spending, but actually we don't have any increase in investment on transport, for example, which is really crucial to growth, and a big increase in defence investment spending, which is a different set of objectives that we have.

25:44And the issue, of course, is all of this investment spending and the issue with, well, I think it's good that they're doing it, is it's all long term. So, you know, the impact on the economy is for the long run. So that's why it's always difficult to prioritise in the short run. And I think it's to the credit of previous chancellors and this one that they are prioritising the long run, despite the fact that they would almost certainly get more bang for their political buck if they were to be spending even more of it on schools and teachers and so on. So it's not the rules that are the problem or having these rules.

26:18It's the way they're being used. This is basically not being managed well. There's not a relentless enough focus on those measures which would generate growth within these fiscal parameters. Yeah. And look, we've had a long period of very poor growth. We've had a period since 2016 of absolute political stasis and chaos, which you can't undo all of that in the first year of a government. And you're going to struggle to undo much of it over a whole parliamentary term. So we also have to think very carefully about what are reasonable expectations of governments. But again, going back to your point, Robert, about the lack of growth after such a long period of lack of growth.

26:59And actually, remember back to 2010 and 2015, an electorate at that point, which was willing to vote for quite big spending cuts, they were made very clear in the 2010 Conservative Manifesto and even clearer, amazingly, in the 2015 Conservative Manifesto. You know, we're going to keep punching you. We are going to keep cutting. We're going to cut welfare. And that got voted for. But after 15 years of lack of growth and an election campaign last year where everyone was saying, it's fine, we're not going to cut anything or increase taxes. I think the electorate is understandably pretty cynical about a lot of this.