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Public finances post-crisis: rebuilding with balance

Author: ICAEW Insights

Published: 08 Nov 2021

The impact of the COVID-19 pandemic, along with the lasting scars of the financial crisis, have sapped the UK’s fiscal strength in a period of major transition. The Resolution Foundation has some recommendations for recovery.

As we look towards recovery from the COVID-19 pandemic, we also have to think about the resilience of public finances. Serious thought needs to be given to what a successful economic strategy might look like over the next 10 years, particularly as we transition towards net zero.

Whatever the government settles on as its plan to move forward into a new decade, policymaking must be holistic, considering economic growth, welfare, infrastructure, education and health. This is needed more than ever; the UK’s public finances have been left in a poor state thanks to COVID and the financial crisis before it.

“Dealing with future pandemics and driving the transition to net zero requires fiscal capacity,” says James Smith, research director for the Resolution Foundation. “A chunk of that work will focus on the overall macroeconomic policy frameworks: how we approach fiscal policy, how much of that repairing we do in the coming years.”

Where is our competitive advantage?

The number one priority for the government should be repairing the economic damage from our twin crises, says Smith. This means careful decisions around taxation. One aspect that needs consideration is the transition in revenue sources as the economy moves towards net-zero. A petroleum tax, for example, should eventually become obsolete as the economy becomes less carbon-intensive.

“The core of it is: how does the UK economy generate good jobs, by which I mean high pay, stability, high living standards, prospects for advancement, that sort of thing? What that means is thinking about how you define a collection of domestic policies. What industries do you prioritise for the country to thrive in the future? Where is our comparative advantage?

Global trends and changes also need to be taken into account, says Smith. The UK needs to consider its place in the world: what future trade deals will look like, whether we’ll see longer supply chains or more onshoring. “All these issues will play into the type of strategy.”

The Resolution Foundation advocated for a health and social care levy, which has been adopted by the government, albeit at a lower rate than the Resolution Foundation recommended. Hypothecated taxes of this kind could be useful in addressing some of the issues the UK faces, says Smith, but raising taxes is always tricky. The health and social care levy is an easier sell as the pandemic has brought home how essential and hard-working health and social care workers are.

“The impacts of the crisis are particularly skewed in terms of who's ended up seeing their earnings fall and who's gone through this crisis and actually managed to come out of it wealthier. That also builds the case for thinking about something that is progressive in terms of tax changes.”

A similar measure probably would not work for the transition to net zero. Instead, tax and incentives should be used carefully to drive changes in behaviour. The government should be careful to ensure that any transition does not disproportionately impact people on lower incomes.

“Tax rises on energy bills would be particularly punishing for those on lower incomes, so you have to really think about how we compensate people for that. Also, you need to think about how you provide incentives for people to move towards greener sources of heating and travel, for example.”

A sense of balance

For Smith, it all comes back to a sense of balance and viewing everything holistically. For example, Nordic countries have relatively high levels of public service provision but also have high levels of taxation. Jobs are focused in high-value-added services. “You can straightaway see across the board – your health, education, industrial strategy, tax policy – there's a clear link about the type of policy and the type of country they want to be.”

The UK needs to repair the economic and fiscal damage first and foremost, with that balance in mind. “Taxing incomes from those at the bottom of the income distribution has tremendous consequences. It will make people's lives much harder, particularly as they're being clobbered with a big rise in energy bills, high inflation, and so forth. But it's also bad macroeconomics because that group will spend every penny that they get. It has a larger effect than, for example, changes impacting on people with a higher income.”

Insights special: Repairing public finances

ICAEW Insights takes a closer look at the efforts being made to repair public finances in the wake of the coronavirus pandemic.

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