Undercover Economist

How do you strip down the state?

Government cuts are shrinking the state, but gauging its size in the first place is hardly straightforward

Love this government or hate it, the consensus is that it is rolling back the state with a vengeance. Supporters agree with David Cameron’s pre-election diagnosis: “it is more government that got us into this mess.” Sceptics accuse the coalition of unnecessary cuts, fuelled by an ideologically driven love of small government.

All of which made me wonder: how big is the British state? It’s not a straightforward question. One could consider measures of regulation, or public sector employment. Then there are tax revenues, which since the mid 1990s have never been less than 36 per cent of national income, and never more than 39 per cent.

An alternative is to look at government spending. I prefer this as a measure of the size of the state, because – barring a default – all spending must eventually be paid for by taxes (or inflation). By this measure, the state is much bigger: total managed expenditure is more than 46 per cent of national income this tax year.

What’s more, according to “Green Budget 2012”, recently published by the Institute for Fiscal Studies, expenditure would have stayed near that level indefinitely without action. That action was pencilled in by then-Chancellor Alistair Darling as the impact of the recession became clear, and has since been amplified by George Osborne. The coalition’s austerity measures – four-fifths of which are spending cuts rather than tax increases – will eventually push spending back below 40 per cent of national income, which is where it was for most of the time that Gordon Brown was chancellor of the exchequer.

So assuming Osborne gets spending back down to 40 per cent of national income, would he have succeeded in producing a small state?

That spending includes pensions and benefits – in other words, redistributing money to the unemployed, the retired and the fecund from childless people with well-paid jobs. Then there’s free healthcare, free education, the army, the police, the courts, and infrastructure such as roads.

This is a lot. Is it worth £40 of every £100 that you earn? You can be the judge of that. Many people would regard it as good value for money. But it certainly does not look like a vision of a stripped-back, “night-watchman” state to me. If the austerity is motivated by libertarian ideology, true libertarians will be unimpressed with the results.

This is not to say the austerity is timid. Many economists would prefer more of the spending cuts to be deferred for a year or two until the economy is stronger (that said, according to the IFS, the cuts are not well advanced: 12 per cent down and 88 per cent to go). And spending 40 per cent of GDP will feel like a smaller state in 2015 than it did in 2003 or 1995. This is because, thanks to an ageing population and a rapidly growing national debt, the cost of providing pensions, paying interest and funding the National Health Service will all rise substantially.

Is there an alternative? A Labour government would have cut more slowly and perhaps would have cut less, but it is hard to imagine closing the deficit through tax increases alone – that would require tax revenues as a percentage of national income to rise by about a quarter. Imagine VAT up to 25 per cent, income tax up to 25, 50 and 65.5 per cent, and 14p on the price of petrol, and you get a rough-and-ready idea of what sort of taxes might be needed. Such taxes could be paid, but would be a huge departure from how we have grown accustomed to organising our society.

There are good reasons to object both to the timing and the details of the spending cuts. But the idea that they will produce anything like a stripped-down state looks far-fetched.

Also published at ft.com.