Andrew Haldenby, Director of Reform, argues that the Government needs an approach that protects young people through spending control, realistic taxation and improved education
In many respects, 2007 has been the year in which the IPOD generation (Insecure, Pressurised, Over-taxed and Debt-ridden) have taken centre stage in global politics, according to Reform’s latest report – Class of 2007: Inaction sinks the IPOD generation – published today. Much of the world has finally recognised the immense pressures that demographic changes and tight public finances will impose upon young people. In simple terms, fiscal policy decisions today matter for the taxpayers of tomorrow. The developed world is facing an unprecedented demographic change, as the “baby boomer” generation moves into retirement and the ratio of working age people to retired people falls sharply. Politicians will face temptations to increase entitlements to healthcare and pensions; but these will place an unfair burden on the smaller numbers of young people.
Led by the US, governments now talk of fiscal restraint; of reductions in the tax burden; and of guarding young people’s priorities. The testimony of Ben Bernanke, the Chairman of the Federal Reserve, to the Senate in January 2007 is a must-read (it is included as an appendix to the report). He said that the rising costs of healthcare and pensions demand “early and meaningful action”; without which, “the US economy could be seriously weakened, with future generations bearing much of the cost”. That action should include sustained efforts over many years to control public spending; new fiscal rules, including targets measuring public spending as a ratio of GDP; and accurate estimates of the unfunded costs of pensions and healthcare programmes.
In spring and summer, there were strong indications that the UK would also be swept up by this tidal swell in favour of young people. Just before his departure, Tony Blair said that the key economic challenge for the Government was to meet the needs of young first-time buyers. On his accession as leader of the Labour Party, Gordon Brown said that helping first-time buyers would be one of the three key policy priorities. Most importantly, the Government pledged that its Comprehensive Spending Review would meet the challenges of the next decade, of which an ageing population is clearly one of the most important.
However, the early signs were misleading, and 2007 subsequently saw inaction on the part of the Government. The policies which have tipped the tax / spend balance against young people – higher health and pensions entitlements and higher public spending overall – have remained in place. And the specific decisions of both the Pre-Budget Report & Comprehensive Spending Review (PBR & CSR 2007) and Budget 2007 have actually worsened the situation.
PBR & CSR 2007 pledged major spending increases on both healthcare and state pensions. They did not introduce a new fiscal rule relating to the public-spending-to-GDP ratio (the OECD criticised the “golden rule” specifically because it does not “prepare the public finances for the long term challenges due to the ageing of the population”). And they showed that the Government has been unable to control the level of borrowing. For the five years 2002-03 to 2006-07, the Government’s initial projections underestimated the eventual true level of borrowing by a total of £121 billion.
Rather than helping first-time buyers, the proposal of an 18 per cent rate of capital gains tax will help owners of second homes and buy-to-let investors. People aged under 30 comprise only 1.9 per cent of second home owners.
Already, then, a new approach is required; one which protects young people through spending control, realistic taxation and improved education.
As Ben Bernanke has explained so clearly, spending control is essential if the burden on future generations is to be managed. Spending on health and pensions needs particular attention – because today’s young people pay for those services without using them, and because future entitlements can rise much more quickly than expected. Spending control can also prevent high levels of borrowing, which is simply spending deferred.
Reform has previously advocated a “Growth Rule” which would hold public spending below the rate of growth of the economy, in order to achieve a spending-to-GDP level of 35 per cent in two Parliaments’ time.
For health and pensions, co-payments will also be necessary to enable a fairer burden of costs on both younger and older people. This is realistic given the changing pattern of wealth of older people. Much public policy used to be based on the assumption realistic in the past that late middle age was the path to growing poverty. However, the baby boomer generation now has, in many cases, high net worth as result of the rise in housing wealth from £1.2 trillion in 1996 to £3.8 trillion in 2006.
Greater control of public spending will allow targeted tax reductions so as to maximize the return to labour force participation and to additional effort. The increase in the stamp duty threshold recently proposed by the Conservative Party is in line with previous recommendations of Reform’s IPOD reports.
An important consequence of realistic taxation will be the ability for individuals to invest in themselves. At present investment is something done or stimulated by government while individuals consume. This produces a belief that the key route to social responsibility is to increase tax revenue. Tax policy has squeezed the margin available for investment. If individuals are to be free to develop their own careers and contribution they need a reasonable “investment margin” on top of day-to-day living expenses. Future Budgets should include an estimate of the “investment margin”.
I am under no illusion that this is easy – either in terms of politics or policy. Most people would agree that the easy short term political decision is to increase spending on health and pensions. And after all, older voters are much more likely to turn out.
But I am equally certain that politicians need to look beyond the short term challenge to the very great long term benefits of reform – and the very great costs of inaction. As Ben Bernanke concluded his Senate testimony (I hope you will forgive the long quotation):
“To summarize, because of demographic changes and rising medical costs, federal expenditures for entitlement programs are projected to rise sharply over the next few decades. Dealing with the resulting fiscal strains will pose difficult choices for the Congress, the Administration, and the American people. However, if early and meaningful action is not taken, the U.S. economy could be seriously weakened, with future generations bearing much of the cost. The decisions that Congress will face will not be easy or simple, but the benefits of placing the budget on a path that is both sustainable and meets the nation’s long-run needs would be substantial.”
