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Public spending and receipts: a pandemic displacement effect?

The COVID-19 pandemic had a stark effect on countries’ public finances. Governments had to make difficult fiscal choices around spending and taxation to safeguard public health, and the protection of jobs and incomes both in the present and in the future. The fiscal choices were to have historically large effects on the size of public spending and on the size of public borrowing.

Here we briefly summarise the magnitude of these effects on public spending, receipts and borrowing in the UK.

The public sector comprises both national government and local or regional government. In financial year 2019/20 public spending in the UK was £886 billion. This would rise to £1.045 trillion in 2020/21. To understand better the magnitude of these figures we can express them as a share of national income (Gross Domestic Product). In 2019/20 public spending was 39.8 per cent of national income. This rose to 52.1 per cent in 2020/21. Meanwhile, public-sector receipts, largely taxation, fell from £829.1 billion in 2019/20 to £796.5 billion in 2020/21, though, because of the fall in national income, the share of receipts in national income rose very slightly from 37.3 to 37.9 per cent of national income.

The chart shows both public spending and public receipts as a share of national income since 1900. (Click here for a PowerPoint of the chart.) What this chart shows is the extraordinary impact of the two World Wars on the relative size of public spending. We can also see an uptick in public spending following the global financial crisis and, of course, the COVID-19 pandemic. The chart also shows that spending is typically larger than receipts meaning that the public sector typically runs a budget deficit. .
If we focus on public spending as a share of national income and its level following the two world wars, we can see that it did not fall back to pre-war levels. This is what Peacock and Wiseman (1961) famously referred to as a displacement effect. They attributed this to, among other things, an increase in the public’s tolerance to pay higher taxation because of the higher taxes levied during the war as well as to a desire for greater public intervention. The latter arose from an inspection effect. This can be thought of as a public consciousness effect, with the war helping to shine a light on a range of economic and social issues, such as health, housing and social security. These two effects, it is argued, reinforced each other, allowing the burden of taxation to rise and, hence, public spending to increase relative to national income.

If we forward to the global financial crisis, we can again see public spending rise as a share of national income. However, this time the ratio did not remain above pre-crisis levels. Rather, the UK government was fearful of unsustainable borrowing levels and the crowding out of private-sector activity by the public sector, with higher interest rates making public debt an attractive proposition for investors. It thus sought to reduce the public-sector deficit by engaging in what became known as ‘austerity’ measures.

If we move forward further to the COVID-19 pandemic, we see an even more significant spike in public spending as a share of national income. It is of course rather early to make predictions about whether the pandemic will have enduring effects on public spending and taxation. Nonetheless the pandemic, in a similar way to the two world wars, has sparked public debates on many economic and social issues. Whilst debates around the funding of health and social care are longstanding, it could be argued that the pandemic has provided the government with the opportunity to introduce the 1.25 percentage point levy from April 2022 on the earned incomes of workers (both employees and the self-employed) and on employers. (See John’s blog Fair care? for a fuller discussion on the tax changes to pay for increased health and social care expenditure).

The extent to which there may be a pandemic displacement effect will depend on the fiscal choices made in the months and years ahead. The key question is how powerful will be the effect of social issues like income and wealth inequality, regional and inter-generational disparities, discrimination, poor infrastructure and educational opportunities in shaping these fiscal choices? Will these considerations carry more weight than the push to consolidate the public finances and tighten the public purse? These fiscal choices will determine the extent of any displacement effect in public spending and taxation.

Reference

Alan Peacock and Jack Wiseman, The Growth in Public Expenditure in the United Kingdom, Princeton University Press (1961).

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Questions

  1. What do you understand by the term ‘public finances’?
  2. Why might you wish to express the size of public spending relative to national income rather than simply as an absolute amount?
  3. Undertake research to identify key pieces of social policy in the UK that were enacted at or around the times of the two World Wars.
  4. What do you understand by the terms ‘tolerable tax burden’ and ‘inspection effect’?
  5. Identify those social issues that you think have come into the spotlight as a result of the pandemic. Undertake research on any one of these and write a briefing note exploring the issue and the possible policy choices available to government.
  6. What is the concept of crowding out? How might it affect fiscal choices?
  7. How would you explain the distinction between public-sector borrowing and public-sector debt? Why could the former fall and the latter rise at the same time?
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Apple v Fortnite

Competition authorities across the globe have recently been paying close attention to the activity of large firms in high-tech markets, in particular Google, Amazon, Facebook and Apple. One estimate suggests that 30 cases have been opened by the authorities since 2010, and a third of these were launched in 2020.

One of the most prominent recent cases in the US courts concerns a complaint made by Epic Games, producer of the popular Fortnite game, against Apple. The background to the case is Apple’s standard practice on its App Store of taking a 30% cut of all paid app and in-app purchases. Therefore, a Fortnite player purchasing $10 worth of in-game currency would result in $7 for Epic and $3 for Apple.

However, in August 2020 Epic decided, contrary to Apple’s terms and conditions, to offer players an alternative way to purchase in-game currency. Gamers would see a choice screen giving them the option to buy currency through the Apple App Store or to buy it directly from Epic. Crucially, purchasing directly from Epic would be cheaper. For example, the same $10 worth of in-game currency on the App Store would cost only $8 if purchased directly from Epic.

It is clear to see why Epic was in favour of direct payments – it earns revenue of $8 instead of $7. However, note that the benefits for gamers are even larger – they save $2 by buying directly. In other words, Epic is passing on 2/3 of the cost saving to consumers.

Apple very quickly responded to Epic’s introduction of the direct purchase alternative by removing Fortnite from the App Store. Epic then filed a complaint with the US District Court.

The Epic v Apple court case

The case concerned Apple restricting game developers’ ability to promote purchasing mechanisms outside the App Store. However, more broadly, it also examined Apple’s complete control of the iOS app market since all apps must be distributed through the Apple App Store. Epic had previously disrupted PC games distribution by launching its own platform with lower fees. The setup of iOS and Apple’s actions against Epic make this an impossible way to reach users.

The Court’s analysis of the Epic v Apple case depended upon several key factors. First, the market definition. To be found to have breached competition law Apple must have a significant share of the market. If the market is defined as that for iOS apps, this is clearly the case. However, if, as Apple argues, it is broader, encompassing the options to play Epic games through web browsers, gaming consoles and PCs, then this is not the case.

Second, even if the market is narrowly defined, Apple argues that its control of the app distribution market is essential to provide user friendly and secure provision of apps. Furthermore, revenue extracted from app producers can enable more investment in the iOS. Without Apple controlling the market, app producers would be able to free-ride on the visibility the App Store provides for their apps.

The ruling

The US Court announced its ruling on 10 September 2021. The judge decided that the market was broader than just iOS and thus Apple is not considered to be a monopolist. This has been touted as a major success for Apple, as it will allow the company to maintain its control of the app distribution market. However, the Court also ruled that Apple must allow game developers to link and direct users to alternative purchasing methods outside the App Store.

The Court’s decision in the Epic v Apple case closely follows concessions recently made by Apple for so called ‘reader apps’ such as Spotify and Netflix. Following an investigation by the Japanese authorities, these concessions allowed such apps to promote and receive purchases directly from consumers as long as they were made outside the app. These apps could be treated differently, as digital goods are consumed on multiple devices. However, the decision in the Epic case now extends such concessions to gaming apps.

It is unclear whether Apple will appeal the decision in the case Epic brought. If not, Apple stands to lose considerable revenue from its 30% share of in-app purchases. It will be very interesting to see how this ruling affects how Apple runs the App Store. Epic, on the other hand, has already made clear it will appeal the decision, aiming to prevent Apple gaining a share of any payment users make outside the app.

Matt Olczak and Jon Guest

Articles

Questions

  1. Why might a firm involved in a competition case, such as Apple, try to convince the authorities to define the relevant market as broadly as possible?
  2. Using the example of the Epic v Apple case, explain how Apple’s actions could be seen as both exclusionary and exploitative abuses of a dominant position.
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The economics of fast fashion

For many goods and services, economists argue that relatively unregulated markets often do a pretty good job in delivering desirable outcomes from society’s view point.

However, for these desirable outcomes to occur, certain conditions need to be present. One of these is that all the benefits and costs of consuming and producing the good/service must be experienced/incurred by the buyers and sellers directly involved in the transaction: i.e. there are no externalities. The market can still work effectively if people outside of the transaction are affected (i.e. third parties) but the impact occurs through the price mechanism.

The fast fashion industry

Fast fashion refers to designs and trends that rapidly pass from catwalks and designers to retailers. The clothes sell for low prices and in high quantities. The business model relies on regular purchases and impulse buying. It is particularly popular in the UK where annual clothing consumption per capita is significantly greater than in other European countries – 26.7kg vs 16.7kg in Germany and 14.5kg in Italy. On average, people in the UK have 115 items of clothing. Unsurprisingly, 30 per cent of these garments have not been worn for at least 12 months.

Externalities in fast fashion

There is lots of evidence that the fast fashion market fails to meet the condition of no externalities. Instead, it generates lots of external costs across its whole supply chain that do not affect third parties through the price mechanism. For example:

  • Growing cotton requires large amounts of water. Some estimates suggest that on average it takes 10 000 litres of water to cultivate just one kilogram of cotton. As water is a common resource (rival and non-excludable), its use in cotton production can exceed socially desirable levels. This can have serious consequences for both the quantity of drinking and ground water and can lead to previously fertile land being transformed into arid regions that are too dry to support vegetation.
  • Growing cotton also uses large amounts of pesticide. Some estimates suggest that 6 per cent of global pesticide production is applied to cotton crops. Extended contact with these chemicals can cause illness and infertility. It also has a negative impact on the long-term productivity of the soil. For example, the chemicals destroy microorganisms, plants and insects and so decrease biodiversity.
  • The manufacture of synthetic fibres such as polyester has a smaller negative impact on the use of water and land than the cultivation of a natural fibre such as cotton. However, because it is derived from oil, its manufacture generates more CO2 emissions. One study compared the CO2 emissions from producing the same shirt using polyester and cotton. The former generated 5.5kg whereas the latter produced 2.1kg.
  • The waste water from the use of solvents, bleaches and synthetic dyes in the manufacture of textiles/garments often flows untreated into local rivers and water systems. This is especially the case in developing countries. Estimates suggest that this is responsible for between 17 and 20 per cent of industrial global water pollution.
  • There are excessive levels of textile waste. This can be split into producer waste and consumer waste. Producer waste consists of 10–15 per cent of the fabric used in the manufacture of garments that ends up on the cutting room floor. It also includes deadstock – unsold and returned garments. For example, Burberry admitted that in 2017 it incinerated £28.6 million of unsold stock. In the same year, UK consumers disposed of 530 000 tonnes of unwanted clothing, shoes, bags and belts. This all went for landfill and incineration.
  • Textiles are one of the major sources of microplastic pollution and contribute 35 per cent (190 000 tonnes) of microplastic pollution in the oceans. A 6kg domestic wash can release as many as 700 000 synthetic fibres.

Addressing the externalities

The House of Commons Environmental Audit Committee published a report on the fashion industry in February 2019. One of its key recommendations was that the tax system should be reformed so that it rewards fashion companies that design products with lower environmental impacts.

The UK government has tended to focus on the use of plastic rather than textiles. For example, it introduced a charge for single use carrier bags as well as banning the use of microbeads in rinse-off personal products and plastic straws/stirrers.

In April 2022, a new tax is being introduced in the UK on the plastic packaging of finished goods that is either manufactured in the UK or imported from abroad. The rate, set at £200 per metric tonne, will apply to packaging that contains less than 30 per cent of recycled plastic.

One specific proposal made by the Environmental Audit Committee was for the government to consider extending this new tax to textiles that contain less than 50 per cent recycled polyester. A recent study found that just under 50 per cent of clothes for sale on leading online websites were made entirely from new plastics.

The committee also called for the introduction of an extended producer responsibility scheme. This would make textile businesses responsible for the environmental impact of their products: i.e. they would have to contribute towards the cost of collecting, moving, recycling and disposing of their garments. It could involve the payment of an up-front fee, the size of which would depend on the environmental impact of the product.

In its Waste Prevention Programme for England published in March 2021, the government announced plans to consult with stakeholders about the possibility of introducing an ‘extended producer responsibility scheme’ in the textile industry. The House of Commons Environmental Audit Committee is also carrying out a follow-up inquiry to its 2019 report.

Articles

Government and Parliament documents and reports

Questions

  1. Using the concepts of rivalry and excludability, define the concept of a common resource.
  2. Explain the ‘tragedy of the commons’ and how it might apply to the use of water in the cultivation of cotton.
  3. Draw a diagram to illustrate how negative externalities in consumption and production lead to inefficient levels of output in an unregulated competitive market.
  4. Using a diagram, explain how imposing a tax on producers of textile products that contain less than 50 per cent recycled polyester could reduce economic inefficiency.
  5. Explain the potential limitations of using taxation/regulation to address the pollution issues created by the fast fashion sector.
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Microeconomics in the news

For those of you embarking on a course in economics, one of the first things you’ll come across is the distinction between microeconomics and macroeconomics. The news is full of both microeconomic and macroeconomic issues and you’ll quickly see how relevant both branches of economics are to analysing real-world events, problems and policies.

As we state in Economics (updated 10th edition), ‘microeconomics is concerned with the individual parts of the economy. It is concerned with the demand and supply of particular goods, services and resources such as cars, butter, clothes, haircuts, plumbers, accountants, blast furnaces, computers and oil.’ In particular, it is concerned with the buying, selling, production and employment decisions of individuals and firms. When you go shopping and make choices of what to buy you are making microeconomic decisions. When firms choose how much of particular products to produce, what techniques of production to use and how many people to employ, these choices are microeconomic ones.

Microeconomics examines people’s behaviour when they make choices. In fact many of the recent developments in microeconomics involve analysing the behaviour of individuals and firms and the factors that influence this behaviour.

Open any newspaper, turn on the TV news or access any news site and you will see various microeconomic issues covered. Why are rents soaring? How is AI affecting various businesses’ productivity? How rapidly is the switch taking place to green energy? How do supermarkets influence spending patterns? Why are wages so low in the social care sector? Why are private PCR tests so expensive for holidaymakers retuning from abroad?

Many of the blogs on this news site will examine microeconomic issues. We hope that they provide useful case studies for your course.

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Questions

  1. Look through news sites and identify five current microeconomic issues. What makes them ‘micro’ issues?
  2. If world oil and gas prices rise, why is this a microeconomic issue?
  3. What do you understand by ‘scarcity’? How is microeconomics related to scarcity?
  4. Are all goods scarce?
  5. What is meant by ‘opportunity cost’? Give some examples of how opportunity cost has affected recent decisions you have made.
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Fair care?

With waiting lists in the NHS at record highs and with the social care system in crisis, there have been growing calls for increased funding for both health and social care. The UK government has just announced tax rises to raise more revenue for both services and has specified new limits on the amounts people must pay towards their care.

In this blog we look at the new tax rises and whether they are fair. We also look at whether the allocation of social care is fair. Clearly, the question of fairness is a contentious one, with people having very different views on what constitutes fairness between different groups in terms of incomes, assets and needs.

Funding

In terms of funding, the government has, in effect, introduced a new tax – the ‘health and social care levy’ to come into effect from April 2022. This will see a tax of 1.25% on the earned incomes of workers (both employees and the self-employed) and 1.25% on employers, making a total of 2.5% on employment income. It will initially be added to workers’ and employers’ national insurance (NI) payments. Currently national insurance is only paid by those below pension age (66). From 2023, the 1.25% levy will be separated from NI and will apply to pensioners’ earned income too.

The starting point for workers will be the same as for the rest of national insurance, currently £9568. Above this, the additional marginal rate of 1.25% will apply to all earned income. This will mean that a person earning £20 000 would pay a levy of £130.40, while someone earning £100 000 would pay £1130.40.

There will also be an additional 1.25% tax on share dividends. However, there will be no additional tax on rental income and capital gains, and on private or state pensions.

It is estimated that the levy will raise around £14 billion per year (0.7% of GDP or 1.6% of total tax revenue), of which £11.2 billion will go to the Department of Health and Social Care in 2022/23 and £9 billion in 2023/24. This follows a rise in income tax of £8 billion and corporation tax of £17 billion announced in the March 2021 Budget. As a result, tax revenues from 2022/23 will be a higher proportion of GDP (just over 34%) than at any time over the past 70 years, except for a short period in 1969/70.

Is the tax fair?

In a narrow sense, it can be argued that the levy is fair, as it is applied at the same percentage rate on all earned income. Thus, the higher a person’s earnings, the greater the amount they will pay. Also, it is mildly progressive. This is because, with a levy-free allowance of just under £10 000, the levy as a proportion of income earned rises gently as income rises: in other words, the average levy rate is higher on higher earners than on lower earners.

But national insurance as a whole is regressive as the rate currently drops from 12% to 2%, and with the levy will drop from 13.25% to 3.25%, once the upper threshold is reached. Currently the threshold is £50 270. As incomes rise above that level, so the proportion paid in national insurance falls. Politically, therefore, it makes sense to decouple the levy from NI, if it is being promoted as being fair as an additional tax on income earners.

Is it fair between the generations? Pensioners who earn income will pay the levy on that income at the same rate as everyone else (but no NI). But most pensioners’ main or sole source of income is their pensions and some, in addition, earn rent on property they own. Indeed, some pensioners have considerable private pensions or rental income. These sources of income will not be subject to the levy. Many younger people whose sole source of income is their wages will see this as unfair between the generations.

Allocation of funds

For the next few years, most of the additional funding will go to the NHS to help reduced waiting lists, which rocketed with the diversion of resources to treating COVID patients. Of the additional £11.2 billion for health and social care in 2022/23, some £9.4 billion will go to the NHS; and of the £9 billion in 2023/24, some £7.2 billion will go to the NHS. This leaves only an additional £1.8 billion each year for social care.

The funding should certainly help reduce NHS waiting lists, but the government refused to say by how much. Also there is a major staff shortage in the NHS, with many employees having returned to the EU following Brexit and fewer new employees coming from the EU. It may be that the staff shortage will push up wages, which will absorb some of the increase in funding.

The additional money from the levy going to social care would be wholly insufficient on its own to tackle the crisis. As with the NHS, the social care sector is facing an acute staff shortage, again aggravated by Brexit. Wages are low, and when travel time between home visits is taken into account, many workers receive well below the minimum wage. Staff in care homes often find themselves voluntarily working extra hours for no additional pay so as to provide continuity of care. Often levels of care are well below what carers feel is necessary.

Paying for social care

The government also announced new rules for the level of contributions by individuals towards their care costs. The measures in England are as follows. The other devolved nations have yet to announce their measures.

  • Those with assets of less than £20 000 will not have to contribute towards their care costs from their assets, but may have to contribute from their income.
  • Those with assets between £20 000 and £100 000 will get means-tested help towards their care costs.
  • Those with assets over £100 000 will initially get no help towards their care costs. This is increasing from the current limit of £23 250
  • There will be a limit of £86 000 to the amount people will have to contribute towards their care costs over their lifetime (from October 2023). These costs include both care in a care home and care at home.
  • These amounts will apply only to care costs and not to the board and lodging costs in care homes. The government has not said how much people could be expected to contribute towards these living costs. A problem is that care homes generally do not itemise costs and hence it may be hard to distinguish care costs from living costs.
  • Where people’s care costs are fully or partly covered, these will be paid by their local authority.
  • A house will only count as a person’s asset if the person is going into a care home and it is not occupied by a spouse or partner. All financial assets, by contrast, will count.
  • Many people in care homes will not be judged to be frail enough to be in receipt of support from their local authority. These people’s expenditure would not count towards the cap.

Setting the cap to the amount people must pay at the relatively high figure of £86 000 may ease the pressure on local authorities, as many people in care homes will die before the cap is reached. However, those who live longer and who get their care paid for above the cap, will pay no more no matter what their level of assets, even though they may be very rich. This could be seen to be unfair. A fairer system would be one where a proportion of a person’s assets had to be used to pay for care with no upper limit.

Also, the £1.8 billion is likely to fall well short of what local authorities will need to bring social care back to the levels considered acceptable, especially as the asset limit to support is being raised from £23 250 to £100 000. Local authority expenditure on social care fell by 7.5% per person in real terms between 2009/10 and 2019/20. This means that local authorities may have to increase council tax to top up the amount provided by the government from the levy.

Articles

Video

Government document

Data

Questions

  1. How would you define a ‘fair’ way of funding social care?
  2. Distinguish between a proportional, progressive and regressive tax. How would you categorise (a) the new health and social care levy; (b) national insurance; (c) income tax; (d) VAT?
  3. Argue the case for providing social care free at the point of use to all those who require it.
  4. Argue the case for charging a person for some or all of their social care, with the amount charged being based on (a) the person’s income; (b) the person’s wealth; (c) both income and wealth.
  5. Argue the case for and against capping the amount a person should pay towards their social care.
  6. When a tax is used to raise revenue for a specific purpose it is known as a ‘hypothecated tax’. What are the advantages and disadvantages of using a hypothecated tax for funding health and social care?