Tag: COVID and public finances

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).

Articles

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?