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    Brexit or no Brexit – I am already worried about England and Wales as UK councils are going bust

    February 2019

    As the crow flies, London is about 100 km to the southeast, and Birmingham about 70 km to the northwest, putting Northampton pretty much in the centre of England. And right now, the city of 215,000 and surrounding county that’s home to another 500,000 more, is pretty much at the centre of a funding crisis – one that is playing out across England and Wales, and is having a very dramatic and immediate effect on people’s lives, much more so than the political shenanigans under way at Westminster and the UK’s place in Europe.

    Northampton council is broke. Last year in February, it effectively went bankrupt. No, it’s not a story of gross misspending of resources or a waste of money – like at least 35 other local government councils up and down the UK, it simply can’t raise enough funds to keep its services going, receives just too little from the Westminster government in London, and can’t continue to provide the level of services required by law – looking after the elderly, fixing roads, contributing to policing, maintaining infrastructure, collecting rubbish, caring for children in crisis, keeping street lights turned on and books in libraries.

    Across the UK, funding for local governments has fallen by at least 60% since 2010, and by the time 2020 rolls around, there will be a staggering 21 billion Pound shortfall in funding for councils. Councils are the lowest levels of government, and can levy a tax on homes and charge fees for some services as well as collecting a nationally set tax on commercial properties and keeping a share of it. But for years they depended on funds from Westminster – and since 2010, under the Conservative government’s policy of austerity, the council’s funding has largely dried up. Northamptonshire council just about has enough money to pay for basic mandatory services – everything else has stopped – and two outside commissioners have been appointed from London to oversee its activities and finances.

    Northamptonshire was the first flashing red light. East Sussex County Council, run by Conservatives, recently announced it would reduce services to the “legal minimum”. The Conservative – led county council in Somerset warned it might be facing bankruptcy too. UK local authorities are heavily reliant on central government grants – the Revenue Support Grant – which has historically accounted for 70-75% of the income of local authorities.

    At the same time, local authorities are finding that social care and other statutory duties costs are increasing without a sufficient match in the funding from central or local sources to match the need. Such a dramatic deterioration in the financial position of local authorities with increased demand for services was always going to end up problematic. Local authorities have cut back significantly on the services they offer and have made numerous efficiency savings, but there are not many more savings which can be made now. Northamptonshire council went so far as to sell the building it’s based in, then lease it back. Even then it couldn’t find enough money to stave off the inevitable.

    So what is the solution to this chronic underfunding of local government services? More taxation ability on behalf of councils?

    How will the UK manage its public finances in the decades ahead?

    With great difficulty is my answer.

    Its public sector balance sheet and long-term fiscal outlook are in poor shape. The implications are also clear: in addition to managing the public sector balance sheet as wisely as possible, the country will have to increase taxes. But that will be impossible to do without courage, both intellectual and political. Will this happen? I fear not.

    According to the International Monetary Fund’s latest Fiscal Monitor, the UK’s public sector net worth is minus 125 % of gross domestic product, second worst after Portugal of the 31 countries analyzed. French public sector net worth was minus 42%, Germany’s minus 20% and that of the US minus 17%. The Office for Budget Responsibility’s Fiscal Sustainability Report of July 2018 predicts that the picture will get worse. On current policies, the primary fiscal deficit (before interest payments) and debt would be 8.6% and 283% of GDP, respectively, 50 years hence.

    Huge uncertainties exist around such forecasts. Nonetheless, the underlying reality is clear. The UK is an ageing country with politically compelling commitments to spending on health, education and social welfare. These commitments were cut to the bone after 2010. Even There’s May recognized this reality in the case of the National Health Service, making huge unfunded commitment last June.

    The prime minister also claimed that this would be funded by a “Brexit dividend”. Those without her sense of humour know that either some other spending must be cut or taxes must rise. The politics and long-term forecasts, together, make clear it must mainly be the latter. This challenge would exist whatever happens over Brexit. That merely makes the fiscal challenge bigger, because Brexit seems sure to have a sizeable negative effect on the economy and tax revenue over the long term.

    Can the additional revenue be raised and, if so, how? That ought to be a focal point of serious political debate.

    The answer to the first question is a clear “yes”. A large number of countries are both substantially richer than the UK, while also raising significantly greater revenue as a share of GDP. According to the IMF, Germany’s real GDP per head, for example, is 16% higher than the UK’s, while revenue is 45% of GDP against the UK’s 37%. So raising revenue, without destroying the economy, is quite possible in principle. At the same time, it is obviously difficult to do so: the UK’s ratio of revenue to GDP has not been above 42% since the early 1950s and has not risen above 40% in the past 35 years.

    The evidence of history suggest, therefore, that there is great resistance of turning the UK into a country with taxes comparable to those of successful Northern European welfare states. The important question, then, is whether it would be possible to raise revenue in a way that does little, if any, economic damage, while also being politically sustainable. The preliminary answer is an encouraging one. The UK tax system is such an incoherent mess that it would not be at all difficult in theory to raise taxes while improving economic efficiency and the distribution of income. Paul Johnson, director of the Institute for Fiscal Studies, made this point last year. He focused on the unreasonably light taxation of capital and wealth and the way in which this benefits the prosperous elderly. I would stress the need to focus on the taxation of rents, not just from land.

    Unfortunately, the victims of new taxes are always far louder in opposition than beneficiaries are in support. Moreover, a new tax often seems offensive. That makes reform difficult in almost all circumstances, but even more so when the aim is to raise, rather than lower, the overall tax burden. This creates a form of Catch-22 in current politics. A big reason for reforming the tax system is to make it less costly to fund higher spending over the decades ahead. But the fact that the reform will be designed to raise revenue will make them more politically unpalatable than they would otherwise be.

    Is there a way out? No easy one exists.

    But the starting point must be with a debate on what the country wants and how to fund it. The pressures will not vanish. As so often, politics has to find an answer.