A rule for the size of the state?

David Davis has set out his stall on the size of the state and tax cuts:

A Conservative Government led by David Davis would introduce a new ‘growth rule’, ensuring that public spending increases by one per cent less than the trend rate of growth in the economy. This would allow for a reduction in the nation’s tax bill of £38 billion a year by the end of the next Parliament, which could be used to cut the basic rate of tax by 8p in the pound.

That sounds nifty.  Public spending up, tax bills down, without adding to borrowing.  All through the miracle of economic growth.

Is this as good a rule as Wat Tyler, Euroserf, The Right Way, and Andrew seem to think? 

No, it isn’t.  Here’s why:

  1. It locks in whatever level of spending a Davis Government inherits – which might follow a pre-election spending spree, or a cyclical spending trough. 
  2. It chokes off the automatic stabilizers, adding to the boom and bust cycle. Public spending should vary counter-cyclically. Spending on benefits rises naturally when economic growth is slow. This rule would force cuts in discretionary spending to offset those cyclical increases.  (An alternative formulation of the rule would have trend growth of spending slower than trend growth in GDP; this is avoids the mistake of being pro-cyclical, but at the expense of being impossible to monitor and enforce).
  3. It is too blunt – it fails to distinguish government spending on goods and services, in which the government actually pre-empts the use of the economy’s resources, from transfer payments which move purchasing power from one person to another.  It is not at all obvious that these two – which have very different economic effects – should be subject to the same target growth rate.
  4. It is too centralist – a central government target for General Government Expenditure means that central government has to set limits on local spending and stifle local decision making.  But then you cannot delegate choice to local communities to spend less, or more, on their local services.  Under this rule, if local communities decide to pay less tax, and reduce their local services, then central government would immediately step in to expand spending and tax elsewhere in the system to compensate.
  5. It is not ambitious enough – it is a managerialist rule under which everything would grow a little bit every year.  A change of government should be the opportunity for radical reforms to produce a smaller public sector – for example by abolishing CAP, industrial subsidies and the independent nuclear deterrent.
  6. It creates perverse incentives to fiddle the figures – a ceiling on General Government Expenditure creates incentives to pursue policy in sub-optimal ways such as through complicated tax reliefs instead of spending subsidies or by shifting spending to public sector corporations. 

(I cannot resist making the ultra-pedantic point that the growth of public spending should be one percentage point, not one per cent, below the trend growth of the economy.  This only matters because it suggests that whoever wrote the policy does not have much feel for economic statistics.)

Deciding the right size of the state is one of the most important choices any government can make. It defines the scope Government’s program and ambitions, and its attitude to the relationship between state and citizen.   A simplistic rule like this does not do it justice.

Update 3 November: Check the comments.  On my estimate, the Davis Rule would involve increasing spending by £30 billion a year by the end of a 5-year parliament. It would be £14 billion a year lower than if spending grew in line with GDP (not £38 billion a year lower as DD claims).

17 thoughts on “A rule for the size of the state?”

  1. Two possible reasons: (a) he’s trying to establish a hard-nosed image with the markets by donning a straightjacket from which his future (ahem) government cannot wriggle free, and/or (b) given the failure of past Conservative tough-talkers to turn the trend government share downwards, this is a slightly more foolhardy attempt to convince his backers that it can be done this time.

    Giving Chancellors “options” isn’t really the way either party is going (least of all, demand management), but this policy seems to throw pragmatism out the window in the expectation of future “trickle-down” benefits.

  2. Economically speaking you are right. Politically speaking I think you are wrong.

    What Davis is doing is creating a credible plan for cutting tax, by recognising:

    1) The public didn’t believe us at the last election.
    2) The scare stories of our opponents always seem to work.

    This is a steady reform of the public finances, that should allow tax cuts without scaring the horses.

    I would prefer the Conservative leader to promise to sack at least 1 Million of the useless parasites that we pay to make our lives more miserable, and repeal the regulations that made them necessary. Unfortunately it is not going to happen.

  3. It’s even more interesting for what it didn’t say, which is anything about the power of the state. Perhaps he should make a commitment to reduce that by one percentage point every year?

  4. I’m glad we agree that the economics of this proposal is dodgy. The politics I will leave to others to discuss: I don’t have a dog in this fight. I offer only the observation that bad economics is rarely good politics.

  5. The trouble is that good economics is often unwise politics: the majority of the electorate seems unable to grasp the concept of free trade good: subsidies bad.

    And the Serf is right about the politics. In order to win, Davis has to persuade the traditional conservatives that he will bring in a smaller state, but not put the wind up those who receive the vast bribes, sorry, benefits that Gordon has doled out…

    DK

  6. The trouble is that good economics is often unwise politics: the majority of the electorate seems unable to grasp the concept of free trade good: subsidies bad.

    And the Serf is right about the politics. In order to win, Davis has to persuade the traditional conservatives that he will bring in a smaller state, but not put the wind up those who receive the vast bribes, sorry, benefits that Gordon has doled out…

    DK

  7. Another point is that the key variables include two which vary with the actual, not the trend, rate of growth. Those are: nondiscretionary spending on benefits and such, which largely varies with unemployment, and (more importantly) revenue.

    If trend growth is 2.5%, the Davis policy assumes GGE rising at 1.5% on average. But trend growth of 2.5% could cover 5% this year and -2.5% the next (yes, this is an exaggerated example), in which case the budget deficit/surplus will be hopping about all over the place.

    I always thought stability was one of the aims of economic policy.

  8. Hmm, I’m not sure some of your economic arguments are justified if you look into the detail of the Growth Rule, or at least that proposed by the think tank Reform, which is basically the same as Davis’ policy. That said, I’m not an economist by trade, so this could be total bollocks:

    The counter-cyclical nature is accounted for both by time-limiting the policy (over at most 2 parliaments – hopefully less than or equal to the length of an economic cycle), and by only applying the rule to specific departmental spending, rather than public spending as a whole. Spending on benefits would be maintained at or above growth. The idea is that we need a one off cut in the size of overall spending, and once it decreases to an appropriate level, we can elect to maintain it there. In Davis’ case, he has proposed 40% of GDP, although that’s clearly an arbitrary choice. I think that answers your objections 2 and 3.

    As for it being centralist, sure, but that’s the system we currently deal with and are likely to inherit. We can’t go for a big bang localisation without reforming our attitude to government spending.

    Your comment about it not being ambitious enough seems odd, as you cite only abolishing CAP, industrial subsidies and the independent nuclear deterrent. The total cost of these 3 alone is about 22bn a year, from what I can tell with a quick Google. Davis is planning on cutting 38bn a year by the end of the first parliament. It seems he is more ambitious than you, Owen.

    A simplistic rule like this does not do it justice.

    Sure, but the rule is a way to monitor a broader principle, that the state should be smaller than it currently is. Holding the government to account is increasingly difficult. Providing a measure for us and particularly the media to do that can only be good, even if it is simplistic.

    Finally, this rule is just a small part of an economic package. Obviously, we’d expect some magic voodoo to correct any problems with it over time.

    Apologies for any economic illiteracy. I am an amateur in the field.

  9. Owen- I go along with the Serf- the economics might well be a little blunt, but this is about gripping a political reality. Politicos of whatever hue never find it agreeable to cut spending. The Growth Rule may not be perfect, but it reins in those pols.

    So taking your points…

    1. locks-in what he inherits…well, no- it’s a rule to deliver a progressive reduction in what he inherits (as% of GDP)

    2. trend spending- er, yes…DD’s website I’m sure should have made that clear- this is meant to be the Reform rule

    3. like we say- this is a blunt instrument which sets an overall budget for those pols to allocate within

    4. fair point- ultimtely bestto go down the Direct Democracy route of full fiscal decentralisation- the growth rule would then be recalibrated to exclude LA spending

    5. agreed- but it’s a start and heaps better than what we’ve got now

    6- we need an independent Budget Office to whistle blow

  10. Andrew

    The good thing about public finance is that you don’t need to know any economics – it is basically all just arithmetic.

    1. The Davis rule, as published on his website, says he will ensure that “public spending increases by one per cent less than the trend rate of growth in the economy” (note: no mention of trend public spending, though he does mention trend growth). If this is a mistake, he should correct it. It is a quite different proposition, with different implications. If that is indeed what he proposes, that would indeed answer objection (2). But it would create a new objection, which is that it is almost impossible to estimate the level of trend public spending (I used to be the Treasury guy who had to do this, and the estimate is very sensitive to a bunch of assumptions.) Such a rule would have no bite at all – in any given year it would be easier to change the estimate of trend spending than to take the political decisions needed to meet the rule.

    2. If, as you say is the intention, the Davis rule would apply only to Departmental Expenditure Limits (which were £283bn a year in 2004-5) then it would save only £14bn over a 5-year Parliament, compared to allowing DELs to grow in line with GDP. It would not be close to the £38 billion that he claims. (Even if he covered all managed expenditure, I reckon his rule would only save £24 billion a year in today’s prices.)

    3. On ambition, I’m afraid you’re making the mistake of believing your own camp’s propaganda. As the Davis team has discovered, the key to effective presentation of public spending numbers is to pick your baseline carefully. On the Davis plan, public spending will rise, not fall, compared to today’s spending. The plan would cut £38 billion (his number; I make it £14bn) from the spending that would occur if spending rose in line with GDP. You have compared this with my suggestion of abolishing some big ticket items. You reckon that abolishing CAP, DTI and the nuclear deterrent would save £22bn a year which is compared to today’s spending. So these two comparisons are against different baselines. Let’s compare them with each other: if you had a policy of sticking to today’s total spending in real terms, minus those three spending items, spending would be £52 billion a year less than the Davis plan by the end of a 5-year parliament.

    4. Assuming you are right that the Davis rule would cover only departmental spending and exclude the cyclical spending, then the rule would not constrain some large spending items which have a strong upward trend (annually managed expenditure has grown 6% a year over the last 5 years). That growth in spending would absorb the money released by the Davis rule applied to the departmental expenditure limits. So the Davis rule applied only to departmental expenditure limits would not make any room for tax cuts unless he also has a rule in mind for the rest of public spending.

    Owen

  11. for example by abolishing CAP, industrial subsidies and the independent nuclear deterrent.

    CAP? Is this the farming subsidies that you are talking about? If so, how could we do that? Is it not EU controlled? If you are advocating exiting the EU, and leaving the Eurozone to stew in its own stinking economic juices, then I’m right behind you, boyo! If not, how do we cap CAP, as it were?

    Drop the DTI: fair enough (except that you would have to drop taxes as well, at least on small business profits, or else no one would start a business).

    IND? Rather keep it myself. I don’t like relying on the US for our defence capabilities, and I’m afraid that you cannot uninvent the bomb.

    DK

  12. for example by abolishing CAP, industrial subsidies and the independent nuclear deterrent.

    CAP? Is this the farming subsidies that you are talking about? If so, how could we do that? Is it not EU controlled? If you are advocating exiting the EU, and leaving the Eurozone to stew in its own stinking economic juices, then I’m right behind you, boyo! If not, how do we cap CAP, as it were?

    Drop the DTI: fair enough (except that you would have to drop taxes as well, at least on small business profits, or else no one would start a business).

    IND? Rather keep it myself. I don’t like relying on the US for our defence capabilities, and I’m afraid that you cannot uninvent the bomb.

    DK

  13. Owen: I may be incorrect in asserting that Davis is using that version of Reform’s rule – alas, his website doesn’t make it clear. Reform actually proposed two versions of the Growth rule, one of which I was discussing here, which involves not touching the cyclical spend, and one of which does. I guess Davis has gone for the more aggressive version, which Reform costed out to save around 42bn a year (at the end of the next parliament, compared to what would occur if spending rose in line with GDP). I don’t really have a problem with the way the figures are presented – the left will just attack a basic tax cutting message as a plan to sack every nurse, doctor, policeman, etc… in the country, so I don’t see why we shouldn’t play the spin game to even the odds.

    if you had a policy of sticking to today’s total spending in real terms, minus those three spending items, spending would be £52 billion a year less than the Davis plan by the end of a 5-year parliament.

    Yes, but you wouldn’t get elected to implement it, so it’s all theoretical… (but my maths is dodgy in that section as you’ve noted, not accounting for inflation and all that).

  14. Out of interest, what would your plan to constrain the size of the state and lower public spending be? Assuming that is your goal, of course. And then, how would you sell it to the public?

  15. Late arriver on this one, but I think Wat and Serf get it right – politics isn’t friendly to best policy, all the more so for oppositions trying to get into power.

    Yes, this is a blunt, centralist and inambitious rule. But let’s not compare it to the best policy, but the prevailing norm, which has evolved to the current state over several decades. So, on centralism – yes, you’re right, but then that already happens. On ambition – it might be meek and mild, but at least its facing the right (to us who favour tighter control of public spending) way, rather than the constant drift upwards we’ve seen.

    There’s also an issue here that I hope the Davis team grasps – that simply cutting spending, outside of a few easy hits at the margins, is not going to get you anywhere except a reputation for penny-pinching. If you want to cut spending, you have to change domestic policy and the demand for spending it creates. In the shorter-term, that normally costs more money, not less.

    I would though agree that the rule needs to be clarified in tending towards the ‘discretionary’ side of the budget, with transfer spending subject to a different approach. That isn’t to say that transfer spending should be allowed to grow unabated – quite the opposite – but that it shouldn’t be subject to arbitrary cuts.

    One more thing: Jarndyce is entirely right to touch on the issue of state power versus state spending; I live in hope that one day we obsess a little less over spending:GDP ratios. But I’m not optimistic.

    P.S.: has Davis got the £38bn from using nominal prices?

  16. Blimpish

    I think the key point is as you put it above:

    If you want to cut spending, you have to change domestic policy and the demand for spending it creates.

    That is why I am distrustful of rules of thumb, such as the one Davis proposes. They are nothing more than wishful thinking: willing the ends, but not articulating the means by which those ends will be achieved.

    I do not think voters should be asked to approve an agenda of spending reductions without any clarity about how those spending reductions will be achieved. There are some spending reductions I would support – I have mentioned some examples above – and others that I would oppose. In general I support an overall reduction in the level of public spending, but my experience is that Governments operating under tight spending targets, especially ones that apply from year to year rather than over the medium term, rarely make long term strategic decisions which are in the overall economic interest of the nation.

    On the contrary, we have seen governments make disastrous decisions aimed at meeting short term targets – such as cutting investment in road and rail maintenance, flood defences, infrastructure investment in public services – which save money in the short term but end up costing us more in the long run. And when they run out of daft penny-pinching, it is easier to meet targets by changing the way the totals are measured than it is to take tough decisions.

    I am in favour of policy changes aimed at bringing public spending down sharply. I believe that we could make substantial savings in public sector management by competent use of IT, and by replacing managerialist target setting with a more delegated and empowered, and less hierarchical structure, in line with best practice across the rest of the economy. Furthermore, a government that was willing to stand up to vested interests in the public and private sector could make substantial savings and improve the supply side of the economy. (I confess that my agenda might well result in a substantial parade down Whitehall of farmers, sub-postmasters, firefighters, the aerospace industry, the arms industry, prison officers, civil servants, the sugar barons, the food processing industry, and others.)

    Unlike some other people I am much not greatly worried about churning (that is, taxing people with one hand and returning their money to them with the other). I think ambitions for reducing the size of the state should be primarily on the net take of the government from the citizen. (On this basis, government takes about 20%, rather than about 40%, of our national income).

    That is not to say that I am wholly indifferent to the size of transfer payments by government; but I think they require a different analytical framework which focuses in detail on the microeconomic impact of the incentives they create and transactions and incentive costs they impose, rather than their overall size.

    Owen

  17. Owen – thanks for getting back. We’d pretty much agree on many of the technical policy points (and indeed, the potential benefits of reducing public consumption), but my feeling is that capping global spending in some way might be the only way to concentrate minds on those jobs. And, at least it’s not as fiscally risky as a Stockman-style “starve the beast” strategy.

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