Though it may seem hard to remember a time before 'the crisis of living standards' tripped off the tongues of politicians and wonks, in truth it really only entered the economic lexicon after the crash. Economic forecasters believe the toxic cocktail of stagnating wages in the middle and lower part of the wage distribution since 2003; the lack of availability of cheap credit to boost incomes since the financial crisis in 2008; and increasing prices of big-ticket items like housing, transport and energy bills is not going away any time soon. The squeeze that families are experiencing in trying to make ends meet is one of the key issues that politicians from left and right have to grapple with. It doesn’t seem unreasonable to ask, therefore, what the Chancellor’s Budget tomorrow – the big economic set-piece policy event of the year – is going to do about it.
The Budget needs to meet both a short-term and a long-term living standards test. In the short-term, there’s not much available to the Chancellor save using the tax and benefit system to do what he can to ease the burden on families. It’s these short-term levers that all of the pre-Budget speculation has focused on: wealth taxes, childcare subsidies, accelerating planned increases in the personal allowance, and delaying the rise in fuel duty. Osborne’s problem though is that his hands are tied because he has indicated he won’t be budging from his Plan A: reducing public spending and increasing taxes as a way of trying to close the deficit – when from a macroeconomic perspective, he would be better off filling this gap by using demand-side policies to boost family incomes that would also ease the living standards squeeze, and by investing in infrastructure that could also immediately help to create jobs and demand at the same time as delivering long-term returns.
So the expected announcements on childcare tax breaks and fuel duty, even taking into account the increases in the personal allowance already announced, are very unlikely to outweigh the hit that families – particularly families with children – have taken since 2010 – cuts to child tax credits, working tax credits, other working and non-working benefits and child benefit. The majority of families will most likely be worse off as a result of overall changes to the tax and benefit system since the general election: a net negative effect on living standards.
A mansion tax – the most radical tax proposal on the table from both Labour and the Lib Dems – could be of huge symbolic significance: a sign that we are all genuinely in it together, and that it is not just for families of moderate means to bear the burden of spending cuts. Yet a tax of 1% on homes worth over £2m would only raise a modest £1.7bn, less than half of what it would cost to reduce the basic rate by 1p by the Treasury’s own calculations.
These sorts of figures show the issue with focusing on the tax-benefit system as more than a short-term solution to the living standards issue. Even pretty substantial changes to the tax-benefit system can only go so far to address the impacts of some of the long-term economic trends that sit at the heart of the living standard crisis. Wage inequality has grown over the past thirty years: if current trends continue, the High Pay Commission has predicted that by 2035 the top 1% of earners will take home 14% of national income, a ratio last seen in Victorian England. Wealth inequality and the cost of housing has increased, fuelled by a housing price bubble: for the first time in recent history, the majority of under 35s on low to middle incomes live in private rented property. Transport and energy bills are forecast to continue to rise, even though some of these companies’ profits seem to be healthier than ever.
In reality, using the tax-benefit system to fix growing inequality in living standards in the long term is not going to cut it – growing wage and wealth inequality cannot be fixed with ever-greater redistribution. Moreover, there is a renewed recognition, particularly on the centre-left, in the idea of the dignity of labour: that it is fundamentally wrong that people are not able to earn enough to support their families through working full-time, a situation many in minimum-wage jobs find themselves in.
What does that mean for tomorrow’s Budget? If it were really going to grapple with some of these long-term issues of predistribution, it would explicitly be trying to shift policy towards trying to boost real wages in the bottom half of the wage distribution and bringing down the costs of housing, childcare and energy.
There are two key problems with this approach. The first is that no politician – or indeed, economist – really has the answer on how to change the shape of the wage distribution. It probably needs to be some sort of mix of industrial policy, skills policy and policies to empower employees to demand a better deal in the workplace. Yet there is a big elephant in the room: our low skill, low-pay service sector that has grown as a result of the increase in the number of high-skill jobs that have been created in recent decades. The UK can be characterised as a relatively high wage inequality country with a moderately sized redistributive state. There are other models around the world – Sweden, which has relatively high wage inequality but a larger redistributive state funded through higher progressive taxation, which makes possible the provision of universal free childcare; or Japan, which has low wage inequality and a relatively small state. We can look to Sweden or Japan as exemplars but the reality of trying to transition to a different model is there is no clear policy path to follow. It is much harder to predict the impact of a particular industrial policy on living standards than it is changes to the tax and benefit system.
The second is that while there are much clearer proposals for what to do on big-ticket spending items like housing, childcare, energy and transport, the solutions are radical for a Conservative Chancellor. For example, on housing, building more houses has to be a core part of the solution. On childcare, it would be more efficient to concentrate on expanding the supply of free childcare places. Yet in both of these areas, George Osborne will be announcing demand-side reforms, through help for first-time buyers and childcare tax relief. Neither address the fundamental supply side issues.
Unfortunately for Britain’s families this means the Budget tomorrow is likely to fail on both a short-term and long-term test.