New Internationalist

Are public service cuts justified?

Issue 437

The belief that governments have no alternative but to reduce budget deficits by cutting public services has become a touchstone of current economic orthodoxy – and ‘deficit denial’ a cardinal sin. But, with protests across Europe as the cuts begin to bite, the argument has only just begun. Two protagonists take issue from opposing sides of what turns out to be a less than clear divide.

Every issue we invite two experts to debate a hot button issue in The Argument, and then invite you to join the conversation online - we’ll read all your comments and select the best to print next issue. (We’d prefer you to use your real name, but would love to hear what our readers have to say either way.) You can also vote in our poll:

Are public service cuts justified? Yes No Not sure

See October’s Argument: Is it ever right to buy or sell human organs?

Dan Mobley:

Dan Mobley was a senior advisor to the UK Treasury before moving to Standard Chartered Bank in London. He speaks in a personal capacity.

The Western world is awash with debt. The financial crisis originated, and was worst, in places where everyone – people, companies, banks and governments – had borrowed too much. The causes of this indebtedness are many and varied, but governments have been spending far more than they collected in revenue over many years, despite a long period of economic growth with high tax receipts.

The recession, stimulus measures and the cost of bailing out banks have dramatically revealed the problems, but long before the crisis governments had embarked on sustained and unaffordable overspending, including ever-rising entitlements to pensions and healthcare.

There are three ways to eliminate debt: economic growth, which brings rising revenues and reduces the costs of social failure (primarily from unemployment); raising taxes; and cutting spending. We can debate the exact mix, but Western countries will need all three, or face a further deterioration and the need for even more drastic action later.

We should tread carefully on the timing of tax rises and spending cuts over the next few years to avoid tipping us back into recession. Recovery is fragile and growth is likely to be weak for years to come. But we cannot avoid change forever.

Unsustainable public debt is harmful and unfair. We waste valuable resources by paying interest. Ultimately our debts will have to be repaid by future generations who will have more pressing concerns, including the sharply rising costs of climate change we will also bequeath them. We cannot spend more than we earn indefinitely and we should not expect our children and grandchildren to pay our bills.

John Christensen:

John Christensen is a development economist and former government adviser who now directs the international secretariat of the Tax Justice Network http://www.taxjustice.net/

The West is awash with debt because wages have been suppressed for decades and the so-called ‘wealth-effect’ of house-price inflation was used to substitute for rising earnings. Falling property prices squeezed the banks, leading to the massive bank bail-outs which now encumber us. The huge fiscal boosts of the past three years have prevented an all-out crash, but signs of recovery are elusive and private sector investment won’t plug the gaps. What to do?

The cuts will hit poor people, slow down economic recovery and increase unemployment – John

Well, imposing massive austerity on public investment is exactly what not to do at this stage. The cuts will hit poor people, slow down economic recovery and increase unemployment. Radical new measures are therefore required to boost government revenues at a time when public investment is the only way of preventing prolonged depression.

Introducing a financial transactions tax such as the Tobin Tax (see Glossary of financial terms below) would raise significant sums while also dampening harmful speculative activity. Taxing land values (see Glossary) would also raise significant revenues without causing harmful economic distortions. Tackling tax evasion, which runs to hundreds of billions annually across the world, and devastates countries like Greece and Pakistan, would go a long way towards cutting budget deficits. Cutting some of the extraordinary tax exemptions granted to companies would also raise billions without causing pain.

The decision to impose austerity at this stage in the economic cycle is purely political. Alternatives exist which will not victimize poor people for mistakes made by powerful banks. Now is the time to shift towards a tax justice agenda.

Dan Mobley:

If we want to prevent future crises, we need to draw the right lessons from this one. The many incompetent and arrogant bank CEOs and boards deserve the full weight of public fury, but this justified rage should not blind us to the fact that bankers were feeding the addiction of individuals, governments and companies to cheap borrowing, using the glut of savings flowing uphill from Asia to the West.

Macroeconomic policy failed: governments ran massive structural deficits long before the crisis, bribing their electorates with unaffordable promises (with much of the cost hidden off balance sheet). The ‘Great Moderation’ of the 1990s was actually a borrowing and spending spree.

I would love to plug some of the gap by closing tax havens and clamping down on tax evasion. But history teaches us how slow progress is internationally – the G20’s failure here is scandalous but predictable – and how quickly new loopholes are found by rich individuals and companies.

We could fill a magazine debating the Tobin Tax. Even if one believes it works – and if so-called speculative activity was curbed, this would mean little revenue raised – there is no chance of it being agreed by all governments globally.

Campaigning activity would be much better focussed on corporate tax transparency and (internal corporate) transfer pricing (see Glossary).

We should delay spending cuts (and tax rises) until we have stronger signs of economic recovery, to avoid tipping us back into recession. But the day of reckoning cannot be delayed forever.

John Christensen:

Paul White / AP Photo
Spanish demonstrators march in Madrid in September 2010 as part of a general strike to protest against government spending cuts. Paul White / AP Photo

We have common ground on tackling corporate tax transparency, transfer mispricing and the scandalous failure of the G20 countries to tackle tax havens, almost all of which are (rich) OECD countries or politically connected to OECD countries. Your point about savings from the South flowing uphill is fundamental: a large proportion of those flows are illicit (embezzled funds, trade mispricing, tax evasion etc). Global macroeconomic imbalances will not be remedied without action to improve cross-border co-operation and information exchange, which bankers are lobbying flat-out to prevent.

Action must be taken to reduce personal and corporate debt. Since housing costs are responsible for a majority of household debt in most countries, priority must be given to providing affordable, energy-efficient housing. This would form part of a Green New Deal investment programme, providing the stimulus to boost economies and reduce energy consumption. Public investment of this type can be partly funded from new taxes (a land value tax is especially suitable for this purpose) which will raise significant sums without stalling economic recovery or worsening inequality.

Excessive corporate debt needs urgent action. One of the reasons why private equity investors have loaded companies (and football teams) with so much debt is because tax relief is given to loan capital, but not equity capital, creating a bias in favour of the former. The solution is to withdraw the tax relief on interest payments.

None of which precludes immediate public spending cuts, which should focus on the obscene sums spent on weapons programmes.

Dan Mobley:

We are in danger of furious agreement! Abolishing tax relief on debt interest is long overdue but technically challenging (I watch in despair at the debt laden onto my beloved Liverpool FC). Criminal activity by tax evaders is illegal and immoral. Increasing land taxation is a great idea. But…

Tax evasion represents only a tiny proportion of the ‘uphill’ capital flows from East to West that drove the borrowing binge and bubbles. The global economy must rebalance – with the West spending less and saving more while Asia does the opposite (driving down poverty as governments spend more at home on welfare). Banks could become part of this solution, not the problem – helping develop capital markets in poorer countries and facilitating flows ‘downhill’ from the rich world.

The spending supertanker can only be turned around if we include cuts to public services – Dan

Rebalancing requires reduced spending in the West. We must slash socially or economically useless expenditure, whether defence or export subsidies. But the spending supertanker can only be turned around if we include entitlements and public services. The US, UK or France spend two to four per cent of GDP on defence – yet face a ‘demographic shock’ of unfunded pension and welfare entitlements of around 450 per cent of GDP. Governments should concentrate our limited resources on the poorest in our societies while insisting the majority of us consume less and save more.

John Christensen:

Yves Logghe / AP Photo
Yves Logghe / AP Photo

Hang on a second: illicit flows from poorer countries running at upwards of $1 trillion a year contribute significantly to these macroeconomic imbalances – and tax havens sit centre-stage as villains of the piece. Irritatingly, I don’t see either the G20 or bankers queuing up to support civil society efforts to tackle this glaring fault-line in the globalized financial markets.

But the issue at hand is one of public spending and how democratic societies respond to the crisis. The far right sees this as the opportunity to move forward with their project to kill off public services. This will worsen existing inequalities: poverty, which jumped worldwide in 2009 – not least in the US – will inevitably deepen. Look at the other end of the spectrum and around the world you’ll find extraordinary concentrations of wealth and income. Forget about trickle-down theory, wealth has cascaded upwards to tiny élites who evade hundreds of billions of tax dollars every year.

So, no, I don’t agree that this is the time to abandon universal welfare provision and slash and burn the public sector. We, as societies, must decide whether such things as publicly funded education, healthcare, pensions, environmental protection and suchlike take precedence over frivolous and conspicuous consumption. We also need to take steps to force our politicians to take action against the scandal of tax havens and all who use them. This is why the time has come for a tax justice agenda.

Photo by: William Murphy under a CC Licence
Photo by: William Murphy under a CC Licence

Glossary of financial terms

Loan capital:

A long-term loan which finances a company’s everyday operations.

Equity capital:

Money invested by individuals or entities into a company in exchange for an ownership interest in that company.

Tobin Tax:

Small tax of 0.1-0.25% on financial transactions in the stock market and on foreign exchanges. Proposed, not implemented.

Land value tax:

Annual tax on the rental value of land, ignoring buildings, properties or other works.

(Internal corporate) transfer pricing:

Establishing the price for a transaction of goods and services between two entities owned by the same company.

Transfer mispricing:

Abuse of the above.

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