The State of Shrinkage | The Economist

SHRINKFLATION IS A scourge of the British buyer. For years, producers quietly reduced product sizes rather than raising prices. A multipack of Frazzles, a more indulgent bacon crisp, cost £1 ($1.36) and contained eight bags. Now it contains six. Cadbury’s Custard Eggs sold in half a dozen; now they come in fives. Quality Street, a box of chocolates, weighed 1.2 kg in 2009; today, only 650g. A box of Jaffa Cakes once contained a dozen cookies; now just ten.

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The logic behind shrinkage is that consumers are less likely to notice it than its alternative: higher prices. For years, the government worked on the same principle. Taxpayers paid about the same, but state services withered. Now an era of price hikes in the form of tax hikes has begun. In an ugly combination of inflation and shrinkage, voters will be expected to pay more for less.

It will be an awkward change. Since coming to power in 2010, the Conservatives have used shrinkage just like retailers. In the early years of austerity, the state shrank, but not its cost. As a percentage of GDPit fell from a post-financial crisis peak of 46% to GDP at 39%. Taxes remained around their historic norm of around 32% of GDP. But citizens received fewer services.

And, like when shoppers don’t notice the missing bundle of Frazzles or a few Jaffa cakes, voters didn’t care much at first. Weekly trash collections have become fortnightly or monthly. Once generous legal aid has become stingy; work-related benefits have fallen; the police solved fewer crimes. But eventually, voters — and buyers — are starting to feel puzzled. Has a Quality Street box always been so small? Have the police always been so blasé about fraud? Also, shrinkage cannot continue indefinitely. Just as people won’t buy an empty packet of Frazzles, taxpayers won’t pay for government services that aren’t provided at all. Eventually, prices must rise, as the Tories find out. By 2026, the tax burden will be 36% of GDPhighest since post-war, under Clement Attlee.

This will cause several problems. The first is that of expectations. Attlee’s government promised a new Jerusalem: voters accepted higher taxes in exchange for a welfare state. Likewise, when new Labor governments raised taxes in the 2000s, they provided more in return. They increased National Insurance, a payroll tax, to bring healthcare spending in line with other European countries. Schools have been rebuilt and renovated; sleeping rough plunged; civic art, although sometimes of dubious quality, appears in town squares.

Unfortunately, this time higher spending will at best prevent things from getting worse. Sajid Javid, the health secretary, admits the health and social care systems will struggle even after a 2.5 percentage point increase in National Insurance. “Is this all we get for £12billion?” asked the Daily mail, a newspaper that tends to agree with the Conservatives, when the plan to cut hospital waiting lists was announced. It is often said that British voters want American taxes and a European welfare state. Instead, they have to pay European taxes for services as meager as those in America.

The second problem is a mismatch between who pays and who benefits. The additional taxes are for services that largely benefit older voters. According to the Resolution Foundation, a think tank, by 2032 an additional £100 billion (at today’s prices) will be spent each year on healthcare and pensions. This now represents the bulk of the education budget. By 2024, the NHS will account for 44% of daily government spending, up from about 27% in 2000, according to the Institute for Fiscal Studies, a think tank. In relative terms, the rest of the state shrinks. The British state will look more and more like a health care system with nuclear weapons.

This is bad business for young people. The parts of the state they rely on, like in-work benefits, are increasingly fragile. Yet they will pay more for services they don’t use. Meanwhile, the tax system is changing to their detriment. Soon a pensioner with an annual income of £30,000 will be paying a marginal rate of 20%; a 28-year-old graduate on the same salary will face a de facto marginal rate of 42.25%, once student loan repayments and National Insurance increases are included.

A more expensive state is inevitable. Areas where the state still promises comprehensive support, such as health and social care or education, suffer from “Baumol’s cost disease”: they are labor intensive and therefore become relatively more expensive as wages rise to keep pace with sectors where productivity improves faster. Teachers’ salaries may increase, but not the number of children each can teach. Demography makes the situation worse. By 2030, there will be 4.4 million people over 80, compared to 3 million today. The state spends around £20,000 a year for each school-aged child, but around £40,000 a year for each person in their late 80s.

Life is like a Quality Street bathtub

A larger state can be financed in three ways. The first is economic growth. If this had continued after the financial crisis at the same rate as before, taxes would bring in around £200billion more a year than they do now, the Resolution Foundation points out. This is enough to cover the entire education and defense budgets, with the remaining currency. Yet neither the Tories nor Labor show much appetite to do what is needed. Growth-suppressing policies (such as leaving the EU) has proven popular; those that could stimulate it (such as planning reform) did not. Too many voters don’t want to accept the downsides of growth, like more houses spoiling their view. Many may not feel the need. After all, the state has not diminished for some.

The second option is a fairer tax system. Asset-rich retirees could contribute more. Yet higher taxes for older voters are taboo for the same reason that restricting their benefits would be: pensioners vote. But unless the government can convince older voters to shoulder more of the tax burden or find ways to spur growth, it is limited to a third option: cut services further. Another episode of state shrinkage is looming.

Read more from Bagehot, our columnist on British politics:
The Rise of Impulism (February 12)
Sue Gray delivers a first report on these evenings in Downing Street (February 5)
Boris Johnson makes boring politics attractive (January 29)

This article appeared in the Britain section of the print edition under the headline “The State of Contraction”

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