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Garvan Walshe is a former National and International Security Policy Adviser to the Conservative Party. He runs Brexit Analytics

In 1920s America, Charles Ponzi hit on an ingenious way to make money. Attract investors with too-good-to-be-true returns. Pay them out of deposits made by the next round of investors, gaining more publicity for the scheme. Attract the next round of investors…

The astute reader will have spotted a flaw. Ponzi wasn’t actually investing his customers’ money. He simply used each new wave of customers to pay the previous one. It “worked” as long as each new tranche was big enough to support the old, but once the supply of new marks dried up, the scheme crashed, and Ponzi, fearing arrest, handed himself over to the authorities, who charged him with larceny. (He was later deported to his native Italy and became an agent for Mussolini’s state airline in Brazil).

Outrageous though this fraud may be, it is also the basis for the British system of public finance. Unusually for an advanced country, the entire welfare state is paid for out of current tax receipts. Because voters rarely tolerate the tax take rising or falling very much (if it dips below 40 per cent, don’t be surprised if people vote Labour; when it rises to approach 50 per cent, expect the Tories to do better), this can only work if national output expands more quickly than the cost of pensions, health and education. As exciting and technologically forward-looking as a review of the gig economy sounds, it is really a side-show.

The welfare state is bust. One statistic (originating in the UCL’s Christian Dustman’s work on immigration) puts this most clearly. Between 2004 and 2014, the native British population took £671 billion more out in benefits and services than they paid in taxes. That’s equivalent to half the NHS budget, and almost twice defence spending, a year. To put it in the perspective of other current debates, this £67 billion a year is more than six times our net annual contribution to the EU and 12 times the net contribution of EU migrants to the British Exchequer. It’s far bigger than Brexit. “Auto-enrolled” pensions are the start of the necessary tax increase, but there is some way to go before the black hole can be filled. We used to be proud of our relatively low labour taxes, but the things that other countries pay for with social security charges still have to be paid for out of future general taxation. We were very good at creating jobs, but it looks increasingly like we bought them on hire-purchase.

Worse, though spending restraint was needed after the financial crisis, the manner in which austerity was carried out perpetrated a major intergenerational injustice. By deciding to exempt the health and pensions budgets from cuts, the Coalition and its successor majority Conservative Government imposed the heaviest burden not on those with the broadest shoulders, but the young. Current taxation was to be used to pay the pensions and healthcare of the old, but not the higher education of their grandchildren. They were hit instead with a deferred stealth tax disguised as a fee, expensively financed in the private capital markets, while budgets for training and support for the young unemployed were also slashed.

Third, the aftermath of the financial crisis coincided with a house price bubble. Low interest rates, needed to soften the recession, mean people can be assessed to afford higher mortgages. Help to Buy inflated prices further while planning laws and NIMBYist parliamentarians continue to limit the supply of new housing. The Right to Buy was a huge step forward for people lucky enough to have a council house in the 1980s. But money wasn’t made available to allow the generations that followed them the same opportunity. The effect has been to load the young up with more debt, and hand wealth over to the older, asset-rich generation. Alarmingly, not a few of the old have used their new freedom to spend their pension early to spend their nest eggs.

Britain’s political economy has turned into a machine for transferring income (through tax and spend) and wealth (through the frothy housing market) to the baby boom generation. It’s hardly surprising the young think the system isn’t working and that even without Brexit, which the young are against, Corbyn is gaining traction.

His plan, naturally, is the redistribution of income and wealth, and while the former is possible, the latter is not. In Britain, houses aren’t just a place to live, but also a savings vehicle. Quite a lot of their value derives from the belief that it will not be taxed, redistributed or, indeed, requisitioned. This proportion of the nation’s wealth wouldn’t go to the poor. It would simply be extinguished.

The “right” answer is of course to move the UK into a direction where each generation bears its own risk (or at least its own plus that of the rearing of its children), and the people don’t use housing as a savings vehicle, but getting there would be difficult even in stable times.

The only way out of this mess is to find some way to improve Britain’s terrible productivity. This has to be more than just the mathematical expedient of replacing people with machines that do the same work as, or slightly more, cheaply. Total output needs to increase if the books are to balance. We need to find ways for:

  • Workers to train more throughout their lives (and employers to understand why this matters);
  • Persuading businesses to apply more capital to their activity – this is a cultural problem in the UK, which is internationally famous for its penny pinching;
  • Making much better use of women in the workforce; female employment levels are high, but obscenely expensive childcare means too many work part-time and spend longer than they want (and the country needs) outside the labour force.

None of those challenges are new, and it is fair to say that addressing them will be difficult. But I fear our political system is far happier to argue about why we left Euratom without thinking about its implications instead.

166 comments for: Garvan Walshe: The Taylor review is a distraction. The real problem facing Britain is that our Welfare State is bust.

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