http://www.timesonline.co.uk/tol/comment/letters/article7093518.ece

Public finance and size of the State

A basic principle of public finance is that permanent expenditures should be tax-financed, while temporary expenditures may be largely debt-financed

Sir, The debate on national insurance contributions diverts attention from the main fiscal issues: what should be the role of government (which determines the proportion of our income spent by government) and how to pay for this expenditure?

Based on recent Budget reports, since 2001 the proportion of GDP spent by government has increased from 47 per cent to 55 per cent of GDP. Over the same period total revenues decreased from 48 per cent to 42 per cent of GDP; while total expenditures increased by 70 per cent, total revenues increased by only 25 per cent. Although the gap between expenditures and revenues widened as a result of the recession, it has been growing steadily since 2001. This shows that the deficit has a structural basis and is not just due to the recession.

The rates of growth in expenditures in the three largest items are: social protection and services, 92 per cent; health; 102 per cent; and education, 76 per cent. The main sources of tax revenue increased by much less: the increases in the three largest sources of tax revenues are income tax, 36 per cent; national insurance, 56 per cent; and VAT, 1.6 per cent.

A basic principle of public finance is that permanent expenditures, such as those on welfare, health and education, should be tax-financed, while temporary expenditures, such as those incurred as a result of recession, may be largely debt-financed. The implication is clear: to deal with the burgeoning structural fiscal deficit since 2001, the UK either needs to cut its government expenditures or increase its main sources of tax revenue.

The remaining issue is the size of the State. A sobering fact is that the correlation between total economic growth in the EU since 1998 and the average proportion of GDP spent by government is minus 0.74. This suggests that steadily increasing the size of the State, as in recent years, may not be such a good thing.

This is what the debate should be about.

Professor Michael Wickens

Professor of Economics, University of York and Cardiff Business School