The shrinkflation state

SHRINKFLATION IS A bane of the British shopper. For years, producers have quietly cut product sizes rather than raise prices. A multipack of Frazzles, a moreish bacon crisp, used to cost £1 ($1.36) and contain eight bags. Now it contains six. Cadbury’s Creme Eggs used to come by the half-dozen; now they come in fives. Quality Street, a chocolate box, weighed 1.2kg in 2009; today, just 650g. A box of Jaffa Cakes once contained a dozen biscuits; now just ten.

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

It will be an awkward shift. Since coming to power in 2010 the Conservatives have used shrinkflation just as retailers do. In the early austerity years the state shrank, but its cost did not. As a percentage of GDP, it fell from a peak after the financial crisis of 46% of GDP to 39%. Taxes stayed around their historic norm of about 32% of GDP. But citizens received fewer services.

And, as when shoppers fail to notice the missing packet of Frazzles or couple of Jaffa cakes, voters did not care much at first. Weekly bin collections became fortnightly or monthly. Once-generous legal aid became miserly; in-work benefits fell; police solved fewer crimes. But eventually voters—and shoppers—start to feel perplexed. Was a box of Quality Street always so small? Were the police always so blasé about fraud? Moreover, shrinkflation cannot continue indefinitely. Just as people will not buy an empty packet of Frazzles, taxpayers will not pay for government services that are not provided at all. Eventually prices must rise—as the Conservatives are discovering. By 2026 the tax burden will be 36% of GDP, the highest since the post-war era, under Clement Attlee.

This will cause several problems. The first is one of expectations. Attlee’s government promised a new Jerusalem: voters accepted higher taxes in return for a welfare state. Similarly, when New Labour governments raised taxes in the 2000s, they provided more in return. They increased national insurance, a payroll tax, in order to bring health-care spending in line with other European countries. Schools were rebuilt and renovated; rough sleeping plunged; civic art, albeit sometimes of questionable quality, appeared in town squares.

Unfortunately, this time higher spending will at best stop things getting worse. Sajid Javid, the health secretary, admits that the health- and social-care systems will struggle even after a 2.5 percentage-point rise in national insurance. “Is that all we get for £12bn?” asked the Daily Mail, a newspaper that tends to see eye-to-eye with the Tories, when the plan to cut hospital waiting-lists was announced. British voters are often said to want American taxes and a European welfare state. Instead, they face paying European taxes for services as skimpy as those in America.

The second hitch is a mismatch between who pays and who benefits. The extra taxes are intended for services that largely benefit older voters. According to the Resolution Foundation, a think-tank, by 2032 an extra £100bn (in today’s prices) will be spent annually on health care and pensions. This amounts to the bulk of the education budget today. By 2024 the NHS will account for 44% of the state’s day-to-day spending, up from about 27% in 2000, says the Institute for Fiscal Studies, a think-tank. In relative terms, the rest of the state is shrinking. The British state will increasingly resemble a health-care system with nukes.

This is a poor deal for young people. The parts of the state they rely on, such as in-work benefits, are increasingly flimsy. Yet they will be paying more for services they do not use. Meanwhile, the tax system is changing to their detriment. Soon a pensioner with an annual income of £30,000 will pay 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 payments and the national-insurance increase 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 labour-intensive, and hence become relatively pricier as wages rise to keep pace with sectors where productivity improves faster. Teachers’ salaries may go up, but the number of children each can teach does not. Demography makes the situation worse. By 2030 there will be 4.4m over-80s, up from 3m at the moment. The state spends around £20,000 per year on each child of school age, but about £40,000 per year on each person in their late 80s.

Life is like a tub of Quality Street

A bigger state can be paid for in three ways. The first is economic growth. If that had continued after the financial crisis at the same pace as before, taxes would bring in about £200bn more annually than they do now, points out the Resolution Foundation. That is enough to cover the entire education and defence budgets, with change left over. Yet neither the Conservatives nor Labour show much appetite for doing what would be necessary. Policies that crush growth (such as leaving the EU) proved popular; those that might boost it (such as planning reform) did not. Too many voters are unwilling to accept the downsides of growth, such as more houses spoiling their view. Many may not feel the need. After all, the state has not shrunk for some.

The second option is a fairer tax system. Asset-rich pensioners could contribute more. Yet higher taxes for older voters are taboo for the same reason that restraining their benefits would be: pensioners vote. But unless the government can convince older voters to carry a larger share of the tax burden, or find ways of boosting growth, it is limited to a third option: cutting services further. Another bout of state shrinkflation looms. ■

Read more from Bagehot, our columnist on British politics:
The rise of unpopulism (Feb 12th)
Sue Gray delivers a first report on those Downing Street parties (Feb 5th)
Boris Johnson is making boring politics look attractive (Jan 29th)