Why are we so scared of the 's' word?

Spending is fine ... and if we spend well we can preserve the welfare state, says Yvette Cooper

If You watched the economic events of last week, you could have been forgiven for believing that the welfare state was in crisis. First we found out that the government overdraft had risen even further than we expected. Borrowing in the first three months of this year turned out to be higher even than last year.

This is alarming and confusing. Taxes have been pushed up substantially since the election. Meanwhile those in the public sector tell us that schools and hospitals are starved of cash, and benefits are being cut once more. All this pain, and still the public purse isn't filling up.

Then on Wednesday, right on cue, a Treasury planning document was leaked to the press. It revealed that Treasury officials believe it is seriously possible that we might privatise the welfare state in the next 30 years. The pundits embraced the document with enthusiasm, arguing that such radicalism was essential to get us out of our current plight.

So the picture painted for us at the end of the week was clear. The welfare state is escalating out of control, gobbling up more and more of our national resources. We cannot afford to watch it rise any further; higher public spending will damage our international competitiveness and push ordinary families beyond their budgets. So drastic, unthinkable action is needed.

But the entire story is ridiculous. For a start there is no reason why a properly managed welfare state should be exploding out of control. And second, the constraints on how much we can tax and spend are not economic at all, they are political.

There is, admittedly, a real hole in the public finances right now, and it needs to be closed. Despite four years of growth, and billions in tax increases, the deficit for this year will be pounds 27bn. But the gap is largely a result of foolish spending and taxing decisions made over the past few decades. It would be perfectly feasible - if a little uncomfortable in the short term - to sort the problem out.

The Government's mistake has been to pursue short-term tax cuts at the expense of long-term investment. Look at the way we sold off the family silver. Getting rid of those rusting dinner plates wasn't the problem. Many are doubtless better polished in the private sector. But when the assets were sold, the income streams were lost too, yet the money raised was not invested. Privatisation proceeds along with the revenue from North Sea oil went into current spending and tax cuts. No wonder then, now that the cupboard is bare, we are having trouble meeting our bills.

At the same time we are paying the consequences of cutting public investment again and again. Infrastructure repairs are delayed until they become more expensive. Better investment in the education of the current generation of disaffected youth might have saved on unemployment benefits today, and even raised national income in future.

Similarly money spent investing in people's future employability - through wage subsidies, training or child care - can save cash by getting the unemployed off welfare and into work. Sensible policies to shift resources may be painful in the short term, but in the long term they will generate returns.

Certainly there are additional upward pressures on public spending in the future, but these are political rather than economic. How much we pay in benefit to those who cannot work - such as carers, the disabled, and the elderly - is a moral and political question. How we respond to the middle classes' demands for higher-quality healthcare and education is a difficult political problem. Allowing them to opt out into the private sector creates a two-tier system based on wealth. But funding luxury for everyone in the public sector is expensive.

Politicians on both sides would like to pretend their hands are tied by economics. The Right tell us that there's a magic number below which state spending must fall. Kenneth Clarke likes 40 per cent of GDP. William Waldegrave prefers 35 per cent.

However, the evidence in support of their claims is extremely tenuous. When the economists Vito Tanzi and Ludger Shuknecht studied the matter in some detail for the International Monetary Fund, they found that the growth and inflation records of high-spending nations were no worse than those of low- spending nations. The high spenders did have higher unemployment, but it is hard to know whether lots of people out of work pushed up their welfare bills or whether high taxes undermined job growth.

Although in theory it seems plausible that governments which push taxes and spending up too far will pay an economic price, in practice there is little evidence that we have reached the critical level. Nor is there much risk that other countries will seduce our workforce away with their lower taxes. As the economist John Hills points out, we are a relatively low-taxed country already by international standards. But also, what is cut from taxes in some countries often has to be paid for privately. So in the US, for example, personal taxes are low but private health insurance is high. In Singapore taxes are low but there are compulsory private savings for pensions instead.

Even looking closer to home it is silly to claim that we cannot afford current levels of public spending. Ordinary families are not - as many politicians try to claim - over-taxed. Certainly taxes on low incomes are too high; many people are discouraged from finding work because they are better off on the dole. But the average household still faces roughly the same tax burden today as 20 years ago. And given that real incomes have risen, it seems ludicrous to argue we can't afford to pay more.

Most families in Britain can afford to pay more. The trouble is they don't want to. According to the pollsters, the public would like to see more spending on hospitals and schools. However, the politicians who have most to lose from misjudging the public mood clearly believe, on the basis of their own research, that voters don't want to pay more. Whether it be because they distrust politicians to spend it properly, or because they enjoy spending the money themselves, or because they simply don't want to subsidise other people, the consequences are the same.

So Mr Clarke is right to be worried about reconciling Conservative demands for tax cuts with the public spending bills his own government's short- termism has created. Likewise Gordon Brown is right to be cautious about making new spending pledges that the public aren't prepared to pay for. But the rest of us shouldn't kid ourselves. The tax and spending strait- jacket stems from our own unwillingness to pay.

Moreover, our selfish short-termism may serve us right in the long term if politicians and Treasury officials take us too seriously. Our welfare state - including the National Health Service and social insurance system - is actually extremely good value for money. If we tried to do it all privately, it would cost us much, much more.

Constraints on how much we can tax and spend are not economic, they are political

The tax and spending strait-jacket stems from our unwillingness to pay