NHS running out of money

(click on the chart for a larger image)

According to a report by NHS managers, the National Health Service is about to run out of money. Apparently, it is a cost side problem. An ageing population and the cost of new treatments are beginning to put unsustainable pressures on the healthcare budget.

Let's assume for a moment that the problem is genuine and that this isn't another cynical attempt by public sector insiders to squeeze out more resources from the taxpayer. What should the government do?

All budgets are a matter of simple arithmetic. If the government wants to spend more money on health it can either raise more taxes, cut expenditure in another item of the budget, or borrow money and kick the problem into the future.

Whatever else we might say about Gordon Brown, he has provided an answer to this perennial question. He would prefer to avoid any difficult expenditure discussions with his rebellious ministers. Nor does he want to distress today's voters by raising tax rates. This leaves just one option; increased government borrowing.

What does this decision mean in terms of long term budgetary arithmetic? Currently, health care consumes about 18 percent of the budget. It is the second-largest category after social protection.

As borrowing increases so does the interest payments on the debt. Interest payments on government debt accounts for four percent of the budget. In the short run it might be possible for the government to borrow more in order to cover these higher interest payments. If the government persists in running large deficits, interest payments will eat up a growing proportion of total expenditure.

Here we arrive at a nasty truth about public sector interest payments. They have first claim on any revenues if the government is running a deficit. The government cannot default, because if it does, it will longer be able to borrow, and expenditures will have fall immediately in order to make tax revenues. Therefore, it will be categories like healthcare and social protection that will bear the burden of any future fiscal adjustment.

Running large deficits today makes the expenditure choices in the future more painful. It seems an obvious point, but it is one that seems lost on today's government.

So if the NHS management is right and there are deep structural reasons, such as an ageing population for rapid cost increases in health care, then the sensible thing to do would be to minimise other expenditures such as interest payments. This would mean running a balanced budget today rather than an utterly irresponsible deficit amounting to 12 percent of GDP.