The question of public sector finances has descended into an irrational bunfight. Watch the “contestants” hurl abuse at each other on “Question Time”. Last month I was invited by Eddie Mair of Radio 4’s PM programme to comment on the level of senior salaries in the public sector. My observation that taxes raised from the private sector are the sole source of public sector funding elicited listeners’ feedback that was polarized between eulogy and castigation – as did my suggestion in “Accountancy” a couple of months ago that excising waste in public finances would be a good start.

There is a perception that tax on public sector pay also contributes to the exchequer. Think about it: how can tax on salaries that are themselves funded entirely out of taxes be anything other than a notional shifting of taxpayers’ money from one government pocket to another?

Public sector activities do not feature in the calculation because their cost is borne by taxes

All taxes come from gross domestic product (GDP) since it represents the entirety of economic output. Its measure is an added value calculation for the country as a whole – not the sum of all turnovers, because businesses trade with each other: one company’s sales are another company’s inputs. Net outputs in the whole economy therefore constitute GDP. Taxation, interest, wages and profits belong on the distribution side. Public sector activities do not feature in the calculation because their cost is borne by taxes, a distribution rather than an ingredient of the national cake.

Choose your model

In a Marxist economy everything is state-owned, so the only way to approximate national income is to add up the total subsistence paid to workers. Seen thus, the public versus private sector argument is spuriously dualistic. The choice is rather between socio-political models. Scandinavian countries tend to favour ponderous state involvement: high taxes and correspondingly less personal spending choice. At the other extreme is Hong Kong, with low taxation and a culture of care within the business or family unit, to whom the notion of welfare dependency is abhorrent.

In a democracy there is choice. But what the UK cannot choose is to be a Swedish spender and a Hong Kong taxer. In the Thatcher years much that was state-owned was privatized. Yet despite criticisms that this created weakly regulated cartels, hardly any industry previously privatized was re-nationalised under New Labour.

Yet the state sector burgeoned. Over the past 10 years its head-count has risen to 7 million; welfare spending rose by 40% in real terms leaving 5 million people on out-of-work benefits; housing benefit doubled to a level that dwarfs spending on the police. Dependency on such a scale exceeds the country’s taxable capacity, which cannot stretch to over 50 per cent of national income.

Cutting with care

Public sector cuts must not be indiscriminate. Government contracts with private sector entities that enhance public life – schools, hospitals, telecoms and infrastructure projects (such as Crossrail) must not be axed lest, like happened in Japan, an obsession with debt control stifles recovery.

That still leaves scope for massive savings. We cannot afford to prop up corrupt tyrants in Africa in the name of aid. Over $300 million from Western governments to “Global Fund” in Uganda, for combating aids, malaria and tuberculosis, has been stolen and probably resides in Switzerland. We have also doubled our contribution to the biggest sin-bin of all, the European Commission, when that obese outfit is fulminating against Britain over the size of its deficit.

But the real target is top-heavy, overpaid management. Government employment of managers rose by 80 per cent in seven years at a cost of £14 billion. What do all these people actually do? And the quangos? We don’t need state-funded agencies to tell people what to eat.

Turn the question on its head. Which activities are absolutely essential to government? The private sector will regenerate the economy – provided government recognizes that its role is simply to unburden it.