Why does the deficit matter?
In recent years, we’ve grown accustomed to seeing the UK budget deficit beat expectations each month. Indeed, as recently as January, there was actually a surplus (ie: the level of tax revenue received by the Exchequer exceeded the total spent by the Government on everyday costs such as welfare and public services) – the largest on record for the month of January.
However, this trend has suddenly taken an unexpected turn, as we learned last week from Office for National Statistics (ONS) figures that borrowing swelled to £7.2bn for the month of June - the highest figure recorded for June since 2015, and twice the level borrowed in the equivalent month last year. It's sparked fears among economists that Britain could miss its fiscal targets for 2019/20, and, while month-on-month figures are prone to volatility, Government has already borrowed £17.9bn so far this year (£4.5bn more than at this stage last year).
But what does it all mean? And why does it matter? This will be our focus in the next section.
Why the deficit is important
The budget deficit and the national debt are inextricably linked, in that the latter represents an accumulation of the former over time. The latest ONS figures revealed that national debt now stands at a staggering £1.82tn - or 85.2 per cent of GDP (as at the end of 2018/19).
Interestingly, this puts it lower than the likes of France (98.4 per cent), the United States (106.1 per cent), Singapore (112.2 per cent) and Japan (253 per cent). Nevertheless, this remains an exceptionally high debt-to-GDP ratio historically for the UK (the levels of which have not been seen for more than 50 years), and there are a number of reasons it can hold our economy back.
Firstly, it crowds out investment in the economy itself, as investors lend their money to Government, rather than businesses and consumers within the private sector. Increases in tax rates also become a necessity to pay off the debt, which in turn have a negative impact on growth. Furthermore, in times of recession, poor public finances will invariably leave our Government hamstrung, in that lenders will be more reluctant to finance the stimulus required if they are concerned about our ability to pay it back.
And then, of course, there is the legacy that comes with such a vast debt: interest on the repayments. Before a single penny can be spent on public services, the national debt must be serviced, and last year this cost amounted to over £50bn. To provide some context, that is roughly four times the police budget for England and Wales.
Where to from here for our public finances?
It must be said that government borrowing has shrunk significantly from its peak of £153.1bn in 2009/10, with just £23.5bn being borrowed in the last tax year. Nevertheless, a falling deficit has still amounted to a rapid increase in the national debt over this period. The numbers are set to take a turn for the worse too, as Ruth Gregory, senior UK economist at Capital economics, noted in This is Money that a change in the accounting treatment of student loans in September is set to increase the deficit by more than £10bn a year. Little wonder then that the Office for Budget Responsibility now predicts UK borrowing will balloon to just under £30bn this year.
And it is against this backdrop that the new prime minister has made some lavish spending promises; seemingly covering everything from broadband to buses.
These may be noble endeavours, and, cloaked under the £26.6bn of 'fiscal headroom' which has often been spoken of, could even appear viable. However, this headroom is something of a myth, as it simply refers to the current budget deficit against GDP (1.2 per cent) versus a rate of borrowing of 2 per cent. As such, spending this 'extra' money would simply amount to more borrowing, unless recouped through higher tax revenues elsewhere.
A tough balance to strike
Preservation of the public finances is becoming an increasingly difficult sell to an austerity-weary country, and politicians on all sides of the House of Commons appear to now favour a fiscal stimulus. Unfortunately though, more debt means a greater share of Government spending being eroded by debt interest in the years to come.
Let us not forget that, while ultra-low interest rates look set to endure in the short term, the expectation must be that they will normalise in the not-too-distant future. And when they do, the cost of servicing our debt is likely to soar. Deficits also tend to increase in times of recession, usually as a result of falling tax receipts from rising unemployment and reduced consumer spending. Given that we now find ourselves a decade into the economic cycle, and with the threat of a global downturn upon us, it's reasonable to assume that tough times could be on the horizon.
So, despite it not necessarily being an election-winner of a policy, we would urge our elected MPs to respect the need for restraint, and avoid a reckless bidding war. That's not to say that some gradual, carefully-considered tax cuts to give businesses or consumer spending a boost aren't warranted. Nor that investment in infrastructure, education, tech, innovation and R&D aren’t justified. On the contrary, these can drive growth whilst paying for themselves over the medium term.
But uncosted spending pledges that blow a hole in the public purse threaten to undo all the hard work that’s been done since the financial crisis, and it is future generations who will pay the price. With monetary policy all but stymied by near-zero interest rates, fiscal policy may well be the lever we need to pull when the next recession rolls into town. All the more reason to keep the deficit coming down in the meantime, and to ensure we are in the best possible position to protect our economy if and when the time comes.
Our website offers information about saving, investing, tax and other financial matters, but not personal advice. If you're not sure whether peer-to-peer lending is right for you, please seek independent financial advice, and if you decide to invest with Lending Works, please read our Key Lender Information PDF first.
Wednesday’s Budget speech, coupled with the cut to Bank of England rates, represented a decisive response to the coronavirus. Here we analyse the impact it will have on mitigating disruption from Covid-19, along with the long-term implications of this significant fiscal stimulus.
Rumblings from the Treasury ahead of next week's Budget suggest tax grabs will be needed to fund increased spending, and it appears UK enterprise could be in the firing line. Here we articulate why targeting entrepreneurs and small business is ill advised.
In a difficult climate, customer acquisition and lead generation present stern challenges for UK retailers, and a great deal of marketing spend invariably gets directed towards getting feet through the door.
Over the last decade, there can be little dispute that the reputation of mainstream banks – and particularly the so-called ‘Big Four’ (HSBC, Barclays, Lloyds and RBS) – is at its lowest ebb.
The 2019-20 ISA season has been a damp squib, with banks disinterested in attracting savers’ cash, rates cut, and the stock market in freefall. However, the emergence of the IFISA means alternatives beckon for those seeking a stable middle ground in terms of risk and reward.
In a decade of slow recovery, the rapid rise in asset prices has been the standout. But how sustainable has price growth been, and could we be in the midst of a bubble?
Most people consider income tax to be a given, but in the UK it is barely two centuries old. In this article, we look at how this tax has developed over the years, and also why it is set to remain at the core of our tax system for many decades to come.
Open banking celebrated its second birthday last month, but has the ‘revolution for financial services’ that was promised actually come to pass? In this article, we look at the progress the initiative has made so far, and what the future holds in the face of high levels of scepticism.
On the face of it, a 'broken' energy market needed fixing, and the price caps introduced in early 2019 were heralded as the solution. But, one year later, have they actually helped consumers save?