Government Spending

The IFS estimates that around 50% of the planned fiscal adjustments to tax and spending announced in 2008 have been implemented. The PSNCR is forecast to fall to £91.3bn this financial year, or 5% of GDP. This is considerably higher than forecast two years ago. Why the persistently high public sector deficits?

1. A shift to part-time and self-employed income earners has led to lower than expected tax receipts. There is a time lag in collecting such tax, and also a tendency for a significant proportion to be undeclared (the ‘shadow economy’ estimated at 10% of GDP). For this reason tax receipts were revised down in 2014-15 by almost £8bn. Even so, the government is still forecasting a small budget surplus in 2017-18.
2. Declines in real incomes are reflected in a wage freeze or effective real wage cut of 9% 2007-14. Put another way, public spending tends to rise with inflation (unless cut in other ways) but receipts stay fairly constant as a proportion of income.
3. The Government announced a rise in tax thresholds from £5,500 in 2007 to £10,500 in April 2015, and a reform of stamp tax duty on property sales in 2014. This has cost the UK £27bn lost income tax receipts and has taken 3.2m workers out of tax.
4. Welfare reforms (to unemployment and housing benefits) have combined with lower unemployment generally to bring cyclical expenditure down (that caused by trade cycle factors). In an election year it is worth noting that the Labour Party intends to control current spending but increase the capital spending component of G.

Public spending is forecast to fall from its present level of 41% of GDP to 35% in 2019-20. If it’s achieved, this will be its lowest level in 80 years. The two peak years were 2008-9 (44.5%) and 1978-9 (49.5%).

Does the level of UK debt (£1.3 trillion) overall matter? Remember that the total level of debt is the sum of all past deficits less the surpluses. Arguably the key indicator is debt as a % of GDP. Debt rose from 37% of GDP to 72% of GDP in 2014**. In other words, it has doubled in this period. However, the question is whether this can be financed by the sales of long term gilt-edged stock. The exceptionally low interest rates reflect the fact that the UK is perceived by domestic and overseas investors to be a safe haven for funds. As long as this confidence remains, then we might conclude that the level of debt and of the deficit is not as significant as sometimes portrayed. As a historical point, the key year for UK debt to GDP was just after the Napoleonic wars. In 1819 debt was 210% of GDP – three times its present level. On that comparison, we have some way to go.