THE TRUTH ABOUT THE UK DEFICIT

There has been much written about the UK budget deficit which has a stranglehold over the entire political debate in Britain.  It dominates the discussions over the economy, social policy and growth policy.

The political discourse is dominated by the orthodoxy that there was a massive structural budget deficit in the UK at the last election (2010), and that this is as a result in large part to the Labour government’s spending plans.

So is this the case?

Well lets look at the facts. If we strip away the politicking from the right or left, what was the budget deficit that Labour’s spending decisions were responsible for.

If we are to look at the real structural deficit, simply as a result of the Labour governments spending decisions, we need to go back to before the financial crises hit, in 2007.  This is before the run on Northern Rock and before the bank bail outs and the recession which has led to the tax take decreasing substantially.

At the time the banking crises began to hit the world in 2007 the level of deficit in the tax year 2007/08, in other words the difference between the tax take and the amount spent by government, was 2.7% of GDP and £38.7 billion.  In 2006/07 it was 2.6% of GDP. (ONS, 2008)

General government debt, the amount in total we as a country actually owe in total was £614.4 billion in 2007/08. (ONS, 2008)

This figure is not considered reprehensible or beyond any tolerance levels for a developed economy either in historic terms or in purely economic terms.

Governments are not like households, but more like blue chip companies who have long track records in borrowing money in order to invest in the future growth of the economy.  Some would call this “credit” rather than “debt”, as our economy is built on a growth model which creates money through credit, to invest and grow.

It can be argued politically that not all the 2.7% was investment.  But even if it wasn’t, this amount of deficit is by no means out of control.

Within the European Union there are agreed levels of debt that should be adhered to. The Maastricht Treaty’s Excessive Deficit Procedure sets deficit and debt reference levels of 3 per cent and 60 per cent respectively for all EU countries. The UK’s compliance is assessed on a financial year basis. The debt measure used under the Maastricht Treaty does not take account of assets held by general government.

Another figure quoted is the cyclically-adjusted deficit used by economists. This was stated in the 2007 pre-budget report as being 3.1%. The OECD also published a report stating that under Labour the cyclically-adjusted deficit had grown in its time in office by 1%.

The graph below shows the historical data of the UK debt.

Below is a graph showing the percentage of that debt, and how it is projected to grow.

Now to put this into context we can see how tax revenue and government spending have conspired to cause the economic problems we are in now.

It can be seen quite clearly that the relationship between tax revenue and government spending were matching pace until the financial crises hit, and were within the tolerance levels of the Maastricht criterea of 3% deficit as a share of GDP.

The Politics

What we can see with these economic facts are that, yes government spending was higher than the tax revenue, but within responsible levels and was not out of control as claimed by the coalition.

However, it is also not true that there was no structural deficit as claimed by Ed Balls before Christmas 2010.

There is a debate as to whether the deficit was even as bad as these figures suggest as Labour would say that they were investing rather than simply spending tax revenue, on such things as capital spending programs, which increase GDP, provides skills and jobs and infrastructure enhancement. However, this is not really the point.

Since the financial crises hit in late 2007 – 2008, tax revenues have plummeted making the government spending plan unaffordable.

However, it is also worth bearing in mind that the Conservative Party had a specific pledge to maintain Labour’s spending plan before the financial crises began. (BBC website, 2007)

The real debate is not how much Labour was spending prior to the recession, but what we do now and what is the most equitable way of dealing with the deficit.

There is no doubt that the deficit is now way above the 3% tolerance set by the EU.  Although in the short term this is acceptable due to the effects of a recession, it cannot go on indefinitely.

There are political choices to make, like who pays more taxation, and what gets cut.

The Labour party will not tell us any details regarding a plan for spending cuts.  This is not surprising as they have just lost an election and there is no reason for them to do so.  After the 2005 election it took David Cameron two years to come up with any policy initiatives at all, and if they were in opposition they would not be announcing spending cut plans.

There is also no doubt that spending cuts are not the only consideration.  Over time, the government debt will be dealt with via inflation and growth in the economy.  If we have no growth, tax revenue will not recover.

So we are walking the economic tightrope as discussed in a previous post http://bit.ly/eJ29mI

At the end of March 2010 general government debt was £1000.4 billion, equivalent to 71.3 per cent of GDP, far higher than the 60% quoted by the EU and the deficit is 11.4% of GDP.

The problem is not the spending of the last government, which George Osborne agreed with, hence their policy to match spending plans, but the effect of the financial crises, caused in large part by the lack of regulation of the banking sector.

The sooner the Conservative/LIBDEM Coalition stops just blaming the Labour party and deal with the structural issues of the banking sector the better.

Global Finance website, (2010), Public Deficit By Country, [online], available at
http://www.gfmag.com/tools/global-database/economic-data/10395-public-deficit-by-country.html#axzz1CWgFSXTA

Gold Switzerland website, (2010),Hyperinflation will drive Gold to unthinkable heights, [online], Gold Switzerland website, available at http://goldswitzerland.com/index.php/general-commentary/

BBC website, (2007), Tories to match Labour’s spending, [online], available at                                                                                                                      http://news.bbc.co.uk/1/hi/uk_politics/6975536.stm

ONS website, (2008), [online], available at
http://www.statistics.gov.uk/pdfdir/maast0908.pdf

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8 responses to “THE TRUTH ABOUT THE UK DEFICIT

  1. Good article.

    You may have already stated this but what is behind the big fall in tax receipts from 2009 onwards? Surely that is important to any Govt and needs to be addressed if we are to keep the deficit at a reasonable level.

    Was it purely the result of the credit crunch? Or was it companies avoiding tax, for example?

    - G

  2. And why isn’t this a problem with the massive US debt that they don’t worry about increasing (lending to themselves?)

    • Thanks for your comment

      Basically the big fall in the tax take appears to be because the banks were unable to re-finance their debt arrangements as banks would not lend to each other because no one knew who was holding the bad debt. Therefore the cost of credit increased which led to less availability of credit both between banks and from banks to businesses.

      This led to a slow down in the economy and the recession and continues to affect us today.

      No doubt companies have tried even harder to avoid paying tax, and this would have decreased tax take further, but by far the largest aspect of tax revenue reduction has come due to the slow or negative growth of the economy and the lack of availability of credit.

      The US have been using a keynesian model of stimulating the economy to help their economy grow. Gordon Brown did the same thing initially in the UK but at some point you have to deal with the deficit and turn the “tap” off. The US is able to continue borrowing for longer due to the Dollar being a “banker” currency. People turn to the dollar in times of trouble. It is also one of the most important and the biggest economy in the world and therefore investors trust it’s ability to pay off it’s debt more than say a Greece.

      It is interesting though that President Obama has been talking about reducing this deficit recently and so the stimulation of the US economy may well be coming to an end, but then the US economy is now growing again.

      The non payment of tax is an issue more with the cuts than the creation of the deficit in the first place. If large corporations are not paying as much as £13bn in tax revenue, this would make a big dent in the deficit reduction program of £83bn of the government. see articles on this – http://www.guardian.co.uk/business/2009/feb/02/tax-gap-avoidance
      and http://www.guardian.co.uk/commentisfree/2011/feb/19/taxavoidance-barclay?INTCMP=SRCH

      and see my post on Banks are the biggest tax avoiders: Should we rethink the cuts.

      Hope this helps

      All the best

  3. Pingback: I fecking hate Tories - Page 3 - RedPassion.co.uk - Wrexham

  4. Am I right in thinking that most of the debt is in the shape of government bonds that are, in fact, bought by our own pension funds? If so, is it out of the question ( or just too schizophrenic ) for the debtors to come to deal with their creditors? Surely most people would be happy to forego some return on their immediate investments if it kept them in jobs. I am surprised that nobody seems to have mentioned this. Perhaps the middlemen are preventing it.

  5. Very interesting blog entry !

  6. This article overlooks one key aspect. Downturns happen. There hasn’t been a donwturn in history that hasn’t created a gap between tax receipts and spending. This downturn was caused by a financial crisis, who knows what will cause the next one? You can’t avoid them but you absolutely have to be prepared for them. We were not economically prepared for this one due to the excessive spending of the last government.

    If the author is right that government spending was appropriate prior to the donwturn and that our government debt problems were exclusively caused by the downturn, then the logical response would be stimulate growth and leave spending unchanged, right? Not even the author seems to believe that. The last Labour government should have been spending less and paying down the deficit up until 2007 as it was period of relative economic prosperity. We should have been nowhere near the 3% EU limit at that point in the cycle and yet we were right up against it. We should have had no structural deficit, particularly one created in part by excessive spending on public services that does not add to future economic growth. And yet that is where we found ourselves.

    As for the donwturn itself, well it arose from banks taking inappropriately risky steps to meet OUR insatiable demand for larger mortgages and loans to continue OUR consumer spending. We should regulate the banks to control the supply of consumer debt, but we also need to reduce our demand for it. How can it be right that the consumer debt of citizens of prosperous western economies such as ours is, in effect, funded by the savings of citizens of developing countries such as China? Shouldn’t the opposite be true? We are being truly naive if we believe banks got us into this mess and that bank regulation will get us out. We need to take a long hard look at ourselves.

    • There are various inaccuracies here. First of all I think you mean the “debt” – not the “deficit” in the 2nd paragraph. It is also a matter of opinion whether you can avoid downturns or when they occur. It is also a matter of opinion that the banks lent recklessly to “meet our insatiable appetite”. I think your confusing the systemic problems with blaming individuals for wanting to own their home or live a reasonable life.

      We have now been in the economic mire for 5 years, and we are likely to be in it, along with the rest of Europe and elsewhere for another 5 years. This was not an ordinary downturn but a systemic failure. Without growth you cannot pay down the deficit no matter how much austerity we have. The none sense about the Labour party having spent all the money is simply an easy scapegoating to allow the systemic changes that need to happen to be watered down or forgotten all together. The problem is NOT simply the spending, or selfish individuals, but a systemic failure that WILL happen again unless we change.

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