The new Government inherits a mixed set of public finances. Government debt is high but borrowing is low.
It’s likely that there will be a loosening of the purse strings during this Parliament. The Government will likely increase spending to deliver on its campaign pledges, and this spending will come on top of previously agreed increases in departmental budgets.
The Government can currently borrow more, to increase spending, at very low cost, but a prudent Chancellor will be wary of future challenges: healthcare and adult social care costs are increasing, and the outcome of the UK’s exit from the EU is uncertain.
When the Government spends more than it receives in taxes and other revenues, it needs to borrow to cover the difference.
Government debt is the total amount it owes; broadly speaking, it is the stock of past Government borrowing. Both debt and borrowing are often expressed as a proportion of the country’s national income – gross domestic product (GDP). Provided that the economy is growing quickly enough, it is possible for debt or borrowing to rise in cash terms but fall as a proportion of GDP.
The Government’s financial inheritance
Reductions in borrowing may be coming to an end
Annual Government borrowing is low, relative to the past 60 years, and has fallen from the peaks that followed the 2007/08 financial crisis. In 2009/10, the Government borrowed around £1 of every £4.50 it spent, but by 2018/19 this had declined to £1 in every £20.50. Much of the fall in borrowing is the result of the Government limiting its spending, with day-to-day spending on public services particularly squeezed. This is what people often mean by ‘austerity’.
Borrowing is not expected to fall in the next few years. Government spending will increase in 2020/21, following September’s Spending Round. Forecasters also expect weak economic growth to slow the growth in tax receipts.
Debt is high, but falling
The large amounts borrowed by the Government following the financial crisis significantly increased its debt. Before the financial crisis, Government debt was worth around £21,000 per UK household, but by 2018 it was closer to £64,000. Debt has been falling – relative to the size of the economy – since 2018. However, it remains at a level last seen in the mid-1960s, when it was still recovering from reaching more than 200% of GDP during World War II.
The Government’s debt interest costs have remained low, relative to its debt. The Government has been able to borrow at historically low interest rates and has benefited from the Bank of England owning more than one fifth of its debt.
Party leaders say they will take advantage of historically low interest rates to borrow in order to invest in public services and infrastructure.
Government spending was set to increase in 2020/21 even before the election campaign. Pledges to increase spending were a major part of the manifestos, so we should expect further increases.
A recent history of public spending
Since 2010, total public spending has been little changed after adjusting for inflation. The Resolution Foundation describes this as an “unprecedently long pause” in spending. Population increases have meant that total spending per person is now projected to be about 9% lower in 2019/20 than in 2010/11. Changes in spending were not spread evenly across Departments. While some areas, notably health and education, saw increases in their total budget, others, such as justice and local government, saw significant decreases (see chart 3). The Institute for Government reports that several public services are under strain from these cuts, and that even the recently announced future spending increases may only be enough to keep up with demand, rather than making improvements.
The end of austerity?
Government departmental budgets for 2020/21 were set in September’s Spending Round. Relative to 2019/20, an extra £13.4 billion is being provided overall, with no Department seeing cuts to day-to-day spending.
The Spending Round implemented several spending commitments, some of which had been announced previously. More funding was provided for the NHS, schools and the recruitment of police officers. Departments also received funding to help in establishing a new relationship with the EU.
For some, these spending increases brought the austerity of the last decade to an end. However, the Institute for Fiscal Studies (IFS) says that, while this is indeed a change in the trend of public spending (that is, spending is now increasing), the total level of spending on many services next year will still be well below where it was in 2010. It is therefore unclear whether these recent increases represent an end to austerity or merely a pause.
What was promised in the manifestos?
The Liberal Democrat and Labour manifestos promised large increases in day-to-day public spending. The IFS estimates that the Liberal Democrats would have spent an extra £37 billion in 2023/24, while Labour would have gone further still, with around £100 billion of additional spending. The Conservative manifesto proposed a much smaller increase of £3 billion.
The Liberal Democrats and Labour proposed tax increases to pay for some of their spending. In 2023/24, the Liberal Democrats would have increased tax receipts by a little over £35 billion, while Labour looked to raise an extra £80 billion or so. Again, the Conservative proposals were more modest, with tax policies that would raise an additional £3 billion.
All three parties also wanted to spend more on infrastructure. Chancellor Sajid Javid said that the Conservatives would raise investment spending for long-term projects from around 2% of GDP to a level that “will not exceed 3% of GDP,” which would mean about £20 billion more per year.
Labour proposed a five-year, £150 billion “social transformation fund” to be spent on things such as schools and hospitals, along with a 10-year, £250 billion “green transformation fund” for transport and energy infrastructure.
Impact of Brexit
The form that Brexit takes could have a large effect on public spending. Departments have already received £8.3 billion since 2016 to prepare for Brexit, and any economic disruption may result in higher spending. Chancellor Sajid Javid has said that a no-deal exit would be met with a “significant policy response.”
Even under an orderly Brexit, there will be spending decisions to make, not least about how to replace programmes funded by the EU. The May Government guaranteed funding to the end of the existing programmes, even if the UK leaves the EU without a deal, and also proposed a Shared Prosperity Fund to replace the EU Structural Funds, but few details have emerged about this since its announcement in 2017.
Challenges for public finances
Pressures on spending and taxes
Both public spending and taxes face known challenges, with health and social care services facing the most significant cost pressures.
An ageing population will put pressure on health and social care spending. These services also face non-demographic spending pressures. For example, technological advances in healthcare generally lead to an increase in spending, as treatments for more health conditions become available, which increases demand. Society also demands more from health and social care services as incomes rise. In the near term, the money pledged during the election campaign should help. According to the Office for Budget Responsibility’s (OBR) 2018 Fiscal Sustainability Report, in the longer term, without a change in Government policy, health and social care spending could nearly double, relative to the size of the economy.
In the near term, Brexit’s impact on the public finances will depend on how orderly a departure the UK makes from the EU. Official forecasts assume that the UK will leave in an orderly way and transition to a new long-term relationship with the EU. A less orderly departure is likely to weaken the wider economy, reduce tax receipts and increase borrowing.
In the long term, the terms of any future UK-EU trade agreement will, in the main, determine Brexit’s impact on the UK economy. The vast majority of analysis shows that the higher the barriers (cost) of trading with the EU (via tariffs and non-tariff barriers), the larger the negative impact on the UK economy and, in turn, the public finances.
At some unknown point in the future, the UK economy will enter a period of recession. The OBR’s 2019 Fiscal Risks Report estimates that there is a one-in-two chance of a recession in any five-year period.
When the recession comes, its effect on the public finances will depend on how deep and long it is and how quickly the economy recovers. It isn’t possible to eliminate the risk of a recession, but the Chancellor can prepare.
More interest is being taken by policy makers, including at the Bank of England, in the impact of climate change on the economy. The OBR says that climate change could bring both sudden shocks and slower-building pressures on the public finances.
Much depends on the extent to which temperatures rise. Climate change’s impact on the economy and public finances is likely to be smaller if global mitigation efforts are successful.
Decisions for Parliament
The most pressing piece of financial business for the new Parliament will be the passing of a Budget and its accompanying Finance Bill. This must happen before the end of the financial year in March 2020. Parliament will also need to debate and agree Departments’ revised spending plans for 2019/20.
The Government will need to seek the House of Commons’ approval if it wants to introduce new rules for managing the public finances. The Labour and Conservative manifestos proposed rules that would curb borrowing for day-to-day public spending but would allow more borrowing for infrastructure spending.
Other spending decisions also loom. For example, the provisional local government Finance Settlement is usually published in December, and local authorities are coming to the end of the current four-year settlement.
A full Spending Review is due by the end of 2020, when departmental budgets will be set for the next few years. This will likely also accompany other funding reviews and major decisions on the direction of spending across government.
- The budget deficit: a short guide, House of Commons Library
- Public spending: a brief introduction, House of Commons Library
Insights for the new Parliament
This article is part of our series of Insights for the new Parliament. This series covers a range of topics that will take centre stage in UK and international politics in the new Parliament.