This note aims to answer some FAQs related to the budget deficit.
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- The budget deficit: a short guide (PDF, 281 KB)
1. What is the budget deficit and how big is it?
When the government spends more than it receives in tax and other revenues it borrows to cover the difference. This borrowing is known as ‘public sector net borrowing’ but is often referred to as the deficit.
In 2019/20, government revenue – from taxes and other receipts – was £824 billion while government spending was £887 billion. The deficit was therefore £63 billion, equivalent to 2.8% of national income.
Borrowing financed around 7%, or nearly £1 in every £14, of public spending in 2019/20. Borrowing of £63 billion is equivalent to around £940 per head of UK population.
2. What are the trends over time?
It is not unusual for the government to borrow. Since 1970/71, the government has had a surplus in only six years.
The annual average budget deficit has been 3.4% of national income since 1970. It has varied significantly over this period as the chart below shows. Large budget deficits occurred in the mid-1970s and early 1990s and more recently after the financial crisis. Borrowing peaked at £158 billion (10.2% of national income) in 2009/10.
The big increase in the budget deficit from 2008 onwards was caused by both an increase in government spending and a fall in government revenue. Public spending increased from 40% of national income in 2007/08 to 46% in 2009/10. At the same time, government revenue fell from 37% of national income to 36%.
3. How will coronavirus affect the budget deficit?
Public health measures taken to slow the spread of the coronavirus have restricted people’s movement and activity. Much economic activity has been suspended. The Chancellor has taken various steps to support businesses, workers and incomes during the crisis.
The public finances will be significantly affected by the economic shock caused by the coronavirus outbreak. The Government’s budget deficit will increase as tax revenues fall and government spending increases.
At this stage no one can say by how much the deficit will increase in 2020/21 nor the extent to which future deficits will be affected. The longer the crisis continues, the more the cost to government will rise.
In an illustrative scenario the Office for Budget Responsibility (OBR) analysed what might happen if there is a three-month lockdown followed by another three-month period where the lockdown is gradually lifted. In this scenario, the OBR estimates that UK GDP (economic output) would fall by around 13% in 2020. The budget deficit would reach around 15% of GDP.
In the scenario it considered, the OBR assume – for simplicity – that there is no lasting economic harm from the coronavirus. This assumption means that the economy fully recovers once the crisis ends. In turn, tax revenues recover and spending in areas such as welfare subsides. In such a scenario, the budget deficit naturally returns to pre-coronavirus levels.
However, if there is lasting economic damage the UK could be left with a bigger ‘structural’ deficit, which won’t be eroded once the economy reaches its new level of capacity. We discuss the structural deficit below. The OBR will revisit their assumption of no lasting economic harm in the future.
More detail is available from the Library briefing Coronavirus: Effect on the economy and public finances.
4. How does the UK’s budget deficit compare with other countries?
The IMF – who use a slightly different measure of governments’ net borrowing – report UK government borrowing of 2.1% of GDP in 2019, higher than the European Union average of 0.6% but below the average for advanced economies of 3.0% of GDP. UK borrowing in 2019 was also below the average amongst the G7 group of advanced economies of 3.8% of GDP.
Governments across the world are borrowing more because of the coronavirus pandemic. The IMF forecast that across advanced economies borrowing will average 10.6% of GDP in 2020. For the G7 group of advanced economies the IMF forecast borrowing of 12.0% of GDP. The IMF forecast UK government borrowing of 8.3% of GDP in 2020.
5. How is the budget deficit financed?
The budget deficit is financed by sale of government bonds. These are essentially interest paying “IOUs” which the government sells to investors. Purchasers of government bonds include pension funds, insurance companies, households and overseas investors. Further information is available in the Library Insight Coronavirus: Government debt, an explainer.
The Government is selling record amounts of bonds during the coronavirus pandemic as its deficit is high. Investors are still demanding the bonds which means that the interest rate paid by Government remains low. Rates had been low before the pandemic. Some of the demand for government bonds is coming from the Bank of England who have been buying government bonds from investors (on so called secondary markets) in order to support the economy during the coronavirus pandemic. Further information is available in the Library briefing paper Coronavirus: Effect on the economy and public finances.
6. How much interest does the government pay on its borrowing?
Interest payments on borrowing are a significant part of government expenditure. Interest is paid on all outstanding government debt, accumulated over many years. In 2019/20, gross debt interest payments were £47 billion; net debt interest payments were £36 billion.
The lower net interest figure includes the impact that the Bank of England’s quantitative easing has on the government’s debt interest payments. The Bank has bought government debt from private investors such as pension funds and insurance companies largely to get money into the economy. As some of the government’s debt is being held by another public sector body – the Bank of England – it means that when the government comes to make interest payments it is giving these payments to another part of the public sector. The net effect is that these debt interest payments are cancelled out for the public sector.
7. What is the current budget deficit?
The current budget deficit is the difference between government’s day-to-day spending and its revenues, or more formally its current spending and current receipts. This measure differs from the overall budget deficit as it does not include government’s net investment spending.
The current budget deficit was £14 billion in 2019/20, equivalent to 0.6% of national income.
8. What is the structural deficit?
A distinction is often drawn between the cyclical and structural elements of the budget deficit. The size of the deficit is influenced by the state of the economy: in a boom, when the economy is above its potential, tax receipts are relatively high and spending on unemployment benefit is low. This reduces the level of borrowing. The reverse happens in a recession when borrowing tends to be high.
The structural deficit is that part of the deficit that is not related to the state of the economy. This part of the deficit will not disappear when the economy recovers. It thus gives a better guide to the underlying level of the deficit than the headline figure. The structural deficit cannot be directly measured so it has to be estimated.
The economy was estimated to be running slightly above its potential in 2018/19, so the structural deficit was a little larger than the actual deficit.
9. How much did the financial crisis contribute to the budget deficit?
This is not a straightforward question. Government support for the banks took a variety of different forms, including share purchases, loans and guarantees which have different effects on the public finances. Guarantees, for example, are more likely to give rise to contingent liabilities which will only materialise under certain circumstances. This is quite different from purchases of bank shares where there is an outlay of cash.
While the overall level of support for the banks was very large, the impact on the deficit was comparatively small. The Government has said that the financial crisis accounted for around 5%-6% of the deficit in 2008 and 2009.
10. What is the difference between the deficit and government debt?
The deficit is the difference between government revenue and spending, usually measured over a single financial year. Debt is the total amount owed by the government which has accumulated over the years. As a result, debt is a much larger sum of money. At the end of 2019/20 public sector net debt was £1,804 billion (i.e. £1.8 trillion), or 93% of national income. This is equivalent to around £27,000 per person in the UK.
11. Where can I find more information?
The Office for Budget Responsibility (OBR) has produced a brief guide to the public finances, which provides a brief introduction to the UK public finances and to the terms used to describe them in the official statistics.
In March 2016, the ONS produced a data driven explanation of the deficit and debt.
Those wishing to delve further into technical areas are pointed towards the Office for National Statistics’ (ONS’) Public Sector Finances Methodology Guide. The ONS have also produced a public sector finance glossary.
Data on the deficit, debt, expenditure and receipts are available from the OBR’s public finances databank. Some of the series begin in the 1920s, and the data includes forecasts.
The Library has published the following relevant briefings:
- Public finances
- Government borrowing, debt and debt interest: statistics
- Coronavirus: Government debt, an explainer
- Coronavirus: Effect on the economy and public finances
- Public sector debt: a Q&A
Download the full report
- The budget deficit: a short guide (PDF, 281 KB)