The deficit is a measure of the gap between the amount of money spent across the public sector and the amount of money raised by government through taxes and assets each year. If the government receives more money than it spends, then it is said to be in surplus, although in the 68 years since 1946 this has only happened on 14 occasions, most recently in 2001/02.
There are actually two widely used measures of the deficit: one looking at the amount the public sector borrows, and one looking at the difference in its income and expenditure. While the distinction might seem trivial at first, your choice of measure could add or remove several billion pounds from the ‘deficit’.
‘Public sector net borrowing’ includes all money borrowed by government, including that used to finance investment spending. It is also sensitive to one-off transactions, such as the transfer of assets to government from the Royal Mail Pension Plan, which removed £28 billion from the deficit at a stroke. The other measure – known as the ‘current budget’ – excludes these, looking just at current spending against current receipts.
Economists also sometimes distinguish between two different types of ‘deficit’: the cyclical deficit and the structural deficit. Because public finances tend to reflect the country’s wider economic performance – at times of high employment and productivity, for example, tax receipts tend to be higher – the state of the government’s balance sheets can improve or degenerate without any fundamental change in fiscal policy.
This portion of the deficit that could be removed through a return to the peak of the economic cycle is known as the cyclical deficit. That which remains even when the economy is performing optimally is called the structural deficit (sometimes also known as the cyclically-adjusted deficit). As there is no definitive answer to the question of what optimum economic performance looks like, there is often disagreement about how much of the deficit is cyclical and how much is structural.
Public sector debt (often called the national debt) is the total amount of money that the government owes to its creditors. Money borrowed by government in any year will add to this total, while running a budget surplus will help the Treasury to bring it down.
At the end of 2013, UK net debt stood at £1.25 trillion (excluding financial interventions). This is the highest it has ever been, although the same could be said for the level recorded in all but 10 of the past 39 years. The reason for this is that as the economy grows, so does the government’s capacity to borrow money.
To control for this, economists often look at public sector debt as a proportion of GDP. In December 2013, the value of public debt was 75.7% of the total value of the country’s economic output, also the highest since the ONS began recording the data in its current format in 1975.
While debt is currently high by recent standards, by using older data sources we can see that it is still a great deal lower than was generally the case earlier in the 20th century, when public debt peaked at over 250% of GDP.
It is important to note that these figures don’t include the effects of ‘financial interventions’ – government purchases of equity in banks such as RBS, Lloyds and Northern Rock – as these are counted as assets which can be sold in the future (part of the taxpayer’s stake in Lloyds was sold by the government in 2013). Including these financial interventions on the government’s balance sheet increases public debt significantly, taking it to over £2.2 trillion at the end of 2013 (134.5% of GDP).
While the numbers involved are undoubtedly large, the government does at least have some breathing room when it comes to repaying it. According to the Debt Management Office, the average government gilt or Treasury Bill – the instruments used to borrow money for the public purse – is due to be repaid in just under 15 years. The biggest single creditor is the Bank of England, and just over a quarter of debt is held overseas.
Last year, HMRC received nearly £470 billion in tax payments handing over £437 billion to the Treasury after tax credit payments were deducted. Nearly three quarters of the money received came from income tax, national insurance and VAT payments.
Income tax in particular often receives a great deal of attention around the Budget. This year there have been calls for the Chancellor to raise the 40p tax threshold, which workers currently pay on earnings over £32,011. Since 2009/10, the number paying the Higher Rate (to give the 40p rate its proper name) has risen by 1.2 million, while the number of workers taxed at the Basic Rate (20p) has fallen by 2.3 million over the same period.
There has also been a great deal of political controversy about the tax paid by the very rich, with Labour accusing the Chancellor of introducing a “tax cut for millionaires” (referring to the drop in the additional rate of tax paid on incomes over £150,000 from 50p to 45p in 2013), while the government has suggested that the richest will pay more in every year of the Coalition than they did under any year of the previous government. According to HMRC data, recent years have seen those earning over £1 million pay a higher proportion of their incomes in taxes.
Last year, £673.4 billion was spent by government on providing public services and excising its other obligations. This is a real terms fall of £45.9 billion from the 2009/10 financial year, which was the last of the previous government. Over half of this money is spent on providing social protection (including welfare payments, pensions and social services) and the National Health Service.
The Treasury divides its spending into two broad categories: Departmental Expenditure Limits (DEL) and Annually Managed Expenditure (AME). The DEL is the money given to departments by the Chancellor to spend on the programmes and services Ministers choose to prioritise. AME is the money allocated to financing government commitments that it can’t completely control because they are demand-led.
For example, the cost of providing the state pension will depend upon the number of retired people claiming it, while the amount paid out in welfare will reflect wider economic trends such as unemployment.
This isn’t to say that the government can do nothing to control AME spending. In last year’s Budget, the Chancellor announced caps on a number of areas of spending falling within the AME budget, including some elements of welfare expenditure. AME currently accounts for just under half of all government spending.
While the announcements made by the Chancellor in the Budget are often treated as fact, in many cases they are simply predictions based on the direction the economy is expected to move in. Since 2010, the independent Office for Budget Responsibility has been tasked with producing these projections.
To get a sense of why we might want to be cautious about reading too much into the longer-term forecasts made in the budget, we can compare the position the UK economy was expected to be in in 2014 when George Osborne announced his first Budget in June 2010 with the latest predictions made in December’s Autumn Statement. Whereas the June 2010 Budget expected the deficit to be 3.5% of GDP, the latest figures suggest it will be close to double that.
Early predictions about GDP growth, inflation and unemployment have also proved to have been overly optimistic, although the Autumn Statement did provide a rosier outlook than was the case in last year’s Budget.