Why did the UK have to borrow so much?
The claim
“Labour’s leadership candidates say that spending was not the problem. It was taxes. Nonsense. In just two financial years up to the election, public spending rose by 10 per cent in real terms. That’s a rise after inflation of £59 billion.”
Chris Huhne MP, Climate Change Secretary, press conference attacking “Labour’s legacy”, 11 August 2010
The background
The Tories and Lib Dems joined forces today to attack what they see as Labour’s years of waste and overspend. Labour’s leadership frontrunners have said the current raggedly state of the public finances is (broadly speaking) a result of the financial crisis and collapsing tax revenues rather than over-spending. But today, Chris Huhne stood next to Conservative chairman Baroness Warsi and reeled off figures showing that spending went up over the past couple of years by far more than taxes went down.
The analysis
Put simply, governments rake in money through taxes, and spend the cash on anything from schools, police, roads, benefits and interest on the national debt. If the government spends more than it raises in a given year, it has to borrow to fund the excess. This borrowing, or budget deficit, has spiralled since 2008.
At the same time, spending has gone up – something Huhne pounced on today.
There are three main reasons for the inflation-busting rise. Firstly, the “automatic” extra costs of the recession, such as increased spending on unemployment benefits, which the government can’t do much about. Public service budgets were set in 2007 for the next three years, but inflation turned out to be much lower than had been expected at the time, so the government got more bang for its buck in real terms. Labour also chose to spend some extra money on one-off giveaways, mostly for pensioners and children.
And all this extra spending played a bigger part in pushing up the budget deficit than the falling tax take did, the Institute for Fiscal Studies told FactCheck. This isn’t necessarily that surprising. Taxes are fairly responsive to the size of the economy – less business activity and fewer people in work means less income tax, national insurance and corporation tax for the exchequer.
The UK was particularly exposed to the fall in corporation tax that came with the banking crisis – although the financial sector had only made up around 10 per cent of the UK economy pre-credit crunch, it paid more like a quarter of all corporation taxes. There were also some discretionary tax cuts – the government kissed goodbye to around £12bn in tax revenue with a one-off VAT cut throughout 2009.
Treasury figures show the tax take went down by around two pence in every pound generated by the economy in the past couple of years, while spending had gone up by just over six pence in every pound.
The financial crisis also means the whole economy has permanently shrunk – by nearly 6 per cent, according to the latest figures.
So even if the UK’s books had been perfectly balanced before the crisis hit, public spending would have to be cut in order to match the new, smaller size of UK plc.
But Labour was already borrowing some money to fund its spending before the crisis hit. Whether it should – without hindsight – have been more fiscally prudent better is open to debate.
“In fairness to the Labour government, there weren’t a lot of people in the run-up to the crisis saying we were running a vastly unstable fiscal position,” said Gemma Tetlow, senior research economist at the IFS. But on the other hand, she says, although pre-crisis our debt and borrowing levels weren’t terrible compared with other countries, many industrialised countries had done a lot more than the UK to pay down their debt between 1997 and 2007.
The verdict
We come short of stamping Huhne’s claim fact as falling tax revenues did play a part in the swelling of the budget deficit. But increased spending did more to ramp up the billions of pounds the UK had to borrow. This doesn’t take into account of how well – or badly – the economy would have fared without the extra spending. We wait to see whether fears of a double dip recession in the face of coalition cuts will materialise.
There are 6 comments on this post
[...] Is it any wonder the Coalition is afraid and trying to blame the coming economic downturn on Labour with these snazzy ads? (but at least the BBC is on hand to help by showing it without checking its claims). [...]
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If you’re that certain that there will be a double dip, which no-one else seems to be from the financial analysts to the government to the BoE, you should have the guts to print your name with your post.
Typical socialt cant – twisting the facts to fit theory instead of the theory to fit the facts. You guys do politics like its a religion.
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Additionally explanation is needed:
Instead of growing by 5% in 2008 & 2009, our economy shrunk by 6.5%. Which would mean that tax revenues would come in at least 11% less than had been budgeted for.
Perhaps more taxes were lost than that 11% of budget because of the way tax revenues are collected via banks in the UK, and not by ‘withholding taxes’ that are used in other countries.
Moreover, banks are allowed to write-off anticipated dud loans against profits in that year. Which encourages extra large provisions in their balance sheets that delay tax bills.
As the stimuli (Oct 2008) have worked in sustaining our economy, those bad-debt provisions have been unwound and profits recorded for the current year: hence the unusually buoyant ‘profits’ now reported by British banks. They will start paying Corporation taxes on those delayed profit declarations next year.
Thus part of the large droop in government tax revenues was caused by accounting conventions in the Banking industry. The remainder were mostly due to The 2nd Wall Street crash.
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This is very suspect and quite ideological – though the article doesn’t tell you that, of course.
What would have been the cost if the additional spending (e.g. propping up banks) had NOT taken place?
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I don’t know where to begin on this. Perhaps let’s start with the fact that the last government didn’t borrow a penny in 2009/10 – they simply got the Bank of England to “print” £200bn via QE instead.
The UK’s borrowings have been dominated by banks meeting the “customer funding gap” – the difference between deposits and mortgages and loans, as Chris Huhne should well know with his BTL portfolio. When foreign banks went bust or didn’t renew their loans, government did some off balance sheet borrowing of its own which hasn’t been factored into spending at all, propping up the banks and house buyers via the Credit Guarantee Scheme and Special Liquidity Scheme to the tune of over £300bn. Much of the disaster is due to the failure of Brown’s banking regulatory system.
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Isn’t it a fact that a great chunk of UK boprrowing was to bail out banks? therefore on the balance sheet would show as a debit and a credit cancelling each other out unless the banks are allowed to default on paying the UK taxpayers back. So when the banks pay it back a large chunk of borrowing will disappear. By that time economic recovery should be in place allowing tax receipts to grow and much of the structural deficit to also disappear. The Cameron/Osbourne 3 card trick is now to over compensate for the deficit so after 5 years they have sufficient for a pre-election giveaway.
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