The public finances

The deficit has come down significantly since it peaked at 10% of national income in 2009-10. In 2016-17 it was 2.5% of national income, similar to the level it was prior to the 2007-2008 financial crisis. But this is still higher than the historical average.

Since the crisis, large deficits have led to a significant increase in government debt. At the end of March 2017 government debt was 87% of national income, high by recent historical and international standards.

The incoming Government inherits spending and tax plans designed to achieve deficit and debt targets. Although the plans may change, they highlight the choices and challenges facing the new administration.

Key deficit and debt targets

The inherited overarching objective is to eliminate the overall deficit ‘at the earliest possible date in the next parliament’. One might expect the early election to bring this deadline forward from 2025 to 2022. To meet it the Government would need to find an extra £15 billion of tax rises and spending cuts in 2021-22. However, the Conservative Manifesto interprets the target as still focusing on a 2025 deadline.

To support the overarching objective, there is a short term target for the deficit. This focuses on the structural deficit, which is the deficit remaining once elements related to the ups and downs of the economy are removed. According to the latest forecasts, the target – a structural deficit of less than 2% of national income in 2020-21– will be comfortably met by sticking to the inherited tax and spending plans.

The target for debt is that it should fall, as a share of national income, between 2019-20 and 2020-21.

Under inherited plans public spending is forecast to increase by around 5%, in real terms, over the next five years…

This is a fairly modest increase by historical standards, but more than was seen under the Coalition Government. There are differences between areas of public spending, and not all areas will increase.

…demand-led spending is forecast to increase by around 7%…

Demand-led areas, making up just over half of public spending, are difficult to control. An obvious, and financially significant, example of this is welfare. The Government can set policies for welfare but the amount spent is largely dictated by economic conditions.

… and departments’ budgets are set to increase by 3%, with differences between resource and capital

Government departments’ budgets for delivering and administering public services make up just under half of public spending. In the current plans, departments’ capital budgets – spending on assets that last for a number of years – are set to increase by over 30% in the next five years. At the same time resource budgets – spending that is used up each year, such as wages – will fall by just under 2%. In 2018-19 and 2019-20 resource budgets are expected to decrease by around 1% in real terms.

Departments' resource and capital budgets face quite different annual changes over the five years

Uneven distribution across departments

Some departments’ budgets were protected by the previous Government. Such political choices mean resource budgets do not change evenly across departments. (see Chart 2)

Plans for 2016-17 to 2019-20 see small real terms increases in the resource budgets for defence, education and health and a larger increase for international development. At the same time, grants to local government are set to decrease by 40%. Most of those departments facing reduced budgets have already experienced decreases since 2010.

Reductions in departments' resource budgets are not evenly shared between 2016/17 and 2019/20

Tax revenues are forecast to increase by around 10%, in real terms, over the next five years

In 2019-20, taxes as a share of national income are forecast to increase to a level last seen in the early 1980s. Economic conditions play a significant role in determining the amount of tax raised. For instance, if workers’ earnings increase by 1% we would expect income tax revenues to increase by over £2 billion.

Government spending, taxes and deficit

With tax revenues forecast to increase faster than public spending, the deficit is forecast to fall. By 2021-22 inherited spending and tax plans see the deficit decrease to 0.7% of national income, according to the latest forecasts. Smaller deficits and economic growth are expected to bring debt below 80% of national income.

The public deficit is forecast to rise slightly then continue falling over coming years

The new Government will have its own priorities and policies…..

None of these targets and plans are set in stone. They will change as the incoming Government implements its manifesto commitments and approach to managing the deficit and the debt.

….but may need to be flexible

The performance of the economy is essential to the public finances. Economic growth influences the size of tax receipts and areas of public spending, such as welfare.

The future of the economy is always difficult to predict. With ongoing negotiations over Brexit, the outlook for this Parliament is particularly uncertain. So that it can adapt to changing economic circumstances, the incoming Government may need to adopt a flexible approach for managing the public finances.

This article is part of Key Issues 2017 – a series of briefings on the topics that will take centre stage in UK and international politics in the new Parliament. More Key Issues posts will be published on this blog throughout June, subscribe via the homepage to get instant alerts

Picture credit: Numbers And Finance by Ken Teegardin; Creative Commons Attribution-ShareAlike 2.0 Generic(CC BY-SA 2.0)

The government’s deficit is the difference between its spending and income from taxes and other revenues. A “large deficit” implies that spending substantially exceeds revenues.

The government’s debt is the total amount it owes. Broadly speaking it is the stock of borrowing arising from past deficits. Both debt and deficit are often expressed as a proportion of the country’s national income (GDP). Provided the economy is growing quickly enough, it is possible for the debt or deficit to be rising in cash terms, but falling as a proportion of national income.