Articles - UK budget 2012: The terms of the debate


 "The total accumulated debt issued by the UK government is just over £1 trillion, equivalent to about 67% of GDP. This excludes the money that the government borrowed to bail out the banks in 2008/09, since much of this is expected to be recouped through repayments by the banks themselves and the eventual sale of bank shares owned by the government.
  
 How did it get so large?
  
 "The rising debt level is due to three distinct elements:
     
  •   Structural deficit. Even before Lehman Brother's collapse and the recession we were spending more than was being raised in taxes, with a deficit of 3% in 2008-2009. The government is focusing its attention on this element, through reducing structural spending in areas such as (non-cyclical) welfare payments and defence. It aims to have a balanced cyclically-adjusted current budget (CACB) by 2016-17.
  •  
  •   Cyclical deficit. So-called ‘automatic stabilisers' kick in as an economy weakens, such as payments to the unemployed, while at the same time receipts suffer as income and corporate tax revenue declines. The cyclical part of the deficit will recover automatically when growth recovers.
  •  
  •   Reliance on financial services and housing for tax receipts. It turned out that the boom in tax revenue from these two sectors, in the decade prior to the collapse of Lehman Brothers, was cyclical and not structural. The government is hoping that a mix of new taxes and a broadening of the tax base will provide new revenues, but it must tread carefully for fear of choking off economic recovery.
 
 Why didn't past governments save for a rainy day?
  
 "While John Maynard Keynes, British economist, recommended saving budget surpluses in the good times to spend in the bad, in practice it is hard for politicians to do so. Their voters - that is, us - want either cyclical surpluses to be invested in public services (which leads to higher structural spending as new hospitals and schools need to be staffed and maintained), or returned in the form of tax cuts. Sadly, democracy does not help the cause of balanced budgets.
  
 Is the debt growing?
  
 "Yes, we still have a budget deficit. Of the £696 billion that the government is likely to spend this financial year (2011-2012), we estimate that around £120 billion - equivalent to about 8.3% of GDP - will be with borrowed money.
  
 The ‘good' news is that the deficit for this year is around £7 billion less than had been forecasted in November, thanks to stronger than expected tax receipts and spending cuts.
  
 Does that mean George Osborne has £7 billion to spend?
  
 "The Chancellor could decide to increase borrowing to the original £127 billion, and spend the £7 billion he has ‘saved' on growth enhancing and voter-friendly initiatives. But if he does the bond market may take a dim view of his commitment to austerity.
  
 Alternatively he may instead wish to just borrow the £120 billion, and so demonstrate his commitment to austerity. If he does, any new spending measures, such as raising the minimum tax threshold or reducing employers' national insurance contributions (NIC), will have to be paid for by cutting spending on items such as pension tax relief or introducing a primary property-related tax.
  
 When will the budget deficit end?
  
 "Assuming the structural part of the deficit is eliminated in 2015-16, and that growth looks after the cyclical part, the Office of Budget Responsibility (OBR) forecasts a total budget deficit of -0.4% in 2016-17, but the cyclically-adjusted current budget (CACB) to be in surplus at +0.5%.
  
 Why does growth mater?
  
 "Growth matters because it's the denominator of debt and deficit-to-GDP ratios. Policies to boost growth are as important as policies to cut government spending or raise taxes when addressing deficits.
  
 The OBR's forecast for UK GDP growth from November 2011 are below. It is these numbers that the government will use for its budget projections:
 The 2012 forecast looks sadly optimistic, given the contraction of the economy in the fourth quarter of 2011 and the weak economic data year to date.
 The government's target to eliminate the CACB by 2015-16 is dependent on structural changes to government spending rather than economic growth. However, the cyclical part of the deficit is very dependent on growth to ensure the automatic stabilisers go into reverse and growing employment and output results in higher tax revenues.
  
 Why is the bond market so kind to us?
  
 "With the ten year Gilt at around 2% (from around 4% at the time of the 2010 election), the bond market has made a clear distinction between the UK and peripheral eurozone countries with similarly large budget deficits. This has helped reduce the cost of servicing the debt. There are several reasons for the low interest rates that the UK is paying:
     
  •   The government is committed to its austerity programme.
  •  
  •   The UK is not in the euro. It can always repay its debt, because it can create the currency to do so.
  •  
  •   Quantitative easing (QE) has contributed to lower yields, as the Bank of England will have purchased £325 billion worth of Gilts by May.

 Short term interest rates, set by the Bank of England, will remain very low in return for the government pursuing fiscal austerity. Why is America able to issue debt at low yields when it isn't pursuing austerity?

 "While many states and municipalities are in an austerity drive in the US, the Federal government is not engaged in austerity and the economy is growing at a reasonable pace while Treasury yields have remained low. This has prompted some economists and politicians in the UK to suggest that the US is an example to follow.
  
 But the US, unlike the UK, provides the world with a reserve currency that is in strong demand in order finance world trade. The dollar is the preferred currency for trade among the emerging economies and, to a lesser extent, within the developed world. Nearly two thirds of all US banknotes are held outside the country. Therefore the risk of the dollar being debased through the monetisation of the deficit is lower than the comparable risk of holding Gilts, since as long as world trade is expanding there is a growing demand for dollars."
  

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