Public finances are mainly comprised of spending in the public sector, taxation, income and debt plus borrowing.
The UK public finances have hit a major deficit and according to the Telegraph, they have hit their “worst state in 15 years” – with the excessive borrowing caused by the undeniable existence of our recession (despite it only being confirmed on the 23rd of January this year). A recession is technically defined as two consecutive quarters of negative growth. The forthcoming inevitability had been pointed out by the BBC, more than a year prior to this, suggesting the onslaught of borrowing to come. I will now examine the main trends of the UK public finances, with additional projections from the statistics available.
The following diagram demonstrates TME (Total Managed Expenditure) for the UK, from 1963 to 2008, with projections for the year ending 2009. These figures, were however, published in 2004 so the projections suggested may not be accurate due to the dramatic increase in government spending (such as significant monetary investment into the banking industry – i.e. Northern Rock).
This trend displays how the real (the monetary values adjusted for inflation) expenditure has increased almost each year. The parts of the graph that have a negative gradient or no gradient are in the minority, suggesting the government may actually be increasing spending – but this may be for political reasons (i.e. votes) as well the economic ones. However, this graph can be misleading for a number of reasons. For example, there are other factors that would contribute to the increase in overall spending (such as increases in population) – which will fall into two main categories: discretionary and non-discretionary (mandatory). Discretionary spending is subjective: the government has a choice whether they wish to assign expenditure to a particular cause.. This can range from a funding increase for education and military, to new technological equipment for hospitals. The mandatory component of the spending (non-discretionary) is created from expenditure that cannot be avoided, such as that on unemployment benefits, and tax credits. This spending is unavoidable cannot be removed. Doing so can possibly cause outrage by the taxpayers, leading to protests and riots.
The following diagram demonstrates the Total Managed Expenditure (the same data that was plotted in the previous diagram), expressed as a percentage of GDP (national income).
This paints a different picture compared to the first, as the negative (and zero) gradients are now in the majority. What appeared to be almost unnecessary increases in government expenditure, now appear to be an integral part of helping the economy grow. This can demonstrate the point that the economy is growing at a faster rate than the government expenditure – thus an overall falling trend.
However, due to the recent “emergency” measures that the government have made, the previous projections can be deemed to be invalid. Industry wide bailouts have caused government expenditure to reach dangerous levels.
UK debt is defined as the total amount that is owed to the private sector by the government. This has been demonstrated using the graph on the left, where the diamond shape points indicate the level of expenditure that would have taken place if the government did not intervene in the financial sector. As a direct result of this involvement, public sector spending exceeded 45% of GDP – reaching £697.5bn (or 47% of GDP) .
The main trends indicate to be an increase in real expenditure by the government, year-on-year. Since 1997, the Labour party
have managed keep this below the rule of 40% for the majority of the time.
Additionally, taxation and the proportions paid have changed dramatically over the past few decades. We observe a progressive taxing system, where the higher you earn, the higher the proportions you pay in tax. Income tax is the main source of these, with thresholds to discriminate betweens different levels of earning, encouraging a more ‘fair’ system.
There have been some significant changes to the tax structure. There has been a large reduction in the top rate of tax, from 83%-93%, falling down to 40%, where it appears to have settled. Similarly, there have been adjustments in the basic rate of tax, falling to 20% (from 33%). However, as a direct consequence of this, “fiscal drag” has begun to occur. This is where the thresholds for the taxing system are not adjusted to account for inflation, meaning that the real tax that is paid has risen. In 2007, Mr. Brown has kindly used fiscal drag to plug a £10bn hole, accounting for half of the full £20bn that was required. Other changes have taken place, such as abolition of additional tax for married couples (and those with children), and providing support to children and low income households through the use of ‘tax credits’.
National Insurance Contributions – another source of revenue for the government has also been changed to reflect the ‘standards’ of income tax. The 2% ‘entry fee’ was removed and contributions continue to be paid once they have reached above the upper earnings limit.
The predicted trends on the left show that the forecast of percange changes in output, it set to fall by 4%. As a result, the government are issuing measures in an attempt to get the economy back into its (previous) stable state and stabilise or decrease the borrowing simultaneously. Interest rates is one of the main methods that they are employing in an attempt to increase aggregate spending, but despite their best efforts at cutting the base rate to 1%, it doesn’t appear to be working. Consumers are aware that the economy in an unstable state, and they are therefore reluctant to spend. Further interest rate cuts and admissions of instability only add to their fears, causing spending to butting back more. As a result, Mervyn King has announced that he feels further interest rate cuts will not assist in the recover process and other measures need to be taken – such as physically printing more money. This projection demonstrates the severity of the problem; previous projections only suggested that percentage change output would be negative for a ‘very short time before ‘bouncing back’’.