Since March, Government spending has gone through the roof in an attempt to counter the economic impact of the coronavirus pandemic.
Many people are wondering where the money is coming from and what future impact this could have for them. This blog attempts to shed some light on this, with various considerations being thrown into the mix.
In this year’s budget the Government projected that they would need to borrow around £55bn in order to balance their books i.e. make up the shortfall between what they spend and what they receive in tax receipts.
However, with tax receipts falling off a cliff and spending skyrocketing it has been forecast that the Government’s borrowing requirement could balloon to around £300bn in 2020/21. This is not, however, the end of the story when it comes to Government borrowing. Each year, borrowing from previous years has to be refinanced as repayments fall due and the amount coming up for refinancing this year is around £100bn.
The way in which borrowing is being financed (both this year’s and previous years debt) is by the sale of gilts. These are IOUs issued by the Government which pay a fixed amount of interest over a fixed term. At the end of the term the capital lent to the Government is repaid.
Taking into account the sums of money the Government needs to borrow, unsurprisingly, the main buyers of gilts are not the general public but large life companies, pension funds and banks, in particular the Bank of England. In the Bank of England’s case this is quite often under the guise of quantitative easing.
The Bank of England plays a crucial part in all of this. As well as one of the largest investors of gilts it is effectively providing capital to the Government on tap by way of an overdraft. Until recently this facility had been little used but has been extended ‘temporarily’! This is more of a back up in the event gilt sales falter.
National Savings plays a minor financing role. Its financing target for 2020/21 was £6bn so is just a drop in the ocean when looking at the bigger picture.
So the huge cost of the pandemic is initially being met by borrowing, but looking longer term how is this massive widening of the deficit going to be brought down?
Taxation alone is unlikely to be an immediate solution. The Government starts from a tricky position with its manifesto pledge that there would be no increases to income tax, national insurance contributions or VAT (the three largest revenue raisers). However, election promises haven’t always been kept! If that promise is broken adding 1% to any of those rates would raise around £6bn to £7bn a year.
Taxing just the wealthy is not going to bring in enough either: adding 1p on the basic rate would raise the same revenue as about 4.2% on the higher rate and 28p on the additional rate. The middle income group therefore is likely to be a target too.
Given the much publicised cost of pension tax relief, the removal of higher rate tax relief and the introduction of a lower flat rate may be ripe for the picking. This has been threatened many times before, although it would be harder than it looks to implement with a number of consequences to be taken into account.
Reform of Inheritance Tax (IHT) is another area, although in revenue terms it would make no serious dent. Doubling the IHT take would raise less than a ‘NHS 1p’ on income tax and probably would create a lot more angst.
Other possibilities include a ‘Covid-19’ tax surcharge, along the lines of the solidarity tax Germany levied after reunification. This was introduced in 1991 and will be finally abolished for 90% of taxpayers this year – a reminder of the danger of ‘temporary’ levies! Or the introduction of a wealth tax as a one-off levy or annual payment. Although such a measure could be a significant revenue raiser the politics and practicalities of this may make this a non-starter.
When things are more back to normal it is likely that Government expenditure will be trimmed in places, so we are likely to see a combination of spending cuts and tax increases. The triple look guarantee for state pensions looks like a candidate for a cull. With inflation and earnings growth both set to fall, the 2.5% triple lock floor could be reduced or removed. However, tax increases are easier to introduce than spending cuts and are likely to produce faster results so the balance may be skewed more towards tax increases.
One way a Government can pay its debts is to print money. Although it can have a wealth destroying inflationary impact (as in Zimbabwe) it does have its supporters. Quantitative easing is often described as electronic money printing and has been used extensively by the Bank of England as part of its gilt purchase programme both in this crisis and the financial crisis back in 2008. Despite all the money that the Government has pumped into the economy inflation is currently at a low level and below target. However, this may only be in the short term and we may see higher inflation return.
In practice any solution to tackle the debt mountain is likely to be a combination of factors, and it is unlikely very much will emerge in the short term. In times like these when these issues seem so vast and uncertain it is much better to focus on the things that matter and the things we can control in our lives; and through the process of planning for a better financial future to check in regularly and make course corrections if need be.