The topic of government borrowing is a complex and often contentious issue. Why does the government borrow money? How does it affect the economy, and what are the implications for future generations? In this blog, we will delve into the intricacies of government borrowing, exploring the reasons behind it, the mechanisms involved, and its impact on the country’s financial health.
Why Does the Government Borrow Money?
The primary source of government income is taxation. Income tax, value-added tax (VAT), and corporate taxes contribute significantly to government revenues. Ideally, the government could fund all its expenses through taxes, but this is not always possible. When the expenses exceed the income, the government has three options: raise taxes, cut spending, or borrow money.
Raising taxes can have adverse effects on the economy. Higher taxes mean individuals and businesses have less disposable income, which can reduce spending and profits, potentially leading to job losses. Lower profits for companies also mean reduced tax revenue. To avoid these negative repercussions, governments often resort to borrowing to fill the fiscal gap.
Government borrowing serves two main purposes:
- Economic Stimulation: Borrowing can be used to boost economic growth during challenging times. By injecting borrowed funds into the economy, the government can stimulate demand, create jobs, and support businesses, ultimately leading to increased tax revenue.
- Funding Large Projects: Governments also borrow to finance major infrastructure projects like railways, roads, and public utilities. These investments are expected to have long-term economic benefits that can offset the cost of borrowing.
How Does the Government Borrow Money?
Governments borrow money by issuing financial products called bonds. Bonds represent a promise to repay the borrowed amount with regular interest payments over the bond’s lifespan. In the UK, government bonds are known as “gilts” and are considered very safe investments. They are primarily purchased by financial institutions such as pension funds, investment funds, banks, and insurance companies.
The government can also engage in quantitative easing, a process where the central bank (in the UK, the Bank of England) buys government bonds to support the economy by increasing the money supply.
The UK Government’s Borrowing and National Debt
The amount the UK government borrows varies from month to month. The annual borrowing figures are more informative than monthly data. In the 2022-23 financial year, the government borrowed £128.4 billion, £5.5 billion more than the previous year. In September 2023, the government borrowed £14.3 billion, the sixth-highest borrowing figure for September since records began in 1993.
The total amount that the government owes is known as the national debt, which currently stands at around £2.6 trillion. This is approximately equal to the UK’s annual gross domestic product (GDP). While this may seem high, it’s essential to consider that today’s debt figures are still relatively low compared to the last century and other leading economies.
Interest on Government Debt
The larger the national debt, the more interest the government must pay. When interest rates are low, this cost is manageable, but as rates rise, it becomes more significant. If a substantial portion of the budget goes towards servicing debt, it can limit the government’s ability to fund public services and investments.
During the 2022-23 financial year, the government spent £108 billion on debt interest, surpassing the budget allocated to education.
The Impact of Government Borrowing
Economists hold varying opinions on government borrowing. Some believe that excessive borrowing may harm the economy and future generations. They argue that additional borrowing can lead to higher taxes, reduced public spending, and increased interest payments.
The Office for Budget Responsibility (OBR) warns that public debt could surge as the population ages, leading to lower tax income and higher pension payouts. According to OBR projections, debt could exceed 300% of GDP by 2070.
However, other economists argue that large economies like the UK have room for increased borrowing, and the negative consequences may be overstated.
Government’s Approach to Debt
The government recognises the importance of managing its debt. Chancellor Jeremy Hunt has pledged to make “difficult but responsible” decisions on public finances, aiming to reduce the underlying debt within five years. Prime Minister Rishi Sunak has also prioritised reducing the national debt as one of his key promises.
Understanding the Deficit and Debt
It’s crucial to differentiate between the government deficit and debt. The deficit represents the difference between government income and expenditures. When expenditures exceed income, a deficit occurs. Debt accumulates when there is a deficit, and it decreases when there is a surplus.
Government borrowing is a multifaceted topic with significant economic and social implications. It serves as a vital tool for managing fiscal shortfalls, stimulating economic growth, and financing essential projects. However, it also comes with challenges, particularly in terms of interest payments and long-term debt management. The government’s approach to borrowing and debt plays a pivotal role in shaping the nation’s financial future. As we navigate these complexities, it is essential for policymakers and citizens alike to understand the nuances of government borrowing and its consequences.