The scale and cost of Britain's budget deficit

These StarChamber pages are being kicked back into life over coming days with examination of the proposals from The TaxPayers' Alliance and the Institute of Directors for £50bn of cuts in public spending. Before that process begins, however, it is worth reminding ourselves why cuts are necessary. The TPA and IoD set out to do that in the introduction to their report. Their arguments are summarised below:

HOW BRITAIN'S DEFICIT EXPLODES IN SIZE DURING THE RECESSION...

1. The Treasury forecasts that net borrowing will peak at £175 billion, or 12.4 per cent of GDP, in 2009-10.
2. The European Commission predicts that borrowing will reach 13 per cent of GDP in 2009-10.  
3. The IMF forecasts that general government borrowing will reach 13.3 per cent of GDP in 2010.
4. The OECD expects the deficit to reach around 14 per cent of GDP in 2010.  

...BUT WILL PERSIST IN BETTER ECONOMIC TIMES

1. The Treasury expects the structural budget deficit (which excludes the fiscal stimulus as well as the higher welfare spending and lower tax revenues that are due to the recession) to peak at 9.8 per cent of GDP in 2009-10.  
2. The IMF predicts that the structural deficit will peak at 9.9 per cent of GDP in 2009.
3. The European Commission forecasts that it will be 11.6 per cent of GDP in 2009-10.

THE DEFICIT WILL STILL BE 5% OF GDP FOUR YEARS FROM NOW IF ECONOMIC GROWTH HITS 3.25%...

The Treasury forecasts that net borrowing in 2013-14 – four years from now – will still exceed 5 per cent of GDP, but this is based on an assumption that growth will return to 3.25 per cent in 2011-12 and will remain at that high level.

...SLOWER GROWTH WILL PRODUCE A MUCH LARGER DEFICIT

The IoD forecasts that, if growth recovers to 2.5 per cent (rather than the Government’s projection of 3.25 per cent) and the Government’s fiscal plans are followed, net borrowing will exceed 8 per cent of GDP in 2013-14.  If growth only recovers to 2 per cent, then following the Government’s fiscal plans will mean that net borrowing will still exceed 10 per cent of GDP in 2013-14.

Similarly, in a report for the TaxPayers’ Alliance, the Centre for Economics and Business Research found that under a more modest recovery scenario than predicted by the Treasury, the budget deficit will remain over £160 billion in 2013-14 and £140 billion in 2017-18.  

BRITAIN COULD BE PAYING £43 BILLION IN DEBT SERVICING NEXT YEAR... AND MORE IF INTEREST RATES RISE

The Treasury projects an increase in debt servicing costs from £27.2 billion this year to £42.9 billion in 2010-11.   Net borrowing of over £700 billion is forecast for the next five years,  which, at a yield of 4 per cent, would add £28 billion a year to debt servicing costs. 

Treasury forecasts, however, are based on relatively low interest rates on government debt.  They assume the Government can continue to borrow at the current average rate of 4.3 per cent.   But if a lack of credible promises to tighten fiscal policy causes the bond markets to lose confidence in the UK’s fiscal sustainability, the cost of government borrowing will shoot up.  The Institute for Fiscal Studies has calculated that just a one percentage point increase in the Government’s average interest rate by 2015-16 would raise the debt servicing burden by around one percent of GDP, or about £15 billion per annum.   As recently as the 1990s, the average interest rate was 7 per cent, nearly 3 percentage points higher than now.