These two simple ideas still seem to cause trouble for some politicians and political commentators. Let’s have another go at explaining where we are.
The UK has a large state debt. This is the accumulated borrowings taken out by successive governments to spend more than they collected in taxes over many years. These borrowings do not suddenly have to be repaid. They are regularly refinanced or rolled over, as bonds issued become due for repayment. The UK tends to have longer term borrowings than many other countries, and can currently borrow very long at low interest rates.
The rate of increase in these borrowings has been very fast in the last two Parliaments. Labour doubled the debt, and the Coalition has increased it by around 50%. This is a matter of concern. Whilst so far it has been easy to raise the money, the amount it costs to pay the interest on the debt builds up to unacceptable levels if a state simply carries on borrowing at an excessive rate. This government has benefited from interest rates going lower and staying lower for longer, but even so, the interest costs are rising. Most people in the debate – including Labour – believe there has to be some limit on the rise in interest costs. One day interest rates will go up again, and then the progressive impact on the public finances will be uncomfortable as new debt is issued at ever higher rates.
The deficit is the annual increase in the amount borrowed. It is the amount of extra spending being undertaken each year which we cannot afford out of tax revenues. State borrowing is deferred taxation. Every year a government borrows it is saying to current taxpayers we will let you enjoy higher public spending than you are paying for. However, those same taxpayers and their children will have to pay the interest on the borrowings on top of regular spending in future years, and may at some point have to pay off some of the debt.
All the main parties in the election now accept the need to reduce the deficit. Labour says we only need to eliminate the deficit for current spending, and can carry on borrowing lesser amounts for investment or capital spending. The Conservatives say the whole deficit has to be eliminated in view of the debt mountain already incurred.
To do either of these feats requires a lower level of public spending and or higher tax revenues. Conservatives say that cutting public spending by 1% a year for the next three years will do the job. There is no need for tax rises. As the economy grows so more revenue comes in. Labour so far has not specified how much it wishes to achieve by tax rises, and how much by spending cuts.
This Parliament the deficit has been brought down by one third in cash terms or one half as a proportion of the economy, by moderating the rate of growth of public spending and by the VAT rise. Other tax rises like the CGT increase and the 50p Income Tax rate actually lost the Treasury revenue. This experience shows there will be no return to the 1930s, no hacking away at the NHS or other crucial services, to achieve the elimination of the deficit.
Current level of state debt (excluding pension liabilities) £1.5 trillion.