Worsening public finances give next PM a sharp 'reality check'

Pledges by Boris Johnson and Jeremy Hunt to cut taxes and increase spending have come just as the UK’s public finances have shown a marked deterioration, according to the latest official figures.

In what analysts called a “reality check” for the two Conservative prime ministerial contenders, the Office for National Statistics said the government needed to borrow £7.2bn last month – more than double the £3.3bn in the same month a year ago.

The government’s finances are measured each month by the Office for National Statistics (ONS). Tax receipts make up the vast majority of government income, while spending on welfare and services make up most of its outgoings.

Income tax, national insurance and value added tax (VAT) are the biggest sources of income. Spending on schools, healthcare and a welfare bill dominated by pensions are the major costs.

Since the 2000/01 financial year, government’s have consistently racked up deficits, tough not all have added to the overall debt to GDP ratio.

A deficit of 2% expected this year compares to a likely GDP growth rate of 3.5% before taking inflation into account. That means a small annual deficit, all other things being equal, will still allow the government to bring down the overall debt to GDP ratio.

On the standard measure of public sector net borrowing (PSNB), the ONS will exclude borrowing to finance state-owned banks and the effects of the Bank of England’s complicated quantitative easing scheme.

Higher spending and lower tax receipts were responsible for the highest June deficit – the gap between government income and spending – in four years, amid signs that the economic slowdown is starting to feed through into the public finances.

Hunt and Johnson have promised big cuts in corporate and personal taxes while campaigning to succeed Theresa May, prompting a warning from the independent Office for Budget Responsibility on Thursday that there was no fiscal “free lunch”. The OBR warned that the contenders’ proposals were uncosted and would be likely to raise government borrowing by tens of billions of pounds.

The government’s budget deficit has been on a declining trend since the end of the financial crisis a decade ago and stood at about 1% of national income (gross domestic product) in the last financial year.

However, borrowing in the first three months of the 2019-20 financial year is running £4.5bn higher than the same period of 2018-19. In Treasury forecasts produced for Philip Hammond’s spring statement, the OBR said it expected borrowing to rise by £2.4bn for the year as a whole.

Ruth Gregory, UK economist at the consultancy Capital Economics, said part of the June deterioration was down to a £2.1bn surge in debt interest payments, because of past rises in RPI (retail prices index) inflation to which index-linked bonds were pegged. She said the performance of the UK economy could be a factor, too.

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“But the overshoot in borrowing relative to the official forecasts may also reflect the recent economic weakness. Indeed, annual growth in tax receipts of 1.5% fell well short of the OBR’s forecast of 2.9% for the year as a whole,” Gregory said.

“Meanwhile, 7% annual growth in central government current expenditure in June exceeded the OBR’s full-year estimate of a 2.7% rise.”

James Knightley, chief international economist at the investment bank ING, said: “With prime ministerial candidates promising tax cuts and a spending splurge, the latest fiscal numbers offer something of a reality check to their plans.”


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