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      United Kingdom: higher taxes or growth needed to reach fiscal targets given spending pressures
      WEDNESDAY, 29/11/2023 - Scope Ratings GmbH
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      United Kingdom: higher taxes or growth needed to reach fiscal targets given spending pressures

      The UK’s debt-to-GDP ratio is set to rise above official forecasts given continued pressure for more welfare and government spending unless future governments raise tax revenues, reduce the welfare state or significantly improve growth prospects.

      By Eiko Sievert, Sovereign and Public Sector

      We expect rising government indebtedness over the medium term to pressure future governments to raise taxes, unless there is a sustained improvement in the UK’s growth outlook. Economic output is set to increase by 0.6% this year and slow to 0.4% in 2024 before returning to the UK’s potential growth of around 1.5% in 2025.

      The share of UK (AA/Stable) government gross debt as a percentage of GDP stood at 101% in 2022, below that of peer countries such as France (AA/Negative), 112%, and Belgium (AA-/Negative), 105%. However, given the increasing spending pressures, flexible fiscal framework and little headroom in fiscal targets kept by the current chancellor compared with his predecessors, we expect debt to gradually increase towards 110% by 2028, broadly in line with France.

      Government departmental spending likely to exceed current spending plans

      Current spending plans do imply a significant decrease in public sector net borrowing between 2023-24 to 2028-29 from 4.5% of GDP to 1.1% (Figure 1). This would be the lowest deficit in more than twenty years and significantly lower than during the five years before the Covid pandemic of around 3%. The decline would be largely driven by higher tax receipts (-1.0% of GDP), a reduction in departmental spending (-1.1% of GDP) and a reduction in interest costs (-0.5% of GDP).

      The overtly optimistic element is the planned real decline in departmental spending. Public sector productivity remains around 5% below pre-pandemic levels and future spending reviews are likely to result in higher spending in core areas such as health and social care, education, defence and transport. The government has not detailed spending priorities over the entire forecast horizon, which will need to be agreed following the next general election, due before end-January 2025 and possibly taking place next autumn.

      Figure 1: Spending plans imply a sharp reduction in public sector net borrowing
      Public sector net borrowing, % of GDP

      Source: Office for Budget Responsibility, Scope Ratings.

      In combination with the current fiscal framework, this casts doubt on the UK’s ability to meet the forecasted debt-to-GDP trajectory by the Office for Budget Responsibility, which shows that the government continues to meet its fiscal targets.

      The framework has been amended on six occasions since 2011 as there are no constitutional anchors that require significant cross-party support to approve changes. The most recent amendment in January 2023 introduced less restrictive fiscal rules. The aim is for net debt as a share of GDP to decline by the fifth year over a rolling five-year forecast horizon, rather than the previously targeted three-year horizon. The target for public sector net borrowing is below 3% of GDP over the same period. In principle, the rolling nature of the targets is such that they can be met even with net debt and public sector net borrowing rising indefinitely.

      New post-war high tax burden, but still below many large European sovereigns

      High inflation has pushed more people into higher income tax bands, resulting in a rising tax burden and increased tax revenues for the government. The government decided to use the resulting additional headroom to implement tax cuts, including cuts to corporation tax to incentivise private investment.

      Even so, the overall tax burden is still expected to reach record levels, rising by around 5pp of GDP over the past two decades (Figure 2).

      However, compared with other large European economies, the UK tax burden is still relatively low, leaving room for additional fiscal consolidation, with tax revenues as a share of GDP at 37.9% in 2022 compared with Spain (38.3%), Germany (42.1%), Italy (42.9%) and France (47.6%), but significantly higher than the United States (27.5%).

      Figure 2:  UK tax burden remains below many large European sovereigns
      Total tax burden including social contributions, general government revenue as a share of GDP

      Source: European Commission, Scope Ratings.

      While past governments have often raised taxes through increases in National Insurance or value-added tax, future governments may consider more ways to tax wealth in addition to income. Without raising taxes or stronger economic growth, the country is likely to face either a continued deterioration in public services and welfare provision or higher budget deficits.

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