UK borrowing hits four-year high – what does it mean for the economy?

A series of economic shocks in quick succession have sparked alarm among economists over high government debt levels.
Before the 2008 global financial crisis, the average debt-to-GDP ratio among G7 countries was about 83 per cent. It now stands at 129 per cent. In order to soothe their respective economies’ scarring from the financial, Covid-19 and energy crises, G7 governments spent big, pushing up borrowing substantially.
Compared with its international peers, the UK ranks towards the bottom of the pack. Its debt-to-GDP ratio of about 100 per cent is lower than that of Italy, the United States and France. Japan is the anomaly within the G7, with a debt burden more than twice the size of the entire economy.
In Britain overall government spending climbed by £3.5 billion annually in July to £107.4 billion, the Office for National Statistics said on Wednesday. Benefit expenditure jumped by £2.7 billion to £26 billion, while general operating costs — which includes things like pay for civil servants — rose by £1.3 billion.
These spending increases offset the £1 billion decrease in debt interest expenditure. Rachel Reeves, the chancellor, also identified billions of pounds worth of departmental overspending as part of her “fiscal audit” last month, most of which came from the asylum system.
Frozen tax thresholds — a policy first launched by Rishi Sunak in March 2021 — continue to be a lucrative source of income for the government. Income tax receipts rose by £1.7 billion on an annual basis in July due to workers being subjected to higher tax rates after they receive a pay rise, a process known as “fiscal drag”. Corporation tax and VAT receipts were also up.
Part of this rise in revenue was offset by a fall of £1.1 billion in national insurance receipts thanks to the 4 percentage-point reduction in the main rate, a policy launched by Jeremy Hunt, the former chancellor.
Despite economic growth exceeding most analysts’ expectations so far this year, a surprise that has increased tax revenues, the UK government spent the largest share of its yearly budget since at least 1997 in the first four months of the fiscal year, according to the Institute for Fiscal Studies. Borrowing has exceeded the Office for Budget Responsibility’s forecast by £4.7 billion.
This probably means that tax rises are very likely in Reeves’s first budget on October 30 to prevent her from breaching the fiscal rules: getting the debt burden falling in five years and balancing the current budget. Headroom against the fiscal targets was wafer thin after Hunt’s budget in March, at £8.9 billion.
Philip Shaw, chief UK economist at Investec, said: “Fiscal progress remains disappointing so far this year and strengthens our view that the government will be forced into some tax rises.”
There is a polarised debate within the economics profession over whether it matters if countries continue to run their economies with high levels of debt. There is no clear consensus over what specific ratio of debt to output triggers a crisis in financial markets akin to the fallout from Liz Truss and Kwasi Kwarteng’s mini-budget in September 2022.
Danny Sriskandarajah, chief executive of the New Economics Foundation, a left-leaning think tank, said: “Borrowing doesn’t have to be scary — it’s responsible for a government to borrow for investments which will improve our lives and benefit us all in the long run.”
Others are more alarmed. Cara Pacitti, senior economist at the Resolution Foundation, another left-leaning think tank, said: “The fiscal inheritance facing the chancellor is one of rising taxes, increasing spending challenges, and very little wriggle room in the event of bad economic news. This combines to create a challenging backdrop for the new government to realise its ambitions of boosting growth while putting the public finances on a sustainable path.”
Much like central bankers have to convince financial markets of their intentions on interest rates, politicians have to convince bond traders that their tax and spending plans will yield growth. Truss and Kwarteng broke this bond because they opted to lower taxes for the rich rather than lift investment.
The National Institute of Economic and Social Research has warned that the Labour government will fail in its mission to lift the UK’s GDP growth to the top of the G7 rankings without an additional £50 billion in public sector investment.
There is a risk that Reeves will lose the newfound confidence of international investors in the UK economy if austerity measures are put back on the table.