Government debt, budgets and the deficit - what are they?

Government debt, budgets and the deficit - what are they?

Newspapers and television news programmes are always mentioning Government spending and how responsible (or otherwise) the party in power is. However, have you ever taken a moment to truly understand what it all means?

A quick background to the finances of running a country.

Running a country is just like running any household or company – there is money coming in and money going out. In terms of income, that’s in the form of your own salary, or for companies, the sales they make. For governments, what’s relevant is what’s known as ‘government receipts’ – taxes and other sources of income such as social housing and interest payments on its assets, including student loans.

When it comes to money out, as an individual, you will have your housing costs, transport costs, food and such like. A company will have their overheads to pay for such as salaries and rents alongside research and development costs, IT and infrastructure. As for governments, their spending covers things such as health & social care, defence, education, transport, energy and pensions.

For any household or business to be a success, typically income has to be greater than expenditure. However, for governments, this rule doesn’t seem to apply, as we’ll explore later on.

What is the UK government’s income?

In 2021/22, the UK government raised around £915 billion in receipts (about 39% of GDP) and the biggest contributors by a long margin are Income Tax (£228 bn), National Insurance (£161 bn) and VAT (£143 bn). Together, these three items alone make up around 60% of the UK government’s income.

The next tranche of income receipts includes corporation tax (£66 bn), capital taxes (£41 bn) and council tax (£40 bn). Followed by the various duties on fuel (£26 bn), tobacco and alcohol (£23 bn) and business rates (£22 bn). The government also earns money from ‘other sources and unspecified taxes’ amounting to £167 bn.

As you can see, if a government decides to increase corporation tax from 19% to 25%, for example, in very simple terms, it could mean an additional £20 bn in revenue ((£66 bn/19)*25)) available for spending. Obviously, companies may decide to reinvest more or pay larger salaries/bonuses to reduce their corporation tax bill, but it does illustrate the possible impact on income that such policies could have.

For context, the UK raises more revenue when compared to GDP when compared to the USA, Japan and Korea, but less than Norway and Denmark.

What is UK government spending?

In 2021/22, the UK government total spending was £1.055 trillion. Yes, that’s right, trillion with a ‘T’ – £1,055 billion. This included £218 bn on health, £95 bn on education and £44 bn on defence.

Remember that theoretical additional £20 bn that could be raised from increasing corporation tax? In context, that’s nearly half of annual defence spending but less than 10% of the amount the government spends on health.

What you will quickly notice is that £1,055 bn is £140 bn more than the £915 bn of income the government received doing the same period. This difference is known as the deficit and gets added onto the national debt, along with the previous year’s deficit and all those that came before it.

In countries such as Norway, Russia, Denmark and the UAE, where government spending is less than income, the cash left over at the end of the year is known as a surplus and can be used to pay for large infrastructure projects, increase benefits or to be held in reserve and invested.

Norway, for example, created the Government Pension Fund to invest the surplus profits derived from their vast oil reserves and, in 2021, the fund owns over £1tn in assets that provide additional income for the state to spend or reinvest.

For international context, public spending in the UK as a share of GDP is slightly above the average of other industrial countries and the UK spends much more than Japan and Korea, but much less than Finland or France.

Overall, the UK is running a budget deficit that’s far above the industrial world average.

What is the national debt of the UK?

The national debt can be expressed in cash terms, which is the actual figure it would take to pay it off, or as a percentage of GDP. These measures against GDP are used to give some context when compared to the overall economic activity of a country.

In individual terms, it’s a bit like comparing two people with £400,000 of debt (mortgage, credit card and loans). If one of those households has a gross income of £200,000 each year and the other’s gross income is £95,000, it would stand to reason that the higher-earning household is better placed to manage that debt.

In 2021-22, the UK national debt was approximately £2.3 trillion (£2,365 bn), to put that in context, it is around £87,000 for each household in the UK and is the equivalent of nearly 100% of GDP. This is slightly more than the EU27 average but slightly less than Canada and France. Japan has a substantial debt when compared to GDP of over 250% and the USA is around 130%.

Conclusion.

So there you have it, government finances in a nutshell. Any chancellor has a lot of levers they can adjust to either increase income (by increasing taxes) or reduce their outgoings (by cutting government spending). They can also decide whether to spend more than they receive each year, or less and they may choose to reduce the national debt or add to it.

With health spending currently running at £218 bn (23% of total income), just a 5% reduction in spending would free up over £10bn each year – more than the entire cost of the UK justice system (just over £9 bn each year). This is certainly food for thought and hopefully helps to illustrate the difficult position every chancellor is in. What would you do? Let us know in the comments below.

What’s next?

If you need help or advice on your personal or business finances or if you want to consider investing to make your money work harder, you can get in touch with one of our advisors for independent financial advice. We offer a free initial consultation and although we are based in Tunbridge Wells, we advise clients across the UK.

Don’t forget, this article offers general financial information and should not be taken as personal advice. Remember that investments and pensions can go up and down in value, so you could get back less than you put in. Tax rules can change and the benefits depend on individual circumstances.