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Balancing the Budget

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Balancing the Budget

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When is a budget in a deficit?

When spending exceeds revenue, the government is running a deficit.

This tends to happen in periods of economic contraction, when automatic fiscal stabilisers reduce tax revenue and increase spending, to support the economy.

This gap between revenue and expenditure is paid for by borrowing.

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When is a budget in a surplus?

When revenue exceeds spending, the government is running a budget surplus.

This tends to happen when the economy is in a strong position. Automatic fiscal stabilisers mean that tax revenue tends to be higher when the economy is in a good state.

This surplus means that the government does not need to borrow to pay for its spending.

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This chart shows that the government’s deficit increases when spending exceeds revenue. Also, it is worth noting that this arises in times of economic downturn (see Automatic Fiscal Stabilisers).

OBR Public Sector Finances July 2022223.4KB

What happens when the government runs a deficit?

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If the government spends more than it receives in revenue and it has to borrow money to pay for its spending, its debt levels increase.

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For around two decades, the UK government has run a deficit, causing debt levels to soar. When the deficit increases sharply - as a result of an economic shock - debt also increases quickly. Just like a personal loan or a mortgage on a house, the government has to pay interest payments on its debt. This means that as debt levels rise, debt interest payments rise too. The government can continue to borrow and increase its debt as long as it can afford to pay its interest payments.

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The USA Debt Dilemma: In May 2023, the US Government was days away from ‘running out of money’, and sending the global economy into meltdown. How did this happen? The USA was quickly approaching its ‘debt ceiling’, a debt limit that limits the amount of money the government can borrow to pay bills. If the ceiling was reached, the government would be unable to complete social security payments and pay federal workers, government spending would stop, creating economic turmoil and reducing investor confidence. After intense negotiations, Biden’s Government reached an expected agreement to increase the debt ceiling, despite strong opposition , narrowly avoiding catastrophe. In the past, votes to raise the debt ceiling have been something of a formality, yet the aforementioned vote was only passed with a 50-48 majority. This turmoil has led to many commentators asking just how high can debt rise, and will the ceiling continue to increase?

US debt ceiling - what it is and why there is one

Congress has approved a deal on the debt limit. But what is the debt ceiling and why does it exist?

www.bbc.co.uk

US debt ceiling - what it is and why there is one

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However, money spent on debt interest means less money available for other public spending. For this reason, governments must be careful to avoid debt levels rising too high, too quickly. This is why the government must take care not to allow debt levels to rise too much. According to the Office for Budget Responsibility, in 2022, “debt interest spending hit a record high – for both the single month of June (£19.4 billion) and for the year to date (£33.7 billion)” (June 2022, OBR).

The September 2022 mini-budget: when deficit spending goes wrong

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The mini-budget of September 2022 was announced by the former Chancellor of the Exchequer, Kwasi Kwarteng, on 23 September 2022. It included £45bn of unfunded tax cuts which included:

Cutting the basic rate of income tax from 20% to 19%;
Abolishing the 45% higher rate of income tax in England, Wales and Northern Ireland - not including Scotland as it is a devolved power;
Reversing plans to increase the corporation tax from 19% to 25%; and,
Cancelling the increase in National Insurance contributions that was due in April 2022.

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The aim of the budget was to quickly boost growth and avoid the UK falling into a recession by encouraging people to work more. However, many economists viewed this as a gamble since the proposed tax cuts might not have necessarily led to economic growth.

If the tax cuts did not create the growth which Truss and Kwarteng were expecting, the budget deficit would have increased substantially since the proposed tax cuts were not equally matched with cuts in spending.

Financial markets, who lend money to the government to fund the No access, were concerned that the mini-budget would increase debt levels to an unsustainable level due to it being unfunded and unlikely to create substantial growth. Furthermore, Truss and Kwarteng refused to consult the Office for Budget Responsibility (independent government watchdog) regarding their economic forecast. This led to chaos in financial markets with the cost of borrowing rising rapidly, leading to the eventual scrapping of most of the policies.

Weekly update - the aftermath of the mini-budget | FAI

For some in Westminster, a week in politics will never have seemed longer. Financial markets are still reeling from the announcement of the £40bn of deficit-financed income tax cuts announced last…

fraserofallander.org

Weekly update - the aftermath of the mini-budget | FAI