The source of the deficit

There are innumerable claims from the Coalition government and its supporters that the source of the public sector deficit is Labour’s over-spending. But one graph, on the Treasury’s own website, demonstrates that assertion is untrue.

There are innumerable claims from the Coalition government and its supporters that the source of the public sector deficit is Labour’s over-spending. But one graph, on the Treasury’s own website, demonstrates that assertion is untrue. Scrolling down to the bottom of the screen reveals a chart showing public outlays and public sector incomes since FY1998/99 and the difference between the two; the level of public sector net borrowing.

What the chart shows is a widening in the deficit in FY 2008/09, which coincided precisely with the onset of the recession in Q2 2008. The deficit is a recession effect.

There are two direct recession effects on government finances. For economies with some degree of social safety net spending rises automatically as more people require welfare. For all economies with a tax regime, tax revenues decline as activity falls. In this particular case, public sector current expenditure rose by £15.4bn (June 2010 Budget Redbook, Table C16).

This is a modest rise of 2.8%. At the same time public sector current receipts fell by exactly the same amount, £15.4bn (Treasury Databank, C4, http://www.hm-treasury.gov.uk/psf_statistics.htm). They fell further again in the last FY, for a cumulative fall of £34.6bn over the 2-year period.

But, as we see from the chart, prior to the recession both revenues and outlays were rising as the economy expanded. From the time when Labour was elected in 1997 to the recession at the beginning of 2008, public sector current receipts rose by an annual average 6% (Databank, C1). But the trend growth in government spending over that period was 5.5% (Databank, B1).

To extrapolate, if the recession had not occurred and those trends had been maintained, spending would have been £597.5bn in the last FY. Instead, the outturn was £600.6bn, just £3.1bn higher. On the same trend basis, current receipts would have been £617.1bn.

But the outturn in the last FY was £514.6bn, a shortfall of £102.5bn. This is 66% of the entire public sector borrowing requirement of £154.7bn, while the increase in spending above trend is just 2%. The deficit is overwhelmingly attributable to plunging taxation receipts. (In the chart, the cost of the bank bail-out is included in public secto rborrowing- this is the other major source of the deficit.)

One of the Coalition’s arguments is that the Labour governments allowed spending to rise above taxation receipts over a prolonged period, well before the recession began. As the chart shows, there is indeed a deficit beginning in the FY 2002/03.

But this was after 4 years of surpluses. And again, it is important to look at the source of this deficit. From FY2002/03 to FY2007/08 (that is, before the recession) public sector current expenditure averaged 37.3% of GDP, whereas during the Thatcher years (FY 1979/80 to FY 1989/90) public sector current expenditure averaged 39.7% of GDP (Redbook, C16). Labour spent less than Thatcher.

The deficit from 2002/03 onwards is because Labour taxed too little. Current receipts averaged 37.6% during Labour’s entire period of office, compared to 42.4% under Thatcher. Labour taxed much too little, much less than Thatcher.

Now, with an extra 4.8% of GDP in tax revenues under its belt (equivalent to £65bn currently) a Labour government could engage in a significant programme of investment , which remains the key to long-term prosperity. It would revive businesses and get people back to work, and get both back paying taxes, the key to reducing the deficit.

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134 Responses to “The source of the deficit”

  1. Michael Ward

    The real source of UK deficit http://bit.ly/9vtPfK

  2. Jude Shirres

    RT @OtherTPA: So good I'm tweeting it again – the REAL source of the deficit: http://bit.ly/9vtPfK (via @leftfootfwd)

  3. Tom Earnshaw

    RT @leftfootfwd: The source of the deficit http://bit.ly/9vtPfK

  4. Steve

    Ash quotes me as sayig ““the graph shows that despite falling revenue they kept increasing spending. Their choice, a prudent government would have reigned in spending as revenue fell” and responds with

    …but this isn’t right. Spending automatically rises when revenue falls during a recession, because tax revenues fall and welfare payments rise; and a bit of discretionary spending to stimulate growth at such times is also generally regarded as a prudent investment. (Even the Tories weren’t calling for spending to be cut *during* the recession – that would have been crazy.)”

    Also not right. Welfare spending rises only when unemployment rises. It didn’t to any degree during the period under discussion. Government spending rose yes, but it was not welfare that was driving the rise, it was discretionary spending.

    Simply, you can only increase spending when revenue falls by increasing borrowing. Ultimately that capital must be repaid, and in the interim the interest must be paid. We now have future annual interest payments higher than the whole education and defence budget combined. The answer surely is that in a recession, unnecessary borrowing must be reigned back to finance any increase in spending required to compensate. Just to blindly continue increasing spending in those circumstances without regard to how on earth we are going to pay that debt was the act of a madman.

  5. Michael Burke

    Steve,

    you seem to have missed the point of the post- it was falling taxes (66%) which are responsible for the deficit, spending increases hardly at all (2%). Of the remainder the bulk is the spending on the bank bailout.

    It is also not true that ‘welfare spending only rises when unemployment rises’ as govt. spending also automatically rises when impoverishment occurs through short-time or temporary work increases. It can also increase if government decides that welfare benefits are insufficient for subsistence.

    Lastly, if you ‘reign back’ spending during a recession you introdce a pro-cyclical policy, one in which government cuts exacerbate the downturn. (And presumably do the opposite during a boom, thereby accentuating the boom-bust cycle).

  6. Robert John Carr

    RT @OtherTPA: So good I'm tweeting it again – the REAL source of the deficit: http://bit.ly/9vtPfK (via @leftfootfwd)

  7. George W. Potter

    Sorry, I seem to be missing something here. The graph shows that public spending has outstripped income sine 02-03 – long before the recession. If anything, this seems to reinforce the Coalition argument.

  8. Stephen Tall

    V odd @leftfootfwd post trying to prove Lab innocent of deficit http://bit.ly/9XI3j6 yet shows spend>income during growth part of econ cycle

  9. James Graham

    RT @stephentall: V odd @leftfootfwd post trying to prove Lab innocent of deficit http://bit.ly/9XI3j6 yet shows spend>income during growth part of econ cycle

  10. Nick Thornsby

    *Actual facepalm*. Depressingly stupid RT @stephentall: V odd @leftfootfwd post trying to prove Lab innocent of deficit http://bit.ly/9XI3j6

  11. haydoni

    You’re mad.

    The argument appears to be: the difference only became *much* greater during the recession, so if there wasn’t a recession it wouldn’t be so bad. But you must recall that there *was* a recession, wasn’t there.

    *Why* weren’t Labour taking enough in taxation during the ten year boom? If
    we’d have had surplus, maybe we could have afforded to “spend our way out of recession”, but we didn’t, did we.

  12. Ian Hopkinson

    RT @stephentall: V odd @leftfootfwd post trying to prove Lab innocent of deficit http://bit.ly/9XI3j6 yet shows spend>income during g …

  13. t b

    RT @stephentall: V odd @leftfootfwd post trying to prove Lab innocent of deficit http://bit.ly/9XI3j6 yet shows spend>income during g …

  14. Nick Barlow

    RT @NickThornsby: *Actual facepalm*. Depressingly stupid RT @stephentall: V odd @leftfootfwd post trying to prove Lab innocent of deficit http://bit.ly/9XI3j6

  15. Chris Jenkinson

    Dear Michael Burke, look at the data in future before writing silly blog posts http://bit.ly/9vtPfK

  16. Steve

    This graph dosen’t take into account PFI. Nor that Brown has about half a billion of liability not declared as public sector spending.

    Frankly, this is a half baked analysis based on half the facts.

  17. Jenni Jackson

    True source of current deficit – fr Treasury website… http://bit.ly/abNwPv

  18. Emma Burnell

    RT @jenni_jackson: True source of current deficit – fr Treasury website… http://bit.ly/abNwPv

  19. Jo C

    RT @jenni_jackson: True source of current deficit – fr Treasury website… http://bit.ly/abNwPv

  20. S

    RT @jenni_jackson: True source of current deficit – fr Treasury website… http://bit.ly/abNwPv

  21. Adam Bell

    Bizarre @leftfootfwd article claiming that the recession wasn't caused by Labour, including graph that shows opposite. http://bit.ly/9XI3j6

  22. Sam Browse

    RT @leftfootfwd: The source of the deficit http://bit.ly/9vtPfK <= great, understandable article by Michael Burke.

  23. Milena Buyum

    RT @leftfootfwd: The source of the deficit http://bit.ly/9vtPfK

  24. James Chan

    RT @leftfootfwd: The source of the deficit – less tax revenue (unemployment) and the bank bailout – http://bit.ly/9vtPfK

  25. Michelle Swallow

    This is rly interesting RT @michaelward82: The real source of UK deficit http://bit.ly/9vtPfK

  26. Time to join a union | Bright Green

    […] say we can probably afford to borrow another 50% of GDP without long term consequences, while the bulk of the increase in deficit recently is caused not by spending too much but a falling tax take. Cutting back on […]

  27. Melissa Nicole Harry

    if you haven't seen this already… the REAL cause of the deficit http://bit.ly/9vtPfK (via @leftfootfwd)

  28. Robert Levy

    RT @leftfootfwd: The source of the deficit http://bit.ly/9vtPfK

  29. Alys Tarr

    @sunny_hundal @sowadally Disagree with you comment here completely: it's too high, but not because of Labour's doing: http://bit.ly/amZRkm

  30. Martin Johnston

    @steve_lake indeed. I've got a file of things for voters to read this should be in there too http://bit.ly/c9dmtT

  31. Stewart Owadally

    @jazzifull And to demonstrate why it isnt, we can use the source of the deficit http://tinyurl.com/2u8muga The deficit is a recession effect

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