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.

134 Responses to “The source of the deficit”

  1. Michael Burke

    Richard Blogger.

    Spending was an average 36.7% of GDP under Labour, 39.7% under Thatcher.

    Tax revenues (in proportion to GDP) were:

    FY1997/08 to FY2009/2010 (Labour) 37.6%
    FY1979/80 to FY1989/1990 (Thatcher)42.4%

    (Treasury Databank, Table C1)

    Taxes were much lower under Labour than under Thatcher. One of the key aspects of that was that, during her time in office, there was a North Sea Oil bonanza. Govt. revenues were equivaent to over 17% of GDP uring her time in office. That will not be repeated; Britain is a net importer now of both oil and (early this year) natural gas.

  2. JoshC

    “Actually what the graph clearly shows is from 2002 onwards the government starting spending more than their income – what is generally called running a defecit. As this defecit was funded by by borrowing it was clearly going to be a disaster if the economy turned down which it duly did, regardless of Gordon’s claim to have got rid of boom and bust. 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 all the head in the sand froom Labour will not obscure the truth.”

    Steve, revenues only fell when the recession started so the central theme of the blog post, that the Tories are being less than truthful when they blame the spending on the public sector over Labours 13 years for the recession, is still valid.

    Spending increased largely BECAUSE of this as the banks were bailed out to prevent a worse catastrophe and more people claimed benefits as they lost their jobs, which also put an added burden on the public sector. Are you actually saying that Labour should have done what no other country affected by this global recession did and slash it’s public spending instead of using that spending to cushion the economy? Not bailed out the banks but instead let them foreclose on a million mortgage deals instead? Not protected certain industries with stimulus packages? Cut the public sector at the very time more people needed it? Not learn a thing from the 1930s?

  3. Anna Feruglio

    RT @wendybradley: "The deficit is overwhelmingly attributable to plunging taxation receipts" http://bit.ly/9vtPfK

  4. Tony Dowling

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

  5. Tony

    You say that it was fine to create a deficit in 2002 because of the time when Labour was following the conservatives spending plans had created a surplus…

    Actually that surplus was paying down the debt as Keynes prescribed so that when the economy does start it’s inevitable down turn the country can safely create a larger safety net and protect Jobs in the private and public sector without cuts. Unless you’re arguing that the state shouldn’t help protect the economy during a recession?….

    You also compare the economy of Thatcher to the time of Labour. For starters the Tories inherited an economy in the toilet, that seems to be a familiar picture for Labour. Secondly the global economy during the time was nowhere near as benign as it was under Brown, and that benign economy is something thats not going to occur again for a long time.

    So basically the deficit is Labours creation with Brown spending the futures ‘fiscal stimulus’ when the economy was at it’s strongest. It’s no wonder he tried so hard to lie about the abolition of Keynes and economic cycles. And its such a shame that the media was complicit in his lie.

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