CONTENTS Page No.

Fiscal deficit data (2000-2010): Table 1.1 2

UK National Debt: Table 1.2 3

UK Government expenditure: Table 1.3(2010) 3

Changes in UK Fiscal Deficit

Balance of Trade payments 4

Taxation policy 4

Vat structure 4

Corporation Tax 5

Reflationary fiscal stance 5

Crowding out phenomenon 5

Car scrappage scheme initiative 5-6

Reduced Government borrowings 6

Consequences on the economy and business

Financing the deficit 7

Increase in Government borrowings 7

Effects on Business 7

Inflation 7

Unemployment 8

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ECONOMICS: UK FISCAL DEFICIT ANALYSIS

The UK fiscal deficit is a measure of the Governments spending in relation to its earnings and usually linked to the GDP of the country. UK has been suffering from considerable level of changes in the fiscal deficit for quite some time now. Some economists argue that it is because of the UK Governments deliberate stance to increase taxation and changes in the spending decisions. They also believe that the current state of the fiscal deficit is not a result of factors such as unemployment in the country, pace of economic growth or inflation.

In the case of UK, the Government’s borrowings amounted to 11.4% of the GDP with a net borrowing of £ 159.8 billion. The Government’s deficit as a percentage of the GDP shows a steep rise by 4% since the year 2008/2009. (Office for National Statistics)

Table 1.1 Compiled from data as published by the Office for National Statistics (ONS)

Financial year

Current budget (the deficit), £m, inc financial interventions

Current budget (the deficit), £m, exc financial interventions

Pub sector net

borrowing, £m (inc financial

interventions)

Pub sector net

borrowing, £m (exc financial

interventions)

Net debt as % of GDP (inc

financial interventions)

Net debt as % of GDP (exc

financial interventions)

2001/02 12 144 12 144 -243 -243 30 30

2002/03 -11323 11 323 25 128 25 128 31 31

2003/04 -17418 17 418 33 041 33 041 32 32

2004/05 -19249 19 249 39 823 39 823 34 34

2005/06 -13953 13 953 37 409 37 409 35 35

2006/07 -5021 5 021 30 862 30 862 36 36

2007/08 -4651 4 651 33 484 33 337 43 37

2008/09 -49865 49 417 86 444 96 000 53 44

2009/10 -100504 106 510 145 553 155 935 62 54

Table 1.2 Compilations of Data from Guardian.co.uk, November, 2010.

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Sectors Debt in cash terms(£ Trillion)

Debt in cash term (£ Trillion)

Debt as % of GDP Debt as % of GDP

Households 1.5 1.9 110 101

General Government

0.9 1.4 67 77

Non financial companies

1.7 2.2 122 116

Financial Sector 3.4 4.5 245 242

Total UK Debt 7.5 10.2 543 536

The table above gives a breakdown of different sectors that have been contributing to the national debt in the UK. The total national debt in UK is set to hit £ 10.2 trillion by the year 2015 as per reports submitted by the firm Price Water House Coopers. (Guardian.co.uk)

The UK Government has been spending its tax revenue predominantly on Health care, pensions and welfare. The Table given below shows the data and expenditure concerned. The total tax receipts for UK for 2010 have been £ 519.8 billion, 37% of the GDP. However, its expenditure gap is at £ 141.2 billion.

Table 1.3 Compile from data published by: UKpublicspending.co.uk

Total Spending 2010 (£ Billion)Pensions 117

Health care 122Education 84Defense 46Welfare 109

Total Expenditure 661

Factors that lead to the change in the fiscal debt between 2000 and 2010

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The fiscal deficit has changed since year 2000 in the UK by a substantial amount. The Fiscal Policies adopted by the government are responsible for these changes. From the figures in table 1.2 above it can be noted that the measure of the fiscal deficit also includes households in addition to businesses within the financial sector. This implies that policy changes affect the way these factors behave, and have an impact on the fiscal deficit.

The current account deficit in 2010 reduced as the surplus income increased by £ 6.5 billion. Increase in the exports of finished manufactured goods, semi manufactured goods and oil also lead to an increase in the net value of exports by £ 3.2 billion. The current transfers also fell by £0.1 billion to £4.1 billion as the payments due to EU Institutions were not made within that quarter. Overseas earnings on investments were also increased by £ 4.2 billion. All these factors resulted into a reduced current account deficit and altered the balance of trade payments accordingly.

Figures courtesy: Office for National Statistics

Since the year 2000, there has been a constant increment in the tax levels. This has had an effect on the incentive to work in the UK. Since increased tax reduces the income after tax, the disposable income of the individual’s income is also affected. The businesses have seen a reduction in the sales due to this. High tax levels have also reduced the incentive to work longer hours as a result of tax cuts on the net income.

The VAT has also been scheduled to rise to 20% from the current 17.5% by the year 2011. This will again have adverse effects on the cost of production of goods & services. The producers in turn will push this cost on to the consumers who will face

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increased price levels which will have similar effects of reduced consumptions as in the

case of increased taxes. (HM Revenue & customs)

The government’s imposition of Corporation tax has also changed considerably over the years. The Corporation Tax in the year 2000 was 30% of profits; this has now reduced to 28% in the year 2010. This policy has encouraged the favorability of direct foreign investments in the UK. However, in order to attract more investment opportunities, there has to be sizeable reduction in the corporation tax. This could potentially affect the aggregate demand and supply. The capital account deficit could largely be reduced as a result of increased foreign direct investments. (HM Revenue &

customs)

Since UK’s fiscal deficit has been prevalent since a few years now the economy has been adopting reflationary fiscal measures. The government has had to borrow money in order to increase the aggregate supply and encourage increased activity in the economy. The government has increased its borrowings to look into the sectors of transport, health & education since 2000. The annual spend in 2000 was £ 364 billion. This has now increased to £ 661 billion in 2010. The added pressure of reflationary fiscal stance has therefore increased the government’s borrowing since. (www.ukpublicspending.co.uk)

The fiscal stimulus programme also might have lead to the fiscal crowding out phenomenon and has affected the fiscal deficit of UK. When the government is seeking to increase the aggregate demand in the country it seeks to borrow more money in order to inject it into the economy. This might lead to transfer of resources from the private sector to the public sector. This implies that the UK Government faces a budget deficit. The UK Government issues bonds in a bid to raise the funds. However, in order to attract the firms or individuals to purchase these firms, the government has had to increase its interest rates. At the same time the interest rates can increase across the markets in order to keep up with the increase in the demand for government bonds. Thus, the purpose of the fiscal stimulus fails and the aggregate demand also reduces. (www.economists.com)

The UK monetary policy of 2009- 2010 saw measures such as reduction in interest rates up to 0.5% being taken. Quantitative easing was also considered by the UK Government, however, the Bank of England put a temporary halt to the £ 200 billion asset purchases in February 2010. (www.guardian.co.uk)

The UK government also adopted the car scrappage scheme which turned out to be a success. The government had pumped in £ 400 million into the scheme. Under the scheme owners of car 10 years or older could get £ 2000 discount off the price of a new one. The Fiscal deficit benefited with this scheme because it generated demand for UK

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car sales, protecting jobs and supporting the supply chain in the car manufacture sector when it was struggling during the economic down turn. (www.news.bbc.co.uk)

The UK coalition government has also come out with cost cutting measures to reduce government borrowings in the long term which have been criticized by many. For instance the Ministry of Defense’s budget has been cut down to £ 3.35 billion from £ 4 billion. 7000 soldiers, 5000 sailors and airmen each are set to lose their jobs. The Government is also looking forward to save £ 5 billion by increasing the pension age to 66 by 2020. (The Telegraph)

Fiscal deficit: Likely consequences on the economy and the business

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Financing a deficit- Economists believe that the government will have to continue borrowing money through issues of new government debts. The government can issue these to the domestic or overseas investors. However, if the deficit remains high for a longer period of time the government will have to find ways to attract more investors. They might have to increase interest rates to that effect. This is turn will result in slower economic growth as the aggregate demand falls due to the widespread increment in interest rates due to demand for these government debt issues. The fiscal crowding out phenomenon is widely expected by the speculating economists in the long run. However, at present UK is largely able to attract foreign investors, due to its low interest rates.

The more the UK Government borrows, the more its national debt increases. They are obligated to pay off this debt as soon as they can afford to do so. However, there is an opportunity cost involved. The same money could have been used to purchase assets, investments in health services and education. There will also be a redistribution of wealth from those who pay taxes to those who hold these government bonds.

The Businesses in UK will find it difficult to sell their products as consumers start saving more as a result of the rational thinking perspective. If taxes are reduced to increase aggregate demand in the country, the perception of the consumer will be such that, there will be a rise in price in the future to make up for the low taxation rates in the present. This will induce more savings and less spending, back firing the policy.

The Government has to pay interest on the bonds and gilts it sells. In 2010, the UK Government had to part with £21.6bn in the first six months. (As reported by Office for National Statistics) Therefore, it is scheduled economic growth the cost of the National debt is very high. In order to make up for the interest pay outs, the government might increase taxes in the near future. This will result in lack of incentive to work and reduce productivity in the future.

There could also be a danger of inflation if the government sells short term gilts to the banking sector. From the perspective of a bank, gilts are synonymous with money (currency) and hence there will be an increased level of money supply which might lead to inflation. There could also be a possibility of fall in the exchange rate of UK’s currency.

The UK government’s move to reduce fiscal deficits has also resulted in the highest levels of unemployment in the UK. The CIPD chief economic adviser, John Philpott, has warned that unemployment levels will reach 3 million as a result of spending cuts instead of tax rises. (www.ft.co.uk)

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Based on the compilation of different opinions of economists, the major consequences of fiscal deficit on the UK economy will revolve around problems of inflation, unemployment, fall in exchange rates, and reduced aggregate demand. According to the chancellor, George Osborne, the UK economy is back on the right track. The third quarter of 2010 (July to September) recorded a GDP growth of 0.8%, twice the rate anticipated. (www.guardian.co.uk)

Apart from the concerns above, in my opinion UK has still some struggle to endure in the near future. Unemployment is a rising concern these days. The new regulations for immigrants and students will reduce the amount of students coming into the UK. In 2007/2008 international student’s expenditure studying in UK universities amounted to £ 2.3 billion. The output generated by these students was estimated at £3.3 billion. The enforcement of the new regulations will definitely curtail these revenue generating factors. (Universities UK)

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REFERENCES

ONS. (2010) UK Government debt & deficit. Office for National Statistics [Online]Available at: http://www.statistics.gov.uk/CCI/nugget.asp?ID=277 Accessed on 18/12/2010.

Evans, L., (2010) what is Britain’s true national debt- & will it reach 10.2 Trillion? Guardian.co.uk. [Online] Available at: http://www.guardian.co.uk/news/datablog/2010/nov/09/economicgrowth-debt-relief Accessed on 18/12/2010.

Chantrill, C., (2010) Total planned public spending expenditure. UK Public spending.co.uk [Online] Available at: http://www.ukpublicspending.co.uk/ Accessed on 18/12/2010.

ONS. (2010) Balance of Payments: Current account deficit reduced. Office for National Statistics. [Online] Available at: http://www.statistics.gov.uk/cci/nugget.asp?id=194 Accessed on 18/12/2010.

HM Revenue & Customs. (2010) Increase in the standard rate of VAT to 20%. [Online] Available at: http://www.hmrc.gov.uk/vat/forms-rates/rates/rate-increase.htm. Accessed on 18/12/2010.

HM Revenue & Customs. (2010) Corporation Tax. [Online] Available at: http://www.hmrc.gov.uk/rates/corp.htm Accessed on 18/12/2010.

The Economist. (2010) Economics: A to Z Resources. Crowding out. [Online] Available at : http://www.economist.com/research/economics/alphabetic.cfm?letter=C#crowdingout Accessed on 19/12/2010.

Seager, A.,(2010) Bank of England halts Quantitative easing. [Online] Available at: http://www.guardian.co.uk/business/2010/feb/04/quantitative-easing-bank-of-england Accessed on 19/12/2010.

BBC News. (2010) UK car scrappage scheme extended by a month. [Online] Available at: http://news.bbc.co.uk/1/hi/business/8497239.stm Accessed on 19/12/2010.

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The Telegraph. (2010) Spending Review 2010: What it will mean for key departments. [Online] Available at: http://www.telegraph.co.uk/news/newstopics/spending-review/8072784/Spending-Review-2010-what-it-will-mean-for-key-departments.html Accessed on 19/12/2010.

Groom, B., (2010) Economists warn on job losses. [Online] FT.com. Available at: http://www.ft.com/cms/s/0/ec58e834-73f8-11df-87f5-00144feabdc0.html#axzz18Za7V9cZ Accessed on 19/12/2010.

Watt, N., Inman, P., (2010) George Osbourne declares economy back on track after GDP increase. [Online] Guardian.co.uk. Available at: http://www.guardian.co.uk/business/2010/oct/26/gdp-growth-osborne-construction Accessed on 19/12/2010.

Universities UK. (2009) The impact of Universities on the UK economy. [Pdf-Online] Available at: http://www.universitiesuk.ac.uk/Publications/Documents/EconomicImpact4Summary.pdf Accessed on 19/12/2010)

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