Macroeconomic News

Paying for the Pandemic

With the huge amounts of government spending that have taken place throughout the COVID-19 pandemic, it is no surprise the question of how it will be paid for has arisen. For the month of January 2021, the UK government budget was £8.8bn in the red; the first time there has been a deficit during this month for 10 years and the highest level of borrowing since records began in 1993. The chancellor, Rishi Sunak, is set to announce his next budget on March 3rd and there is expectation he will take this as the chance to begin addressing the country’s gaping deficit. 

Borrowing Britain 

Britain’s indebtedness, relative to output, has risen to levels not seen since wartime. UK public borrowing is set to exceed £350bn in 2020-21, which equates to 17% of the country’s national income. Data from the UK statistical agency was better than expected for the current financial year, partly reflecting how tax revenues are holding up strongly. But this is likely to change as government support, in schemes such as the furlough scheme, comes to an end, so it cannot be guaranteed tax revenues will remain strong due to the fragility of many jobs. Data was still more positive than expected, with self-assessment tax payments (which are paid in January) rising 7% compared to the year before, however, this is largely because they involved income earned in 2019-20. The government’s procurement spending was £9bn lower so far in 2020-21 than previously anticipated, said the Office for National Statistics (ONS), leading to a large downward revision in the deficit figure for the financial year. Isabel Stockton, at the Institute for Fiscal Studies, said the current state of public finances was £69bn better than expected at this stage of 2020-21 by the Office for Budget Responsibility. But, she believes this improvement was likely to be an exaggeration, because £30bn of that difference resulted from expected defaults on government-backed loans to companies, which the ONS has not yet included in its calculations. So despite there being debate around the level of public debt and borrowing, it can be seen public finances are in the worst state since World War Two and will need to be addressed. 

Rishi’s plan of action

Rishi Sunak, the Chancellor of the Exchequer, has pledged to put Britain’s public finances on a “more sustainable” footing after the figures of a record deficit in January. It is thought he may take some first steps to increasing taxes in his March 3rd budget, although the biggest measures to generate extra revenues for the Treasury are likely to come later in the parliament. There is the expectation of the deficit being addressed with some tax increases, among ideas circulating is that of a tax on wealth. In particular, an independent Wealth Tax Commission is recommending the UK introduce a one-off wealth tax in order to reduce public debt. 

But, with Boris Johnson, the UK Prime Minister, publicly rejecting austerity and backbench opposition to tax rises, it may not be so easy for the Chancellor to repair this problem — despite his determination. Also, the political shift of Tory party voters adds to this issue. While many Tory MPs remain committed to a small state, the party’s electoral coalition of voters, like that of the Republicans in the US, has become increasingly working class and opposed to further public service cuts. This may be what has led to the rejection of austerity coming out of the pandemic by the Prime Minister, as opposed to its application during the recovery from the 2008 Financial Crisis. So the budget is likely to be a large trade-off between different ideas in order to try to keep both the general public and the rest of the Conservative party happy. 

Back to the past

Levels of government spending, and therefore borrowing, of the heights witnessed during the last year have not been seen since wartime. So it can be helpful to look back on how wars have been financed and see if these ideas can be applied to today’s problem. What has been described as “probably the most significant wartime fiscal innovation” by economic historians Stephen Broadberry and Peter Howlett is the Excess Profits Duty (EPD). The EPD was signed into law in 1915, first taking effect in 1917, and aimed to tackle the financing of World War One. It was the first tax levied on corporate rather than individual income. Businesses were to pay tax on a rise in profits of more than £200 (£14,189 in 2020) above the average they achieved in two of three years between 1911-1913. Alternatively, they could pay tax on profits that were more than £200 above a 6% return on capital employed as of August 1914. These ‘excess profits’ were to be taxed at 50%. By the last fiscal year of the war, 1918-19, EPD accounted for a third of the revenues raised by Britain, and was nearly as great as the money raised from increased income tax on individuals. 

Like the pandemic, the war did not treat all civilians equally. During World War One, living standards of the poorest took a hit because supply chain distortions caused a rise in prices faster than wages were rising. The perception was business owners were getting increasingly rich at the expense of their workers – leading to this idea of a tax on corporate profits. This same inequality has been seen over the last year, with UBS finding billionaires increased their wealth by 27.5% at the height of the crisis from April to July. Meanwhile, millions of people around the world lost their jobs, were working in low-paid jobs on the frontline or struggling to get by on government schemes. During the war, this led to strikes ensuing, demonstrating that inequality in experiences during times of turmoil can be politically as well as economically destabilising — a lesson the UK government should pay attention to. With the emergence of a “K-shaped” recovery granting outsized profits to businesses in certain sectors such as online retailing, and staggering losses to others such as tourism, the Tory party needs to prepare for a rise in inequality. The application of a tax policy that aims to address the issues of revenue raising, helping reduce public debt, while also improving fairness in the effects of the pandemic, is an idea deserving of consideration.

A battle for another day 

Many believe it is not yet the time to address the problem of the UK’s skyrocketing public debt. With low interest rates, the UK currently faces no immediate financing problem. Therefore, it is thought it would be a mistake to raise taxes or cut spending at this point in recovery. There is large uncertainty over the economic, and therefore fiscal, outlook. If the damage from the pandemic to businesses and households is temporary, a one-off increase in the government debt burden will be easy to cope with thanks to low interest rates and the long maturity of the UK’s debt stocks. A more permanent loss of national income, however, would merit a very different approach, requiring sustained tax increases to stabilise borrowing. So it would be premature to try and scale back borrowing now, whether by raising taxes or cutting spending; it would only make the pessimistic scenario look more likely by increasing the number of failed businesses and unemployed workers. Fiscal stimulus is called for until the recovery sits on firm foundations. It is too early to raise taxes, but it is not too early to start thinking and talking about it — especially with the differing opinions in the Conservative party.

Others argue it is not a problem that needs addressed for a longer while, with the problem appearing a lot worse due to out-of-date metrics when assessing today’s fiscal risks. The Office for Budget Responsibility forecast a jump in the ratio of net public debt to GDP from 34% in 2007-8 to 109% in 2023-4. Yet, crucially, the debt interest paid by the government (net of the Bank of England’s holdings) is a mere 1% of GDP, down from 2% in 2007-8 — the lowest in the post-war era. What largely matters when judging the burden of debt is the real interest rate. This is currently negative, meaning lenders are paying the government to borrow from them; according to the Bank of England, the UK government can now borrow at minus 2% for 40 years. Borrowing by the government for any programme or project with a zero or greater real return must then be profitable. Such a programme might be to sustain aggregate demand, e.g. via investment, in order to minimise long-term scarring caused by the pandemic. So instead of worrying about levels of borrowing, the government should actually be trying to exploit the great borrowing environment they are currently faced with to help aid recovery. 

In conclusion, there is no denying how large levels of public debt are at the moment. It may seem sensible for the government to implement increased taxes, hopefully one that can help address the inequality caused by the pandemic. However, it is not yet the time for this. It is vital to ensure the UK has a firm foundation of recovery before spending is reduced and taxes increased. The optimal borrowing conditions for the government give further reason why a recovery should be fully concentrated on and financing the public debt put on the back burner. There are many things to worry about, but the current level of debt relative to GDP is a worry for a later date. 


Leave a Reply

Your email address will not be published. Required fields are marked *