Tax and Fiscal Policy

Britain faces worst ever peacetime fiscal crisis


Britain now faces one of the most serious fiscal crises in its peacetime history. One reason is that the UK is now caught up in a sudden and severe international recession. However, the government has also recklessly increased its discretionary spending since 2000, and is trying to fight the present recession with costly Keynesian pump-priming measures of doubtful effectiveness.

The question is whether it is possible to fund such high levels of expenditure. The government’s Budget constraint means that all public spending has to be financed either by taxes, borrowing in the financial markets or borrowing from the central bank.

But taxes on income and wealth, indirect taxes plus local authority levies, and social security taxes have all reached their effective upper limits in relation to national output over the past two-to-four decades.

Raising the tax burden on the private sector of the UK economy is therefore not a realistic option. The next question that arises is therefore whether the government’s borrowing projections are sustainable.

The Budget forecasts imply that the ratio of the current budget deficit to factor-cost GDP will rise from 2.6% in 2008, to 9.1% this year, and 10.8% in 2010. This is a far larger current deficit than that recorded in the slump of the inter-war period, let alone the post-1945 experience.

The HM Treasury projections are noticeably smaller than the deficits recorded during the two world wars, however. On both occasions the UK was largely kept afloat by loans from the USA. It seems unlikely that Britain will be so lucky this time round, particularly now that Chinese officials have stated that they are not interested in adding further British government liabilities to their foreign exchange reserves.

There must be serious doubt whether deficits on this scale can be financed in a non-inflationary manner, at a reasonable real rate of interest, without very large capital inflows from abroad. In turn, it is hard to see why such inflows should be forthcoming. Rising taxes and stifling regulations have gradually undermined the productive potential of the UK, making it an increasingly unattractive destination for overseas investment.

Professor David B. Smith is the author of the report, How Should Britain’s Government Spending and Tax Burdens be Measured? A Historic Perspective on the 2009 Budget Forecasts, released by the IEA today.

Shadow Monetary Policy Committee

David B. Smith studied at Trinity College, Cambridge and the University of Essex. His subsequently career was mainly spent in the financial sector, commencing with the Bank of England, thereafter in clearing banks and securities houses. David B Smith is a Visiting Professor at the Derby Business School, has been a member of the SMPC since its inception in July 1997 and its Chairman since 2003. He maintains his own macroeconomic forecasting model at Beacon Economic Forecasting and has published numerous articles on monetary policy and the effects of public spending and taxes on economic performance, amongst other subjects. He has been a regular interviewee on radio and television since the early 1980s.


2 thoughts on “Britain faces worst ever peacetime fiscal crisis”

  1. Posted 13/06/2009 at 19:52 | Permalink

    Same takes place in Russia. Just a few days ago President Medvedev was quoted in a media by saying that “there is no money, not a piece of it”. Well, they have got the issue because of oil price falling down; now it is rising back, with more than 70USD per barell. The UK is alsooil exportingstate – this is one of the main reasons for strength of the UK pound against euro, when the latter “suddenly” makescyclic moves against US dollar. My point is customs revenues will now slighly rise, as oil continues its upward trend, both in the UK and Russia. But in amonth when there comes time for collecting them.

  2. Posted 13/06/2009 at 19:52 | Permalink

    Same takes place in Russia. Just a few days ago President Medvedev was quoted in a media by saying that “there is no money, not a piece of it”. Well, they have got the issue because of oil price falling down; now it is rising back, with more than 70USD per barell. The UK is alsooil exportingstate – this is one of the main reasons for strength of the UK pound against euro, when the latter “suddenly” makescyclic moves against US dollar. My point is customs revenues will now slighly rise, as oil continues its upward trend, both in the UK and Russia. But in amonth when there comes time for collecting them.

Comments are closed.


SIGN UP FOR IEA EMAILS