Tax and Fiscal Policy

Government s Profligate Fiscal Policies Likely to Lead to 1970s-Style Stagflation


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UK faces deficit crisis
In a damning indictment of Gordon Brown’s economic competence, a new report suggests that Britain’s current fiscal policies are more likely to lead to 1970s-style stagflation than cure the recession.

The author, Professor David B. Smith of the University of Derby deploys a more accurate methodology than the government to estimate national income. The result is a far more realistic picture of the dire state of the public finances.

Using the 2009 Budget forecasts he calculates that next year the ratio of government expenditure to national income will rise to 53.4%, the highest ratio since World War II and 6.9% above the peak recorded in World War I.

The ratio of public expenditure to private spending, which was 92.4% in 2008, will rise to 107% in 2009 and 114.5% in 2010 – the highest burden since 1945. The private sector will therefore have to carry more than its own weight in government activity.

To fund this, public sector net borrowing will increase from 8% of national income in 2008-09, to 14.1% in 2009-10, and 13.5% in 2011-12.

Professor Smith commented:

“This represents the longest and largest run of fiscal deficits in Britain’s peacetime history. There must be serious doubt whether deficits on this scale can be financed in a non-inflationary manner, without very large capital inflows from abroad. And it is hard to see why such inflows should be forthcoming now that the British economy has become so highly taxed by international standards.”

Government borrowing on this scale means that there is a significant risk that the budget deficit and total spending will start feeding on themselves because of rising debt servicing costs leading to a sharp rise in the real returns on gilt-edged securities.

Moreover, the rise in non-productive government spending as a share of GDP since 2000 is likely to have cut the UK’s sustainable growth rate by some 1.0% to 1.7% per annum. Such a drop in productive potential will have reduced investment returns, acting as a huge disincentive for overseas investors considering supplying desperately needed capital to the UK.

Read the full report here.