Introduction

The rising cost of public services and benefits in the UK has led to a higher-than-expected increase in government borrowing, according to official figures released by the Office for National Statistics (ONS). In July 2024, borrowing reached £3.1 billion, marking the highest level for the month since 2021. This unexpected surge has sparked widespread discussion among economists and policymakers, with many speculating on the potential tax and spending adjustments that may be announced in the upcoming autumn Budget by Chancellor Rachel Reeves.

The increase in borrowing highlights the growing fiscal pressures faced by the UK government as it grapples with rising public service costs, inflation-linked benefits, and an overall economic environment characterized by uncertainty. This article will delve into the factors contributing to the rise in government borrowing, the implications for public finances, and the tough choices that lie ahead for the Chancellor.

The Current State of UK Government Borrowing

In July 2024, the UK government borrowed £3.1 billion, a significant increase compared to £1.3 billion in July 2023. This marks the highest borrowing level for July since 2021, when borrowing reached £4.7 billion. The figure was also £1.1 billion higher than most economists had predicted, signaling a concerning trend for the nation’s public finances.

Factors Contributing to the Surge in Borrowing

Several key factors have driven the recent increase in government borrowing:

1. Rising Cost of Public Services: The cost of public services, including healthcare, education, and social care, has been rising steadily. This increase is partly due to higher demand for these services, an aging population, and the government’s commitment to maintaining service levels in the face of inflationary pressures.
2. Inflation-Linked Benefits: The UK government has also faced higher costs due to inflation-linked benefits. With inflation rates remaining stubbornly high, benefits such as pensions and welfare payments have risen accordingly, adding to the overall fiscal burden.
3. Reduced National Insurance Contributions: Another contributing factor has been the reduction in National Insurance rates by the previous Conservative government. In July, compulsory social contributions fell by £1.1 billion, largely due to these rate cuts. This reduction in revenue has exacerbated the gap between government spending and income.
4. Debt Interest Payments: While income tax receipts grew strongly in July, debt interest payments remained a significant drain on public finances. The ONS reported that the interest payable on central government debt was £7 billion in July, the second-highest amount for that month since records began in 1997. Although this figure was lower than the Office for Budget Responsibility (OBR) had forecast, it still represents a substantial cost to the government.

Economic and Political Implications

The rise in government borrowing has significant implications for the UK’s economic and political landscape. With borrowing already overshooting Budget forecasts, there is mounting pressure on Chancellor Rachel Reeves to address the growing fiscal deficit.

Potential Policy Responses

Economists and political analysts have speculated on the potential policy responses that may be unveiled in the autumn Budget. Rob Wood, chief UK economist at Pantheon Macroeconomics, suggested that the Chancellor may be forced to raise taxes and borrow more in the medium term to cover the rising costs of public services. This view is echoed by Isabel Stockton, senior research economist at the Institute for Fiscal Studies, who noted that Reeves faces “tough choices” in her first Budget on October 30.

These “tough choices” will likely involve a delicate balancing act between raising taxes, cutting public spending, and finding ways to stimulate economic growth. While the Chancellor has previously stated that she would not raise VAT, National Insurance, or income tax, the growing fiscal pressures may necessitate a reconsideration of these commitments.

The Fiscal Rules and Credibility with Financial Markets

The government’s decisions on taxation and spending will also be influenced by its own fiscal rules, which are designed to maintain credibility with financial markets. These rules, which most governments in developed countries adhere to, set limits on borrowing and debt levels to ensure long-term fiscal sustainability. As the government prepares for the autumn Budget, these rules will play a crucial role in shaping the policy responses to the current fiscal challenges.

Political Fallout and Public Perception

The rise in government borrowing has also fueled a political row between the Labour and Conservative parties. Chancellor Rachel Reeves has previously claimed that the government will need to raise some taxes to address what she describes as a £22 billion “hole” in the public finances, left by the previous Conservative administration. The Conservatives, however, have denied these claims and accused Labour of misleading the public on the issue of tax rises.

Darren Jones, Chief Secretary to the Treasury, added to the political tension by stating that the latest borrowing figures are “yet more proof of the dire inheritance left to us by the previous government.” He argued that taxpayers’ money is being “wasted on debt interest payments rather than on our public services,” highlighting the challenges the current government faces in managing the nation’s finances.

The Broader Economic Context

The UK’s rising government borrowing must be viewed within the broader context of the country’s economic challenges. The national debt remains at its highest level since the early 1960s, reflecting the significant fiscal pressures the government faces. In July 2024, government spending totaled £107.4 billion, an increase of £3.5 billion from the previous July. This level of spending, combined with the rising cost of debt interest payments, underscores the difficulties the government faces in balancing its books.

Inflation and Its Impact

Inflation remains a key concern for the UK economy. Despite recent efforts by the Bank of England to curb inflation through interest rate hikes, the rate of inflation has remained elevated, driven by factors such as supply chain disruptions, energy costs, and wage pressures. The persistence of inflation has put additional strain on public finances, particularly through the indexing of benefits and the increased cost of servicing government debt.

Global Economic Uncertainty

The UK’s fiscal challenges are further compounded by global economic uncertainty. The ongoing geopolitical tensions, fluctuations in global commodity prices, and the impact of climate change on economic stability all contribute to an unpredictable economic environment. These factors make it even more challenging for the government to plan and implement effective fiscal policies.

Looking Ahead: The Autumn Budget

As the autumn Budget approaches, all eyes will be on Chancellor Rachel Reeves as she prepares to outline the government’s fiscal strategy for the coming years. The decisions made in this Budget will have far-reaching implications for the UK’s economy, public services, and the overall standard of living.

Potential Tax Increases

Given the current fiscal situation, it is likely that the Chancellor will announce some form of tax increases to help close the budget deficit. While Reeves has ruled out increases in VAT, National Insurance, and income tax, other taxes, such as corporation tax or capital gains tax, could be targeted. Additionally, the government may explore new revenue-generating measures, such as digital taxes or environmental levies.

Public Spending Cuts

In addition to potential tax increases, the government may also consider cutting public spending in certain areas. This could involve a review of government programs and initiatives to identify areas where efficiencies can be achieved. However, any cuts to public spending will need to be carefully balanced against the need to maintain essential services and support economic growth.

Stimulating Economic Growth

Another key focus of the autumn Budget will be measures to stimulate economic growth. The government may introduce policies aimed at boosting investment, supporting small and medium-sized enterprises (SMEs), and encouraging innovation. These measures will be crucial in helping to drive economic recovery and reduce the reliance on borrowing to fund public services.

Conclusion

The rise in government borrowing in July 2024 highlights the significant fiscal challenges facing the UK government as it grapples with rising public service costs, inflation-linked benefits, and global economic uncertainty. As Chancellor Rachel Reeves prepares for the autumn Budget, she faces a daunting task: balancing the need for fiscal responsibility with the demands of maintaining essential public services and supporting economic growth.

The decisions made in the upcoming Budget will have a profound impact on the UK’s economic future, shaping the direction of public policy for years to come. As the government navigates these challenges, it will need to strike a delicate balance between raising revenue, controlling spending, and fostering an environment that supports sustainable economic growth.

With the UK’s national debt at its highest level in decades and borrowing continuing to exceed expectations, the stakes could not be higher. The autumn Budget will be a critical moment for the government, one that will test its ability to manage the nation’s finances in the face of unprecedented challenges. The choices made in the coming months will determine the future trajectory of the UK’s economy and the wellbeing of its citizens.

photo source: Google

By: Montel Kamau

Serrari Financial Analyst

22nd August, 2024