The latest data on the UK’s public finances have provided more ammunition for those arguing that the government cannot afford to cut taxes. However, the economic reality is far more nuanced – especially when it comes to interest payments.
The bad news is that the government borrowed another £14 billion in May, £3.7 billion more than forecast by the Office for Budget Responsibility (OBR). This reflected both lower-than-expected tax receipts, despite the increase in National Insurance contributions, and higher spending, including £7.6 billion in debt interest costs.
This means that the government has already borrowed £35.9 billion in the first two months of the new fiscal year, or £6.4 billion more than forecast. To rub it in, these figures will get worse before they get better. In particular, debt interest costs will almost certainly top £20 billion in June alone, because the inflation uplift on index-linked government bonds (gilts) will be based on the jump in the Retail Price Index (RPI) between March and April.
This OBR was already forecasting that debt interest payments will cost the government over £87 billion in the current financial year (2022-23). A figure nearer £100 billion is now plausible. This has led a number of well-placed commentators to rally to the support of the Treasury. For example, Robert Peston was quick to compare that potential £100 billion to government spending on education and to endorse the Chancellor’s line that ‘rising inflation and increasing debt interest costs pose a challenge for the public finances, as they do for family budgets’.
Indeed, despite the bad news on new borrowing, the latest public debt to GDP ratio of 95.8 per cent in May was actually 0.1 per cent below the latest forecast. This is presumably because the denominator, which is nominal GDP, was higher than expected. In other words, higher inflation still reduces the real burden of government debt.
Rising inflation and debt interest costs, therefore, pose a much smaller challenge to the public finances than they do to family budgets. In particular, the government’s income rises automatically when inflation increases, because the tax base is larger, while it is much better able to spread the cost of interest payments over time.
To be clear, it would also be incorrect to argue that we can forget about the additional debt interest costs, just because they will not actually materialise for many years. Nonetheless, payments in the future are usually valued differently than payments now. In this case, assuming at least some real growth in the economy, the burden of paying £100 billion in dribs and drabs over many years, even if uprated in line with inflation, should be less than the burden of paying £100 billion in one chunk now.
What’s more, the RPI uplift will have relatively little impact on the government’s cash requirement (known in the jargon as ‘CGNCR ex’) in 2022-23. This is the amount that actually has to be raised from the markets to cover the gap between cash inflows and outflows. Put another way, there will still be plenty of cash to spend on other areas, without having to issue loads more new gilts.
In short, will the government really be spending as much as £100 billion on debt interest this year? In purely accounting terms, and on an accruals basis, yes, and that is all some people might care about. But in my view, this figure gives a misleading picture of the economic, financial and policy implications of the jump in debt interest costs. It is therefore still right to view each proposal for tax cuts – or indeed spending increases – on its own merits. These benefits could actually include reducing inflation, both directly and indirectly, or at least doing more to ease its impact on households and businesses. But the Treasury’s dodgy arguments about the impact of inflation on the public finances are not helpful to anybody.