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We expect emerging market government debt over the medium term to prompt long-term UK governments (rated according to Scope Ratings AA/Stable Outlook) to raise taxes, unless there is a sustained improvement in the outlook for expansion. Economic output is expected to grow by as much as 0. 6% this year and slow to 0. 4% in 2024 before returning to the UK’s prospective expansion of around 1. 5% in 2025.
The UK government’s gross debt ratio as a percentage of GDP will be 101% in 2022, below that of comparable countries such as France (rated AA/negative outlook), 112%, and Belgium (AA-/negative outlook), 105%. However, given the increasing spending pressures, flexible fiscal framework and the current Chancellor’s limited fiscal area compared to his predecessors, we expect debt to gradually increase to 110% until 2028, very much in line with France.
Current spending plans mean a significant reduction in public sector net borrowing between 2023-24 and 2028-29, from 4. 5% of GDP to 1. 1% (Chart 1). This would be the lowest deficit in more than two decades and particularly reduced than five years before the Covid pandemic, around 3%. This decrease is largely due to an increase in tax revenues (-1. 0% of GDP), a relief in departmental spending (-1. 1% of GDP) and a relief in interest fees (-0. 5% of GDP).
The overtly positive detail is the expected real drop in departmental spending. Public sector productivity remains at around 5% of pre-pandemic degrees and long-term completion reviews are expected to lead to higher completion in must-have spaces such as fitness and social care, education, defence and transport. The government has not detailed the final priorities over the entire forecast horizon, which will need to be agreed after the next general election, scheduled for before the end of January 2025 and likely to be adopted next autumn.
Table 1: Spending Plans Mean Strong Relief in Public Sector Debt
Net public sector indebtedness, as a percentage of GDP
Combined with the existing fiscal framework, this casts doubt on the UK’s ability to meet the debt-to-GDP trajectory set out through the Office for Budget Responsibility, and it appears that the government continues to meet its fiscal targets.
The framework has been amended six times since 2011, as there is no constitutional anchor requiring all parties to approve significant changes. The most recent change, in January 2023, brought less restrictive tax rules. The goal is that net debt as a percentage of GDP will decline through the fifth year over a five-year rolling forecast horizon, rather than the past three-year horizon. The public sector net debt target is less than 3% of GDP over the same period. In principle, the evolutionary nature of the targets is such that they can be achieved even if public sector net debt and net borrowing accumulate indefinitely.
High inflation pushed more people into the tax brackets of higher sources of earnings, leading to an increase in the tax burden and tax gains for the government. The government has to use the resulting additional margin to implement tax cuts. , adding corporate tax cuts, to inspire personal investment.
Despite this, the overall tax burden is still expected to reach record levels, expanding by around five percentage points of GDP over the next two decades (Chart 2).
However, compared to other major European economies, the UK’s tax burden remains low, leaving room for further fiscal consolidation, with tax revenue as a percentage of GDP at 37. 9% in 2022, compared to the 38. 3% from Spain and 38. 3% from Germany. (42. 1%), Italy (42. 9%) and France (47. 6%), although they are particularly higher than the USA (27. 5%).
Figure 2: The UK’s tax burden remains lower than many major European states.
Total tax burden, adding social contributions and public benefit as a percentage of GDP
While previous governments have raised taxes through the expansion of national insurance or value-added tax, long-term governments would possibly consider other tactics for taxing wealth in addition to income. Without higher taxes and stronger economic growth, the country will most likely face either a continued deterioration of public facilities and social benefits, or larger budget deficits.
For a review of all of today’s economic events, check out our economic calendar.
Eiko Sievert is Head of Public and Sovereign Sector Ratings at Scope Ratings GmbH.
This article originally published on FX Empire
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