The government have repeatedly pointed to their ‘achievement’ of cutting the budget deficit by 25% in the past two years. But, how has this been achieved? and has it actually helped the UK economy?
UK Net Borrowing
|2012-13||£127.3bn – estimated|
This shows a 25% fall in annual borrowing between 2009-10 and 2011-12.
(Net borrowing – is the annual amount the government have to borrow. The amount spending exceeds tax revenue.)
Public Sector Net investment – HM Treasury psf
This shows that since 2009/10, there has been a sharp fall in net public sector investment. (Note: net public sector investment means the total amount of new capital created. It is total spending on new investment – depreciation.)
Factors that helped the deficit to reduce
1. Cuts in Public Investment.
The biggest component of the deficit reduction are the cuts in public sector investment. (Which is ironically now what the government are saying the economy needs). Capital investment (spending on roads and new infrastructure) is often the easiest politically component of government spending to reduce because voters don’t see an immediate reduction in benefits or public services. However, it has an adverse impact on the long-term performance of the economy. Business have often expressed concerns about the under-investment in transport and infrastructure creating supply side bottlenecks. This can damage the long-term productivity of the economy.
Also, this cut in investment has arguably had a large negative multiplier effect on demand. During the double dip recession the biggest components of GDP to decline were in the construction sector.
further reading: Impact of cut in public sector investment
2. Expiration of Tax Cut
During 2009, VAT was temporarily cut from 17.5% to 15%. That was estimated to have cost £12bn in lost revenue. 
On January 4, 2011, the standard rate of VAT increased from 17.5% to 20%. That was estimated to have improved finances by around £12bn
3. Overall spending cuts
- Changes in government spending 2009-10 +4.6%
- Changes in Government spending 2010-11 +0.3%
- Change in government spending 2011-12 -1.5%
- see more: How much has UK government spending been actually cut?
The reduction in the deficit was really planned anyway. With the expiration of VAT cuts and then the increase in VAT to 20% – this accounts for a large share of the shift in the budget deficit. The rest of the deficit reduction has mainly come from freezing spending and cuts in public sector investment.
A better question to ask the government may be – why hasn’t the deficit fallen more? We have had the damaging effects of large cuts in public sector investment, yet little to show for the pain.
The other over-riding issue has been the impact of austerity on confidence, economic growth, and consequently tax revenues. The recent IMF report suggested that fiscal austerity during a recession had a significant impact on reducing aggregate demand and the rate of economic growth. The fiscal austerity pursued after the election was a key factor in the UK’s double dip recession. The recession could have been even deeper, if the government had cut spending by as much as they threatened.
Another reason why the reduction in the UK budget deficit has been disappointing is that the second recession has led to very disappointing tax revenues. Tax revenues in August 2012, were 0.8% lower than the previous year because of a fall in corporation tax, (2). It has also meant the government have had to spend on unemployment and welfare benefits.
This is a major reason that the budget deficit is liable to be higher in 2012/13 than in 2011/12.
Unfortunately, the government response to this is to push for more spending cuts. It reminds you of the camel who keeps eating thorns although the mouth bleeds – just do a bit more of what hurts.
The reduction in the deficit during 2010-11 was unfortunately timed. It did not solve the most essential economic problems of the UK.