Recession and Government Finances

Readers Question: Indicate the problems which are created for the government’s finances as a result of having to help avoid an even deeper recession.

In a recession, automatic fiscal stabilisers automatically cause a rise in borrowing. The UK recession hit tax revenues hard.

  • Income tax receipts fell as top earners were made unemployed.
  • Corporation tax fell as company profit decreased
  • VAT receipts fell as consumers spent less
  • A fall in house prices and fall in property transactions led to a marked fall in stamp duty.

At the same time Government spending on unemployment benefits and other forms of welfare increased due to the rising unemployment levels.

Therefore we have seen a large rise in cyclical borrowing.

In addition the government have pursued expansionary fiscal policy measures. Notably a cut in VAT rates from 17.5% to 15%.

Most of the rise in borrowing has come from the cyclical effects rather than changes in discretionary fiscal policy.

Problems of Government Borrowing

Worries over Credit Rating. The annual borrowing of 12-13% of GDP is very high and there are fears about the creditworthiness of the UK if borrowing keeps rising at this rate. If credit rating was downgraded it would become more expensive and difficult for UK to borrow. The UK still retains a high triple A rating, but, there are concerns this is under threat unless the UK can show it has plans to reduce borrowing in medium term.  Higher interest rates could reduce investment and growth.

Evaluate Problems of Government Borrowing

Problems of Government Borrowing

However, as we discuss here. – What Should Governments do about Borrowing? Borrowing may be a necessary requirement in the recession.

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