THE independent Office for Budget Responsibility was established in 2010 to monitor the public sector’s finances. Twice a year – usually alongside each Budget and Spring or Autumn Statement – we produce detailed forecasts for the coming five years, assessing the likely impact of any policy decisions and expected developments in the economy. We then use these forecasts to assess the Government’s performance against the fiscal targets that it has set itself for the management of the public finances.

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This guide provides a brief introduction to the UK public finances and to the terms used to describe them in the official statistics. In doing so we are looking at the finances of the public sector as a whole – which encompasses not just central government, but also the devolved administrations, local councils and public corporations.

The figures presented in this guide are taken from our November 2020 forecast, which covers the five fiscal years up to 2025-26. Each fiscal year runs from April to March.

 

A pdf version of this guide is also available to download here:

Brief guide to the public finances

This guide provides a brief introduction to the UK public finances and to the terms used to describe them in the official statistics. We describe the main sources of government income and spending, and explain how these are used to calculate whether the government is running a surplus or a deficit. We also explain how government debt is defined and calculated.

January 6, 2021 – 324 KB


Overview

Bar cart of spending receipts and deficit

IN each forecast we assess how the public finances are likely to evolve on the basis of existing Government tax and spending policies and our best guess at the likely evolution of the economy. In particular we try to estimate:

  • how much money the public sector will raise from taxes and other sources of revenue. In 2020-21, we expect it to raise £771.0 billion, equivalent to around £27,000 per household or 37.3 per cent of national income.
  • how much it will spend on things like public services, state pensions and debt interest. In 2020-21, we expect it to spend £1,164.6 billion, equivalent to around £40,000 per household or 56.3 per cent of national income.
  • whether it will spend more or less than it raises – in other words whether it will run a budget deficit or surplus. In 2020-21, we expect a peacetime record deficit of £393.5 billion. Because spending is forecast to fall faster than receipts, we expect the deficit to fall over the next 5 years to reach around £100 billion.
  • how much will be added to – or paid off – the national debt in each year. In 2020-21, we expect debt to be equivalent to 105.2 per cent of national income – the highest ratio since 1959-60. It is equivalent to around £2,270 billion or £79,000 per household. From 2021-22 we expect the ratio of net debt to national income to increase slightly and peak at 109.4 in 2023-24 before falling to 104.7 per cent in 2025-26. In cash terms we expect it to stand at £2.8 trillion by then. Taking out the effect of Bank of England loans to banks and building societies, which are expected to be repaid by 2025-26, the debt ratio rises in every year of the forecast to stand at 97.5 per cent of national income by then.

Income

Receipts in 2020-21IN 2018-19, we expect the public sector’s income to amount to £771.0 billion, equivalent to £27,000 per household or 37.3 per cent of national income. These are called ‘public sector current receipts’ in the official statistics and come from many sources.

Taxes are the most important at 90 per cent of the total in 2020-21. The taxes that bring in the most money are income tax and National Insurance contributions, which together are expected to raise around £330 billion. Value added tax (VAT) is the next most important, expected to raise £116 billion. Other big taxes include corporation tax, council tax and fuel duty. No other tax is expected to raise more than £20 billion, although business rates receipts are only slightly below this level this year due to reliefs for the retail, hospitality, leisure and nursery sectors.

The public sector also receives other revenues, including interest earned on its assets (such as foreign exchange reserves and student loans), while public corporations generate some income.

Over the next five years, we expect total receipts to rise by 30 per cent, slightly faster than the growth in the cash size of the economy. We expect some taxes to rise more quickly, including capital gains tax (driven by asset markets, like housing and the stock market) and corporation tax (as overall business profits rebound after the coronavirus outbreak). But some tax receipts are expected to rise more slowly than the economy as a whole, including income tax (due to weak earnings growth), council tax (because of limits on annual increases) and tobacco duty (because people are smoking less).


Spending


Spending in 2020-21THE public sector raises money in order to spend it
, mostly on the day-to-day costs of providing public services, on capital investment and on cash transfer payments that support the incomes of various individuals and families.

In 2020-21, we expect public spending to amount to £1,164.6 billion, which is equivalent to around £40,000 per household or 56.3 per cent of national income. This is called ‘Total Managed Expenditure’ and covers many different types of spending.

In 2020-21, we expect central government departments to spend £456.0 billion on the day-to-day (’current’) running costs of public services, grants and administration. This is 39 per cent of public spending. The biggest items are health (£149.8 billion), education (£72.9 billion) and defence (£41.2 billion). This spending is subject to multi-year limits set by the Treasury – known as ‘Resource Departmental Expenditure Limits’ or ‘RDEL’.

We also expect the public sector to spend £135.7 billion – around 12 per cent of the total – on capital investment (such as roads and buildings) and on loans to businesses and individuals. Around 50 per cent of this will be spent by government departments, again subject to multi-year Treasury limits – ‘Capital Departmental Expenditure Limits’ or ‘CDEL’. Some of the remainder will be carried out by local authorities (mostly roads, schools and housing) and public corporations (like Transport for London), but around 30 per cent of capital investment is on business and student loans.

The Government set out detailed department-by-department plans for RDEL and CDEL in its 2020 Spending Review. This set RDEL and CDEL plans for all departments for 2021-22. The NHS settlement announced in June 2018 means NHS plans currently run to 2023-24, the schools settlement runs to 2022-23, while the defence settlement runs to 2024-25.

The biggest component of AME is cash transfers through the welfare system, expected to cost £246.2 billion in 2020-21. Around 52 per cent of these are paid to pensioners, with state pensions the largest item at an expected £103.6 billion. Other big items include universal credit and the tax credits and benefits it is replacing (£82.9 billion) and disability benefits (£26.3 billion, around three-fifths paid to people of working age).

Similar to welfare payments are the two schemes introduced by the Government to support the incomes of employees and the self-employed who are adversely affected by the public health measures introduced to contain the coronavirus. Combined, the coronavirus job retention scheme and the self-employment income support scheme are expected to cost £83.4 billion in 2020-21 (but currently nothing thereafter)

Interest payments on the national debt are expected to cost £39.5 billion in 2020-21. This includes the interest government pays to private sector holders of the bonds it issues – known as ‘gilts’ – and also the interest paid by the Bank of England on the money created during the ‘quantitative easing’ of monetary policy since the late 2000s financial crisis and recession. Net debt interest (interest paid minus interest received), one of the Government’s fiscal targets, is expected to be 2.7 per cent of non-interest receipts in 2020-21, falling to 2.2 per cent by 2024-25.

Bar chart of total managed expenditure

Over the next five years, we expect public spending to fall by 5 per cent in cash terms.

We expect AME to fall by 7 per cent, mostly due to the winding up of coronavirus support measures. Offsetting that, spending on some items continues to rise quickly (e.g. the cost of state pensions as ageing increases the number of claimants and the triple-lock increases the amount); on other items it is almost flat (e.g. universal credit spending, including the benefits and tax credits it replaces, due to the recovery from the pandemic. The Government’s multi-year spending plans mean that RDEL will fall by 9 per cent in cash terms by 2025-26, so it will fall by 6.4 per cent of national income.


Deficits and surpluses

WHEN total spending in a year is higher than total receipts, the Government needs to borrow to cover the difference. This gap is known as the budget deficit or ‘public sector net borrowing’. When receipts are higher than spending, the government runs a surplus. Deficits and surpluses are similar to losses or profits for a company.

Receipts and spending line chart

In 2020-21, we expect a deficit of £393.5 billion or 19.0 per cent of national income – its highest since the second world war and around double the peak during the financial crisis (£157.7 billion or 10.1 per cent of national income in 2009-10). We expect spending to fall faster than receipts next year, so we forecast that the deficit will get smaller. It falls slowly after that and by 2025-26, we expect the deficit to be £101.8 billion, by when receipts would be 38.1 per cent of national income and spending 41.9 per cent.

Swings into deficit have become steadily more pronounced over the post-war period. And budget surpluses have been achieved in only 12 years since 1948 and only five years since 1971-72.

Bar chart of PSNB

Movements in the budget deficit are in part the result of the ups and downs of the economy. When the economy is strong, the deficit will be lower as taxes flow in and welfare spending costs are reduced. The opposite is true when the economy is weak.

The ‘structural’ budget deficit is an estimate of how large the deficit would be if the economy was operating at a normal, sustainable level of employment and activity. We never know precisely what this ‘normal’ level would be, so these estimates are always uncertain. Currently this concept is particularly problematic, due to the effect on potential output of the temporary public health measures that have been introduced to control the coronavirus. Using our usual mechanical approach, we currently estimate that the economy will be 0.9 per cent below normal capacity in 2020-21. So we judge that the structural deficit is slightly smaller than the overall deficit, with a small ‘cyclical’ part of the deficit that would disappear automatically as the economy returns to a normal level of activity. However, a large part of that cyclically-adjusted deficit can, though, be expected to disappear automatically once the restrictive public health measures are eased and activity rebounds.

The headline deficit is the difference between total receipts and total spending, but people are also interested in the ‘current deficit’ (or surplus). This counts all receipts and all current spending, but excludes spending on net investment. As long as net investment is positive, the current deficit will be smaller than the overall deficit. We expect the current deficit to be £312.0 billion in 2020-21 and for it to reach £27.0 billion in 2025-26.

Charts of public sector net borrowing and current budget


Debt

SO far we have been looking at the flows of spending and receipts that take place each year and the deficits and surpluses they result in. But because governments run deficits much more often than they run surpluses, they have built up a significant stock of outstanding debt over time.

Generally speaking, if the public sector runs a deficit in a particular year, debt will rise in cash terms. But it can still fall as a share of national income if the cash size of the economy is growing sufficiently strongly. (That said, it is also important to be aware that some government activity adds to its debt without adding to the deficit in any given year, most significantly providing loans to students and businesses where the loans are financial assets for the government, provided they are expected to be repaid in future.)

The most widely watched measure of debt in the UK is ‘public sector net debt’, which subtracts the relatively small amount of assets that the Government could readily turn into cash if required (for example, foreign exchange reserves) from the gross total. We expect public sector net debt to reach 105.2 per cent in 2020-21 which is equivalent to around £2,270 billion or £79,000 per household – the highest level since 1959-60.

One of the Government’s legislated fiscal targets is to make sure that debt is falling relative to national income in 2020-21, thereby beginning to reverse the big increase associated with the financial crisis and associated recession. The huge rise in borrowing due to the coronavirus pandemic means that target will be missed by a very wide margin, with debt rising from 2020-21 to 2023-24, then falling slightly to reach 104.7 per cent by 2025-26. In cash terms, we expect debt to stand at £2.8 trillion in 2025-26. Taking out the effect of Bank of England loans to banks and building societies, which are expected to be repaid by 2025-26, the debt ratio rises in every year of the forecast to stand at 97.5 per cent of national income by then.

Line charts of debt measures


International comparisons

HOW do the public finances in the UK compare to those in other countries? To answer this question we can look at the data for 42 industrial countries produced by the Organisation for Economic Cooperation and Development (OECD). Unfortunately, the OECD data are not directly comparable with that we have presented so far: for example, the OECD does not cover public corporations, while it defines spending and revenue somewhat differently. These comparisons are also from before the coronavirus hit public finances worldwide, and the impact it had varies hugely between countries.

Those caveats aside:

  • The UK government raises somewhat less revenue relative to national income than the majority of other industrial countries – more than the US, Japan and Korea, but less than Scandinavian countries like Denmark and Norway.
  • Public spending as a share of national income in the UK is close to the average of other industrial countries – the UK spends much more than the US and Korea, but much less than Finland or France.
  • Spending close to the international average, but raising less in revenue, leaves the UK running a budget deficit that’s above the industrial world average. Norway has the largest surplus, thanks to oil and gas revenues that it saves rather than spends.
  • Net debt in the UK is also higher than the average of other industrial countries.

International comparisons of fiscal aggregates