An Idiot’s Guide to Debt and Deficit

In this time of economic gloom it has become the norm to hear politicians chucking around terms like ‘total national debt’ and ‘deficit reduction plans’ – but what is the difference between debt and deficit and what are they made up of? In preparation of the Comprehensive Spending Review, hear is my mini-guide.

Let’s start with the easy stuff, the difference between debt and deficit.

Debt – Is simply how much money we owe as a country. When government needs to spend more than it has coming in it creates government bonds (or gilts) and then ‘sells’ them to investors. It is then paid back, with interest over a specified period of time – not so different to a loan really.  Total government debt is currently running somewhere in the region of £950billion. (Or about 65% of GDP).

Deficit – The deficit is basically the gap between income and expenditure in any given year. So, in the last financial year (2009-2010) the government spent about £670billion but only brought in just over £510billion – leaving a deficit of nearly £160billion that then gets piled onto the national debt.

What do we spend our money on?

In 2009-2010 this is how major government expenditure was broken down.

 

 

Debt interest payments totalled over £30billion, making it the equivalent of the 8th biggest spending department and over four times the amount we deliver in International Aid.

It is thought that the banking crisis is responsible for at least £150billion of the total UK debt. More than that however the recession that developed out of the crisis has sharply impacted on government income – fewer companies, smaller profits, a decreasing number of people in work and a squeeze on wages all mean less taxes for the government to then spend. To put it in context the deficit ran at less than 2.5% of GDP consistently from 1997 until 2008. Since 2008 it has been running over 12%.

Gosh, well none of that sounds good – how do we get out of it?!

This is where it gets interesting (if you are like me that is. If you are not, then to be fair you have probably stopped reading by now). You see there are literally hundreds of different ways of dealing with the deficit and if you look hard you will be able to find economists supporting each and everyone of them. However each and every one of them is a combination of the following three things.

– Facilitating economic growth (and therefore job and wealth creation)

– Cutting government expenditure

– Increasing tax-take

It is also worth noting that no-one really has the definitive answer… we have not seen times like this before, so everyone is winging it to a greater or lesser extent.

It is here that Labour and the Coalition have differing views.

The Coalition believe the country needs to cut hard and fast by primarily cutting government expenditure. In their plans they will cut the deficit entirely within 5 years; achieved through a balance of 80% in cuts and 20% in tax increases. Their argument is that we are living beyond our means and that economic growth depends on cutting public sector and replacing those jobs with a vibrant private sector.

Labour on the other hand proposing  halving the deficit over 5 years with a 60% cuts/40% tax increase formula. They prefer a more gentle realignment of the economy, concerned that any dramatic cuts in public expenditure will stall growth in the economy and create a double-dip recession or an elongated period of stagnant growth, as seen in Japan in the 1980’s

Wednesday’s Comprehensive Spending Review will start to put the meat on the bones of the coalition cuts – expect them to be brutal in areas that have not been ring-fenced. It will also be the first sign of the public’s appetite for cuts as the academic debate begins to become a reality within communities up and down the country.

Let me know if this has answered any of your questions, or if it has created new questions for you. And I shall be back with a slightly more partisan blog-post very soon!

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