How To Fix The Deficit


A deficit arises in any organisation when expenditure exceeds income. For a company or individual if this is not immediately resolved an unpleasant trip to the bankruptcy courts is likely. Prudent companies and individuals therefore maintain reserves for a rainy day and prudent executives keep a close eye on cash flow. What may or may not constitute a profit is debatable. Running out of cash is not.

Some governments have one other option, which is to run a deficit by borrowing money on the international bond markets, pledging to pay it back with future taxation. This is analogous to using a credit card to pay off an overdraft, and to anyone not cursed with a degree in PPE seems a bad idea. Eventually you run out of credit card or, in international finance jargon, you suffer a bond strike – no one wants to buy your bonds. At which point the government is screwed, as are the people who elected it and, tragically, those under 18 who didn’t vote for it, but get the liability anyway. About the only good news for the UK is that we haven’t had a bond strike, yet. If you run lots of one year deficits you get an accumulation of debt called the national debt.

Time for some numbers. The best source of these would be the ONS, but their website is too detailed so I have used Wikipedia. (It tells you something about government when it’s hard to get to the numbers…). Of course, these are all government numbers, so they may be subject to revision etc. But they’re the best I could find and the message is stark:

In 2014:

  • UK GDP will be £1,470 Billion
  • Tax Receipts will be £648 billion
  • Government spending will be £732 Billion
  • The UK national debt will reach £1,272 Billion

Two key observations:

  1. This year, like every other year for over a decade the government is spending more that it raises.  2014’s aspiration is £90 billion.  Or, to put it another way, of every £10 that the government spends is borrows £1.50
  2. The national debt is approaching the size of the entire economy, and represents twice what the government raises in taxation.

The statement of the obvious is that this is unsustainable and we must be getting close to the point at which the bond market will decide that they have had enough.

Now, in any household or company facing insolvency what you do is simple and unpleasant (but less unpleasant than bankruptcy). Unfortunately there are few in government with corporate experience, so I’ll outline it for you here.

Firstly STOP SPENDING MONEY YOU DON’T HAVE.

Then START MAKING MORE MONEY.

Finally PAY BACK WHAT YOU OWE.

Only at the end of that third stage do you get to celebrate. So let’s look at how the government spends money. The chart below is pretty self-explanatory. The data is from:

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/293759/37630_Budget_2014_Web_Accessible.pdf

141001 UK Govt Spending

The first number worth noting is the £53 Billion spent annually on debt interest. That is 8% of all government spending is paying the cost of the borrowing that governments (of all persuasions) have racked up to date. This amount can only continue to rise until we have a government that actually balances the budget. The next thing is “Other.” I don’t know what constitutes other, but at 8% of the budget if I was the chancellor I’d bloody well find out and stop it. The third point is that much of this seems to be covered by euphemism. I guess Public Order & Safety is pretty much the police and Social Protection is welfare, benefits and pensions.

So balancing the budget requires a cut in expenditure of £90 Billion from £640 billion (we can’t cut the interest bill). That is 14%. If we think that we have had austerity so far, we ain’t seen nothing yet. So far pay freezes for public servants have delivered a little, but given the magnitude of the problem that is simply shuffling the deck chairs on the Titanic. The government either has to stop doing something or impose a pay cut on public services. If 50% of the cost of government is wages that represents £365 billion per year. A 5% cut to public sector pay would therefore save £18 billion per year. This is what Ireland did. A  5% cut to manning levels would be better, as these workers would then be redeployed into the public sector where they would generate wealth.

Social protection, at £222 billion comes out at over £8,500 per household. This seems very high given the low level of unemployment and that the UK average income is around £23,000.  Surely one in 3 can’t be on benefits?  Part of it must be pensions, which could be easily reduced by accelerating the rate at which the retirement age is increased.  Today.  Most pensioners caused the deficit – why should they be immune? This level of government provision has only been made possible through bankrupting the country. The older generations are living beyond their means, and it is the young generations who will be paying for it.

But the stark reality is that cutting alone is unlikely to solve the problem. What can be done to increase income or realise cash?

Increasing government income either comes through a higher level of taxation on the current economy, or a constant rate of taxation on a growing economy. The great hope was that growth would deliver a proportionate increase in tax revenue without hurting anyone and the problem would be solved. Sadly though, this has not happened. The growth is being delivered but it is not translating into increased revenue.

The 2014 tax take of £648 billion represents 44% of GDP. Although GDP has grown by 3% (i.e. by about £43 Billion) this has not delivered an additional £18 Billion of tax. Why? The chart below shows where the UK tax take comes from (same source as expenditure):

141001 UK Govt Income

Again, if I were Chancellor I would be worried about “other” constituting some 15% of my income. I guess that includes inheritance tax and capital gains tax.

National Insurance and Income Tax come from employment. If wages are flat, then receipts will be as well, and wages are flat at the moment. Corporation tax is raised on commercial profits. While there are lots of games that multi-nationals can play, most of this comes from SMEs and for those profits are flat, reflecting the reduced margins that companies are operating on. VAT is a tax on consumption, only actually paid by individuals (most companies are VAT registered and can therefore nett off VAT paid against VAT collected).

Of the £648 Billion raised, £425 Billion is paid by individuals (VAT, NI, Excise Duty and VAT).

The total raised is flat because although the economy is growing well it is achieving this through tight cost control. This keeps wages and prices flat, and reduces corporate profits. While this may or may not change (and those who think it might will need to come up with a compelling reason as competition is now global) as it stands the Treasury can only increase the tax take through raising taxes. If margins are tight then this will not help and it could be that the tax take would fall further. There is some evidence that reducing taxes (particularly corporation tax) boosts the tax take as more companies will domicile in the UK. But the prudent course for the purposes of this debate is to assume that the tax take is constant.

The only other option for balancing the books is to sell assets for cash. At the moment the government has significant holdings in two banks (which caused part, but by no means all, of the national debt). Its holding in RBs cost £44Billion and is currently worth about £26Billion. The holding in Lloyds is worth around £15Billion and it may make a profit of about £2Billion when that is sold down. In terms of the numbers facing the UK that is a rounding error.

I can think of only one asset that might solve the problem, and that is to sell off the NHS. At the moment it’s a money pit and it is perfectly possible for private companies to run hospitals – BUPA does for a start. Rather than running one of the largest employers in the world the government would just have to find some way of underwriting health insurance for those who can’t afford it. Every other county in the EC manages this, so there are plenty of precedents and costing models.

The immediate benefit is that government expenditure falls by £140 Billion, which balances the budget and leaves a surplus of £30Billion or so before the costs of providing healthcare insurance to the poor. That is about £500 per head. As a 51 year old that would reduce my personal healthcare cost to about £1 per day. Bargain.

The next benefit is that as the likely buyers will be domiciled in the UK and making a profit, corporation tax will rise. Similarly the insurers will do more business, invest more premiums into the economy and make more profit.

But the greatest benefit of selling the NHS is that it generates a capital income. So what’s it worth?

BUPA has revenues of £9.1 Billion and a net operating income of £0.638Billion, or 7%. Assuming that the NHS could achieve the same, it would generate a net operating income of £9.8 billion. Treating that as earnings and applying the customary prudent p/e ratio of 10, that makes the NHS worth about £100 billion to take straight of the national debt. Of course, people more talented than me might be able to get much more for it.

Reducing the national debt by £100 Billion (to a still shameful £1,170 Billion) is a 8% reduction. This should reduce annual interest payments by the same proportion, saving £4 Billion per year which would put the government into surplus. That alone would get out AAA rating back, and further reduce the cost of debt.

Of course, it won’t happen as the British public are irrationally fond of the NHS – in spite of a spate of scandals that could only happen in a state run enterprise. And of course the Unions (which includes the BMA and the RCS) would be dead against it. But then unions are inherently socialist and oppose all privatisation as it emasculates them. But, as any objective observer can see, privatisation worked well for BA, BT, and British Gas and very well for the UK, which in 1979 was in another socialism induced debt crisis. It would work well again.

2 thoughts on “How To Fix The Deficit”

  1. A government needs a source of income other than just taxation or user fees. it needs to be able to make a profit like any corporation. This defies the current paradigm but needs to be considered.

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  2. Hi Mark
    I’m not sure that a government needs income other than taxation, although of course some asset rich countries do. Sadly all UK has left in North Sea oil id £250Bn, less than a quarter of our debt.
    I do think governments should be compelled to run a modest surplus and that they should be held to account for their performance under similar legal strictures to those applied to directors.

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