Could the UK budget deficit reach £100bn?

The government announced this week that it was borrowing money at a record rate of over £200m a day. Over the last six months, the budget deficit (the difference between government spending and tax revenues) was a staggering £37.6bn - the largest since records began in 1946, when Clement Attlee was prime minister. In September alone the government ran a fiscal deficit of over £8bn.

For the current fiscal year the British government has forecast a budget shortfall of £43bn. This will be impossible to achieve and the likely out-turn will be £65bn or more. But what worries many commentators is that the worst is yet to come. Can the budget deficit reach £100bn?

For an annual deficit to reach such levels, something dramatically wrong needs to have happened to government finances and the state of the economy. But the two factors are closely linked.

In a slowdown which becomes a recession, public sector finances are hit by a double whammy.

On the one hand, tax revenues start to slide because of a shrinking economy. Business profits are falling which means less money from corporation tax. Consumers cut back their own spending which dampens the revenue from VAT and a plethora of excise duties. Unemployment is increasing at a fast rate which impacts on the revenue from income tax and national insurance contributions. And the slump in the housing market is already causing a sharp reduction in the money that the Treasury gets from Stamp Duty.

Going forward, a persistent decline in asset prices will also hit the income from Inheritance Tax and Capital Gains Tax. In short, a recession causes shrinkage in the size of the tax base.

It also causes an increase in the scale of welfare benefits as the jobless total rises and more people claim social security. Added to this is the stated desire by the government to increase spending to pump-prime extra demand into the economy as a means of stabilising demand, output and jobs during the slump.

Higher government spending and falling tax revenues combine to worsen the fiscal deficit in the short term.

And because the annual budget balance is the difference between two huge numbers, small percentage changes in both can have a marked effect on the final borrowing figure.

In 2008-09 the government is forecasting that total managed spending by the state will be £618bn. (Managed spending includes both current and capital spending and welfare payments). The Treasury expects total tax receipts of 575bn. The difference gives you the budget balance – estimated to be £43bn.

Now assume that tax revenues fall 2% below this level and that government spending ends up 2% higher – both the result of a weaker than expected economy.

Government spending would rise to £630bn and tax revenues would decline to £563. The result is that the budget deficit would come in at £67bn instead of £43bn.

The purpose of this back of the envelope calculation is to show that small % changes have a big overall effect on the size of the budget deficit.

If 2009 proves to be a very difficult year for the economy with a deeper than anticipated recession, the idea of the British government borrowing £100bn in one fiscal year – equating to £274m a day – is not that far fetched.

The result would be an enormous increase in the size of the accumulated national debt. I don’t think that Brown could bring himself to use the word prudence ever again in a public speech. The danger is that a budget deficit on this scale could prove highly de-stabilising for the UK economy in the years ahead. Public sector borrowing seems to be taking over from the private sector borrowing binge that has characterised the last ten years or more.

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