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Britain''s public finances are bad. Their future looks worse

Britain's Public Finances: A Grim Present and a Bleaker Future

Britain's public finances are in a precarious state, marked by soaring debt levels, persistent budget deficits, and mounting pressures from demographic shifts and global uncertainties. As the nation grapples with the aftermath of multiple economic shocks, the outlook for the coming decades appears even more daunting. This analysis delves into the root causes of the current fiscal malaise, the immediate challenges facing policymakers, and the long-term threats that could exacerbate the situation, potentially leading to painful choices between higher taxes, deeper spending cuts, or unsustainable borrowing.

At the heart of the problem lies the UK's national debt, which has ballooned to over 100% of gross domestic product (GDP), a level not seen since the early 1960s. This surge can be traced back to the global financial crisis of 2008-09, when the government injected massive stimulus to prop up the banking sector and economy. Austerity measures under subsequent Conservative governments aimed to rein in the deficit but often at the cost of public services and investment. The COVID-19 pandemic then unleashed an unprecedented wave of spending, with furlough schemes, business support, and healthcare expenditures pushing borrowing to record highs. More recently, the energy crisis triggered by Russia's invasion of Ukraine in 2022 forced the government to subsidize household bills, adding billions to the fiscal burden. Inflation, which peaked at over 11% in late 2022, has compounded the issue by eroding purchasing power and increasing the cost of servicing debt through higher interest rates.

Today, the fiscal picture remains dire. The Office for Budget Responsibility (OBR), the UK's independent fiscal watchdog, projects that the budget deficit will hover around 4-5% of GDP in the coming years, far above the pre-pandemic norm of 1-2%. This is despite efforts to stabilize finances through tax hikes and spending restraint. The current Labour government, led by Prime Minister Keir Starmer, inherited this mess upon taking office in 2024. Starmer's administration has pledged fiscal responsibility, adhering to self-imposed rules that require debt to fall as a share of GDP within five years. However, these rules are increasingly seen as inadequate for addressing the structural imbalances. Public spending as a percentage of GDP has risen to about 45%, driven by demands on the National Health Service (NHS), social care, and welfare payments. Meanwhile, tax revenues, already at a 70-year high of around 37% of GDP, are strained by sluggish economic growth, which has averaged just 1.5% annually since 2010—well below historical trends.

Several factors contribute to this stagnation. Brexit has imposed lasting damage, with estimates suggesting a 4-5% hit to potential GDP due to trade barriers and reduced investment. Productivity growth, the engine of long-term prosperity, has flatlined, hampered by underinvestment in infrastructure, skills, and research. The Bank of England's aggressive interest rate hikes to combat inflation have further slowed activity, raising borrowing costs for households and businesses alike. On the revenue side, the tax base is narrowing: corporation tax receipts are volatile, dependent on a handful of multinational firms, while income tax is increasingly shouldered by higher earners amid frozen thresholds—a stealthy form of fiscal drag that drags more people into higher brackets.

Looking ahead, the future of Britain's public finances looks even worse, overshadowed by a confluence of megatrends that will intensify spending pressures while constraining revenue growth. Chief among these is demographic aging. The UK's population is graying rapidly, with the proportion of over-65s expected to rise from 19% today to 25% by 2040. This shift will balloon costs for pensions, healthcare, and social care. State pension spending alone is projected to increase by 2-3% of GDP over the next two decades, as the triple-lock mechanism—guaranteeing annual rises by the highest of inflation, earnings growth, or 2.5%—locks in generous uplifts. The NHS, already creaking under backlogs and staffing shortages, faces an additional £50-100 billion in annual costs by mid-century to cope with chronic diseases and an older populace. Social care, long neglected, requires urgent reform; without it, the burden will fall disproportionately on local authorities, many of which are teetering on the brink of bankruptcy.

Climate change adds another layer of fiscal peril. Britain's commitment to net-zero emissions by 2050 demands trillions in investment for green infrastructure, renewable energy, and adaptation measures. The OBR estimates that transitioning to a low-carbon economy could cost up to 1-2% of GDP annually, not accounting for potential revenue losses from phasing out fossil fuel taxes like fuel duty. Geopolitical tensions, including ongoing conflicts in Ukraine and the Middle East, are inflating defense budgets. NATO allies are pushing for 2.5% of GDP spending on defense, up from the current 2.3%, which could add £10-20 billion yearly amid rising threats from Russia and China.

Economic growth, the traditional escape hatch from fiscal woes, seems elusive. Forecasts from the International Monetary Fund (IMF) and others predict UK growth averaging just 1.5-2% through the 2030s, hampered by low productivity, a shrinking workforce due to immigration curbs and post-Brexit labor shortages, and global headwinds like trade fragmentation. Without a productivity miracle—perhaps through AI adoption, deregulation, or education reforms—the tax base will struggle to keep pace with expenditure needs. Inequality exacerbates this: wealth concentration means that taxing the rich more heavily could yield revenues, but political resistance is fierce, and capital flight remains a risk.

Politically, the situation is fraught. The Labour government has ruled out increases in income tax, VAT, or national insurance for workers, boxing itself into a corner. Instead, it eyes stealthier measures like reforming capital gains tax, inheritance tax, or council tax bands, which could raise £20-30 billion but risk alienating voters. Spending cuts are equally unpalatable; further squeezes on unprotected departments like justice or transport would deepen social divides. The temptation to borrow more is strong, especially with bond markets currently calm, but rising global interest rates could trigger a debt crisis, as seen in the 2022 mini-budget fiasco under Liz Truss.

Comparisons with peers highlight Britain's vulnerabilities. While the US benefits from dollar dominance and dynamic growth, allowing higher deficits, the UK lacks such buffers. Eurozone countries like Germany adhere to stricter fiscal rules, fostering stability but at the cost of growth. Japan, with debt over 250% of GDP, sustains it through domestic savings and low rates, but Britain's reliance on foreign investors makes it more exposed to market whims.

To avert a fiscal crunch, bold reforms are essential. Boosting growth through planning deregulation, infrastructure investment (e.g., via public-private partnerships), and immigration policies to attract skilled workers could expand the pie. Pension reforms, such as raising the state pension age or means-testing benefits, might curb costs, though they are politically toxic. Healthcare efficiency gains, like digitalization and preventive care, could save billions. Tax system modernization—broadening the base while lowering rates—might enhance revenues without stifling incentives. Ultimately, a cross-party consensus on long-term fiscal planning, perhaps through an independent commission, is needed to depoliticize tough decisions.

Yet, optimism is scarce. Without decisive action, Britain's public finances risk a downward spiral: higher debt servicing crowds out productive spending, eroding public services and fueling discontent. The 2020s could see a reckoning, with the 2030s bringing even harsher realities. As one economist quipped, the UK is not facing a fiscal cliff but a slow-motion slide into insolvency. Policymakers must act now to rewrite this narrative, or future generations will pay the price.

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Read the Full The Economist Article at:
[ https://www.economist.com/britain/2025/07/10/britains-public-finances-are-bad-their-future-looks-worse ]