The single most important challenge that the new Government faces is obviously to manage the public finance deficit.
To see why the deficit is such a gargantuan issue, let us take a look at a summary of Government finances for the 2009/10 tax year, which shows overall debt equivalent to £34,000 per household.
Taxes and other revenues brought in £469.2bn, a fall of 5 per cent on the previous year. Not surprising, given higher unemployment and lower corporate profits during the recession.
Overall expenditure and investment were £631.1 bn, an increase of 7.5 per cent on the previous year.
This means the Government spent £161.9bn more than it earned. Add in local govern-ment along with public corporations and the final deficit for the year comes out at £152.8bn, equal to nearly £5,900 per household.
Looking at the big picture, the Government’s overall debt has climbed to £890bn.
Will it get any worse? Sadly, yes. The previous Government’s projections predict overall debt will rise to £1,406 bn by 2014/15, £54,000 per household, which is about the same as the current level of personal debt per household including mortgages.
The new Government appears keen to curb the deficit sooner rather than later but the recently announced £6bn of spending cuts are a drop in the ocean in the context of the above figures.
Debt is not necessarily a bad thing, provided you can afford the interest payments but the Government could increasingly struggle. The interest bill for 2009/10 was £30.9bn, nearly £1,200 per household. Under the previous Government’s projections it is estimated to rise to around £70bn a year by 2014/15, £2,700 per household. To put £70bn into context, it is about half the total amount the Government currently raises in income tax each year.
It is clear that if the new Government is to stop the deficit from soaring and sending interest payments further out of control, then spending will need to be slashed and/or taxes raised significantly. Neither will be comfortable as we are still on the cusp of recession and I think the best we can hope for over the next few years is a slowing in deficit growth without tipping the economy over the edge. The Government is effectively walking a greasy tightrope without a safety net.
But if things are tough here, they are an awful lot worse in Greece, which has a deficit of around £300bn. This may not sound so bad compared with our £890bn but Greece’s GDP is far lower than the UK’s. Greece’s debt is estimated at 116 per cent of its GDP compared with 62 per cent in the UK, so Greece can far less afford to get out of its financial hole than we can.
Markets obviously realised this and pushed up Greece’s borrowing costs (by demanding sky-high rates of interest on Greek debt) to such an extent that the IMF and other eurozone economies have had to step in with a bailout package.
With Japan jumping on the bandwagon of countries with perilously stretched public finances, you might ask when and where will all this end?
It could be five to 10 years before many Western economies are able to rebalance their books to comfortable levels but even then I think they will struggle to recapture former economic glories. Meanwhile, we need to brace ourselves for an onslaught of spending cuts and tax rises. There are tough times ahead.
Justin Modray is founder of Candid Money