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Understanding the Deficit and the National Debt

Sunday 1 May 2011, 21:33
By Dr. Derek Hudson

Dr. Derek Hudson, retired senior civil servant and Deputy Governor of the Bank of BotswnaThe Difference between the National Debt and the Deficit

Government debt is the total of all money owed by a central government. It is the total of all deficits accumulated by a government over many years. In the United Kingdom (UK), we speak of 'the national debt'.

By contrast, the annual government deficit refers to the difference between the money the government raises (government receipts) and spending in a single fiscal (financial) year. In the UK, that is the annual increase in debt over a particular year, due to over-spending from April 6 one year to April 5 the next year.

How Does the Government deal with this debt?

Each year, the government finances the accumulated debt by borrowing money from the public, both domestic and foreign. The money (mostly interest) that is paid out each year to pay for the cost of borrowing is the government's annual 'debt service'. In the UK, this is currently around £45 billion (thousand million) every year, roughly equal to the amount we spend each year on the military.

The government is effectively having to borrow more money each year, to pay for the interest charges on the money it has borrowed in previous years.

If we didn't have any national debt, there would be no annual debt service charge. The annual amount of £45 billion would be released to be spent on health, education, highways and so on.

Could we pay off the National Debt?

Because the annual government deficit is going to be with us for at least the next four years, the national debt will continue to increase, even after taking account of the present budget cuts (which look reasonable to me). That means that the annual debt service charge will continue to increase slowly. It would take a huge financial effort to actually produce a government budget surplus, so that the national debt could be gradually reduced. But no one believes that is politically possible.

How Our National Debt Compares with that of Other Countries

Because all countries face similar debt problems, it is customary to compare the size of a country's national debt with each country's Gross Domestic Product (GDP), the total of the value of all goods and services produced in a country over one year. This is usually given as a ratio: for example, the UK's national debt is currently 77% of the UK's GDP.

Unfortunately, this doesn't tell the whole story. There are 'hidden' debts which are 'off balance sheet', and therefore are traditionally not included in the calculations. The three best known examples are:

  1. The unfunded liabilities of the pension funds of government owned corporations such as the Post Office, for which the government is at least morally responsible;
  2. The unstated debts that arise from 'public private partnerships' (PPP) or 'private finance Initiatives' (PFI); the government asks a private contractor to build a school, a hospital, or a highway; and simultaneously asks the contractor to please find a bank to pay the contractor, on the understanding that the government will eventually pay the bank back at some future date;
  3. What one may call the long term financial worries, due to a rapidly ageing population which will cause more money to be spent in future on an electorate which will need significantly more money to be spent on pensions and health care for the aged.

International credit rating agencies such as Moody's and Standard & Poor examine all the evidence as to how much faith to attach to the promise a government makes to repay the money is has borrowed to finance its national debt. The UK's national debt is "only' 77%" of the UK's GDP, the UK does not try to hide the pension shortfalls of its 'quangos',(quasi-autonomous non-govermental organisations) and there are ways and means to estimate the underlying PPP debt.

These credit rating agencies believe the British government when it puts its hand on its heart and says that it promises it will repay the money it has borrowed. So there is no question of the UK finding itself in the same position as Greece, Ireland, Portugal and Zimbabwe, where their ability to repay their government's borrowings is in some doubt.

However, one has to ask: do we really want the first £45 billion of annual government revenue (income tax, VAT, petrol and diesel excise duty, luxury taxes on alcohol and tobacco, etc) to be 'thrown down the drain' by being spent on the government's annual debt service? Are we going to say that because Japan has a much bigger national debt than the UK, we shouldn't worry too much about getting ourselves further into debt?

It is always hard to live within one's means. It is tempting to rationalize that we need to spend money we don't actually have, on better health services, more motorways, expanded schools, and better equipment for the military, including the Trident nuclear submarine replacement. It is much easier to explain why we can't make the budget cuts any bigger, rather than suggest that income tax should be increased.

In the end, it comes down to asking oneself, how much debt do we want our children and grandchildren to inherit? Is it fair to ask our descendents to pay for what I call our 'unreasonably affluent' life style?


James Phillips
Posts: 1
Re: Understanding the Deficit and the National Debt
Reply #1 on : Mon May 02, 2011, 22:05:35
Thank you for an interesting article :)
Nick Colbert
Posts: 1
Re: Understanding the Deficit and the National Debt
Reply #2 on : Wed May 04, 2011, 15:52:56
An excellent article Dereck, I have tried to make the same point that you conclude with myself.

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