How much is too much borrowing?

Current discussions over the Scotland Bill have seen the Chancellor and SNP Westminster leader Angus Robertson at loggerheads over the role of borrowing in national life. Gemma Tetlow of the Institute for Fiscal Studies discusses the approach of the two governments and their likely implications for taxation. 

As the Scotland Bill was debated in the Commons, Westminster politicians have been making differing statements about the appropriate, or possible, levels of government borrowing. George Osborne has announced that he will put forward legislation requiring UK governments to run budget surpluses in ‘normal times’. Meanwhile, Angus Robertson has implied that some borrowing is still consistent with a stable, fiscally autonomous country.

But what level of borrowing can or should the UK or Scotland have? 
 
Economic theory does not provide an answer to what the right level of borrowing for a country is. There are pros and cons of both higher and lower borrowing. Most obviously, for a given level of taxation, lower borrowing requires lower spending. On the other hand, lower borrowing can lead to debt falling more quickly, leaving the country better placed to accommodate future pressures. 
 
Borrowing 1948_2019
 
Notes: Figures for 1948–1954 are on a calendar year basis; figures for 1955–56 onwards are on a financial year basis.
Sources: Figures for the UK from Office for Budget Responsibility, Public Finances Databank. Projections for Scotland from D. Phillips (2015)
 
 
In 2015–16, the UK is expected to borrow 4.0% of its national income (as shown in the figure). Our (now much-cited) calculations suggest that Scottish borrowing would be 4.6% of national income higher than this figure for the UK as a whole. This is because spending per person in Scotland is higher than across the UK as a whole, while revenues per person are similar. Our calculation uses the same methodology as the Scottish Government use for allocating tax revenues and public spending between Scotland and the rest of the UK. This higher level of borrowing would be the result under full fiscal autonomy if – as is usually assumed – such an arrangement entailed all taxes and the vast majority of spending would be devolved to Scotland, with the Scottish Government making transfers to the UK government to cover a per capita share of things like defence, foreign affairs, and the UK’s existing debt interest payments.
 
4.6% of Scottish national income equates to £7.6 billion, and would put Scottish borrowing at 8.6% of national income (or a total of £14.2 billion), compared to 4.0% of national income for the UK. 
Our estimates suggest that, if currently planned UK-wide spending cuts are applied in Scotland, Scottish borrowing would fall from 8.6% to 4.6% of national income by 2019–20, while the UK is forecast to move to a surplus of 0.3% of national income (see figure). 
 
The SNP have pointed out that the UK has also run deficits in most of the last 50 years. This is correct, and budget surpluses (advocated by Mr Osborne) are not a prerequisite for a successful economy. As the figure shows, the UK has run a budget surplus in only 12 years since 1948, and only one of the four surpluses since the mid-1970s was achieved without relying on an over-inflated economy. However, there have been very few years when the UK has run a deficit as large as 4.6% of national income. Were the UK to run borrowing at this level, debt would be likely to continue rising over the longer term, rather than falling. 
 
What level of borrowing a government chooses in the longer-term is – to some extent – a political choice. Full fiscal autonomy would give the Scottish Government control over what and how to tax and what and how to spend. But it is generally assumed that it would also lead to them losing any net transfer from the rest of the UK. If this were the case, the higher deficit they would likely face would require them to find even bigger tax increases or spending cuts than those currently planned for the UK as a whole to avoid debt rising rapidly. In the longer-run, full fiscal autonomy might or might not lead to better policies that could generate higher economic growth in Scotland, and thus allow at least some of these additional tax rises or spending cuts to be reversed. But the consequences of the short-run arithmetic are not easily avoided. 
 
Gemma Tetlow is programme director of the IFS' work on pensions, saving and public finances. Her research interests include pensions, savings, asset holding and health and their interactions with later life working. Her work also includes analysis of the UK's public finances and public spending.

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Gemma Tetlow's picture
post by Gemma Tetlow
The Institute for Fiscal Studies
17th June 2015

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