It’s time for tough decisions to tackle our national debt

To maintain the level and quality of public services and benefits that people have come to expect, the choice is between tax rises or the state doing less. Addressing this will demand clarity as to the responsibilities of the individual versus that of the state.

A new fiscal framework is needed. Rather than having a continually moving target to reduce debt, the framework should set out how debt as a proportion of Gross Domestic Product (GDP) will be lower on a given date five years ahead, unless there are exceptional reasons. This should include credible tax and spending plans covering five years.

These are among the conclusions of a new report, ‘National debt: it's time for tough decisions’, published today by the cross-party House of Lords Economic Affairs Committee.

As in many developed nations, the UK’s national debt rose fast as a result of increased spending in response to the COVID-19 pandemic. At the end of July, it was provisionally estimated to be 99.4 per cent of GDP, or £2.74 trillion in cash terms.

The UK has experienced high levels of debt before, particularly after the Second World War. Then, the management and reduction of debt was assisted by a number of helpful trends, including the “baby boom”; a gradual reduction in defence spending; and growth in world trade. Economic growth meant that governments could run budget deficits combined with national debt falling relative to GDP.

The committee highlights how these trends have been thrown into reverse. Compared with earlier periods, the UK’s growth rate has been anaemic since the financial crisis. The new Government faces pressure for higher spending to support an ageing population. It is committed to increase defence spending. There is the need to invest in the green transition, our national infrastructure and other public services. Interest rates, and hence the cost of funding government debt, are also likely to be higher than in recent years.

Adding to the challenges are changes to the structure of the UK’s debt. Successive rounds of quantitative easing have seen long-term debt exchanged for short-term debt. At the same time a greater proportion of debt is index-linked and held by overseas investors.

This has made the cost of servicing the UK’s debt more sensitive to changes in interest rates and inflation as well as sudden changes in investor sentiment. Given today’s geopolitical risks, the Government needs a larger fiscal buffer if it is to be prepared for future economic shocks.

Lord Bridges of Headley, Chair of the House of Lords Economic Affairs Committee, said:

“This report highlights a grim reality: our national debt risks developing on an unsustainable path. This has not received the attention it deserves - partly because of a flawed debt rule, created by the last Government, and adopted by the new Government in a similar form.

“If we are to tackle the serious risks we face, muddling through is not an option. To put debt back on a gradual, downward path, tough decisions must be taken in this Parliament. And we need a revised debt rule that has teeth and holds Ministers to account.”

The Committee's other key findings and recommendations include: 

• Other major industrial countries have seen similar increases in national debt and face many of the same trends and challenges. The risks to the UK would increase further if this changed and it became an outlier in terms of its debt.
  
  
• High net migration has previously added to GDP growth, but it has made little impression on GDP per head: high net migration cannot be the solution to debt sustainability.
  
  
• An ageing population and shrinking proportion of those in work might see savings fall and wage inflation rise. This could put upward pressure on interest rates, leading to an increased cost of servicing debt and further pressure on public services.
  
  
• The cost of the transition to net zero will increase pressure on public finances. It highlights the need for the Government to produce and publish a fully-funded, coherent plan for meeting net zero targets.
  
  
• Increases in productivity alone will not contain the projected rise in government expenditure and the government cannot rely on significantly higher economic growth rates to avoid the pressures on public finances. These pressures will increase further if interest rates exceed the growth rate of national income, as this would mean that the Government would have to generate a primary surplus to keep the debt ratio from rising.
  
  
• The OBR should publish annual progress reports which set out how the Government is meeting its fiscal targets and the reasons for any deviation from the plan.
  
  
• As the definition of which government spending should be classed as 'investment' is not clear cut, borrowing for investment should not be accounted for outside the Government's measure for meeting its debt target.

To request an embargoed copy of the report or interview with the committee’s Chair, Lord Bridges of Headley, please contact: Dervish Mertcan mertcand@parliament.uk / 020 7219 6640