Navigating the Coronavirus – Part 6: How will our debt levels be paid?

So how will we pay for the c.£300bn we are likely to borrow in 2020/21 on top of the current c. £1.8trn (yes that’s right Trillion!) that we already owe?

The PSND has been rising over the years, but it’s really accelerated since 2008/9 after the financial crisis and the Quantitative Easing that was carried out.

The huge cost of the Covid-19 measures will initially be met by borrowing and that will be almost entirely in the form of gilt sales (see Navigating the Coronavirus Part 5).

The Bank of England, very large pension schemes, life assurance annuity providers and sovereign wealth funds lend money to the British government in return for a very modest, negatively real, interest payment.  This is known as a gilt (A Gilt/Golden edged government security).

They may even lend money at negative yields, which means, after taking the income/interest payments into consideration, the lender will get back less than they lent, why do it?  Because the British government is still a safe home for your money, and there is plenty of money out there that needs a home.

The UK is rated AA by Standards & Poor, just behind the US at AA+ and the same as the European Union, it will be interesting to see how this table is reallocated after the true cost of the borrowing globally is known. The lower your credit score, the more you should expect to pay in interest when you borrow money, so it helps to have a higher quality rating/credit score, just like a mortgage applicant.

The end result will be that the British government’s Public Sector Net Debt (PSND), the cumulative borrowing to date, will be around £2,230bn by next March. As a proportion of the size of the UK economy, that is not far short of 100%!


How will it be serviced?

On 11 March budget, the government was estimating a £54.8bn PSNBR, and now just three months later it’s estimating the figure will be nearer £300bn.

This will be survived just like you would, from income.  They could cut expenditure, but Boris Johnson took the ‘austerity’ measures off the take at the last election, so it’s down to income, unless he changes his mind?

The largest generators of income for the government are;

  • Income tax,
  • National Insurance and
  • VAT (I am surprised it’s not corporation tax?).

Now the government made a promise in the lead up to the election not to rise these three taxes.  Would he be forgiven if he went back on this promise?  These are unusual times?

We can’t have our cake and eat it?  If we spend what we don’t have, we have to cut back and earn more to repay our borrowings.

Adding one penny on any of these taxes’ would yield between £4-6bn, so a fair sum, but not £300bn!

Because so many more people pay basic rate income tax, you’d need to add over 4p to the higher rate and over 28p to additional rate tax to get the same effect,  but the catch 22 is that increasing these taxes has a diminishing effect on demand.  When you take home less money, you spend less money, so the economy does not get started and that’s a priority for the Chancellor.


Another way to get more money in, is to stimulate the economy.

In order to boost the economy after the corona pandemic, Germany has put together an economic package worth billions. On 3 June 2020, the German parliament proposed to temporarily reduce the VAT rates from 1 July 2020 until 31 December 2020.

  • Standard rate is to be reduced from 19% to 16%.
  • Reduced rate is to be reduced from 7% to 5%

Corporation tax yields just over £50bn, but we need to remain attractive especially considering the pending exit from the EU, continuing to make the UK a competitive place to do business is essential.

Capital Gains tax could be amended to reflect income tax rates, they were recently amended for rates applicable to buy to let properties.

Inheritance Tax is another area to consider although it only yields between £5-10bn pa it may not be large enough to make an impact.

How about a new tax?

Maybe a windfall tax on those companies that have done better (Supermarkets, online retailers etc).

A Wealth Tax – a one-off payment, or an ongoing payment?


Summary

It would be reasonable to see some element of a tax increase in the coming years, perhaps not immediately as the government will focus on economic recovery before debt repayment.

Inflation can have a real benefit of eating away at the cost of the debt, but we are at near 0% at present and unlikely to see this rise with such a fall in GDP.

The Chancellor, Rishi Sunak’s focus will be on getting the economy going again like Germany has and it’s unlikely the government would do anything to risk this.

The government does not need to raise £300bn, they just need to raise sufficient to service this debt, so that they don’t borrow to repay the interest on borrowing, that’s a vicious circle.  What’s in the governments’ favour is that interest rates are at an all-time low, 0.1% so the cost of borrowing is significantly less than in the global financial crisis.

We will see, there is a budget set for the week commencing 6 July, when the government is expected to reveal a huge stimulus package, so I don’t expect big tax rises, unlike many, as this will dampen the economy, but I do expect some changes once the economy is on a more upward trajectory.