DEBT AND DEFICITS

There is a great deal of confusion spoken and published in the media in respect of the national debt and deficit. Apparently only about 10% of the population clearly understand the difference between debt and deficit although the matter is at the very heart of understanding our present financial situation.

There is a fundamental difference between cutting debt and cutting the deficit and I do wonder whether some professional commentators as well as some politicians purposefully add to the confusion.  I will try in the next few paragraphs to set out clearly the difference between debt and deficit and hopefully by doing this it will become clear why understanding the difference is important.

Let's start with deficit.  All governments have income and expenditure.  The income will come from the various taxestheyt raise and collect - income tax, VAT, stamp duty, national insurance etc.  The expenditure is the outgoings on benefits and welfare, schools and hospitals, defence etc.  If a government's annual incomings and outgoings are equal then they are in balance, whereas if the incomings are greater than the outgoings then they are in surplus, or, if outgoings are greater than incomings then they are said to be in deficit.

Most countries plan to run their affairs at a modest deficit, so unlike an individual household who might sensibly try not to spend more than they receive as income, governments start with the intention to spend more than bring in.  This deficit has be financed by borrowing.  Governments borrow by issuing government bonds and pay interest on these loans.  If deficits continue year after year, these borrowings grow. The interest that is paid out on these bonds is another outgoing and in the case of governments who borrow a lot, these interest payments can be a significant level and have to keep being paid, year after year.

In the paragraph above, I used the phrase "a modest deficit" and this is generally around 2% to 3%.  So if income is £100 and expenditure is £103 that deficit of £3 is 3/100 or 3%.  As there is always the opportunity to increase tax rates slightly these modest deficits don't seem particularly scary and hence governments can find lenders who are willing to lend to them. Deficits can be reduced by increasing income (raising taxes) or decreasing outgoings (cutting spending), or a combination of the two.

So why all the fuss about deficits and debt?  Well in recent times governments of most developed countries (US, UK, and many in western Europe) have increased their annual deficits so they are now far from modest. Deficits rates (percentages) have grown to be 10% or more.

The deficits are financed by borrowing.  Just like for an individual, a government who borrows is getting into debt. Debt is defined as the size (amount) outstanding. If a government runs it finances in deficit then the amount it is borrowing - its debt - continues to grow.

So what about all these "savage cuts" that the unions and Labour (and disgracefully the BBC and left-wing newspapers) talk about on a virtually daily basis?  Aren't these just efforts to reduce our debt levels?  The answer sadly is NO!  All the "savage cuts" made to date by the Coalition Government (aka the Evil Tories aided by the LibDems) are merely well-meaning attempts to reduce the deficit.  Attempts to reduce our levels of expenditure but only to the extent that the deficit of outgoings less income narrows but is still run at a deficit.  And by any rational or objective analysis all the cuts to date have been modest.  In fact the government (apparently at the insistence of the LibDems) increased welfare and benefit payments last April by 5.2% so increasing this major expenditure when incomes (and hence income taxes) hardly changed year-on-year.  So as a nation we have had to borrow more to increase our benefit payments.  Total lunacy!

As things stand, our annual deficit which is presently running well in excess of £100billion a year will only reduce to £95billion a year by 2016.  Each year we will continue to run high annual deficits which will continue to add, year after year, to our borrowings - pushing up our high levels of debt to a yet greater and greater level.  By 2016 we will owe as a country over £1.5trillion.  This is several times more than our debt in 1997 when Labour took over running the country for the following 13 years. And running it in such a reckless fashion so that by 2010 a note was left in the Treasury to the incoming Conservative/LibDem coalition saying "sorry there is no money left".  Even then, they couldn't tell the whole truth - what they did in fact leave was an enormous debt level and a welfare and benefits system out of control thus creating further large annual deficits going forward.

Hopefully you are still with me. Its easy just to close your eyes, cover your ears, start humming and hope this awful problem will just go away. If you've got this far then next time you hear a union leader or Labour politician (or their BBC mouthpiece) talk about the cuts as something done by a nasty "evil" government you will realise that these cuts are a neccessary and vital part of getting our out-of-control national finances back, if not into some semblance of balance, at least some first steps towards that goal.

We are leaving our children and grand-children a truly appalling level of debt. Collectively we should all feel ashamed although only that relatively small percentage of the population who voted for, and continue to support Labour are the truly guilty.  Because of their actions our children will have to continue servicing the debt (paying the interest) with high taxes and thus a lower standard of living (reduced house ownership and pension provision) than ourselves.

Glossary:
Deficit - excess of expenditure over income (ie. an annual measure)
Debt - amount of borrowings outstanding (ie. at any one point in time)
Reducing the deficit - reducing the gap between expenditure outgoings and income BUT still running at a deficit and therefore still increasing the level of debt
Eliminating the deficit - bringing annual expenditure levels back into line with annual incomings but still the level of debt doesn't decrease.
Reducing debt levels - can only be done by running the nation's finances in annual surplus which frankly is politically impossible given the size of the public sector.