Public debt levels in the UK could soar to up to 300 per cent of GDP over the next 50 years as governments wrestle with challenges such as climate change and an ageing population, the Office for Budget Responsibility has warned.
As part of its assessment of the long-term fiscal risks facing the economy, the independent watchdog said that policy choices and future spending pressures “put the public finances on an unsustainable path”.
The OBR said: “Over the next 50 years, public spending is projected to rise from 45 [per cent] to over 60 per cent of GDP, while revenues remain at around 40 per cent. As a result, debt would rise rapidly from the late 2030s to 274 per cent of GDP in our baseline projection.”
The report comes ahead of the government’s first budget next month, in which Sir Keir Starmer has warned of “tough choices” on tax and spending. Publication of the OBR’s assessment was delayed from July to avoid coinciding with the general election.
The UK’s debt is just below 100 per cent of GDP and has nearly tripled since the 2007-09 financial crisis, with governments forced to bail out the banking system and fund emergencies during the pandemic.
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The OBR’s modelling factored in long-term policy challenges, such as the UK’s commitment to hit net zero climate emissions by 2050, and modelled the rate at which the population is due to age, with postwar “baby boomers” entering retirement, putting pressure on pensions spending and reducing tax revenues.
In most of its scenarios for the public finances “there is a similar upward debt trajectory in nearly all”, the OBR said, including hitting 300 per cent of GDP in a situation with additional geopolitical shocks. Its central forecast saw debt hit 274 per cent of GDP, the highest outside the Napoleonic wars and the Second World War.
The watchdog said future governments would have to take action in the form of raising taxes, cutting spending, and hoping for a significant improvement in the UK’s stagnant productivity growth to alleviate pressures on the public finances in decades to come.
David Miles, who sits on the OBR’s budget responsibility committee, said the projected rate of borrowing was “unsustainable and at some point it will blow up”.
“You can’t just expect the rest of the world to keep buying up UK debt that rises at an ever accelerating rate. So the problem with our central projection is that it’s almost certain to be unfeasible and at some point it would blow up as people would not be willing to buy up the debt.”
The biggest single revenue source set to diminish in the coming decades is fuel duty, as the sale of new internal combustion engine vehicles is banned after 2035 as part of the UK’s climate change efforts. The OBR said that fuel taxes were due to drop from 1 per cent of GDP to 0.1 per cent, with the widespread adoption of electric cars. This would make up the biggest fiscal cost of the net zero transition, adding 20 percentage points to the debt pile, even if the UK introduces a “comprehensive carbon tax” to replace lost fuel revenues.
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However, if future governments adopt carbon taxes, do not resort to borrowing to fund the transition and replace fuel duty with an equivalent motoring levy, the green transition could help to lower the debt pile by 12 percentage points.
The forecasts show that overall income taxes are likely to remain stable over the next 50 years at around 11 per cent of GDP as retiring workers are replaced by migrants. National insurance contributions are likely to fall slightly from 6 per cent to 5.8 per cent of GDP in the 2070s, with corporation tax and VAT staying broadly stable as a share of the economy.
Climate change adds another layer to Labour’s debt dilemma
The UK’s fiscal watchdog has published its latest annual assessment of the long-term challenges facing public finances over the next half a century. The findings are grim, if unsurprising.
The country’s debt stock, currently at 98 per cent of GDP, is on course to treble to more than 270 per cent of GDP in the next five decades, according to analysis by the Office for Budget Responsibility.
This is as the state grapples with increasing healthcare costs and an ageing population, while managing the climate transition in a world where new sources of tax revenue are scarce and external shocks are occurring more frequently.
The report lays bare the challenge facing the new Labour government which is warning about difficult tax and spending decisions at its first budget in October.
But it also shows that almost every government from now until the 2070s may have to contend with the central conundrum of UK fiscal policy: how to strike the balance between necessary and adequate public spending, with a manageable tax burden on households and businesses, in a way that keeps the public finances on an even footing? Here are some of the key takeways from the report.
Productivity
The most painless route to solving the UK’s fiscal headache would be through a sizeable increase in productivity growth between now and the 2070s.
Economists have long eyed rising productivity as a silver bullet to ensure sustained prosperity and improving living standards in advanced economies, and the OBR agrees with them. It estimates that a 0.1 per cent increase in the UK’s overall productivity could reduce the rise in the debt ratio by 25 per centage points over the coming decades.
“A full 1 percentage point increase, equivalent to a return to pre-financial crisis rates of productivity growth, could keep debt below 100 per cent of GDP throughout the next 50 years,” the watchdog said.
Yet, the UK’s recent productivity performance has been dismal, averaging around 0.5 per cent in the past 15 years. By comparison, productivity enhancements rose at an average of over 2 per cent a year from the 1960s up to the financial crisis in 2007-08.
The OBR still takes a relatively optimistic assumption about productivity growth, which it says will average around 1.5 per cent until the 2070s. In the nightmare case that the current weak rates of productivity continue indefinitely, the UK’s debt pile could explode to upwards of 600 per cent of GDP.
David Miles, a member of the OBR’s budget responsibility committee, said a step up in productivity growth would be the most “benign” outcome for the economy and have the most “transformational” impact on the public finances in the decades to come. He warned, however: “Productivity growth, for very good reasons, is inherently unforecastable. It is about discovering new things and by definition, its main technological drivers are unforecastable.”
Climate change
One of the key focuses of this year’s report is the impact of climate change and the transition to net-zero emissions on the public finances. On the whole, the watchdog finds that greening the economy will result in rising debt levels caused by the phasing out of fossil fuel levies, the environmental damage caused by rising temperatures, and volatile global temperatures.
In an “early policy action” scenario, where the government chooses to borrow to fund its climate investment needs and implements a carbon tax, the transition would raise overall debt levels by 20 per cent of GDP over the next five decades. This is largely down to the loss of fuel duty revenues as motorists are encouraged to switch to electric vehicles.
If the government chooses to introduce a new tax that is as expansive as fuel duty, and chooses not to resort to additional borrowing, green policies end up helping lower the debt pile by 12 percentage points over the same period.
There are also risks attached to delaying climate action. Should the world get on track to reduce overall global heating by 2 degrees celsius, as laid out in the Paris climate change accords, the UK’s GDP would be around 3 per cent lower in 2074. If global heating is only below 3 degrees, GDP would be 5 per cent lower.
Migration
Inward migration will be the main source of population growth in the UK over the next half a century, providing a short-run boost to the public finances as younger working migrants help sustain an ageing population through higher tax revenues. The UK’s population is expected to grow from 68 million to 82 million due to higher than assumed levels of net migration recorded in 2022.
The OBR use a series of assumptions, including migrants entering the workforce at similar rates and earnings levels as the rest of the population, to calculate that migration is an immediate positive for the public finances. But as migrants also begin to age, have children, and increase their reliance on healthcare and public services, the fiscal benefits will diminish over time.