What is the deficit?

The fiscal deficit is is a shortfall between the amounts raised by the government each year in tax and other receipts and the amount of public spending.

It is equal and opposite to public sector net borrowing (PSNB), being the amount that the government needs to borrow to cover the shortfall.

In the rare occasions that tax and other receipts exceed public spending, then the excess is a fiscal surplus that can be used to repay borrowing.

The fiscal deficit is not the same as public debt, which is the cumulative amount of borrowing built up over the years.

In the Spring Budget 2024, the government budgeted for a deficit of £87bn in the financial year ending 31 March 2025 (see Chart 1). The total being the shortfall between expected tax and other receipts of £1,139bn and planned public spending of £1,226bn.

Public spending for this purpose includes capital investment in addition to operational or ‘day-to-day’ expenditures.

How does the deficit affect people and businesses?

Borrowing more to run a larger deficit in the current year allows the government to avoid putting up taxes in the short-term. The downside is that doing so adds to the total amount of debt, increasing the interest bill and weakening the public finances – leading to the prospect of higher taxes in the future.

There is also the risk that too much borrowing could cause debt investors to take fright, as happened following the ‘mini-Budget’ in October 2022 when interest rates rose sharply, and financial markets were disrupted.

The challenges in controlling the deficit

Most developed countries choose to run a deficit. This is because it makes sense to borrow to invest in infrastructure that will grow the economy, or in operational assets that will make the public sector more efficient.

Deficits also occur during economic crises, such as the financial crisis, the pandemic and the cost-of-living crisis. These can cause receipts to fall and spending to rise at the same time, resulting in very large deficits.

Some countries, including the UK, also run deficits to fund current expenditures, deferring day-to-day costs onto future generations. This is often because it can be easier politically to borrow than it is to put up taxes.

Big challenges in controlling the deficit include: 

• More people living longer, which is pushing up the costs of pensions, health and social care.
• Weak productivity which has resulted in low levels of economic growth since the financial crisis.
• The political difficulty in raising tax to fund spending.
• Planning and other constraints that make it difficult to invest in infrastructure that would generate economic growth.
• The deteriorating quality of public services and pressures to improve them.
• Interest rates that increase the cost of debt, squeezing other categories of spending.
• The end of the ‘peace dividend’ that means that it no longer possible to find money for pensions, health and social care by cutting the defence budget.
• Events, such as the financial crisis, the pandemic, the cost-of-living crisis or a major recession, that can cause receipts to fall and spending to rise at the same time. 

What is the outlook for the deficit?

The current plan is to gradually reduce the deficit over the next five years, from £87bn or 3.1% of GDP in the current financial year to £39bn or 1.2% of GDP in the year ending 31 March 2029 (see Chart 2).

To deliver this level of reduction in the deficit will require public spending to be constrained so that it rises at a slower rate than taxes and other receipts.

Given commitments to protect health, defence and education spending, this implies significant cuts in spending will be need to ‘unprotected’ public services, such as policing, the courts, prisons and local authorities, among others.

This is considered by economic commentators to be unrealistic, with the Spending Review for the 2025/26, 2026/27 and 2027/28 financial years (deferred until after the general election) expected to identify the need for higher spending than currently assumed in the forecasts.

In the absence of a stronger economic recovery than anticipated, the new government is likely to raise taxes in its first Budget following the general election (in line with historic practice) and plan for the deficit to fall less quickly than currently envisaged.