Public sector net borrowing, on the targeted definition that excludes the temporary effects of financial interventions, peaked at 11.1% of GDP in 2009-10 and fell to 8.3% in 2011-12. This is above the prior post-war high of 7.7% reached in 1993-94. Current government plans entail a cut to 1.1% by 2016-17, according to the Office for Budget Responsibility. This is ambitious but implies an overall adjustment comparable with that achieved in the 1990s and only slightly larger than in the 1970s / 1980s.


The overall tax burden, however, is higher now that at the start of these two prior adjustments. Then, the deficit could be cut significantly by restoring taxes to a normal level relative to GDP. The current non-oil tax share, by contrast, is about average, at 35.1%. Indeed, the historical data suggest that there is a natural limit to the tax share at 35-36% – attempts to raise it beyond this level may run aground on disincentive effects.


The current large deficit reflects overspending not undertaxation. Current expenditure reached a record 42.8% of GDP in 2009-10. The government plans to cut the share by 6.3 percentage points but the process has barely begun and is already generating major opposition. The Thatcher government of the 1980s, admittedly, managed such a reduction but this was against the backdrop of solid economic growth generated by falling interest rates.


A plausible scenario, therefore, is that the government fails to achieve spending cuts on the required scale and tries to compensate by raising taxes further. The tax share, however, refuses to rise so the end result is slower economic growth combined with a stubbornly-high deficit, implying a continued climb in the debt to GDP ratio. Current miniscule gilt yields, suppressed by official and foreign “safe-haven” buying, offer no compensation for the risk of such a scenario.