Exiting the debt-to-spend doom loop
Derin Koçer
A shorter version of this piece was published by The Entrepreneurs Network.
Since this Labour government took office, every fiscal event has focused on “filling the fiscal black hole.” As my colleague Philip wrote last week in The Entrepreneurs Network’s flagship newsletter, the next one will be no different – except, if anything, the black hole seems to be getting bigger by time. There are numerous short-term, from the outright breaking campaign promises by raising one of the major taxes to breaking them more creatively by expanding the VAT base, as Philip highlighted. Neither approach offers a long-term strategy for “fixing the foundations” of Britain’s public finances – as Labour claimed to be their ambition.
The Treasury’s real problem isn’t a newly formed hole—it is an enduring one. Spending has failed to normalise post‑pandemic. According to the OBR estimates, Government Spending as a share of GDP for 2024-2025 will be at around 44.4%. Although this represents a significant fall from 2020, when the pandemic caused a spike to 50%, it’s still well above the pre-pandemic levels. IMF estimates that between 2015 and 2019, Government spending averaged at 39% of GDP annually. During the Blair Years, the average was around 40%. Given the size of the pie, that 4.5% hedge from ‘normal’ equals roughly 120bn GBP.
The deeper issue lies in debt addiction. Historically, taking on debt to fund government operations has been reserved for major crises. During the relatively calm Blair Years, the Gross Government Debt to GDP ratio averaged just below 40%. It increased drastically under Gordon Brown’s premiership, when crisis struck – reaching 65% in 2009 and 76% in 2010. However, since then, even during the ‘austerity’ years – when returning to a normal level of government spending while tax-cutting was funded through more debt – the debt pile has increased almost every year and peaked at 105% when Covid shut down the economy. IMF estimates that in 2025, it stands at around… 104%. That’s why the interest we will pay on our debt is approaching 4% of GDP and surpasses 9% of Government Revenue. This is even more worrying than it sounds: if the market thinks that the UK Government isn’t getting its fiscal outlook in order, they could demand even higher rates.
Breaking this “doom loop” requires long-term repair, not short-term fixes—and certainly not higher taxes. Britain is already spending far more than before Covid, even though nothing fundamental has changed. Our European peers returned to pre-pandemic norms more quickly, leaving them with a better fiscal outlook. Britain, meanwhile, kept numerous practices designed for the pandemic era in place, which is contributing to the unusual and consistent rise of welfare spending. We need to get back to normal.
The path forward runs through growth. Expanding the economy—not raising the tax burden—offers the best route to sustainable finance. Increasing the tax burden risks contributing to uncertainty in macro factors. The UK already has stickier inflation and higher interest rates compared to our counterparts. Britain’s inflation remains stubborn—core inflation was 3.6% in June, versus 2% in the eurozone—and interest rates are higher than those of many peers. Recent stealth tax rises on businesses have worsened sentiment and weighed on investment. Repeating those mistakes will not yield better results.
Normalising the economy is not austerity. Keir Starmer and Rachel Reeves should do the right thing and cut spending, cut regulations, unleash growth and start paying down the debt. And Conservatives should give them the ‘political headroom’ to do so, if they are serious about sustainably fixing the ‘fiscal headroom’ problem every Chancellor has faced in the past decade.