Just one month into office, the new Labour government in Britain has been vocal about the challenging fiscal situation they inherited from the previous Conservative administration.

In late July, Chancellor Rachel Reeves informed the House of Commons that the former government had left behind a "fiscal black hole" amounting to 22 billion pounds (approximately 28.21 billion U.S. dollars). Prime Minister Keir Starmer's office issued a statement indicating that their fiscal assessment had revealed a country that was "broke and broken."

Economists and critics see Labour's accusations as signaling possible tax increases in the forthcoming October budget. Additionally, this rhetoric is perceived as an effort to criticize the Conservatives in Parliament and shape public opinion on the necessity for fiscal reforms.

However, it is undeniable that Britain is grappling with significant financial challenges, including high government debt, low public investment, inadequate public services, and increasing economic discontent.

Even before the July general election, the Institute for Fiscal Studies warned that the new government would face the most challenging fiscal environment in 70 years.

High debt vs high demand

The British government debt, which is high by historical and international standards, has been a longstanding concern. According to the Office for National Statistics (ONS), Britain's public sector net debt, excluding public sector banks, was estimated at 99.5 percent of gross domestic product (GDP) at the end of June 2024.

Borrowing for the financial year ending in March 2024 was provisionally estimated at 120.7 billion pounds.

"The UK's fiscal difficulties stem from the global financial crisis when public borrowing was significantly increased to support the banks and to implement a fiscal stimulus program in 2009 and 2010," explained Professor Iain Begg from the London School of Economics and Political Science.

During the COVID-19 pandemic, massive public expenditure, such as furlough schemes and business loans, further exacerbated the situation, he added.

Interest payments on past borrowings are a significant burden, especially with rising interest rates as the Bank of England combats soaring inflation. In 2023-2024, government debt interest spending reached 102 billion pounds, equivalent to 3.8 percent of GDP or 8.4 percent of government spending.

High debt limits the government's ability to increase public spending, making it increasingly difficult for public services to meet the needs of the British people.

Understaffed public sectors, inefficient transport networks, and aging infrastructure are just a few of the problems plaguing the country. A recent YouGov survey showed that 84 percent of Britons believe public services are in poor condition.

The National Health Service in England reports that the waiting list for planned hospital care has risen to 7.62 million, with 6.39 million patients currently waiting.

A decade of low growth

While high government debt hampers public spending, the situation is compounded by Britain's sluggish economic growth.

ONS data indicates that over the past decade, excluding the COVID-19 pandemic, quarterly GDP growth has rarely exceeded 1 percent, and year-on-year GDP growth has been below 3 percent.

In the second half of 2023, the British economy entered a technical recession, contracting for two consecutive quarters.

A major study by the Resolution Foundation, a leading British think tank, revealed that the British economy has been stagnating for 15 years, leaving low- and middle-income households "much poorer" than their counterparts in advanced economies such as France and Germany.

"Britain has huge strengths, but it is in relative decline," said Torsten Bell, chief executive of the Resolution Foundation. "A year or two of low investment and flatlining wages is survivable, but 15 years of stagnation is a disaster."

The economic outlook remains bleak, with the International Monetary Fund forecasting a GDP growth of just 0.7 percent in 2024 and 1.5 percent in 2025.

Austerity or stimulus

To alleviate pressure on public finances, Chancellor Reeves has announced that the Labour government will cut spending by 5.5 billion pounds this year and over 8 billion next year.

The government will review Conservative plans to build 40 new hospitals and reform the care sector. It also plans to reduce winter fuel payments for some pensioners and change ministerial severance pay. In education, a 20 percent value-added tax will be imposed on private school fees starting Jan. 1, 2025, to fund public education.

Analysts believe that the current fiscal challenges present a dilemma for the new government.

On the one hand, the large fiscal deficit and the need for fiscal discipline require tax increases and spending cuts. However, this approach could further burden British households and businesses.

The Office for Budget Responsibility (OBR) reports that the tax burden, measured as tax revenues as a percentage of GDP, was at its highest level in over 70 years during the 2022-2023 financial year. Austerity measures could worsen the inadequate supply of public services while dampening economic activity and business confidence.

On the other hand, stimulating economic growth through tax cuts and increased public investment could address the fiscal problem more fundamentally. However, with the government already living beyond its means, raising funds through large-scale borrowing may be difficult in the short term, and significant tax cuts could also reignite inflation.

Professor Patrick Minford of Cardiff Business School cautioned that while raising taxes might improve fiscal numbers in the short term, it could harm Britain's long-term growth prospects.

"We have to get the economy into good shape," he said. "If the economy is in good shape and growing, then these issues pale into insignificance because money pours in to pay for the extra needs of public services."

Begg echoed this sentiment, stating that the government should focus on improving the economy's growth rate through public investment, infrastructure development, research and development, and innovation.

"All these factors affect the debt-to-GDP ratio. A higher GDP denominator will reduce the ratio even if the stock of debt remains unchanged," Begg said.

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