Governments typically spend more than they collect in taxes. To bridge this gap, they resort to borrowing money, which must eventually be repaid with interest. This borrowing can significantly impact broader tax and spending strategies.
Why does a government borrow money? The majority of government revenue comes from taxes, such as income tax from workers, VAT on goods, and corporate taxes on profits. While ideally, all expenditures would be covered by tax revenue, this is not always feasible. When there is a shortfall, governments may increase taxes, reduce spending, or borrow to make up the difference.
Governments in the UK allocate and spend approximately £1 trillion annually. Higher taxes can limit consumer spending, affecting business profits, jobs, and wages. Consequently, lower profits reduce corporate tax revenues. Therefore, governments often choose to borrow money to stimulate the economy or fund large infrastructure projects like railways and roads, which are expected to boost economic growth.
How does the government borrow money? Governments issue bonds to raise funds. Bonds are commitments to repay borrowed money with interest over time. UK government bonds, known as “gilts,” are considered low-risk investments, often purchased by domestic and international financial institutions including pension funds, banks, and insurance companies. The Bank of England also participates in government bond purchases through quantitative easing to support economic stability.
The amount the UK government borrows fluctuates monthly. For instance, tax returns typically result in higher revenues in January. Therefore, annual or year-to-date borrowing figures provide a clearer picture. In the last fiscal year ending March 2024, the government borrowed £122.1 billion. Recent data for June shows borrowing was £14.5 billion, down £3.2 billion from the same month the previous year.