As the UK Chancellor announces his Spring Statement, Professor Michael Ben-Gad takes a moment to reflect on the state of the UK economy and how unforeseen events keep piling on the pressure

By City Press Office(City Press Office), Published

There is little surprise in the Chancellor's announcement, that in the absence of some new negative shock (see below), the debt burden will fall from 83.5% to 79.8% over the course of the next four years. That is a direct result of two factors, both directly related to inflation.

First, because income tax bands are not adjusting to match inflation, fiscal drag (what Americans call ‘bracket creep’) generates more income for the Treasury, not just in nominal terms, but in real terms as well.

The other is the liquidation through inflation of the value of the three-quarters of the nonindexed portion of outstanding government debt.

The Chancellor cited the rising cost of interest payments on indexed debt, but it is important to reiterate that because of fiscal drag, revenues are likely to rise faster than these costs.

Unlike the nonindexed portion of the debt, for which both the costs to the Treasury in interest and payments of principal are declining in real terms, the interest and principal for indexed debt is constant, but not as is often implied rising.

Of course, this is not a ‘free lunch’. The gains enjoyed by the Treasury are losses endured by bondholders, including those with a stake in a pension fund.


The UK has an underlying debt problem driven by unfunded liabilities that do not count as part of the official debt. That is a function of soaring health and social spending driven by the aging of the population. The scheduled increase of 2.5% on most earnings in National Insurance contributions (NICs) is 2.5% this year – the combined increase of 1.25% on employees and employers – is a first attempt to try to fund these growing costs.

Today’s announcement that the threshold for NICs will rise by £3,000 will partly offset the increase in revenue this was meant to generate. Its primary beneficiaries will be the working poor, who will benefit disproportionately. Unfortunately, because the rates for most people remain higher on each marginal pound earned, the disincentivising effects of NICs will still increase.

'Jam tomorrow' politics

The other declines in taxation are clearly motivated by politics. Yes, a decline in the rate of income tax is always welcome, provided we can afford it, but if it is such a good idea, why wait until 2024? The obvious answer is the Chancellor is promising nervous Conservative MPs that he will be ‘there for them’ in the run up to the next election. Perhaps he hopes they will be ‘there for him’ when he moves to replace Boris Johnson?

Same for the cut in fuel duty. It is a general rule of economics that when you tax something, you get less of it. NICs disincentivise work, income tax disincentivises work, savings and investment, whereas fuel duty disincentivises the consumption of fuel. Setting aside the issue of climate change, burning fuel increases pollution, increases road congestion and now – with the crisis in Ukraine – increases Russian leverage on both the UK and its allies.

Fuel duty is an example of a Pigovian tax (named for Cambridge Economist Arthur Pigou): one that taxes activities that, unlike work and ordinary consumption, create negative externalities. However, here too, politics trumps economics; the cut will be visible to anyone filling their tank.

Inflation is forecast to average 7.8%. Take that as a best-case scenario. We macroeconomists have three different theories that can explain inflation: Keynesian, Monetarist, and my favourite, the Fiscal Theory of Price. What unites them all is that they have all pointed to higher and sustained inflation for quite some time.

Defence spending

On spending, the most notable thing was the gap between the high-flown rhetoric in support of Ukraine and the rather laconic phrase in today’s published statement: “Enduring geopolitical tensions might also generate pressure to increase the Ministry of Defence’s budget from the 1.8% of GDP it averages between 2022-23 and 2024-25.”

In 2017, the UK spent the equivalent of $46.6 billion on defence, compared with Russia’s $66.5 billion. However, that is in market exchange rate terms and fails to account for differences in the costs, particularly wage costs between the two countries. In military purchasing power terms, the gap is far higher – Russia outspent the UK by a ratio of nearly 3.6 to 1.

I advocated in 2014, after Russia’s invasion of Crimea, that Nato cannot hope to survive unless it creates a serious deterrent on its Eastern frontier. In response to Russia’s latest aggression, that seems ever more likely. As the US becomes more engaged with countering the rise of China in the Pacific, more of the burden will fall on Nato’s European members to contribute to their own continent’s defence.

No new shocks

This crisis reflects a larger point. Stabilising the public finances is predicated on no new shocks – yet in the last 15 years, we have experienced three 'unprecedented' crises that required extraordinary spending (four over the course of the last two decades if we include 9/11 and the Iraq War).

Who can promise there will be no new crisis, a new pandemic, a Chinese invasion of Taiwan, some altogether unexpected ‘Black Swan’ in the next few years?

By contrast, we can be reasonably certain there will be no mitigating positive shock of equal magnitude (we say in Hebrew 'nothing good is threatening us'). That is the bigger problem.

Against a background of increasing public needs driven by demographic pressures, each new shock ratchets up the strain on public finances and causes the size of the state sector to expand.

Professor Michael Ben-GadAbout the author

Professor Michael Ben-Gad's is Professor of Economics in City, University of London's Department of Economics. His research focuses on Dynamic Macroeconomics with applications to taxation, public debt, the economic effects of immigration, as well as the emergence of multiple equilibria in models of economic growth. He joined City as a Reader in 2007 and served as Head of Department between 2010 to 2013. He has worked in the Research Department of the Bank of Israel, and taught at the University of Houston and the University of Haifa.

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