The UK government typically spends more than it collects in taxes. To bridge this gap, it borrows money, which must eventually be repaid with interest. But why does the government borrow, how does it work, and does it matter? Let’s break it down.
Why Does the Government Borrow Money?
The government’s primary source of income is taxes, including income tax, national insurance, VAT, and corporation tax. In theory, it could cover all its spending through taxes, but this isn’t always practical. Raising taxes too much can reduce disposable income, hurt business profits, and negatively impact jobs and wages. Similarly, cutting spending can lead to reduced public services.
To avoid these issues, governments often borrow money to fund spending, especially during economic downturns or to invest in large infrastructure projects like railways and roads. Borrowing can stimulate economic growth, which in turn generates more tax revenue in the long run.
How Does the Government Borrow Money?
The UK government borrows by selling financial products called bonds, specifically gilts. These are essentially promises to repay the borrowed amount with interest over time. Gilts are considered low-risk investments and are primarily bought by financial institutions such as pension funds, banks, and insurance companies, both in the UK and abroad.
The government issues both short-term and long-term gilts, allowing it to borrow over different time periods at varying interest rates.
How Much is the UK Government Borrowing?
The amount the government borrows fluctuates monthly. For example, borrowing tends to drop in January when many people pay their annual tax bills. Over the full financial year to March 2024, the government borrowed £125.1 billion.
As of January 2025, the government had a surplus of £15.4 billion, the highest January surplus in over 30 years. However, borrowing for the financial year from April 2024 to January 2025 stood at £118.2 billion, which is £11.6 billion more than the same period the previous year.
The total amount the government owes, known as the national debt, is approximately £2.8 trillion. This is roughly equivalent to the UK’s annual GDP (the total value of goods and services produced). While this figure is more than double pre-2008 levels, it remains relatively low compared to much of the last century and is lower than some other major economies.
How Much Does the Government Pay in Interest?
The larger the national debt, the more the government pays in interest. During the 2010s, when interest rates were low, this cost was manageable. However, as the Bank of England raised interest rates from 2021 onwards, the cost of servicing the debt increased significantly.
In December 2024, the government paid £8.3 billion in interest on its debt, £3.8 billion more than in December 2023. This was the third-highest December figure since records began in 1997. Rising interest rates have made borrowing more expensive, prompting concerns about the sustainability of current debt levels.
Why Does Borrowing Matter?
If the government spends more on debt interest, it has less to allocate to public services like healthcare, education, and infrastructure. Some economists argue that excessive borrowing could strain public finances, especially if interest rates remain high. Others believe that borrowing to invest in the economy can lead to faster growth, ultimately generating higher tax revenues.
The government has set a fiscal rule requiring debt as a proportion of GDP to fall within five years. However, rising borrowing costs and economic uncertainty have made this target challenging. In October 2024, Chancellor Rachel Reeves adjusted the definition of debt to include broader measures like public sector net financial liabilities (PSNFL), which account for items such as student loan repayments.
Deficit vs. Debt: What’s the Difference?
- Debt: The total amount of money the government owes, accumulated over years of borrowing.
- Deficit: The annual gap between government income and spending. When spending exceeds income, the government runs a deficit, increasing the national debt. Conversely, a surplus reduces debt.
The Bigger Picture
While the UK’s national debt is high, it remains manageable compared to historical levels and other economies. However, an ageing population poses a long-term challenge, as fewer working-age people mean lower tax revenues and higher pension costs. The Office for Budget Responsibility (OBR) has warned that public debt could rise significantly unless addressed.
The government’s ability to balance borrowing, investment, and fiscal responsibility will be crucial in maintaining economic stability and funding essential public services.
Conclusion
Government borrowing is a tool to manage the economy, fund public services, and invest in growth. However, it comes with costs, particularly when interest rates are high. The UK’s current debt levels, while substantial, are not unprecedented. The key challenge lies in ensuring that borrowing is sustainable and that the economy grows enough to support future repayments without compromising public services.
For businesses and individuals, understanding these dynamics is essential for planning and navigating the broader economic landscape. If you need expert advice on tax efficiency, compliance, or financial planning, contact Taxca Accountants today.
📞 020 3369 7867
📧 [email protected]
🌐 www.taxca.co.uk
📍 353 High Street North, E12 6PQ, London, UK