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Four reasons to fear ballooning government debt

When the financial markets wake up to the real state of Western governments’ finances, it won't be pretty. Bengt Saelensminde explains why, and how to protect your wealth.

Without any fanfare, the Office for National Statistics made a subtle change to our national accounts last week and the results aren't pretty.

By bringing our accounting into line with European standards, the ONS concludes that Britain is actually a further £127bn in the red. And not just that, the new accounts also show that the government has racked up a cool £1.4 trn in debt on our behalf.

Now, forgive me, but wasn't it just a couple of years ago that we passed the eerie one trillion mark? Bearing in mind that that trillion took us hundreds of years to reach, the fact that we're already past £1.4 trillion should be setting some alarm bells ringing.

But hey austerity is going to sort out this intractable dilemma, right?

Not quite. In the first half of this year our government put an extra £45.4bn on the credit card that's 6% up on last year!

Most of us would rather ignore this lamentable situation. I can see why. But ignoring it won't make it go away and it certainly won't do anything for your retirement plan.

That's why I wrote this article. It's not pretty, but here's what you need to know.

This is what's going on right now

1. Income tax is a disaster area

Let's start with the biggie. The Office for Budget Responsibility (OBR) assumed that income tax would yield an extra 6.5% this year. After all, new jobs are up by around 774,000 in the last 12 months.

There's just one problem most of these jobs are on low pay! Meanwhile, as companies cut back and baby boomers retire, many better paid jobs are simply disappearing. Low pay = low tax generation.

And do you remember the 50% so-called bankers' tax' from a few years ago? Well, it turns out that once introduced, a lot of the better-paid found ways to bypass this punitive rate. Conceptually, half of your income is just that little bit too much.

And though the top rate has now come down to 45%, it appears many of those who swindled their way out of paying 50% haven't returned to the fold to pay the lower figure.

The result? Rather than rising 6.5%, it turns out that income tax receipts actually fell by 0.8%. That's a massive miss.

2. The welfare bill goes up

All of those low-paid jobs leave the poor old average Brit with a balance of payments deficit'. In plain English, they can't make ends meet. And that means more state aid even for many of those in employment.

I share some sympathy with the view that corporate profits are assisted by government subsidies on low paid workers. But if the government doesn't do its part, many of the corporates would simply offshore the work (I'll cover that fully in a second).

Anyway. with baby boomers living longer and the health service offering more treatments than ever, the welfare bills keep mounting. We've got decades of increasing health care to contend with yet.

Now, back to that offshoring problem I mentioned...

3. Corporation tax is evaporating

As a business owner and a shareholder, I've been only too pleased to see recent reductions in corporation tax.

We already pay tax as we withdraw benefits and dividends. Why should the income be taxed on the business's net income as well?

It doesn't make sense, and over the years businesses have gradually migrated to low, or nil-based, corporation tax environments. To stem the flow of the absconders, the government has sensibly reduced corporation tax. But of course, it leaves a gaping hole in the finances.

In the light of globalisation, there's precious little the government can do about it. Just consider our burgeoning car industry, where we've become not so much a car manufacturer, as a car assembler.

The Chinese and Indians that make the bulk parts for our rolling stock have paid their dues at home.

I mean, even a cup of Starbucks coffee is merely assembled in the UK, the profit being shifted to more friendly tax jurisdictions.

4. GDP will continue to struggle

Have you ever wondered why governments are so keen to see rising GDP? Of course, it's because it generates tax.

GDP is essentially the sum of our collective spending. And just about every time we spend, a bit of tax is generated. In the case of consumers, the government takes 20% by way of VAT.

This is precisely why the government has been so plucky in its grand housing schemes. A strong housing market gives a GDP boost it's a leveraged effect too.

By that I mean that it's not as if everyone has to sell their home to feel the benefits of a rising market. The feel-good factor is enough to generate an extra bit of spending.

But, of course, such leverage all works in reverse on the way down. Not everyone has to actually feel the pinch of a sinking market to feel bad. And that day will come.

Who knows when? I would suggest certainly before my retirement.

It's also worth noting that our debt-fuelled growth ultimately sucks money out of the real economy too. All of those interest payments will ultimately take their toll. Over the long run, money goes out of public circulation, and into the banks.

Without GDP growth, there's no growth in VAT receipts. That's a grim prospect.

It's not pretty but here's what to do

It's clear that the public finances are getting battered from all sides. Yet, to my mind, a government that isn't at war, presides over a growing economy, with a growing workforce, shouldn't actually need to borrow at all.

As I mentioned at the beginning, despite austerity, and despite the fact that the UK is doing alright', the public deficit is up 6% on last year.

My response is twofold:

One, tuck cash away from the taxman and into Isas and pensions. Tuck away as much as you can afford; fully expect to have to look after yourself in retirement.

Two, get exposure to the emerging markets. Many emerging markets display genuine growth, not some sham driven by the planners. Governments are proportionately smaller than in the developed world and the finances aren't in terminal decline. And of course, the debt burden is tiny in comparison.

One day the world's financial markets will be forced to take a cold hard look at the problems facing governments like ours.

And when they do, it ain't gonna be pretty.

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