The UK is Broke

Yes, really! More broke than you thought, too...

FEW PEOPLE yet realize it, but the UK is bankrupt, writes Professor Kevin Dowd, a Senior Fellow with the Cobden Centre.

The Government cannot pay its debts.

This might sound a little pessimistic. After all, the UK debt to GDP ratio is still under 70%, and the debt to GDP ratio for some other countries is much higher.However, for peacetime the current UK debt to GDP ratio is high and rising fast.

Furthermore, observers of the UK economy have been sounding warnings for some time: one major bond investor early in the year warned his clients that UK Government debt was a "must avoid" as it was "resting on a bed of nitroglycerine."

Unfortunately, the Government's official debt is not the real problem: the Government's 'official' debt is only a small percentage of its true debt exposure. The official debt is merely the tip of a very large hidden iceberg.

The Government's true debt is the present value of all the commitments it has entered into, on the expectation that these commitments will be paid for by future taxpayers. Some prominent examples are the commitments implied by the public sector pension system, the state pension system, the health system and PFI. The costs of these commitments are staggering.

One recent Institute of Economic Affairs study by Nick Silver put this figure at 333% of GDP. Another, by Christian Hagist and his colleagues at Freiburg University, put the figure at 530% of GDP. Two different methodologies by reputable researchers, both painting a very bleak picture. The latter study also carries out an international comparison – and, relative to other countries, the UK comes out as a basket case along with the US: the US is bankrupt too.

Let's take the first figure. This means that a typical UK citizen will be expected to pay well over three times' their annual income just to cover this debt. If we go with the larger figure, then he or she will be expected to pay well over five times their annual income. With an average income of about £22,000 for per person, these figures suggest a future tax bill in the range between approximately £73,000 and almost £117,000 for each man, woman and child in the country.

Yet even these figures are over-optimistic, in so far as they refer only to the unfunded tax burden that has already been incurred, whereas the reality is that this burden has been rising rapidly before the current crisis, and is rising even more rapidly now. So we are looking at an obligation on the future taxpayer that is not only very large, but still rising sharply.

The problem is made worse still because of the way the tax burden will be distributed. For some older people – such as those in retirement – there isn't much problem at all. They benefit from the government's commitments, but are unlikely to have to pay much towards their cost. For young people, it is the other way round: they are expected to pay large amounts into the system and get little back in return; and the younger the person, the worse the deal.

So we have an average, per person, tax burden of £73,000 if we are feeling optimistic and nearly £117,000 if we are feeling pessimistic – but in either case possibly much higher, and certainly rising – that is distributed very unevenly across the population: younger people paying much more, and older people less, if anything at all.

One recent estimate suggested that a UK citizen born in 2011 will inherit, on birth, a debt of perhaps £200,000, and it could easily be much more.

It is simply inconceivable that debts on this scale will be paid off in full. Nor should they. These were not debts that youngsters freely took on, but obligations incurred on their behalf in many cases before they were even born.

The uncomfortable moral question then naturally arises: at what point does the debt become so large that our future children will be born into a new form of slavery, entering the world shackled by the debts of their forbears?

This highlights the underlying moral as well as fiscal bankruptcy of the system. For years, politicians yielded to the temptation to increase spending commitments and put off the costs of those decisions into the future, when it would be someone else's problem. The political system itself encouraged them to do so – handing out goodies is so much easier to sell politically than handing out pain. Even the voters themselves were complicit, because they voted in governments committed to "Spend now, (get someone else to) pay later" policies, instead of penalizing governments for long-term fiscal irresponsibility. Most of those who will pay the burden did not yet have the vote, so they didn't count. No-one took responsibility for the long-term.

In so doing, our political system created a huge intergenerational Ponzi scheme, passing the buck from one generation to the next, until the whole rotten system inevitably collapses under its accumulated weight.

The long-term, even medium-term, outlook is therefore deeply unpleasant. Taxes will rise, sharply, but these rises will not be enough, and will leave younger people with little incentive to work or to save. Benefits across the board will be cut, massively: the government will renege big-time on many of its commitments, breaking its health, pensions and other promises on a huge scale. The social and economic consequences don't bear thinking about. And of course there is the very real danger that even these draconian measures will not be enough: that the government will lose all control of its finances and end up printing money to pay off its debts, so leading to hyperinflation and economic collapse.

Make no mistake about it: the country is bankrupt.

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