UK tax & spending

Every year the UK government raises and spends close to half of national income, drawing money from millions of taxpayers and channelling it into pensions, hospitals, schools, roads and much else. Headlines about “the deficit” and “the national debt” fly past, often used as if they meant the same thing. They do not. To follow any serious argument about the public finances you need to know where the money comes from, where it goes, and how this year’s borrowing relates to the total stock of debt built up over decades.

Where the money comes from

The UK raises most of its revenue from three big taxes. The largest is income tax, charged on most income — chiefly wages — above a tax-free personal allowance. It is progressive: income is taxed in bands at rising marginal rates, so higher earners pay a larger share of each additional pound. Close behind come National Insurance contributions (NICs), paid by employees, employers and the self-employed on earnings. In principle NICs are linked to entitlements such as the state pension, though in practice they largely fund general spending. Third is Value Added Tax (VAT), an indirect tax on most goods and services, charged at a standard rate with many items zero-rated, reduced-rated or exempt, such as most food and children’s clothing.

Beyond this big three sit a long tail of smaller taxes: corporation tax on company profits, fuel and other duties, council tax, business rates, stamp duty, capital gains and inheritance tax. Economists distinguish direct taxes, levied on income or wealth and paid straight to the government, from indirect taxes, charged on transactions and collected by intermediaries such as shops. They also distinguish progressive taxes, which take a larger share from higher earners, from regressive ones, which weigh more heavily on the poor. VAT, because lower-income households spend a larger fraction of their income, can be regressive even though everyone pays the same rate.

Where the money goes

On the spending side, a few areas dominate. The biggest is health — overwhelmingly the NHS — followed by social protection, which covers the state pension and working-age benefits, and then education. Together these three account for the lion’s share of public spending. Defence, public order, transport and debt interest take significant sums too. The balance has shifted over time: an ageing population has pushed health and pension spending steadily upward, squeezing the room available for everything else.

One item deserves special attention because it is easy to overlook: debt interest. The government must pay interest on the money it has borrowed, and in recent years this has grown into one of the larger lines in the budget. When either the stock of debt or the interest rate on it rises, the servicing cost climbs, leaving less for public services or requiring higher taxes to cover it.

Deficit versus debt

This brings us to the distinction that trips up so many discussions. The deficit and the national debt are not the same thing — one is a flow, the other a stock.

The budget deficit is the gap in a single year between what the government spends and what it raises in revenue. When spending exceeds revenue, the government borrows to fill the gap; when revenue exceeds spending, it runs a surplus. The deficit therefore measures one year’s borrowing.

The national debt — formally public sector net debt — is the total accumulated stock of past borrowing that has not been repaid. It is the running total built up from years of deficits, minus any years of surplus. A useful analogy is a household: the deficit is like the amount you overspend in a particular month, while the debt is the total balance owed on your credit card after years of such months.

The crucial consequence is that the debt keeps rising as long as the budget is in deficit at all, even if that deficit is shrinking. Cutting the deficit slows the growth of the debt; only an outright surplus actually reduces it. This is why politicians can simultaneously boast of “reducing the deficit” while the headline debt figure continues to climb — both statements can be true at once.

Measuring it sensibly

Because the economy grows over time, the public finances are usually expressed not in raw cash but as a share of GDP. A debt of a given size is far more manageable in a large, growing economy than in a small one, just as a mortgage is easier to bear on a high salary than a low one. Measuring tax revenue, spending, the deficit and the debt relative to GDP allows fair comparison across years and between countries, and explains why economists watch the debt-to-GDP ratio rather than the cash total alone. Independent bodies such as the Office for National Statistics and the Institute for Fiscal Studies publish and analyse these figures, providing a non-partisan basis for what is otherwise one of the most contested arguments in British politics.