Inside Jeremy Hunt’s £100bn-a-year battle with Britain’s ballooning debt pile

Jeremy Hunt has a £100bn headache. The Chancellor may be enjoying a flood of extra tax receipts thanks to high inflation, but the corollary of that is the country’s debt interest bill is soaring.

Higher debt service costs are expected to continue until at least the end of the decade, according to forecasts from Hunt’s tax and spending watchdog.

The Office for Budget Responsibility (OBR) now believes Britain will still be spending £122.5bn a year on servicing the country’s debt by the end of the decade.

It revised up its forecasts for debt interest by an average of £20bn-a-year over the next five years.

Lord Lamont believes the Chancellor should be worried about Britain’s debt pile, which is already above 90pc of GDP and is expected to keep rising over the next three years.

“The danger is that the debt interest bill grows faster than the economy, in which case debt interest will become an increasingly large part of public expenditure,” says the former chancellor.

A quarter of UK debt is tied to inflation, and more specifically the retail prices index, which has soared over the past year amid a jump in energy costs.

While inflation is now coming down, debt interest spending is still expected to be 4.3pc of GDP in 2023-24. This is 0.6 percentage points higher than the OBR forecast in March and would represent the second highest level since the Second World War.

Debt interest is expected to remain well above pre-pandemic levels for the foreseeable future as interest rates remain higher for longer to tame inflation, pushing up gilt yields.

At 3.8pc of GDP by the end of the decade, debt interest costs will dwarf every government department’s budget other than the Department for Health.

That means less money for the NHS, less money for schools and less money for roads and railways.

In the words of Lord Lamont: “If interest keeps growing faster than the economy, you’re on the road to ruin.”

This has consequences for taxes and spending going forward, says Paul Johnson, director of the Institute for Fiscal Studies (IFS).

He says: “The big picture remains rather as we have known it for a while now. Both tax and spending are at high levels by historic standards. Debt interest spending is set to remain around 2pc of GDP higher than it was back in 2019. That’s the same as the entirety of the defence budget.”

Johnson warns that this means that just stabilising debt at current levels will require Britain to run a “substantial” primary surplus, which means it will need to balance the books excluding debt interest.

The OBR predicts the Government will start doing this in 2025. But these are predictions, and as Johnson highlights, the reality is “we have not done that since the turn of the century”.

He adds: “Given the level of debt and debt interest we will need to get used to running these surpluses. That will require the Government taking more from us than it gives back on everything other than paying interest on its debt.”

Government departments are already facing a squeeze, with inflation also eroding the spending power of Whitehall budgets, which are set in cash terms.

OBR figures show that unprotected areas of government spending, such as prisons, courts and local councils, already face a £19.1bn real terms cut over the next five years on current plans.

Should borrowing costs rise further those departments would have even less to spend, says Paul Dales, chief UK economist at Capital Economics.

“That is going to be an issue from 2025-26 onwards and a problem for whoever wins the next general election,” he says.  

Voters already finding that burglaries are going unsolved, GP appointments are impossible to come by and their bins are only collected every three weeks may struggle to accept such a reality, adds Dales.

“There’s a sense out there that public government departments have not been able to deliver the level of service that the public expects from them,” he says.

He also warns that Labour will face an even tougher time making the sums add up.

“I think it is going to be particularly a big issue should Labour be next in government because typically Labour would want to spend more on public services to improve their provision. According to the current fiscal figures, they’re not going to be able to unless they manage to raise taxes from other areas to fund them.”

However, there could also be some windfall should the OBR’s predictions for how much interest rates will fall prove to be too cautious.

“It’s probably not quite as bad as the OBR expects but it’s nonetheless the case that the government should get used to having to pay out more in debt interest payments than it has been used to for a while,” Dales says.

Either way, the outlook may not be as bright as Hunt would like you to believe.

Of course, the size of Britain’s debt pile would be less of a headache if the economy was growing faster.

Richard Hughes, chairman of the OBR, warned that even this would remain a challenge. He said economic growth was likely to remain anaemic in the short term, with the UK suffering an “unpleasant” combination of high interest rates and low growth that made the outlook for the UK economy worse compared with other rich economies.

He said: “We have a worrying configuration of American-style interest rates, but European-style growth. And so the dynamics are looking particularly unpleasant for us as a G7 member because we’ve got relatively high interest rates, but we haven’t got the American growth to go with it.”

Hunt argues cuts to National Insurance and businesses taxes will help to push up growth, alongside 100 other measures.

“It’s completely wrong to say that I’m relying on some sort of growth fairy in the future,” he told the BBC, adding that his economic growth policies will “increase business investment by £20bn”.

“I could have done a lot of things with the headroom I have,” he said. “But as a Conservative I believe lower taxes are how we grow the economy.”

However, the OBR believes he is swimming against the powerful tide of an ageing population and a rise in the share of Britons with long-term health conditions.

The Chancellor was keen to stress within the first two minutes of his Autumn Statement speech that “our choice is not big government, high spending and high tax because we know that leads to less growth, not more”.

But the IFS’s Johnson believes Hunt may have to eat those words, with the UK’s demographic decline suggesting taxes will be permanently higher.

“Taxes over this parliament have risen by 3pc or 4pc of national income from where they have been for a very long time,” he says. “The forecast I’ve made is that they won’t go back down in my lifetime to where they have been over the first five decades of my life.

“It’s not because this is a government – or indeed any government – particularly wants a massive state and a massive tax burden. But we are going to be spending more on health going forward.”

Johnson adds that the NHS Workforce plan published this year that could see one in 11 workers in England working for the NHS by 2037 will cost 2pc of national income in the medium term on its own.

“We are going to be spending more on pensions,” he says. “And of course, we have a very high level of debt and therefore debt interest spending, so my guess is that we are in a new equilibrium in terms of the scale of tax and spending going forward.”