UK's 'truly horrible' public finances threaten recovery

Tax receipts tumble and borrowing could increase close to 15 per cent of GDP

Britain's public finances plunged further into deficit last month – usually a period when the Treasury sees an inflow of funds. Compared with the £5.2bn positive contribution to the public finances recorded in July 2008, this year saw a net outflow of £8bn, thanks to a collapse in VAT and corporation tax receipts.

City analysts were expecting a net outflow of just £500m, and the news renewed fears that the Government may find it increasingly difficult to fund its deficit – especially once the Bank of England stops buying gilts for its quantitative easing programme.

July is one of four months in the year when a substantial proportion of corporation tax receipts are received by the Exchequer; but corporation tax receipts for July 2009 were 37.9 per cent lower than the same month last year, an indication of the pressure of the downturn on business.

Only four months into the current fiscal year, cumulative public borrowing is running at £49.8bn, more than three times the comparable figure in 2008-9, and more than in the 2006-7 fiscal year. It means that the public finances are well on track to hit the Chancellor's Budget forecast of £175bn total borrowing this year, and many economists believe that borrowing could easily shoot beyond that, to £200bn, or close to 15 per cent of GDP, easily a peacetime record.

Richard Snook, from the firm of analysts CEBR, said: "Borrowing for this financial year is likely to come close to £200bn, giving whichever government takes power in 2010 a once-in-a-generation challenge to bring the debt and deficit back down to manageable levels."

On the expenditure side, the finances have suffered from an increase in the benefits bill as unemployment has climbed to 2.5 million, of which around 1.5 million claim jobseeker's allowance. Expenditure on benefits was 10.4 per cent higher in July 2009 than in July 2008. A "discretionary" boost in infrastructure spending, also announced in the pre-Budget report, is responsible for a jump in public sector net investment. Between April and July 2009 it totalled £9.7bn – 39 per cent higher than in the equivalent period in 2008.

Central government current receipts in July were 15.3 per cent lower than in the same month last year, and receipts between April and July 2009 were 11.9 per cent lower than in the same months of 2008. The Institute for Fiscal Studies, an independent research body, said the Government had been planning on receipts for the whole of 2009-10 to be 7.5 per cent below last year.

Tax revenues have been especially badly hit by the stagnant property market, with a dramatic reduction of stamp duty receipts, while denuded City bonuses have also yielded less tax. The sharpest decline in economic activity since the 1930s has hit corporation tax and VAT, as has the reduction in VAT rates from 17.5 per cent to 15 per cent last December, and other concessions on income tax and stamp duty made by the Chancellor last November. VAT receipts in July 2009 were 33.8 per cent lower than last year.

However, there is some evidence that the VAT cut is helping to sustain retail sales. Retail sales volumes in July again exceeded expectations after furniture and electricals stores delivered their best performance for almost three years, signalling that the worst of the consumer recession is probably over.

Hefty discounting helped retailers to post a 0.4 per cent uplift in sales volumes last month on June, which brought the annual rate of growth to 3.3 per cent, according to the Office of National Statistics.

Richard Lowe, the head of retail and wholesale at Barclays Commercial Bank, said: "Although it may not have been the barbecue summer we were all promised, the public rushed to snap up the sales bargains in July. Valiant retailers have been enticing customers with stronger than usual seasonal discounting, driving footfall and sales."

Between June and July, primarily non-food stores grew sales by 1.1 per cent ahead of the 1 per cent increase posted by grocers, partly because of falling food price inflation.

Richard Hyman, retail adviser to the accountancy firm Deloitte, said: "Today's ONS figures continue to suggest that the retail industry has not been hit as hard as one might have expected in this downturn."

Colin Ellis, UK economist at Daiwa Securities, said: "The public finances are in a dire state. Given the underlying weaknesses that are evident in today's data, if the economy remains weak then the toll on the public sector finances could end up being truly horrible."