This week, the OBR warned that without policy change, the UK could be set for a steep rise in public sector debt. And this is after one of the fastest rises in public debt amongst developed economies.
A rise in debt to 200% of GDP would not be unprecedented, global wars have caused previous spikes, but this OBR forecast assumes no external shock. Unexpected shocks, of course would make the debt rise much faster, and of course, the real killer is that when debt rises, this can cause higher interest rates, and then the government needs to spend more on debt interest payments.
This has already happened to some extent with UK bond yields rising in recent years, causing debt interest payments to become one of biggest sources of government spending over £100 billion. So if the worst case scenario looks really bad, what does the UK have to do bring this under control, and could it be worse than some imagine?
Firstly, you might be sceptical about OBR debt forecasts, but the bad news is that they have tended to under-estimate the trajectory of debt. They dutifully forecast debt will fall, but it never does. To give one example, Rachel Reeves increased spending at the start of parliament and planned to reduce spending and increases taxes at the end of 5 year cycle to meet the so called governments fiscal rule. But she won’t be there to implement this hidden austerity. I can’t imagine the next chancellor will implement tax rises and spending cuts just before next election.
Now the good news is that this compound rise in debt can be prevented by decisive change in policy. The bad news is this means a lot of unpopular trade-offs. One way to increase tax revenue, is to freeze income tax thresholds, or even just increase in line with inflation. The OBR predict, if you increase in line with CPI, you bring more people into paying higher income tax and revenue rises substantially. But, the implication is that even minimum wage workers will become higher rate taxpayers by the late 2060s.
This has actually been the main government strategy, so wouldn’t be a surprise to see more of it. The downside is that higher taxes do have a hidden impact on reducing labour supply and leading to lower economic growth.
An important point is that the UK is set to have an ageing population. The old age dependency is set to rise from 27% to 40% this has the effect of leading to lower economic growth and less hours. One assumed response is more 70 year olds working, something to look forward to for people leaving university with record debt. But freezing tax thresholds is exactly the kind of thing that will hold people back from working.
However, a canary in the coal-mine is that the OBR assume real per capita growth of 1.5% a year. But this is actually much higher than we have seen in the post-crash era of last 16 years. The OBR show the productivity growth was just 0.4 the lowest rate since the 1800s century. The OBR are assuming or perhaps hoping productivity growth returns, the only problem is that they have been hoping for 16 years and it never seems to materialise.
Perhaps the next PM will be different and a new golden age will come. The problem is that if we continue to stagnate, short-term debt will rise faster than expect with high bond yields this creates a debt dynamic where debt interest payments rise as a share of GDP, causing the need for higher taxes to meet interest payments. Combined with structural inflation, this is when things can start to get tricky.
Now the problem with long-term forecasts is that there are so many unknowns. An interesting side point is that the OBR model the impact of AI leading to a lower labour share of the economy. Automation wouldn’t just affect jobs but also hit all the employment based income taxes. You then need to find a way to tax the US tech giants without the US responding with threat of tariffs.
Pension Triple Lock
But, if we look at the OBR projections the real cause of a potential rise in debt, is because of higher spending. This shows how government spending is set to rise on current projections. A good example is the pensioner triple lock. This has become political very popular but look at the comparison in how it affects spending as a share of GDP. The triple lock will see pension spending rise form 5% of GDP to 9% of GDP. but linking to inflation like in the 1980s would see it fall to 3%. This is why it’s such an important choice. It is worth pointing out that these OBR projections assume that means-tested benefits will be linked to only inflation. But look at how this affects the relative value of benefits.
Unemployment benefit would fall from 15% of average earnings to 8% of average earnings. On current trajectory there will huge gap between pension and non-pension benefit. This is an issue if pension age rises but people in late 60s find it hard to work.
Another headache is that defence spending has to rise as a share of GDP. In 2024, the assumption was defence would be 2.5% but now it is 3.5%. You can see how UK spending has evolved in the past century. The post-war decline in defence spending, allow a rise in both social security and health care spending. But, if defence goes back up, it becomes much harder to enable rises elsewhere.
Health care spending is actually one of the biggest growth areas of UK spending, partly because it enjoys broad political support. But future health care spending will have to rise because of ageing population. You can see net fiscal contribution by age, this is why health will have to rise. But it also depends on life-expectancy and health life-expectancy. Unfortunately, there are worrying signs of a decline in healthy life-expectancy, partly covid related but not entirely. In fact, it has been a rise in health conditions amongst young people that have caused an unexpected rise in health related benefits, which is forecast to reach £100bn of GDP.
What to do?
So what should we do about this? Firstly, the sooner minor changes are made to policy the easier it is to stabilise public finances. The longer you leave it the harder and more serious fiscal retrenchment you need. Thirdly, it would be a mistake to meet fiscal budgets by cutting public investment, which Andy Burnham has talked about. We shouldn’t get hung up on HS2’s many failings, many rail projects, such as Elizabeth Line have been much more successful than anticipated. Public investment should depend on rate of return not fiscal targets. Fourthly, it would help massively, if they could be an honest conversation about choices. If you want to maintain triple lock, you must be prepared for tax as a share of GDP to rise to levels you see in France. We can expect a small rise in inheritance tax and Capital gains, but you can’t rely on taxing the rich or printing money, to enable a big rise in pension spending. Also, since 2012, there has been a rise in private pension provision because of auto-enrolment, so if we have more private pensions, do we need to also devote higher share of income to state pension? Also, with electric cars becoming more popular, we are going to lose taxes like petrol tax, with current attempts at taxing electric cars not compensating.
Is the UK doomed? It is important to look beyond the headlines, the UK’s medium term fiscal situation is not in crisis, bond yields are elevated primarily because of inflation, and Bank selling bonds. The projected rise in debt looks scary, but also it can be avoided by changing policy which avoids cumulative changes.
The bigger concern about OBR forecast is that they assume quite high rates of Real GDP per capita growth, that we haven’t achieved since the 2000s.
In past 16 years, UK had the fourth fastest increase in debt compared to other advanced economies in 20 years, It is 45pp above the advanced-economy average and 6pp above the G7 average as of 2025, and UK 10-year yields are the highest in the G7. With all countries seeing a rise in debt, and an ageing population, this means a rise in global debt issuance and more competition, this will be significant for the UK which relies on external buyers of UK debt.
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