The Burdens of borrowing: Government debt and intergenerational fairness

Why is the government’s debt and borrowing an intergenerational fairness issue? Conor Nakkan, IF researcher, explains

Rising borrowing costs

In recent weeks, the government’s borrowing costs have increased. Yields on UK government bonds, known as gilts, have reached levels not seen in over a decade. The yield on 10-year gilts, recently rose to 4.88%, the highest level since the 2007-08 financial crisis. While the yield on 30-year gilts increased to 5.45%, which is the highest for 27 years. These yields essentially represent the interest rate the government pays on its borrowing.

Why are bond yields rising?

Yields rise when bond prices fall. If the government borrows to fund budget deficits, it increases the supply of bonds. A higher supply tends to lower bond prices, which, in turn, raises yields. The UK is forecast to run persistent budget deficits over the coming years, increasing the supply of gilts. Indeed, the Office for Budget Responsibility (OBR) estimates that the deficit will be £127.5 billion in 2024–25, which is around 4.5% of GDP. These deficits also add to the overall amount of government debt, which is expected to peak at 98.4% of GDP in 2024–25. Although this level of debt is lower than some other economies, it still represents a substantial increase from 35% in 2007.

An international phenomenon?

The recent rise in borrowing costs is not unique to the UK. Global factors, such as expectations of persistent (or rising) inflation, energy price volatility, and geopolitical tensions, have also increased borrowing costs in other major economies such as the United States, Germany, Japan, and France. However, in the UK, these international pressures have been exacerbated by sluggish economic growth and higher borrowing levels following the October 2024 Budget.

Debt interest payments

Why do rising borrowing costs matter? One key reason is their impact on debt interest payments. Put simply, higher borrowing costs mean that the government will need to spend more on servicing its debt. In 2024–25, the OBR expects that the government will spend around £105 billion on debt interest alone. To put this figure into perspective, over the same period, the government is expected to spend around £89 billion on education and £37.5 billion on defence.

Fiscal rules

In the recent October Budget, Chancellor Rachel Reeves unveiled an updated set of fiscal rules. The main rule, known as the stability rule, requires that all day-to-day government spending is fully funded by tax revenues by 2029–30. According to the OBR’s October forecast, the government is currently on track to meet this rule, but only by a slim margin of £9.9 billion – referred to as the government’s ‘fiscal headroom.’

Breaching the fiscal rules

However, a significant rise in debt interest payments could entirely erase this fiscal headroom, putting the government in breach of its own fiscal rule. While the government could always amend its fiscal rules to avoid this issue, Rachel Reeves recently affirmed in Parliament that the government is committed to adhering to these rules, stating, “we will meet them at all times.” So, given that the current fiscal rules are here to stay (for now at least), what should the government do if rising borrowing costs wipe out their fiscal headroom? Raise taxes? Cut spending? In evaluating each of these options, we can consider the trade-offs from the perspective of intergenerational fairness.

Raising taxes

To meet their fiscal rules, the government could raise taxes. The real question, however, is which taxes should be raised and by how much? In the Intergenerational Foundation’s (IF) commentary on the tax measures in the October Budget, we raised concerns about the potential impacts of the changes to employers’ National Insurance Contributions (NICs). While this was by far the largest revenue raising measure in the Budget, we argued that it may disproportionately impact lower-paid and younger workers. Any attempts to further increase employers NICs would likely place additional burdens on workers (and businesses) who can least afford them.

A far better approach, from the perspective of intergenerational fairness, would be to move towards equalising the taxation of earned and unearned income. Admittedly, the government made some modest steps in this direction in the October budget, by increasing rates of Capital Gains Tax (CGT). However, CGT rates still remain considerably lower than those on earned income. Previous research from IF suggested that abolishing the system of NICs and incorporating the equivalent rates into a Unified Income Tax Schedule, alongside equalising the tax treatment on all forms of income, could generate an additional £30 billion of revenue each year. This would be more than sufficient to comfortably restore the government’s fiscal headroom.

Reducing spending

Alternatively, the government could cut spending. Again, the question arises, what areas of government spending could be cut and by how much? At a time when public services are already underfunded and many households are struggling to make ends meet, it seems difficult to identify significant spending cuts that wouldn’t impose further undue hardships. For this reason, increasing taxes would clearly be preferable than cutting spending and returning to austerity.

However, if spending cuts had to be made, there are some areas that would be fairer when considered from an intergenerational perspective. As previous IF research has highlighted, overall increases in government spending over the past two decades have been heavily skewed towards older generations, partially reflecting the introduction of the Triple Lock on State Pensions in 2010. As such, one area the government could examine is reforming the Triple Lock on the State Pension, which increased by more than 20 per cent between 2022 and 2024. In April 2025, it will increase by another 4.1 percent, which is well above inflation. This will create an additional £31 billion in pension liabilities by 2030. Meanwhile, working-age benefits will increase by only 1.7 per cent.

Looking longer-term

These options are available to the government to deal with rising borrowing costs in the short-to-medium term. However, it is important not to lose sight of the longer-term implications of ongoing budget deficits and rising government debt. Put simply, today’s borrowing adds to the debt burden that younger and future generations will inherit. If borrowing is used to fund investments that expand the productive capacity of the economy, younger and future generations will be better off. However, such benefits will not accrue to younger and future generations if borrowing is used to finance growing expenditure on pensions and other age-related expenses. Rather, under these circumstances, younger and future generations will only bear the burdens of borrowing.

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