The Treasury’s “fiscal rules” are rather like New Year’s resolutions: many of us make them, but few keep them. Nonetheless, after the spending binge during the pandemic, the Government needs some sort of framework to bring borrowing back under control.
We may not have to wait much longer. The Chancellor is expected to unveil new rules for government borrowing and debt as part of the autumn Budget on Oct 27. The broad principles are likely to be similar to those in place before Covid blew a huge hole in the public finances and caused the legislated “fiscal targets” to be suspended.
In particular, successive governments have adopted some version of the “Golden Rule”, which was first formalised in the UK by Gordon Brown in 1997. This is a commitment to borrow only to invest, rather than to fund day-to-day spending. In other words, the Government should balance the “current budget”.
This makes sense. Day-to-day spending mainly benefits today’s taxpayers and should therefore be paid for with today’s taxes. In contrast, investment should have longer-term benefits, so it is reasonable to take on more debt and pass some of the costs of investment on to future generations.
For what it is worth (perhaps not a lot!), the 2019 Conservative manifesto pledged to follow the Golden Rule.
Rishi Sunak will therefore surely recommit to this principle next month. Indeed, it would be good to see at least one manifesto commitment kept – and this one still commands broad support.
The fallout from the pandemic means it would be unreasonable to expect the Chancellor to balance the current budget any time soon. A promise to stop borrowing for day-to-day spending within three years would be more realistic, but also challenging enough to restore some fiscal discipline.
Thereafter, this could be replaced by a commitment to balance the current budget on average over the economic cycle. This would allow more borrowing in downturns, as long as this is offset by surpluses when the economy is stronger.
The 2019 manifesto also included a promise that public sector net investment would not average more than 3pc of national income (GDP). Combined with the Golden Rule, this should cap overall borrowing at 3pc of GDP as well.
What’s more, assuming normal economic growth and inflation, annual borrowing of 3pc of GDP over the cycle should be low enough to prevent the accumulated stock of debt from rising as a share of national income.
I would probably stop there. Admittedly, the larger the stock of debt, the greater the cost of even a small increase in the interest rates paid on that debt. However, the current level of government debt is not particularly high by international standards, even at 100pc of GDP.
But the Chancellor will probably want to go further, perhaps by setting a target that debt should be falling again as a share of GDP within three to four years.
He might also retain the manifesto commitment to reassess the fiscal plans if debt interest payments reached 6pc of government revenues. This target is now largely redundant, because the Bank of England has refinanced government debt at very low interest rates through its policy of “quantitative easing”. But keeping it might provide a little more reassurance.
Of course, the big question is what all this means for spending – and future taxes.
The Chancellor will clearly be reluctant to announce even more tax hikes next month on top of the substantial increases already in the pipeline. Lest we forget, these include hikes in both corporation tax and income tax (via the freezing of personal allowances and the basic rate limit at 2021-22 levels), to which we can now add the increases in National Insurance Contributions.
The good news is that he should not have to. This is because the Office for Budget Responsibility (OBR) will publish updated economic and fiscal projections alongside the Budget which will be much more optimistic than the numbers on which much of the Treasury’s recent thinking on taxation has been based.
For a start, back in March the OBR was only expecting the UK economy to grow by around 4pc this year. Growth of at least 7pc now looks likely, thanks in a part to the relatively successful rollout of the vaccines.
More importantly, fears of significant long-term scarring to the economy – particularly via a sustained increase in unemployment – look increasingly overdone. This is crucial, because the OBR was suggesting that there would be a permanent “black hole” in the public finances too, which the Treasury might have to fill with more tax hikes.
In reality, a stronger recovery should help to repair the fiscal damage from Covid, reducing both the amount of borrowing, and the burden of debt relative to the size of the economy. This should allow the Chancellor to say he is on track to meet his new fiscal rules too.
It is perhaps a bit too much to hope that this will prompt the Chancellor to cancel the tax increases he has already announced. But he should eventually be in a position to soften their impact, for example, by ending the freeze on the personal allowance earlier than planned (and, by happy coincidence, in good time for the next election).
In short, the autumn Budget could go a long way towards restoring a degree of fiscal credibility – in two ways. First, a reiteration of some sensible fiscal rules would show the Treasury is serious about controlling borrowing and debt.
Second, and at least as importantly, a more upbeat set of economic forecasts should enhance the credibility of these targets, by making it much less likely that taxes will need to rise further to hit them.
This article was first published in the Sunday Telegraph on 18th September 2021