How Rachel Reeves Could Change The Fiscal Rules
There is growing expectation that Rachel Reeves will alter the fiscal rules in her first budget. (Alamy)
5 min read
There is speculation Chancellor Rachel Reeves is exploring changing the fiscal rules to give the new Labour Government more space to borrow and spend money.
Suggestions that Reeves could alter the rules comes ahead of her delivering the Autumn Budget on 30 October — the Keir Starmer Government's first fiscal event since entering office.
Reeves and Starmer have both repeatedly stressed that they will need to make "difficult" decisions at the end of this month to repair the nation's finances and fill what they describe as a "black hole" left by the previous Conservative government.
However, at the same time Labour is under growing pressure to put more money into public services and invest in the country after the party's election-winning campaign promised "change".
What are fiscal rules?
Fiscal rules are imposed upon a government by itself. They set out constraints on how much a government can borrow and spend.
"In general, there's a bit of criticism around changing fiscal rules too much," Cara Pacitti, senior economist at the Resolution Foundation, told PoliticsHome.
"We've seen quite a lot of sets of fiscal rules in the past few years, but it's probably expected that a new government would want to set their own set of fiscal rules to reflect their fiscal priorities and their new stance for fiscal policies."
During the General Election campaign, Labour committed to the previous Tory government's fiscal rules of having debt falling as a percentage of gross domestic product (GDP) within five years, which would mean limiting departmental spend increases to one per cent.
Labour took this approach at least partly because a major part of its election strategy was to convince undecided voters that it can be trusted with the economy.
However, economists warned both Labour and the Tories this would mean implausible, real-terms cuts in parts of the public sector like prisons, courts and local government.
How could the rules be changed?
The most likely way Labour could change the fiscal rules is to focus on the money the Government is making from borrowing to invest, rather than focusing on the debt to GDP ratio — with day to day spending excluded from those plans.
This would see the fiscal focus shift to ensuring the value of the assets is growing, rather than focusing on having debt falling as a proportion of GDP.
Chaitanya Kumar, Head of Economic and Environmental Policy at the New Economics Foundation (NEF), described this potential new approach as "changing the debt rule and swapping it with a 'net worth' rule".
Pacitti told PoliticsHome it would mean moving to "different metrics of debt".
What would the benefits be?
By changing the fiscal rules in this way, Labour could free up billions of pounds in borrowing for capital spending on infrastructure.
"That's probably why the Government wants to change their rules, because they want to do some borrowing to invest — which a lot of economists are quite positive about," said Pacitti.
"When you are borrowing, you're creating more debt to pay off. But you're also doing that to create long term assets that should hopefully benefit the economy."
Think tanks like the NEF support the idea if it enables the Government to take borrowing off the Treasury's balance sheet.
"We really hope she [Reeves] bites the bullet and does the right thing on this front, and all that borrowing will be off balance sheet, which means they won't add to government debt, ultimately," said Kumar.
Taking this approach could have the poticial benefit of pleasing Labour ministers and MPs who fear the Government has been too gloomy since entering office in July and needs a more positive message for the public.
What about the risks?
While changing the fiscal rules to a 'net worth' approach may enable the Starmer Government to borrow billions and stay within their fiscal rules, it is not without risks.
"If you think about a transport project that allows people to commute further distances, or creating more digital infrastructure, or providing more energy security, those things can provide economic benefits," said Ben Zaranko of the Institute for Fiscal Studies (IFS).
"But not all investment is good for growth.
"Building a new aircraft carrier may well be good for achieving our defense objectives, but it wouldn't necessarily boost growth, it wouldn't expand our productive capacity.
"Just because something's investment doesn't make it necessarily something that's going to boost growth and pay for itself."
Zaranko also said borrowing to invest could contribute to inflation, and that there are questions over whether the UK has the work force needed to deliver major investments.
"There'd be a lot of questions about whether we could spend that much effectively, whether we have enough projects ready to go, whether the construction sector could absorb that much, whether we have enough construction workers and project managers, and whether we have enough materials," said Zaranko.
The IFS economist also said it also wouldn't solve other issues facing ministers like welfare spending or pay deals for public sector workers.
"Changing that rule wouldn't alter the challenge when it comes to funding public sector pay and public services and social security, all of that would still remain," said Zaranko.
NEF's Kumar also said there were challenges associated with changing the fiscal rules.
"How do you value a road? A hospital? People will challenge that immediately," said Kumar.
"There's a risk of overvaluation, or risk of undervaluation... what gives us the legitimacy to value something in a certain way? And that's the problem."
There is also a political risk in that the Conservatives would likely accuse Labour of going back on commitments it made during the General Election campaign.
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