Money Matters
7 min read
Seven months on from the Liz Truss fiasco, there are growing calls for the UK to scrap its fiscal rules. Would that be a good idea? Tom Sasse reports.
“And I have another measure, Mr Speaker…” Kwasi Kwarteng said hoarsely, 22 minutes into his “mini-Budget” speech. He had already announced a huge package of energy support, cancelled a rise in national insurance, cancelled a rise in corporation tax, cut stamp duty and abolished the cap on bankers’ bonuses. He wasn’t done. He had the basic and top rates of income tax in his sights. All told, it was the biggest package of tax cuts in 50 years. We all know what happened next.
Yet the core of the Truss government’s implosion was not so much any single measure, but a heedless approach to the framework that governs fiscal policy in Britain. Kwarteng had prevented the Office for Budget Responsibility (OBR) from publishing the forecast it had produced, which would have (unflatteringly) judged his measures against the government’s stated targets.
The chancellor made not a “semblance of effort to make the public finance numbers add up”, said Paul Johnson of the IFS. (Later analysis showed they didn’t.) A week on a humiliating meeting was scheduled with the OBR’s head, Richard Hughes. One official joked it was like “trying to read the manual after you’d broken the thing”.
That manual remains the subject of debate, however. Trussonomics may have been firmly discredited. But a growing chorus of thinkers – on the right and the left – argue that by encouraging short-termism, gaming and perverse decisions, the UK’s fiscal rules are holding the country back.
Useful discipline
While fiscal rules may sometimes appear to have acquired the status of natural laws, they are a relatively modern invention.
Gordon Brown established the first, so-called “golden rule” in his 1997 budget as a way of establishing Labour’s fiscal credibility. It said that over the economic cycle the government would only borrow to invest and not to fund day-to-day spending. He also pledged that debt must average no more than 40 per cent of GDP.
Those rules stayed in place until 2008 and were broadly stuck with. There have since been eight different sets of rules, with chancellors often tweaking them upon taking office, or when circumstances (or poor management) mean they risk being breached. Typically, there is a rule targeting the deficit and a rule targeting debt, with either fixed or rolling time periods.
Some economists argue that we don’t need these rules at all, and should be less concerned about debt. Most think having some fiscal rules – or at least a framework – provides important discipline, and gives both bondholders and taxpayers transparency about the government’s objectives.
“Discipline is helpful in politics. Imagine the chaos without these parameters,” says Poppy Trowbridge, who advised Phillip Hammond when he was chancellor. Now that we have rules, markets may also be suspicious of any attempt to ditch them (or pay them only lip service, as Kwarteng discovered).
But that does not mean that the current approach is working.
A short-term approach
After the budget in March Lord O’Neill, a former Conservative Treasury minister, criticised “the framework government has imposed on itself” for holding back vital investments. The decision to target debt falling in five years’ time without differentiating between day-to-day spending and investment (as most previous rules have) was particularly problematic, he said.
In an op-ed in the Financial Times earlier this month, former deputy governor of the Bank of England Andy Haldane agreed. Rather than “exerting useful fiscal discipline”, he argued, the UK’s fiscal rules were increasingly “constraining investment and growth”.
Several decisions have attracted particular ire. Many economists and tax experts welcomed the introduction of “full expensing” – a policy that allows firms to deduct investments in plant and machinery from tax. To meet his five-year debt target Chancellor Jeremy Hunt had to limit the measure to three years, which wiped out much of the benefit.
Discipline is helpful in politics. Imagine the chaos without these parameters
The same calculation appeared to be behind the decision to delay construction of the Birmingham-Crewe leg of HS2 by two years – pushing the investment beyond the debt target but further chipping away at the scheme’s benefits.
Good rules, bad rules
“There is no one right rule,” says Tom Pope, deputy chief economist at the Institute for Government. Choosing any rule, as Goodhart’s law says, will produce distortions. But some appear worse than others.
Having a rule that targets debt falling on a rolling five-year horizon, as Hunt does, creates especially acute incentives towards short-termism. It means we can perpetually do things for the next three years. That is a problem when the policies that would make a difference to growth – from business investment to infrastructure – rely on a more stable, long-term approach.
The ability to distinguish spending that might lead to economic returns is important. But that is not as easy as it sounds: as former chief secretary David Gauke has pointed out, “an effective public health campaign (current spending) may do more long-term good than building a new hospital (capital spending)”.
When the binding rule focuses on debt, it can encourage egregious fiddling of the books. One example was the decision to sell off the student loan book; the vagaries of the national accounts meant that even selling that asset for less than it was worth improved the government's preferred debt measure.
Bad behaviour
A big part of the problem is not so much the rules, but the behaviour they produce. Politicians and officials have become increasingly deft at gaming them (as an early adopter of fiscal rules, the UK is now a world leader in their manipulation).
One example is what Harriett Baldwin, chair of the Treasury select committee, has taken to calling the “fuel duty fiction”. The OBR has to take the government’s stated intentions at face value. This means that when chancellors say that, despite having frozen fuel duty since 2010, next year they really will increase it, that is what the OBR must score. (The chancellor gets the bonus of an annual charade that shows they’re on the side of motorists.)
A second is making promises about the path of public spending over the medium-term that are clearly unrealistic – only to change them as a spending review approaches. A third, newer gambit is to promise to do things “when resources allow” – as with the government’s aspiration to raise defence spending to 2.5 per cent of GDP – in the hope of getting credit for unfunded announcements.
The amount of “headroom” chancellors leave has shrunk over time. In the latest budget Hunt achieved his target for 2027-28 with just £6.5bn to spare, around half a percent of total spending. Sailing so close to the wind can force particularly damaging adjustments.
“We’ve got into this culture of focussing on the letter of the rule and all the attention goes on getting just fractionally on the right side of them, which isn’t really the point,” says Pope.
Good news and bad news are treated asymmetrically. “Every time the forecast improves slightly, the discussion immediately becomes ‘oh great, we’ve got a £20bn war chest, which tax should we cut?’” says Ben Zaranko of the IFS.
Changing the rules
If it would be unwise to scrap fiscal rules altogether, then there are plenty of ideas around for how their use could be improved.
The OBR has become bolder in calling out gaming. Its latest assessment included a scenario in which fuel duty remains frozen, contrary to government’s “stated, but rarely implemented” intention. Forcing government to be more transparent about the evidence behind spending decisions, and adapting the OBR’s remit, could help lead to a better and more honest conversation. Less theatre and more candour would be a good aim for Budget day.
More ambitiously, Haldane has argued for a more sophisticated approach factoring in net worth, which better captures the positive impact of investments that spur growth, but also take account of natural assets like clean air and water. Many agree this is important, though there are questions about how to do it in practice.
Little of this discussion seems yet to have filtered down into either of the main parties. That may be the result of inevitable sensitivity around claims to fiscal prudence at election time. Yet if politicians are serious about tackling the long-term problems the country faces, they will need to start thinking about the rules of the game.
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