Fiscal rules must not follow the chancellor out the door

A government with a working parliamentary majority of 87 might be expected to be largely free in its choices. However, Boris Johnson’s first budget is likely to come up against constraints that the government has imposed on itself. The government’s own fiscal rules (proposed and supported by Sajid Javid, the now former chancellor) – specifically, that tax revenues should cover day-to-day spending – limit the scope to increase spending on public services.

The rules are reported to have caused tension between the Treasury and No.10, with the PM’s office wanting to announce policies that are incompatible with them. With Javid gone, Boris Johnson might be tempted to ignore the rules and press ahead with ambitious spending pledges.

But there are good reasons to have, and follow, fiscal rules. The prime minister must resist the temptation to ignore these. Despite the chancellor’s resignation, his fiscal rules should stay in place.

Well-designed fiscal rules help maintain sustainable policy

Fiscal rules are not perfect and do not guarantee good fiscal policy. They are blunt instruments that are open to manipulation, and will not always encourage appropriate fiscal policy. For example, during the 2007/08 financial crisis the UK’s fiscal rules were – rightly – abandoned to allow for a fiscal stimulus.

But well-designed fiscal rules can provide an important signal of the government’s plans and are a key part of responsible fiscal management. They can make explicit the trade-offs in a government’s fiscal policy and offer the chancellor some defence against inevitable pressure from special interest groups and cabinet colleagues – who will always call for more spending or lower taxes on their preferred areas.

Governments like spending money and reducing the tax burden on voters. Borrowing is an attractive way to square this circle but, naturally, comes with a cost – adding to the national debt, and placing a burden on future governments. If debt becomes too high, the government risks losing market confidence, or at least being unable to increase borrowing to support the economy in the event of an economic crisis. Well-designed fiscal rules help guard against these risks.

The current rules are looser than the ones they replaced – but still constrain the government

Under Philip Hammond’s chancellorship, the government’s overarching fiscal objective was to eliminate the deficit by the mid-2020s. The government has never been on track to achieve this and, given current low interest rates, many economists have argued that targeting no deficit at all was excessively austere.

The government’s primary fiscal rule, as introduced by Javid in November 2019, now requires that the current budget be in balance – that is, that revenues cover all day-to-day spending rather than all spending, as the previous objective required.

A change in the accounting treatment of student loans and increases in spending on public services announced in last year’s spending round mean this headroom has already been used. While the new rules allow for increases in investment spending, they limit the government’s ability to increase day-to-day spending. This will make it hard to deliver the “world class public services" promised in the Conservative’s 2019 election manifesto.

Fiscal rules offer the Treasury some protection in the spending review

This year’s spending review will allocate money for the administration and delivery of public services over the next few years. As every department fights for a bigger budget, the Treasury must trade off competing claims and resist calls for preferential treatment.

And, when it does, it can point to the fiscal rules – as it did a fortnight ago when it was reported that all departments had been asked to cut their budgets by up to 5%. Conducting a spending review untethered by any fiscal rules would make the process much messier.

The Treasury is right to stick to its fiscal rules. Johnson might well be tempted to use the chancellor’s resignation as an excuse to ‘get around’ the rules, or to force more of his agenda through. This would be irresponsible. Ignoring the rules so soon after they were announced, and without a clear justification, would be a mistake.