25 November 2019

While the winner of the next election will adopt a looser fiscal stance than recent governments, Thomas Pope says that any increases in capital spending must be carefully managed.

Labour and the Conservatives have announced their fiscal rules – the shackles which constrain their tax and spend policies – and the mantra of 'balancing the books' is nowhere to be seen.

Both parties now favour a far looser approach than previous governments. However, removing the fiscal straitjacket brings risks as well as opportunities. 

Both parties would follow a much looser policy than George Osborne or Philip Hammond

In March 2016, then Chancellor George Osborne’s main fiscal rule was to eliminate the deficit by 2019/20. Under Philip Hammond, the target moved to 2025. In contrast, the new rules set out by the chancellor, Sajid Javid, and the shadow chancellor, John McDonnell, make clear that borrowing is likely to be much higher whichever party forms the next government.

Neither party has proposed a fiscal rule directly governing borrowing. Instead, both plan to ensure that tax revenues cover day-to-day spending but also permit borrowing for investment. Last year, net investment was almost £50bn (or 2.2% of national income). Even before further investment proposed by Labour and the Conservatives are factored in, we calculate that the new rules would permit the government to borrow more annually than the average for each year between 1948 and 2007, the start of the financial crisis.

Though the current budget was already in balance last year (with a surplus of £5bn in 2018/19), neither party’s rule would require them to maintain that balance in the short term. Instead, the rules are rolling, forward-looking targets requiring a balanced current budget to be forecast in three (Conservative) or five (Labour) years. This would allow a new government to borrow more and increase the current budget deficit (with extra day-to-day spending commitments or tax cuts). 

A new government can’t easily ‘turn on the taps’ for public services

Many public services are under strain after an unprecedented spending squeeze since 2010. Though both parties’ frameworks are far looser than the one they would replace, they do not end difficult fiscal decisions. Both have pledged to spend more on public services, but there is little room for manoeuvre in the medium term to increase day-to-day spending on, say, hospitals, police or social care – and stay within the fiscal rules – without further tax increases.

Labour’s manifesto does address some of the concerns highlighted in our Performance Tracker, produced in partnership with CIPFA, and sets out plans for £83bn of tax increases to match its spending promises. But the party may struggle to raise this figure, not least as it relies on substantial sums being raised from difficult-to-implement measures on multinational tax and financial transactions.  

New fiscal rules allow for a step-change in investment spending, but money must be spent well              

The new rules would allow the next government to drastically ramp up spending on investment in capital projects. The Conservatives could borrow up to 3% of national income (0.8%, or £17bn, more than last year); Labour plans to borrow up to 4.5%. And if the benefits of investment will be felt by future generations, then it is reasonable to ask those generations to pay for it out of future tax revenues. The argument is even stronger when – as has been the case for the past decade – interest rates are low: when projects can be financed cheaply, they need a lower return to exceed the cost of financing. 

It is also welcome that both parties have adopted a rule that limits debt-interest spending (to 6% and 10% of revenues for the Conservatives and Labour, respectively) rather than simply limiting the level of debt. This has the dual benefit of allowing more investment when the cost of borrowing is cheap and avoiding the problems of debt targets, which have proved too easy for chancellors to ‘game’ in the past.

If spent well, more investment will provide genuine benefits to the UK’s economy in the longer-term and help address its dismal productivity growth. The challenge is to spend this money well. A rapid increase in investment spending risks the money being spent on projects that can be mobilised quickest rather than those with the highest return. On the other hand, the government may struggle to spend the money at all.

This election marks a clear turning point in the UK’s fiscal stance. After a decade of austerity, ambitions to ‘balance the books’ have now been comprehensively abandoned. This does not mean a free-for-all for public services, but it is likely to mean a radical change in public investment. This is an opportunity to address the country’s infrastructure needs and address long-term weaknesses in the economy. But while the fiscal rules have been eased, fiscal decisions won’t become any easier.