Fiscal fantasies reveal deep problems in the UK's fiscal framework

The government is desperately trying to find the cash to announce tax cuts ahead of the election. At the same time, the Labour party has abandoned its long-standing pledge to ramp up investment in the green economy.

Even without these election pressures, budgeting for government has never been harder. Public services are under huge strain, suffering from decades of underinvestment. Growth, and therefore government revenues, are growing extremely slowly at a time where there are unavoidable increases in debt interest costs and calls to provide more funding for defence, investment, healthcare and other pressures related to an ageing population. The impending general election substantially increases the political costs of tough decisions. But tough decisions need to be made.  

That is why we have a fiscal framework, including a set of rules. It is there to help ensure that governments make these difficult trade-offs between the levels of taxation, expenditure and borrowing necessary to achieve their objectives. But it is in dire need of repair.  

While it is easy to blame many of the problems we see on the fiscal rules, an IfG report to be published next week shows that they run much deeper.

There is little chance that either party is on track to meet their fiscal rules

One issue is the government’s “worse than fiction”  ⁴ https://www.civilserviceworld.com/news/article/obr-calling-government-spending-plans-a-fiction-is-generous  spending plans, to which Labour have committed. These are not ‘implausible’ because it is literally impossible to meet them, but because meeting them would require substantial decreases in the quality or quantity of services provided by government which quite obviously neither party are prepared to tell the public they will deliver. because neither has spelled out where the axe will fall.  

The fiscal framework ought not to allow politicians to avoid confronting reality in this way, but it is failing. The government can meet its fiscal rules just by saying that it will, without setting out how. This is because the OBR is required to assess its performance based on stated government policy, regardless of how implausible or vague those statements of policy are. In other areas where we have established independent institutions to monitor government performance, we take a much more comprehensive approach. The Climate Change Committee, for example, won’t just accept government’s claims that it will reach its net zero target: it demands evidence of progress.  

These pencilled in spending plans almost certainly will not be followed through on. Similarly vague plans have been revised up in nine out of ten 10 previous spending reviews (the only exception being the 2010 review).  

To prevent governments from engaging in these kinds of fiction and help ensure that they run policy in a way that is more consistent with long-run fiscal sustainability, the government should reduce the horizon of its rules (to, say, three years rather than five) and commit to a regular cycle of spending reviews. The OBR should also have more freedom and flexibility to call out these practices, and other forms of ‘gaming’ of the rules, in its assessment of government’s fiscal performance.  

A fiscal rule is not a strategy

The OBR’s charter should also be changed to allow it focus on a broader notion of fiscal sustainability (not just compliance with the letter of the rules) as the central plank of its assessment of government policy.  

The challenge for the OBR in doing this is that there is no objective empirical answer to what the optimal fiscal policy is, in the way that there might be for monetary policy. Debt and deficits are not ends in themselves but the means by which governments make trade-offs between outcomes and across time. In that sense fiscal policy is much more about political priorities and objectives than it is about technical calibration.  

Therefore, for the OBR to provide a broader assessment of performance, the government needs to set out a comprehensive fiscal strategy. This should set out how the levers of taxation, expenditure and borrowing should be deployed to achieve the government’s overarching long-term objectives. For example, how much does the government want to invest in infrastructure, and does this need to be financed through taxation, reallocation of spending, or through increases in debt? This should lead to a set of fiscal outcomes consistent with this strategy: these are the government’s fiscal rules. Too often it feels like fiscal rules have become the strategy of both parties, rather than being an output of it.

The fiscal framework needs reform

This change in approach from political leaders is the most important change that needs to take place. It should be accompanied by a set of reforms to the fiscal framework to enable and enforce it.

Government should set out longer-term spending plans on a more regular basis and slow down the pace of fiscal decision-making by having only one fiscal event a year to reduce incentives for gimmickry (Rachel Reeves recently made a welcome commitment to this). It should also reform the OBR’s charter so that it can move away from the unhelpful ‘pass/fail’ nature of its current assessment of the government’s fiscal performance. There should be greater emphasis on the long-term consequences of policy decisions, supported by additional analysis from the OBR and greater emphasis on and development of measures of the public sector’s net worth. And, yes, the rules need reform too: they should bind more quickly than five years hence, they should make a distinction between investment and day-to-day spending, and have sufficient flexibility to allow governments to respond to shocks.  

Neither of the UK’s main political parties has a clear fiscal strategy. Both use a flawed set of loose fiscal rules to fill the vacuum. But a broken framework allows them to meet those rules through fantasies. This nonsensical approach to fiscal policy-making will not enable us to tackle the urgent issues that need addressing in public finances and public services: it’s time for change.