What are fiscal rules?
Fiscal rules are restrictions on fiscal policy set by the government to constrain its own decisions on spending and taxes. For example, they might require that the deficit (the difference between government spending and revenues) stays below a certain level. Another explainer looks at the rationale for fiscal rules in more detail and sets out previous rules adopted in the UK.
What are the government’s current fiscal rules and is it on track to meet them?
The government set out new fiscal rules in November 2022, after the previous set was on course to be missed due the economic effects of the cost of living crisis and higher interest rates.
1. Debt should be on course to fall as a share of national income in five years’ time
The government calls this its mandate for fiscal policy: its primary fiscal rule. It requires that debt (excluding the Bank of England) should be forecast to fall as a share of national income between the 4th and 5th years of the forecast period. For the latest forecast, published in November 2023, this meant that the debt-to-GDP ratio had to be forecast to be lower at the end of the 2028/29 financial year than at the end of 2027/28. The government had 0.4% of GDP (£13 billion) of headroom against this target.
2. Public sector borrowing should not exceed 3% of GDP in five years' time
This rule requires that the difference between total government spending and total government revenues (that is, borrowing or the deficit) should be forecast to be less than 3% of GDP in the fifth year of the forecast period.
When the latest forecast was published in November 2023, this meant that a deficit below this level was required in 2027/28. The government had 1.9% of GDP (£61.5bn) of headroom against this target.
3. Some types of welfare spending must remain below a pre-specified cap
This rule provides additional constraints on spending on social security payments for working-age people and children. (Payments to pensioners – most notably the state pension – are explicitly excluded.) Unlike earlier iterations of this rule, it adjusts if changes made to the economic forecast increase expected social security spending (for example, if wages are predicted to be lower or unemployment higher, leading to higher social security payments). This rule therefore effectively limits the extent to which any policy changes can increase social security spending. According to the November 2023 forecast, this target will not be met and the cap will be exceeded by £8.6bn.
Five other measures will also be considered
On top of these three rules, the government’s Charter for Budget Responsibility explicitly states that the government will make fiscal policy by considering five other metrics, although it does not set targets for these.
Three relate to debt servicing:
- The affordability of debt servicing
- The sensitivity of debt servicing to changes in the economy
- The proportion of government debt issuance held overseas
The other two relate to alternative measures of the public sector balance sheet:
- Public Sector Net Financial Liabilities
- Public Sector Net Worth
Do these rules always apply?
The Charter for Budget Responsibility allows the Treasury to temporarily suspend the rules in the event of a “significant negative shock”, though the mandate does not specify what would constitute such a shock so it is at the Treasury’s discretion.
If the rules were temporarily suspended, the chancellor would need to present to parliament, alongside every subsequent budget, a plan for returning the public finances to a position where the rules could be reinstated.
How do these rules differ from recent fiscal rules in the UK?
In many ways these rules are similar to past iterations adopted by this and previous governments. They target debt and a measure of annual borrowing, and do so in a forward-looking way, so the rule always requires that the government be forecast to be on track to meet the target in the future, rather than the rules binding in the current year.
However, the rules differ from previous ones in two important respects.
First, the borrowing rule is unusual in targeting the overall deficit rather than the current deficit (which excludes investment spending). Since 2019, all deficit targets have been on the current rather than total deficit, with a separate limit on investment spending. And this is the first rolling total deficit target adopted in the UK. Rules that focus on the current budget deficit encourage governments to continue to spend on investment that will bring long-term benefits, rather than meeting rules in the short term by cutting investment budgets, which is what previous governments with total deficit rules have tended to do.
Second, the requirement that the targets be met in the fifth year of the forecast is a less binding rule than previous ones. Rolling targets since 2015 have required that the rule be met in the third year of the forecast rather than the fifth. A five-year horizon gives the government more leeway: it can be forecast to run large deficits and have debt rising as a share of GDP for most of the forecast horizon.