Fiscal rules in the UK since 1997 

What are fiscal rules and why do governments set them? 

Fiscal rules are restrictions on fiscal policy set by a government to constrain its own decisions on spending and taxes. For example, they might require that the deficit stays below a certain level.

Without rules, fiscal policy is known to suffer from ‘deficit bias’: politicians face an incentive to borrow to spend more in the short term, and leave future generations (and future politicians) to deal with the consequences. Governments therefore use fiscal rules as a way to commit themselves to responsible management of the public finances and so increase confidence among taxpayers and investors. Since 1990 almost all OECD countries have adopted some sort of fiscal rule ^undefined International Monetary Fund, Fiscal Rules Dataset 1985 - 2021, www.imf.org/external/datamapper/fiscalrules/map/map.htm

What fiscal rules have UK governments adopted? 

The first fiscal rules in the UK were adopted by the New Labour government in 1997. Those rules applied for over a decade, but since then the UK’s rules have changed more regularly. The current iteration of fiscal rules (set in November 2022) is the ninth set the UK has had. These nine sets of rules between them comprised 26 different rules in total, summarised in the table below.

Table: Fiscal rules in the UK since 1997, and whether they were missed (X) or met (✓)

_{Note: A rule is considered met if the conditions set out by the rule are met, even if the rule was no longer in force by the time compliance could be evaluated. A rule is considered missed if the conditions are not met or, for rolling targets, if the government was not on track to comply with the rule when it was abandoned.}

What is being targeted? 

All the sets of rules bear similarities. In each, there were rules constraining borrowing and debt. However, these rules have also differed in important ways.

Some have targeted the overall deficit (that is, the difference between total spending and total revenues), while others have targeted the current deficit (the difference between day-to-day spending and total revenues). Rules that target the overall deficit constrain investment spending, while the targets for the current deficit do not.

The different debt rules adopted by successive governments have been more similar to one another, with most since 2009 stipulating that debt as a share of GDP should fall between two dates. However, these 'debt falling' rules are different from the initial set of rules that required that debt should remain below a pre-specified ceiling (of 40% of GDP).

Some sets of rules have also constrained other totals, including welfare spending, debt interest spending and investment spending. 

When does the target need to be met? 

One of the most important differences between the rules is whether they have been forward-looking or ‘rolling’ targets, or whether they were ‘static’, applying in a particular year. A rolling target requires that the government be on course to meet a rule a certain number of years ahead based on the latest forecasts, with this date rolling forwards as time moves on. This means that, if the near-term forecast changes, the government does not immediately need to change policy to meet the rule. In contrast, static rules specify one particular year when the rule must be met. If the forecast changes, it can require the government to take rapid action to remain on course to meet the rule.

Rolling targets provide additional flexibility to respond to unanticipated economic shocks because they enable the government to accommodate shocks in the short term before getting back on track in the medium term. However, these rules are less constraining and the spirit of the rules is more easily abused by governments, for example by consistently announcing ‘temporary’ short-term spending giveaways or announcing longer-term tax increases that never emerge.

In recent times, the UK government has shown a clear preference for rolling targets. Between 2019 and 2022, the current deficit targets announced were three-year rolling targets, while the current total deficit target is a five-year rolling target. The debt rule set in November 2022 is also a rolling, forward-looking rule.

Have previous fiscal rules been broken? 

In the first 10 years of the UK having fiscal rules, neither rule changed and neither was broken – although the way the ‘golden rule’ (that government would only borrow to invest, not manage day-to-day spending) was assessed was changed when it appeared on course to be missed. ^undefined International Monetary Fund, Fiscal Rules Dataset 1985 - 2021, www.imf.org/external/datamapper/fiscalrules/map/map.htm  However, the 2008 financial crisis changed this, leading to those first rules being abandoned.  

Since then, rules have tended to have a much shorter shelf life. All the sets of rules that have existed since 2008 have been abandoned because at least one could not be met – only eight of the 22 rules before the current set were met or on course to be met when they were abandoned. Of these, only three were the primary rules that constrained deficits or debt. Other rules – on investment and debt interest – have tended to prove easier to meet.

None of the deficit rules that directly targeted a particular date were met. These types of rules are more difficult to meet, as they are vulnerable to short-term economic shocks. But only two of the four rolling deficit targets have been met too, despite the additional flexibility they afford.

It is a good idea for governments to have the flexibility to respond appropriately to an economic downturn – for example by providing a demand stimulus through spending increases or tax cuts – than to slavishly follow a fiscal rule. The government was right, for example, in March 2020 when the UK entered its first lockdown to suspend its fiscal rules rather than try to prevent the deficit or debt rising, which would have had a far more catastrophic long-term effect on the UK economy.

However, repeatedly abandoning fiscal rules risks undermining their credibility. One approach to reducing this perception of politicians ‘moving the goalposts’ is to define in advance sets of circumstances in which the rules will be suspended. Some of the UK’s sets of fiscal rules have had explicit ‘knock out’ clauses of this sort. For example, the rules in place in 2015 would no longer apply if the Office for Budget Responsibility (OBR) assessed that the UK economy experienced a “significant negative shock”. The current set of fiscal rules also allow for the chancellor to suspend in the event of a “significant negative shock”, although it is at the Treasury’s discretion to define what constitutes such a shock.

The economic circumstances of the last two decades undoubtedly contributed to the high rate of fiscal rule failure. Growth has been consistently weaker than forecasts have expected, resulting in  lower tax revenues – something exacerbated by the twin shocks of the financial crisis and Covid. This stands in contrast to the decade 1997–2007 when economic conditions were benign.

Are fiscal rules still useful even though they are often broken? 

Even if fiscal rules are abandoned, they can still play a useful role. They provide a useful commitment mechanism for politicians, especially when the economic outlook is stable. And they provide a clear statement of fiscal policy objectives, which allows independent observers – in particular, the OBR – to assess whether the government’s policy plans are consistent with its own stated objectives. The role of fiscal rules in maintaining politicians’ fiscal discipline was apparent during September 2022, when a perceived abandonment of the fiscal framework by prime minister Liz Truss and chancellor Kwasi Kwarteng contributed to a loss of confidence in the fiscal competence of the government.