Since the 2019 general election there has been much discussion about the Government’s ‘fiscal rules’. But what are these rules, why do they matter and what changes might be made to them?
What are fiscal rules?
- The government budget deficit (or surplus), which is the difference between public sector income and spending in any given year.
- The national debt, which is the total stock of borrowing resulting from past deficits.
Fiscal rules aim to keep public spending and the national debt sustainable.
In fiscal rules, the deficit is sometimes measured on a ‘structural’ basis, which removes the effect of the current state of the economy. It adjusts for the fact that deficits tend naturally to be larger when the economy is weaker and smaller when the economy is stronger. Or, the deficit might be measured not in one year but on average over an economic cycle.
A distinction may also be made between ‘current’ and ‘overall’ budget balances. The current budget balance compares income only to day-to-day spending, allowing borrowing for investments. Overall budget balance requires both day-to-day spending and investment to be financed from this year’s income.
Fiscal rules in the UK
The UK’s first fiscal rules were introduced by the 1997 Labour Government. These required:
- The current budget to be balanced on average over an economic cycle; and
- The national debt to be less than 40% of national income.
These rules were suspended during the financial crisis and replaced with a target to reduce the cyclically-adjusted current budget deficit “once the economy emerges from the downturn”, ultimately returning to balance.
There have since been several further changes to the fiscal rules. Other targets have included:
- Government borrowing as a percentage of gross domestic product (GDP) to fall in each year 2010/11 to 2015/16;
- Government borrowing to halve between 2009/10 and 2013/14; and
- The national debt to fall between the ends of the financial years 2014/15 and 2015/16.
- The structural current budget to be in balance or surplus at the end of a rolling, five-year forecast horizon; and
- The national debt as a share of GDP to be falling in 2015/16.
- A budget surplus to be achieved by 2019/20 and each year thereafter in “normal times”; and
- The national debt to fall each year.
- The structural deficit to be less than 2% of GDP by 2020/21;
- The national debt to be falling by the same date; and
- The budget to be in balance “as soon as possible” in the following parliament (then expected to be 2020 to 2025).
There have also been caps on specified elements of welfare spending since the 2014 budget.
The new government’s approach
- The current budget to be in balance by “no later than the third year of the forecast period”. This is a rolling target, meaning that current fiscal policy must be set so the Office for Budget Responsibility’s forecast at any time, taking into account this policy, must show a balance or surplus in the third year of that forecast;
- Public sector investment to average no more than 3% of GDP; and
- If debt interest payments exceed 6% of revenue, the Government will reassess its fiscal plans.
The Institute for Government (IFG) commented that these represented a “far looser approach” than the targets set by previous governments. It said they allowed higher borrowing for the sake of investment. However, the IFG saw “little room for manoeuvre in the medium term to increase day-to-day spending”.
The Institute for Fiscal Studies (IFS) criticised previous UK fiscal rules. For example, it said that of the twelve rules put forward between 1997 and 2016, ten had been broken or abandoned. It concluded the “UK has not been very successful in setting out fiscal rules that make a lot of sense economically and that politicians have then managed to keep to”. The Financial Times also argued that the frequent rewriting of fiscal rules is “no way to run an economy” and suggested that a commission be set up to review them.
The IFG welcomed the idea of a rule (as contained in the Queen’s Speech) to limit the cost of interest paid on the national debt, rather than the level of debt itself.
The new Government’s fiscal rules are likely to be set out in its first budget on 11 March 2020. There have been discussions that the rules actually imposed might be looser again than those set out in the manifesto and Queen’s Speech. The Financial Times considered ways in which this might be achieved, such as by reclassifying some current spending as investment or by scrapping fiscal rules altogether.
In its look ahead to the budget, the IFS said that, based on existing policies, “it is not clear that the manifesto pledge to target current budget balance three years out would be met”. If the target was abandoned, the IFS cautioned, this would “undermine any credibility attached to fiscal targets set by this government”. It recommended that any additional current spending set out in the budget should be financed by tax increases.
- Paul Johnson, ‘More Spending Means More Taxes, No Matter What the Budget Holds’, Times (£), 17 February 2020
- House of Commons Library, The Office for Budget Responsibility and Charter for Budget Responsibility, 20 December 2019
- House of Lords Library, Sustainability of the Public Finances: A Long-Run Perspective, 29 March 2018