As Rachel Reeves faced a backlash over government plans unveiled last week to slash spending to balance the books, the chancellor and Treasury repeatedly argued that difficult decisions were necessary to avoid breaking the fiscal rules she adopted last October.
But what exactly are these constraints, and why does Reeves believe them to be so important? In the build-up to Wednesday’s spring statement, why are many economists urging her to flex or even rewrite them, as chancellors have on several occasions since they were first drafted by Labour nearly three decades ago?
Why does the Treasury have budget rules?
Responsible governments should match day-to-day spending with their income and only borrow to invest. This is the “golden rule” adopted by Gordon Brown in 1997 and contained in the charter and fiscal framework George Osborne adopted when he became chancellor in 2010 in the wake of the 2008 financial crisis.
Osborne provided an extra layer of oversight, telling the Treasury it could no longer mark its own homework. To this end, he created an independent forecaster and auditor – the Office for Budget Responsibility (OBR).
Keir Starmer’s government is following the Brown playbook with a view to telling financial markets and voters the public finances are safe in Labour’s hands, and to avoid a jump in the cost of servicing government debt such as the one that followed Liz Truss’s disastrous mini-budget, which avoided OBR oversight.
What is the mandate?
The charter for budget responsibility “presents the government’s approach to operating fiscal policy and managing sustainable public finances in the long-term interests of the UK”.
Within this broad statement of intent, there is a budget stability rule that forces the chancellor to balance spending with revenue over a five-year horizon. It means the costs of welfare and running services should be met by revenues in the 2029-30 financial year, at which point the government will only borrow to invest.
From next year (2026-27), the rule becomes stricter and the chancellor only has a three-year horizon to meet the balanced-budget target. A balanced budget is defined as a surplus or deficit within a margin of 0.5% of GDP.
In a forecast published to coincide with last October’s budget, the OBR estimated a surplus two years early (in 2027-28) but that the situation would not improve much beyond this point. By 2029-30, the expectation is for a small surplus of £9.9bn on a total budget in excess of £1.3tn.
What are the supplementary rules?
A limit on investment spending is tied to a debt rule. This instructs Reeves to reduce the total amount the UK has borrowed as a proportion of GDP in the last year of the parliament. To allow for greater borrowing to fund investment, this rule has been loosened by changing the definition of debt.
Since the October budget, public debt has been calculated using a metric called public sector net financial liabilities (PSNFL), or net financial debt. According to the OBR forecast, Reeves has carefully crafted government spending over the next five years to meet the mandate, using the PSNFL measure. Debt will be lower in 2029-30 than 2028-29 as a share of GDP.
PSNFL includes all the government debt and assets counted within the standard measure used by previous governments – known as public sector net debt (PSND) – with some add-ons that tend to reduce the net debt figure, including funded public-sector pensions, shares in private companies and the student loan book.
A third rule, little mentioned, aims to limit welfare spending but does not set a target.
What is the role of the Office for Budget Responsibility?
Twice a year, the OBR judges whether the government will meet its fiscal rules. A forecast is combined with an assessment of what the government is likely to have to pay for its debt and what it will receive in taxes. A five-year prediction for each is drafted. OBR officials amalgamate the figures to assess whether the government’s finances are going backwards or staying in the black.
What are the flaws in the current system?
The eight changes to the rules since 2010 indicate the difficulties governments have found meeting them. One criticism is the influence of the OBR’s forecasts, which change as the economic picture develops. Before the last election, the Institute for Government warned: “The UK’s fiscal framework is incentivising bad policy decisions shaped by short-termism and fictional spending plans – and does little to promote fiscal sustainability.” Fixed spending targets tied to a movable forecast were a recipe for trouble, it said.
A second criticism relates to what the National Institute of Economic and Social Research calls a flawed set of rules. Meeting a debt rule is tricky when the cost of debt fluctuates daily. Predicting tax receipts five years ahead based on the likely rate of economic growth makes the task harder. Why, ask many economists, would the Treasury allow small changes in the outlook for debt payments and GDP growth, which can quickly reverse, to trigger short-term cuts in spending?
How might the flaws be overcome?
Many economists want the budget framework to stay, setting out how the Treasury manages the government’s finances sustainably, but for the targets to be junked. It might sound like a way for politicians to escape scrutiny, but the goals are widely disliked. Moreover, there is scepticism that investors or voters want long-term policies to be cut or reworked to meet a temporary shortfall en route to meeting a target.
It’s good to have a “golden rule”, says Professor Iain Begg of the London School of Economics, but basing projections of public spending that are in turn based on forecasts of economic growth and debt costs is “heaping one interpretation on another, which is nuts”.
The Institute for Fiscal Studies is in favour of a target that shows how the government will afford public spending in five years’ time, but says “a slavish adherence to a fiscal target is not sensible”.
