The Chancellor Rishi Sunak made several media appearances over the weekend ahead of Wednesday’s Budget.
He was asked about rules proposed in the Conservative manifesto for managing the public finances and whether he would be sticking to them in the Budget. These fiscal rules also featured alongside the Queen’s speech.
Here we start by looking at why over 90 countries across the world use fiscal rules. We then consider why the Chancellor may be thinking about departing from the rules set out in the manifesto, only four months ago.
Why have fiscal rules?
Fiscal rules guide and constrain how a government manages its finances. Governments adopt them for several reasons:
- To self-impose constraint. Fiscal rules can encourage governments to make difficult decisions about tax and spending, rather than simply borrowing more.
- To enhance transparency. By adopting fiscal rules, governments can broadly show voters how they intend to manage the public finances. Financial markets, which lend money to governments, are another audience for fiscal rules. Governments can use them to show how they plan to manage their financial affairs in a responsible way.
- To manage competing priorities. Fiscal rules give governments something they can point to when dealing with competing spending demands. The rules can help to show that compromise is required. This is particularly relevant for the UK as we are expecting a Spending Review this year, in which the Treasury will haggle with departments over their future budgets.
Why might the Chancellor be tempted to change the manifesto’s rules?
For the fiscal rules to mean anything they should constrain the Chancellor in some way. However, it makes little sense to design rules that prevent the Government from achieving its key priorities.
The manifesto sets out three fiscal rules. These concern investment, debt interest and balancing the current budget. It’s possible the Chancellor will see one of these as being too much of a barrier to the Government’s ambitions.
Investment spending and debt interest
The Government wants an “infrastructure revolution” and is willing to borrow to pay for it. It is easier to do so at a time when its cheap for the Government to borrow.
The fiscal rules proposed in the manifesto shouldn’t be an obstacle to the Government’s infrastructure ambitions.
The manifesto’s investment rule allows the Government to increase investment spending on areas such as infrastructure to 3% of GDP. Government investment hasn’t averaged over 3% of GDP since the late 1970s/early 1980s, when there were more publicly owned industries than now.
The manifesto’s debt interest rule is also not a huge constraint at the moment.
The Government is willing to borrow more to invest as markets are currently lending to them at historically low rates. Under the debt interest rule, if this changes and interest payments rise above 6% of its revenues, the Government will reassess.
If interest rates were to increase but the Government kept borrowing at the same level, then it might be in danger of missing its manifesto pledge on debt. This is to have lower government debt at the end of this Parliament than at the start.
The investment and debt interest rules don’t seem to be a barrier to the priorities of the Government and Chancellor. They allow more to be spent on infrastructure while also being in keeping with the Chancellor’s desire to have “responsible management of our public finances.”
Possible issues revolve around the current budget rule
The manifesto’s final fiscal rule is that the current budget (which excludes investment spending) should be forecast to be in balance in three years’ time. Reaching a balance would mean the Government isn’t borrowing to fund its day-to-day spending.
Day-to-day spending includes areas such as public services and welfare payments. To comply with the fiscal rule day-to-day spending would have to be met from tax revenues.
What is the current budget?
The current budget measures the difference between government current spending – day-to-day spending on running public services, grants and administration – and government revenues from taxes and other sources. The current budget excludes government’s net investment spending.
Several analysts say it will be difficult to meet this rule without increasing taxes.
The Resolution Foundation says the rule may be met in 2022/23 (the current target year) but with little in the way of contingency for dealing with changing circumstances. The Institute for Fiscal Studies think the rule will be missed – it forecasts a small current budget deficit in 2022/23.
Whether the rule is just being met or just being missed there appears to be little room for the Chancellor to increase day-to-day spending on services or cut taxes, without raising money in other ways.
If the Chancellor is thinking about changing the fiscal rules, it seems likely this is the one he will be concerned with. He may think that reaching a current budget balance in three years’ time conflicts too much with the Government’s priorities of having a ‘low-tax economy’ and investing in public services.
What effect could coronavirus have?
There have also been suggestions that the fiscal rules may be revisited in response to the economic uncertainty posed by coronavirus.
There should be enough flexibility in the manifesto’s fiscal rules to deal with any temporary economic shock from the virus. The current budget balance target is rolling, with its target date always being three years in the future. As we’re currently in 2019/20, the target year for having a balanced budget is 2022/23. When we move into 2020/21, the target year will move to 2023/24. This allows the Government to take temporary measures to support individuals and the economy.
Ultimately, the economic effects of coronavirus in the UK are intrinsically linked to the spread of the disease, and the response of authorities, businesses and consumers to it. A case could be made for looking again at the fiscal rules if it is deemed the virus may have a longer lasting economic impact.
Further reading:
Spring Budget 2020: Background briefing, House of Commons Library.
About the author: Matthew Keep is a researcher specialising in the public finances at the House of Commons Library.