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Breaking the rules

Chancellor Rishi Sunak might break the government's own fiscal rules next week. This is good, because the rules are daft
March 5, 2020

A mixed metaphor is often a sign of sloppy thinking. So it is with former chancellor Sajid Javid’s description last week of one of his fiscal rules as “the litmus test that was rightly set in stone”. Such horrible phrasing warns us that the case for such rules is in fact questionable.

This matters because his successor, Rishi Sunak, faces a problem in next week’s Budget. The Institute for Fiscal Studies (ISF) has warned that, on current policy, he is unlikely to meet one of these rules – for there to be a balance on the current account budget by the middle of the parliament. This means he must either raise taxes; or abandon hopes of increased public spending and hence of 'levelling up' the regions; or ditch the rule.

There is, in fact, a case for doing the latter. Given the danger that the coronavirus might seriously depress the world economy, now is not the time for spending cuts or tax rises in bad times, which would worsen the downturn.

Also, the rule makes an undue fetish of the distinction between current spending and capital spending. An effective increase in spending on education might well do more to raise future incomes than a vanity infrastructure boondoggle. So why constrain one more than the other? There is a debate within the Treasury about whether to reclassify some education and health spending as investment. There’s a logic to this.

And fiscal rules – like others – can produce perverse incentives. When he was chancellor, Gordon Brown used private finance initiatives to stay within his rules, but these have ended up costing taxpayers more than conventional spending and borrowing would have.

What’s more, there’s something daft about fiscal rules. It’s an odd rule that can be broken without sanction: Julian Jessop, an independent economist, points out that 10 of the 12 fiscal rules adopted between 1997 and 2016 were subsequently missed or abandoned. And it is an even odder one that can be introduced or abandoned unilaterally by the man who will be bound by it – the IFS estimates that there have now been 16 fiscal targets announced over the past decade.

So, why not simply abandon the whole charade of fiscal rules?

It’s because there is a logic for them. Without them, there would be no constraint other than inflation upon government borrowing: the forces of secular stagnation, the global savings glut and shortage of safe assets mean that gilt yields have fallen for 25 years despite a big rise in government debt. And yet there is a danger that an ageing population – and perhaps eventually higher borrowing costs – will require increases in public spending in coming years. Which means we need to preserve fiscal space today. Hence perhaps a need for some rules.

But which ones? The Resolution Foundation has proposed two: a limit of 10 per cent on the proportion of public spending spent on debt servicing (it is currently just over 5 per cent); and a target of increasing government net worth, so assets rise faster than liabilities.

Neither of these rules is tightly binding now. Which is a good thing, because with the economy still weak, inflation low and interest rates near zero, we need a fiscal stimulus. And yet both put a ceiling on borrowing eventually.

Whatever their merits, though, even these rules could be broken or altered by the chancellor, with little sanction. In this sense, fiscal rules are not really rules at all, but merely intentions.