Whoever triumphs on 12th December will play by different fiscal rules

Whatever the result on 12^th December, the next government will adhere to a very different set of fiscal rules from the ones that have applied since 2015. Since the Conservatives won a majority in the election that year, the government has been committed—in theory at least—to eliminating borrowing altogether. But that pledge will be ditched after the forthcoming election—whoever wins—and replaced by rules that will allow more borrowing for investment, particularly when interest rates are low. On the whole, this could make for a positive change but will not eliminate all the problems and scope for gaming that accompanied previous fiscal rules.

Both the Conservatives and Labour have pledged to ensure that tax revenues match day-to-day public spending but have signalled they want more scope for borrowing to invest. Labour’s commitment to balance the current budget in five years’ time is the same pledge the party made at the last election. But the Conservatives’ proposed rule—ditching their commitment to eliminating borrowing and instead promising to balance the current budget in three years’ time—is new. Since government policy has never actually been consistent with eliminating borrowing, the Conservatives’ rule change is a welcome realignment of the formal targets with the reality of policy.

The decision by both parties to allow greater scope for borrowing to invest is in line with growing agreement among academic economists that governments should take advantage of currently low interest rates to invest in infrastructure to help boost economic growth. Both main parties have said that the amount the government will be able to borrow will explicitly depend on debt financing costs—the first time such a rule will have been built into the UK’s fiscal architecture.

Another new aspect of the rules set out by the Labour Party is a focus on measuring and increasing public sector net worth, rather than merely worrying about the level of public sector net debt. The latter has been targeted by UK governments since 1997 and chancellor Sajid Javid has continued to focus on the importance of this measure. But the headline measure of net debt suffers from several shortcomings that have allowed previous governments to game their debt targets.

The last Labour government’s commitment to keeping net debt below 40 per cent of national income encouraged Gordon Brown to get the private sector to finance public infrastructure investment, because those private finance deals did not immediately show up in the headline measure of debt. Later, for similar reasons, George Osborne carefully timed the sale of public assets—such as the student loan book and bank shares—to ensure that debt levels fell at the desired moment. Both former chancellors also responded to an incentive to offload public assets, even at a price below their market value, because the value of those assets is not recognised in the headline measure of debt, but revenues raised through their sale are.

Targeting public sector net worth should get around some of these problems because it is a wider measure which factors in the value of non-financial assets, such as hospitals, roads, schools—and state-owned companies. Labour’s rule would allow the government to borrow to invest in infrastructure and other assets, provided those assets were worth at least as much as the price paid. But targeting net worth would pose a new challenge to the nation’s statisticians and fiscal forecasters, who would need to accurately measure and forecast the value of public assets. They have minimal track record of this so far and there is little experience anywhere else in the world of targeting public sector net worth: the only countries that have done this are New Zealand and Australia.

Both the Conservatives’ and Labour’s proposed rules go some way to combatting the shortcomings of earlier fiscal rules. But they retain other weaknesses. One of these is the pledge by both parties to balance the current budget at some future, ever-moving date—five years hence for Labour, three years for the Conservatives. Because that date will keep rolling forward, the next government could—as others before have—keep promising to be virtuous tomorrow but never actually get there. A forward-looking target is desirable when the country has recently gone through a recession and the public finances are far from balanced, but it is hard to justify such delay when—as now—the current budget is already in balance, the UK economy is operating at its sustainable capacity and with the next recession likely to be closer than the last.

It is welcome that both main parties have set out new fiscal rules, which go some way to addressing the weaknesses of earlier rules and align the stated targets more closely with the reality of government policy. But the proposed new rules do not close all the loopholes. Further tweaks could be made to close them further, but history suggests that just as important in determining the UK’s fiscal future will be the extent to which the next chancellor is committed to the spirit—and not just the letter—of the targets. Such rules provide some important constraints on government tax and spending plans but even the best designed rules are still likely to have holes that can be exploited if ministers are that way inclined. Monitoring such behaviour will require strong institutions—such as the Office for Budget Responsibility—and transparent reporting, just as much as strict rules.