Every government budget is now dominated by how much “headroom” is available for spending or tax cuts. It would be reasonable to assume that term referred to a “surplus” —cash left over after all existing commitments had been met—especially given the language about “windfalls” that usually accompanies any growth in “headroom”.
In reality, the word just means the difference between the government’s current plans and the amount of debt (or deficit) allowed under its fiscal rules. Yet this arbitrary number has become the primary driver of government strategy, with enormous efforts being put into gaming and manipulating it.
The story of how this number became central to our politics is instructive, showing how our institutions and political narratives can end up being formed almost by accident.
You might think, what with the importance now given to fiscal rules, that they have been around a long time. In fact, the first set was created by Gordon Brown as recently as 1997. Then chancellor of the Exchequer, he was determined to increase spending while maintaining a reputation for prudence, and developed an array of theatrical tricks to do so.
Fiscal rules were a part of this. They were a public and testable declaration of probity that was supposed to give bond markets confidence (although traders didn’t seem overly worried about the UK’s position at the time). But Brown, knowing exactly what he was doing, designed the rules with plenty of creative flexibility.
Government, he promised, would spend no more on day-to-day costs than it received in revenue over the economic cycle. This was his “golden rule”, except he didn’t define what the economic cycle was so it kept changing, conveniently, to allow him to boost spending at key electoral moments.
It wasn’t until after Brown became prime minister and the financial crisis hit, in 2009, that chancellor Alistair Darling felt the need to commit to specific targets with dates. Brown was much less convinced, believing the proposed reductions in deficit were too rapid, but he was too politically weakened, by that point, to stop it happening.
Once he was installed at Number 11, George Osborne immediately saw the potential political benefit to the new coalition government. Tightly defined fiscal rules would strengthen his power base at the Treasury, enabling him to block spending by other departments more easily. Osborne also created the Office for Budget Responsibility to provide an independent check on whether the rules were being met, removing another option for Brown-style creativity.
Osborne’s plan for the economy didn’t work as he had hoped. Growth didn’t return to pre-crash levels and forecasts were repeatedly downgraded. Then came Brexit. With austerity increasingly unpopular, the Conservatives ended up repeatedly amending their rules to allow them to spend more. One set of rules required debt to be falling as a percentage of GDP by 2016—which became 2017, then 2021.
The response to the pandemic required another surge of borrowing and two further revisions of the fiscal rules, leaving us with a particularly absurd set at the time of this July’s election. According to this latest version, debt now didn’t need to fall by a particular year at all, but in five years’ time as a rolling target—a target that can never be reached.
All this has led to ever more intricate gaming from ministers. The government pretends that future spending and tax policy will align to hit this target, while everyone knows it never needs to happen in reality. As a result the entire election was fought—by both main parties—on a set of spending plans widely known to be ridiculous but that made the fiscal rule achievable without extra tax rises. The public, who may not be on top of all these details but are also not idiots, were not taken in. It’s a big reason the election was so desultory. Why engage in a fantasy?
New chancellor Rachel Reeves, as was inevitable after Labour won, has said she will revise the rules again to free up more money for capital spending on transport, hospitals, schools, social housing and energy infrastructure. This is much needed but will, again, be done with a technical fiddle to the definition of debt that ignores the bigger question of what these rules are for, exactly.
Frustratingly, the wrong lessons were learnt from the Truss fiasco of 2022. Markets reacted badly to her infamous “mini-budget” not because she chose to abandon the fiscal rules, but because she injected a substantial stimulus (via tax cuts) into an economy where inflation was already rising rapidly.
The real lesson is that we don’t need rigid, arbitrary rules to determine acceptable levels of spending. Real-world rules are already baked into the economy: inject lots of cash into an economy under inflationary pressure and you’ll make it worse, forcing interest rates up; in other circumstances, more spending won’t have that effect. How markets react has nothing to do with a set of made-up numbers. Any half-decent trader knows the rules are being gamed anyway.
