A four-point plan to reform fiscal management
Fiscal tricks served up for voters at the Budget are bad for democracy, growth and the public finances. It’s time for an overhaul.
It was a masterclass of Treasury cunning. Last week’s budget conjured the maximum number of crowd-pleasing announcements from a fairly dire fiscal situation through some world-class fiscal shenanigans. Even the OBR chief Richard Hughes, speaking at the Resolution Foundation’s event the morning after, felt compelled to sound the alarm that “the fiscal framework is being increasingly gamed”.
These tricks aren’t costless parliamentary theatrics. Politically they mislead voters about the state of the public finances and sustainability of public services. Economically they undermine fiscal sustainability, drive bad value for taxpayers’ money and generate precisely the kind of the policy and institutional uncertainty that weighs on investment and contributes to our economic malaise. It’s time we had a fundamental rethink of the fiscal framework.
The three biggest items in the Chancellor’s Red Book were a massive expansion of free childcare, a freeze to fuel duty plus extension of the temporary 5p cut, and the full expensing capital allowance for business investment. Each one exhibits a different kind of fiscal antics.
Stealing from the next government
First, since the government’s departmental spending plans only go up to 2024–25, it can pencil in only high-level totals for departmental spending after 2025. These imply some blood-curdling cuts to already struggling public services in order to meet the fiscal rules, but are vague about where the axe will fall. As the IFS shows, the current plans imply undeliverable cuts of about £18bn for unprotected departments after the election.
To the extent that forecast improvements allow the government to spend more in those years, it can snaffle the windfall for a shiny new childcare offer and not say too much about, say, the collapse of the criminal justice system that might entail. This behaviour is effectively claiming the political credit today for spending money the next parliament will have to raise.
We saw a similar trick from George Osborne who, in the run-up to the 2015 election, pencilled in implausibly tight departmental expenditure totals for after an election the Conservatives appeared unlikely to win. That allowed him to meet his fiscal rules on paper. In the event, with public services creaking, he had to raise taxes substantially once the votes were counted.
Playing the OBR
The second game played last Wednesday was the ‘surprise’ one-year freeze to fuel duty — for the 13th year running — and extension of the ‘temporary’ fuel duty cut. As Paul Johnson put it, “The pretence that fuel duties will always rise next year, when they never rise this year, is becoming increasingly wearisome.”
These annual non-surprises are simply a clever way to get the OBR to flatter the fiscal forecast and give the public finances a clean bill of health under the pretence of future tax rises, while the government speaks out of the other side of its mouth to voters who by now firmly expect stated policy not to be implemented. This make a mockery of the process and creates a hidden fiscal shortfall.
Gaming the fiscal rules
For his third trick, the Chancellor used the full flexibility afforded by his five-year debt and deficit targets (debt falling and a deficit of less than 3% in the 5th year) to make big giveaways in the early years of the forecast which, he then suggested, should come to an end before year 5 in order to meet the rules.
Here, the economic benefits of the Chancellor’s ‘full expensing’ policy — generally accepted by economists to be a good idea for stimulating much-needed business investment — were undercut by his decision to make it last for just three years so it doesn’t break the rules. The OBR’s damning verdict was that this cumulative £27bn giveaway would have “no long-run impact on the capital stock” because the temporary nature of the policy means additional investment is simply displaced from future years. £27bn for nothing, at a time when the government claims to be worried about inflation, is… hard to justify.
Under the current rules there is, of course, nothing to prevent him extending the policy for another year come next year’s budget as the 5-year horizon moves back. That would continue the pattern of maximum cost for minimum impact.
No way to manage the public finances
All of these manouvres carry risks. One is that vague departmental spending plans, tricking the OBR and this Augustinian fiscal rule all create a deficit bias that risks ratcheting up the national debt. That would be bad in normal times. But it’s especially dangerous when we remain mired in an unprecedented productivity slowdown that the OBR’s irrepressible optimism suggests will soon abate (see chart). If it doesn’t then the public finances will deteriorate further. That leaves less ‘fiscal space’ to stabilise the economy by spending big when the next big economic shock emerges from the rolling polycrisis.
A related problem is that, as well as directly failing to incentivise additional investment in the case of temporary full expensing, the wider approach to taxes and infrastructure drives the kind of short-termism and politicisation that scares investors witless. If we want stable public finances and to break out of economic stagnation this has to change. And that means changing the fiscal framework. Four reforms seem necessary.
Reform #1 — From pencil to ink on departmental spending
First is the way departmental budgets are set. It’s the toxic interaction between the end of the spending review plans (in 2024–25) and the political cycle that creates scope for governments to hoodwink the public. It would be far better to align detailed departmental spending plans with the forecast horizon so they go out five years and roll forward a year at each budget.
These could of course be reviewed and revised periodically as priorities change, but having detailed plans in place as a baseline would mean cabinet ministers taking responsibility for their deliverability and specifying what functions are set to be axed. Such transparency would be a politically inhospitable environment for fantasy spending plans.
Reform #2 — A streetwise OBR
The second reform is for the OBR to be empowered to use its own judgement, in limited cases, about the government’s de facto policy stance, rather than only its stated policy. By now we’re entitled to believe that real government policy is to keep fuel duty frozen and the OBR should too. It should be allowed to make more realistic assumptions about policy where there is abundant justification for doing so.
One suggestion made to me a while back by a brilliant wonk was that the Chancellor should be compelled to begin his or her budget speech to Parliament with a frank 300-word statement written by the OBR. The threat of TV footage of the chancellor talking about how he was cooking the books to meet his rules would be a powerful incentive not to play these games.
Reform #3 — Transparency on value for money
The third change we need is something along the lines of the new institution that Rachel Reeves proposed in 2021 — an ‘Office for Value for Money’. David Gauke has gone further to flesh out what an ‘Office for Spending Evaluation’ might do: pre-emptively assessing the costs and benefits of different policies to ensure that strong and well-evidenced spend-to-save measures get higher priority. As Sam Freedman says, this could be a critical tool not just for leaning against the inevitable tendency for government to sacrifice investment for current spending, but also for hard-wiring a long-term policy focus across Whitehall.
The fourth reform that’s needed is to overhaul the fiscal rules that underpin many of the perverse incentives. Past sets of rules have either failed or been scrapped, and this budget demonstrated why the current set don’t work well. After 26 years and more than 20 different fiscal rules, it’s time we went back to the drawing board. This final reform will be the focus of the next post.
