3The fiscal rules
The existing fiscal mandate for borrowing
45.The Autumn Statement 2016 update to the Charter for Budget Responsibility states that the objective of the Government’s fiscal policy is to “return the public finances to balance at the earliest possible date in the next Parliament”.47 Since the 2016 Autumn Statement, there has been a further general election, but the Charter has not been updated. Therefore, the objective in the Charter is open to interpretation as to which “Parliament” is being referred to: the current Parliament (2017–22), or the Parliament that would have been had an election not occurred (2020–25). The 2017 Conservative Manifesto included the commitment to “balance the budget by the middle of the next decade”, a position reiterated in the Chancellor’s Mansion House speech in June 2017.48
46.In its forecasts, the OBR has assessed the likelihood of meeting the objective according to both interpretations. If the objective applies to the current Parliament, the OBR judges that it is likely to be missed. The OBR’s forecast horizon does not extend to 2025, but it judges that meeting the objective would be “challenging”49 even over this longer timescale.
47.In order to achieve its objective, the Treasury’s “fiscal mandate in this Parliament is a target to reduce cyclically-adjusted public sector net borrowing to below 2 per cent of GDP by 2020–21”.50 Similarly to the overall objective, the Charter refers to a Parliament that was dissolved in 2017, and is therefore out of date.
Justification for having a fiscal mandate
48.There have been over a dozen fiscal rules since 1997, only two of which have definitively been met. The rules can be summarised these rules as follows:
Table 2: Fiscal rules since 1997
|
Fiscal target |
Dates in operation |
Target requirements |
Rule met? |
|
Labour |
|||
|
Golden Rule |
1997–2009 |
Current budget balance over the economic cycle |
No. Abandoned due to financial crisis. |
|
Sustainable investment rule |
1997–2009 |
Net debt under 40 per cent of GDP over the economic cycle |
No. Abandoned due to financial crisis. |
|
Deficit falling every year 2009–10 to 2015–16 |
No. |
||
|
Fiscal consolidation plan |
2009–2010 |
Halve budget deficit 2009–10 to 2015–16 |
No. |
|
Net debt falling as a percentage GDP in 2015–16 |
No. |
||
|
Coalition |
|||
|
Fiscal mandate (1) |
2010–2014 |
Cyclically-adjusted current budget balance 5 years out (rolling target) |
Yes. |
|
Supplementary debt target (1) |
2010–2015 |
Debt falling as a percentage of national income between 2014–15 and 2015–16 |
No. |
|
Fiscal mandate (2) |
2014–2015 |
Cyclically-adjusted current budget balance 3 years out (rolling target) |
Yes. |
|
Supplementary debt target (2) |
2014–2015 |
Debt falling as a percentage of national income between 2015–16 and 2016–17 |
Not yet known. March Budget forecast implied yes, our update implies no. |
|
Welfare cap |
2014– |
Cap welfare spending at a level set by the Treasury for every year of the five year forecast |
No. Breached since November 2015. |
|
Conservative |
|||
|
Fiscal mandate (3) |
2015–2016 |
Surplus in 2019–20, and every subsequent year if growth remains above one per cent |
Not yet known. Abandoned after referendum. |
|
Supplementary debt target (3) |
2015–2016 |
Debt falling as a percentage of national income every year to 2019–20 |
No. Debt rose between 2014–15 and 2015–16. |
|
Fiscal mandate (4) |
2016– |
Structural deficit of two per cent by 2020–21 |
Not yet known. |
|
Objective for fiscal policy |
Budget surplus by middle of next decade |
||
|
Supplementary debt target (4) |
National debt falling as a proportion of GDP in 2020–21. |
Source: Adapted from Institute for Fiscal Studies, ‘Winter is Coming: The outlook for the public finances in the 2016 Autumn Statement’, November 2016, Table 5.1. Numbers in brackets indicate later iterations of rules with the same name.
49.Given the regularity with which fiscal rules have been broken over the past two decades, the Committee has previously taken evidence from witnesses as to whether fiscal rules had ceased to be of any benefit for fiscal credibility. There was a broad consensus that fiscal rules are desirable, but that the setting of rules and then abandoning them was damaging. Professor Philip Booth of St. Mary’s University, said:
[he would] rather have a weak framework, than a rule that was either not credible or not adhered to. The worst thing that you can do is to build up a situation where you are getting the benefits of credibility by having a strong rule, then break the rule.51
50.Jonathan Portes, Research Fellow, National Institute of Economic and Social Research, agreed with this view, saying:
[…] one of the points of a fiscal rule is to constrain what the Government do and improve the Government’s credibility, both with financial markets and economic agents in the wider economy.52
Assessment of the borrowing target
51.The fiscal target for borrowing is adjusted depending on the business cycle. Professor Jagjit Chadha was critical of targets that are cyclically-adjusted. He said:
The rules themselves, in terms of having a cyclically-adjusted deficit target, are bordering on the ridiculous. Nobody is able to measure the business cycle in real time and tell you whether the economy is at trend, below trend or above trend; to have a cyclically adjusted deficit target therefore is a complete nonsense. It is not something that makes sense in any way whatsoever. If you want a target for the deficit, the Government should aim for a balance on the primary account before interest is paid. That is something that does not get adjusted because of the business cycle, and is something that is clearly measurable in terms of cash.53
52.As part of the Autumn Budget, the Government announced a delay in the implementation of a shorter payment window for Capital Gains Tax (CGT), from April 2019 to April 2020. In its forecast, the OBR explained that this policy change would delay the temporary £1 billion boost to the public finances generated from 2019–20 to 2020–21. The OBR points out that this change is beneficial to the Government meeting its fiscal target in 2020–21, and that when the policy was initially announced in 2015, it benefited the public finances in 2019–20, which at the that time was also the year of the fiscal target:
The net effect of the Budget measures boosts receipts in only one year: 2020–21, the year in which the Government’s main fiscal target applies. […] reflecting the decision to delay the introduction of the ‘CGT payment window’ by a year from 2019–20 to 2020–21. This flatters receipts in one year only by bringing forward the timing of payments. It was introduced in Autumn Statement 2015, boosting receipts in 2019–20; the fiscal target year then was 2019–20.54
53.The Chancellor told the Committee he had delayed the implementation of the CGT 30-day window to “create a smooth pathway and manage the overall fiscal picture”55 but that he did not think £1.3 billion was “very big” and it was “purely a timing issue”.56
54.Despite a chequered history, a well-designed fiscal rule can add something to the credibility of fiscal policy in the eyes of markets and the public. But with each rule that is abandoned, the task of maintaining credibility is made more difficult.
55.The Charter for Budget Responsibility is out of date, and the fiscal rules that it sets are consequently open to interpretation. If the Government’s objective is now to run a balanced budget by 2025–26, the Charter should be updated to reflect this unambiguously, as a matter of urgency. The Committee recommends it must be updated at the 2018 Spring Statement.
56.To maintain the credibility of fiscal policy, the design and timing of policies should primarily be focused on achieving policy objectives and improving the public finances, rather than meeting fiscal target deadlines. The implementation of a 30-day window for paying Capital Gains Tax appears to be delayed in order to create a one-off windfall to the public finances in the year of the fiscal target. Using the fiscal rules in this way risks damaging the credibility of fiscal policy, the very thing that the rules are designed to protect.
57.As with its predecessor, the new fiscal rule is judged against a fixed point in time. As a result, to meet the target date, large spending cuts or tax increases may be required as the target deadline approaches.
Net Debt Target
58.The Government has set a target “for public sector net debt as a percentage of GDP to be falling in 2020–21.”57
59.Prior to the Autumn Statement 2016, the target was “for public sector net debt as a percentage of GDP to be falling in each year”.58 The net debt target only applies to one specific financial year, 2020–21, the same year when the repayments within the Bank of England’s Term Funding Scheme59 (TFS) will begin.
60.In 2016, the former Committee asked Carl Emmerson, Deputy Director, Institute of Fiscal Studies, for his view of the interaction between the TFS and the net debt target. He said:
It is an unfortunate thing that the Government’s target looks at the measure of debt, which includes the Bank of England effect. It would be better to exclude it for two reasons. First, they have picked a target that should fall in 2020–21, which happens to be just when the financial sector will hopefully—touch wood—be paying back those loans, so the measure of debt will naturally fall very sharply in that year, so it is quite an easy target to meet. Secondly, it is odd to include a target for something that can be affected by things; supposing the MPC decided to do more of this in 2019, say. It would make this target very difficult to meet for reasons that are not really about the total indebtedness of the public sector. It would be better to target a measure of debt that does not have this feature.60
61.It is unclear why the Government has chosen to target a decline in the net debt to GDP ratio in a single year (2020–21), rather than a continuously falling ratio. The net debt to GDP ratio should be put in a framework that signals the intention to bring about a decline over a consecutive run of years, as was the case in the supplementary debt target in force prior to the Autumn Statement 2016.
62.There is a strong case for excluding the Bank of England Term Funding Scheme (TFS) from the net debt ratio target. This is because the repayment of the TFS in 2020–21 produces a material one-off change to the net debt ratio. This change happens independently of Government policy and distorts the underlying trend, which makes the target easier to meet in the Government’s chosen year.
47 HM Treasury, Charter for Budget Responsibility: Autumn 2016 update, January 2017, Paragraph 3.1
48 Conservative Party, The Conservative and Unionist Party Manifesto 2017
49 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9530, November 2017, Paragraph 5.17
50 HM Treasury, Charter for Budget Responsibility: Autumn 2016 update, January 2017, Paragraph 3.3
51 Oral evidence taken on 6 December 2016, HC 837 (2016–17), Q 256
52 Oral evidence taken on 6 December 2016, HC 837 (2016–17), Q 249
53 Q109
54 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm9530, November 2017, Paragraph 4.37
55 Q381
56 Q383
57 HM Treasury, Charter for Budget Responsibility: Autumn 2016 update, January 2017, Paragraph 3.4
58 HM Treasury, Charter for Budget Responsibility: Autumn 2016 update, January 2017, Paragraph 3.4
59 The Term Funding Scheme allows financial institutions to borrow from the Bank, against eligible collateral, for a term of four years. According to the Bank, the purpose of the scheme is to “reinforce the transmission of Bank Rate cuts to those interest rates actually faced by households and businesses” (Bank of England Market Notice, 4 August 2016: Asset Purchase Facility: Term Funding Scheme)
60 Oral evidence taken on 29 November 2016, HC 837 (2016–17), Q9
19 January 2018