Does the Chancellor’s Charter ensure prudent fiscal policy?

13 July 2015

Hidden amongst the Summer Budget’s headline announcements was the unveiling of the Government’s new fiscal rule, or Charter for Budget Responsibility. This rule requires the Government to maintain an overall surplus in “normal times.” The Charter sounds familiar because it represents George Osborne’s fourth set of fiscal rules since 2010.

The present rule requires a structural surplus at the end of a rolling, three-year period, and falling debt from 2016-17. The proposed, “normal times” rule will commit the Government to maintaining an absolute surplus from 2019-20 every year real GDP growth exceeds one percent. The Office for Budget Responsibility will adjudge when RGDP growth falls below this level, and, hence, when the rule should be suspended.

Once suspended, the government of the day will be required to present a plan to Parliament to return the country to surplus. This plan must contain interim fiscal targets, which will be assessed by the OBR. Once a surplus is restored, the rule will once again apply.

Osborne’s termination of the requirement to have debt falling by a particular date is welcome: recent history shows that fixed dates make for fragile rules. The indefinite period of suspension when recession strikes is also preferable to the previous rule’s three-year allowance for returning to surplus. Despite attempts to eliminate it, the recent recession will have seen a continuous, 12-year period of deficits. The new rule would have allowed just that; a rule requiring balance within three years would not. The indefinite period of suspension thus allows the Government flexibility to cope with changing economic conditions.

However, the absolute Budget surplus during normal times requirement is unwarranted. It will force tax revenues to cover both departmental and infrastructure spending and will require today’s taxpayers to pay for tomorrow’s infrastructure.

The rule also fails to provide guidance on the return to surplus following its suspension. This recession illustrates the cost of rapid deficit reduction. This is starkly highlighted by the OBR’s latest forecasts, which revise growth down following the Chancellor’s announcement of fiscal tightening in 2015-16. Strong fiscal rules can provide guidance for Chancellors balancing fiscal prudence with the need to support a weakened economy.

The proposed rule also misses an opportunity to tackle the biggest risk to fiscal sustainability in the UK: long-term demographic change. If current policy is maintained, the OBR expects debt to approach 200 per cent of GDP over the next fifty years. This is primarily due to the rising cost of pensions and healthcare. The Chancellor is right that “without sound public finances there is no economic security”. However, achieving that security will require the Government to lift their fiscal sights beyond the current year to focus on the coming decades.

Alexander Hitchcock, Research Assistant, Reform

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