We can have sustainable debt without Osborne’s inflexible new surplus rule

 
James Zuccollo
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Overall budget surpluses go far beyond the needs of debt reduction (Source: Getty)
Last night, in a speech at Mansion House, George Osborne set out his vision for UK fiscal policy. “In normal times,” he said, “governments of the left as well as the right should run a budget surplus to bear down on debt and prepare for an uncertain future.” This will be cemented with a new rule, legally preventing future governments from spending more than they receive in tax revenue when the economy is growing. That commitment represents a significant shift from the previous policy of balancing the cyclically-adjusted budget within a rolling, three-year window.

It is becoming increasingly clear that, under Osborne’s leadership, the government will go well beyond eliminating the structural deficit and push for rapid debt reduction. He made his intentions clear in the House of Commons following the Queen’s Speech, saying that “as with any challenge, the sooner you get on with it, the better”. This new rule will be his first step along the path.

Osborne is right to focus on the need for long-term debt reduction: the OBR estimates that, if the current policy settings remain in place, rising NHS and pension spending will cause debt to exceed 200 per cent of GDP within 50 years. In each year since 2010, that has caused the OBR to judge the UK’s policy settings as unsustainable. Sustainability is the greatest challenge facing fiscal policy, but it is not one that can be overcome in a single Parliament. It requires a durable, long-term commitment to changing the shape of the UK’s public services.

The new rule reflects Osborne’s eagerness to deal with the problem. The main argument for reducing debt is that it provides some headroom to respond to the next crisis with extra spending. However, the IMF published research just this week assessing members’ debt positions. It gave the UK a clean bill of health and went so far as to claim that active debt reduction, such as Osborne intends to pursue, should be avoided. Instead, it recommended that the debt burden be allowed to naturally decline as the economy grows.

Overall budget surpluses, such as Osborne proposes for “normal times”, go far beyond the needs of debt reduction. Debt is normally assessed as a percentage of GDP, which means that the burden declines whenever the deficit is less than growth in GDP. In normal times, nominal GDP would be expected to grow by 4 to 5 per cent each year, which implies that a deficit of up to 4 per cent would still reduce the national debt burden. Osborne’s plan requires saving up to 5 per cent of GDP more than that each year – equivalent to the size of the entire education budget.

Osborne’s commitment also includes investment within the scope of the rule, which means that borrowing for infrastructure spending would need to be offset by cuts elsewhere. Paying for infrastructure out of current spending is poor policy: a new Tube line in London may be in operation for a hundred years, but the funding for it would need to be found out of today’s spending under the new rule. In effect, today’s taxpayers would fund the infrastructure needs of future generations because of Osborne’s commitment to debt reduction.

There may be a good reason for him favouring tight restrictions: to avoid a repeat of recent history. The UK economy boomed between 2003 and 2007, but the government of the day ran deficits throughout that period, making the pain of the financial crisis harder to bear. However, there exists a better solution which Osborne has already engineered the bones of: the Office for Budget Responsibility (OBR).

This institution may prove to be Osborne’s most enduring contribution to better government. It provides a fiercely independent, expert view of the Treasury’s numbers. A strong, institutional force such as the OBR obviates the need for such inflexible fiscal rules and allows for a more principled approach to policy.

For example, it would be wise to exempt investment spending from the fiscal rule, as was done during Gordon Brown’s years at the Treasury. Unfortunately, that period also saw some spending reclassified as investment; a ruse to circumvent the rules. The absence of independent scrutiny allowed the government of the day to escape censure, but it is unlikely that such games would go unnoticed today. Osborne’s plan delegates the power to determine what “normal times” are to the OBR, but does not take advantage of its scrutiny to loosen the fiscal rules.

A full appreciation of Osborne’s plan for fiscal policy will need to wait until it is fully unveiled at the Emergency Budget, but a bigger role for the OBR and an appreciation of the long-term nature of the fiscal challenge would be very welcome.

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