There was little love lost between the prime minister and the chancellor on Valentine’s Day this year.
On the morning of the 13th February, Sajid Javid was one of the most senior politicians in the country, but by the 14th February he was on the back benches. The reported clash concerned the hiring and firing of the chancellor’s advisors. But it also hinted at a deeper disagreement over the fundamental rules which should govern government spending.
For the past decade, fiscal rules – frameworks which aim to put numerical controls on how much governments can borrow and spend – were a major battleground between the UK government and its critics. In the coalition government’s first budget in 2010, the then chancellor George Osborne introduced rules that aimed to reduce government debt and eliminate the structural deficit by making deep cuts. Despite inflicting ‘great misery’ and economic damage, austerity remained official government policy for the best part of a decade.
The debate about public spending became a key issue during the 2019 general election campaign, with both major parties proposing to reform fiscal rules and increase public investment.
The Labour Party suggested three new targets. First, a more flexible five-year rolling target for balancing the current budget, with the aim that day-to-day government spending (excluding public capital investment) does not exceed the amount of tax receipts at the end of a five-year forecasting period. Second, a pro-investment public sector net worth target, with the aim that the state’s balance sheet (the value of all government assets minus its liabilities) improves over the course of the parliamentary term. And third, that debt interest costs must be kept below 10% of tax revenues.
The Conservative manifesto also proposed a new set of fiscal rules: balancing the current budget in three years’ time, limiting net investment to 3% of GDP, and a commitment to review the government’s fiscal plans if debt interest costs exceed 6% of tax revenues. These signalled a marked change compared with the previous government's rules, which only targeted the overall level of borrowing and the debt-to-GDP ratio.
While this would allow for more capital investment than in recent years, the 3% limit on total public investment is still likely to prove a constraint given the amount of infrastructure that needs to be replaced to achieve a net-zero economy. The commitment to balance the current budget also implies that austerity will continue for much of the public sector. However, with the resignation of Sajid Javid, the battle over fiscal rules appears to have now moved to within government itself. If the fiscal rules do change again, it is unlikely to be for the right reasons.
Boris Johnson and his key advisor, Dominic Cummings, are believed to favour a freer hand in public spending to meet their promises in the upcoming budget on 11th March. But without a well-defined framework, an unconstrained government may end up squandering billions on vanity projects or bailing out failing airlines instead of prioritising the things we actually all need – like investing in clean and efficient energy.
Meanwhile, the Committee on Climate Change reported last year that the UK is on track in only 7 out of 24 indicators to reach its legally binding ‘net zero’ target by 2050, which in itself is unlikely to be ambitious enough.
We need fiscal rules that reflect the need for large-scale public investment in climate mitigation and adaptation, and we need this now. And in the year that the UK hosts COP26 – the United Nations’ Conference of the Parties, a key international decision-making body on climate action – the government needs to lead by example by adopting an ambitious framework of investment for a zero-carbon economy.
The New Economic Foundation has outlined a set of new principles that should guide government in developing fit-for-purpose fiscal rules. First, the Treasury should develop a new framework for measuring so called ‘fiscal space’ – the amount that the government can spend at a given point in time before risking adverse economic effects. Second, a framework should be adopted to help government use its fiscal space to best effect, including an assessment of the true risk of underinvestment in things like zero-carbon infrastructure at this crucial juncture for economy and climate.
With such frameworks, new fiscal rules could guard against both ‘deficit bias’ (the risk of governments overspending) and ‘surplus bias’ (the risk of governments not investing enough). In the coming months we will be working to develop these recommendations further.
Disagreements over finances can severely test any relationship, including that of the prime minister and his chancellor. But putting aside the soap opera over whether Rishi Sunak will survive until the next Valentine’s Day, the real question for this next budget is whether efforts to address the main challenges facing the UK – inequality and the climate emergency – will get the funding they so desperately need.