Budget 2024: How fiscal rules are impeding long-term investments – and what Rachel Reeves can do about it
Before we get onto the budget and what Rachel Reeves might do to fiddle her fiscal rules and give herself a little more room to spend, I want you to ponder, for a moment, a recent report from the Office for Budget Responsibility (OBR).
This wasn’t one of those big OBR reports that get lots of attention – such as the documents and numbers it produces alongside each budget, full of the forecasts and analyses on the state of the economy and the public finances.
Instead, it was a chin-scratchy working paper that asked the question: if the government invests in something – say, a road or a railway, or a new school building – how long does it generally take for that investment to come good?
The answer, according to the report, was: actually quite a long time. Imagine the government spends a chunk of money – 1% of national income – on investment this year. In five years’ time that investment will only have created 0.4 per cent of GDP. In other words, in net terms, it’s costed us 0.6% of GDP.
But, and this is the important thing, look a little further off. A high-speed rail network is designed to last decades, and as those decades go on, it gradually improves people’s lives – think of the time saved by each commuter each day – small amounts each day, but they gradually mount up. So while the investment costs money in the short run, in the longer run, the benefits gradually mount.
The OBR’s calculation was that while a 1% of GDP public investment would only deliver 0.4% of GDP in five years, by the time 10 or 12 years had passed, the investment would be responsible for approaching 1% of GDP. In other words, it would have broken even. The money put in at the start would be fully earned back in benefits.
And by the time that investment was 50 years old, it would have delivered a whopping 2.5% of GDP in economic benefits. Future generations would benefit enormously – or so said the OBR’s sums.
Having laid that out, I want you now to ponder the fiscal rules Rachel Reeves is confronted with at this, her first budget. Most pressingly, ponder the so-called debt rule, which insists that the chancellor must have the national debt – well, technically it’s “public sector net debt excluding Bank of England interventions” – falling within five years.
There is, it’s worth underlining at this point, nothing fundamental about this rule. Reeves inherited it from the Conservative Party, who only dreamed it up a few years ago, after COVID. Back before then, there have been countless rules that were supposed to prevent the national debt falling and, frankly, rarely ever succeeded.
But since Reeves wanted everyone to know, ahead of the election, just how serious Labour was about managing the public finances, she decided she would keep those Tory rules. One can understand the politics of this; the economics, less so – then again, I confess I’ve always been a bit sceptical about all these rules.
The upshot is, to meet this rule, she needs the national debt to be falling between the fourth and fifth year of the OBR’s five-year forecast. And according to the last OBR forecasts, which date back to Jeremy Hunt‘s last budget, it is. But not by much: only by £8.9bn. If that number rings a bell, it is because this is the much-vaunted, but not much understood, “headroom” figure a lot of people in Westminster like to drone on about.
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And – if you’re taking these rules very literally, which everyone in Westminster seems to be doing – then the takeaway is that the chancellor really doesn’t have much room left to spend in the coming budget. She only has £8.9bn extra leeway to borrow!
Every spending decision – whether on investment, on the NHS, on benefits or indeed on anything else, happens in the shadow of this terrifying £8.9bn headroom figure. And since the chancellor has already explained, in her “black hole” event earlier this year, that the Conservatives promised a lot of extra spending they hadn’t budgeted for – not, perhaps, the entire £22bn figure she likes to cite but still a fair chunk – then it stands to reason there’s really “no money left”.
Or is there? So far we’ve been taking the fiscal rules quite literally but at this stage it’s worth asking the question: why? First off, there’s nothing gospel about these rules. There’s no tablet of stone that says the national debt needs to be falling in five years’ time.
Second, remember what we learned from that OBR paper. Sometimes investments in things can actually generate more money than they cost. Yet fixating on a debt rule means the money you borrow to fund those investments is always counted as a negative – not a positive. And since the debt rule only looks five years into the future, you only ever see the cost and not the breakeven point.
Third, the debt rule used by this government actually focuses on a measure of the national debt which might not necessarily be the right one. That might sound odd until you realise there are actually quite a few different ways of expressing the scale of UK national debt.
The measure we currently use excludes the Bank of England, which seemed, a few years ago, to be a sensible thing to do. The Bank has been engaged in a policy called quantitative easing which involves buying and selling lots of government debt – which distorts the national debt. Perhaps it’s best to exclude it.
Except that recently those Bank of England interventions have actually been serving to drive up losses for the state. I won’t go into it in depth here for risk of causing a headache, but the upshot is most economists think focusing on a debt measure which is mostly being affected right now not by government decisions but by the central bank reversing a monetary policy exercise seems pretty perverse.
In other words, there’s a very strong argument that instead of focusing on the ex-BoE measure of net debt, the fiscal rules should instead be focusing on the overall measure of net debt. And here’s the thing: when you look at that measure of net debt, lo and behold it’s falling more between year four and five. In other words, there’s considerably more headroom: just under £25bn rather than just under £9bn based on that other Bank-excluding measure of debt.
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Might Reeves declare, at the budget or in the run-up, that it makes far more sense to focus on overall PSND from now on? Quite plausibly. And while in one respect it’s a fiddle, in her defence it’s a fiddle from one silly rule to an ever so slightly less silly rule.
It would also mean she has more room to borrow to invest – if that’s what she chooses to do. But it doesn’t resolve the deeper issue: that both of these measures fixate on the short-term cost of debt without taking into account the long-term benefits of investment – back to that OBR paper.
If Reeves is determined to stick to the, some would say arbitrary, five-year deadline to get debt falling but wants to incorporate some measure of the benefits of investment, she could always choose one of two other measures for this rule.
She could focus on something called “public sector net financial liabilities” or “public sector net worth”. Both of these measures include some of the assets owned by the state as well as its debts – the upshot being that hopefully they reflect a little more of the benefits of investing more money.
The problem with these measures is they are subject to quite a lot of revision when, say, accountants change their opinion about the value of the national road or rail network. So some would argue these measures are prone to more volatility and fiddling than simple net debt.
Even so, these measures would dramatically transform the “headroom” picture. All of a sudden, Reeves would have over £60bn of headroom to play with. More than enough to splurge on loads of investments without breaking her fiscal rule.
There’s one other change to the rule that would probably make more sense than any of the above: changing that five-year deadline to a 10 or even 15-year deadline. At that kind of horizon, a pound spent on a decent investment would suddenly look net positive for the economy rather than a drain.
Whether Reeves wants to do any of the above depends, ultimately, on how she wants to begin her term in office. Does she want to establish herself as a tough, fiscally conservative Chancellor – with a view, perhaps, to relaxing in later years? Or does she feel it’s more important to begin investing early, so some of the potential benefits might be obvious within a decade or so?
Really, there’s nothing in the economics to stop her choosing either path. Certainly not a set of fiscal rules which are riddled with flaws.
Rachel Reeves is fighting claims that she “lied” to the public about the state of the finances in the run-up to last Wednesday’s budget – in which she raised £26bn in taxes.
It follows a letter published by the Office for Budget Responsibility (OBR), the official watchdog which draws up forecasts for the Treasury, published on Friday.
In it, OBR chair Richard Hughes (who is already under fire for the leak of the budget measures) said he’d taken the unusual step of revealing the forecasts it had submitted to Rachel Reeves in the 10 weeks before the budget, and which is normally shrouded in secrecy.
The OBR sent this table revealing its timings and outcomes of the fiscal forecasts reported to the Treasury
Sir Keir Starmer congratulates Rachel Reeves after the budget
The letter reveals this timeline, which has plunged the chancellor into trouble:
17 September – first forecast
At this point, it was already known that the UK’s growth forecast would be downgraded. The chancellor was told that the “increases in real wages and inflation” would offset the impact of the downgrade. The deficit forecast by the end of the parliament was £2.5bn.
20 October – second forecast
By this point, that deficit had turned into a small surplus of £2.1bn – i.e. the productivity downgrade has been wiped out and “both of the government’s fiscal targets were on course to be met”.
31 October – third forecast
The final one before the Treasury put forward its measures. The finances were now net positive with a £4.2bn surplus.
But the accusation is that Rachel Reeves was presenting an entirely different picture – that she had a significant black hole which needed to be filled.
13 October
Ms Reeves tells Sky’s deputy political editor Sam Coates the productivity downgrade has been challenging but added: “I won’t duck those challenges. Of course we’re looking at tax and spending.”
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27 October
With the Treasury now aware the deficit had been wiped out, the Financial Times was briefed about a “£20bn hit to public finances.”
4 November
Ms Reeves gave a dawn news conference in Downing Street, setting the stage for tax rises. She says she wants people “to understand the circumstances we are facing… productivity performance is weaker than previously thought”, adding that “we will all have to contribute”.
10 November
Ms Reeves tells BBC 5Live that sticking to Labour’s promises not to raise taxes would require “things like deep cuts in capital spending”. The stage seemed set for the nuclear option – the first income tax rise in decades.
13 November
After headlines about a plot to oust Prime Minister Sir Keir Starmer, the Financial Times reported that the chancellor had dropped plans to raise income tax because of improved forecasts [which we now know hadn’t changed since 31 October], putting the black hole closer to £20bn than £30bn.
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‘You’ve broken a manifesto pledge, haven’t you?’
The prime minister’s spokesperson has insisted Ms Reeves did not mislead voters and set out her choices, and the reasons for them, at the budget.
But the issue has had enormous cut-through, with newspapers giving it top billing.
The Sun’s Saturday front page headline – “Chancer of the Exchequer – fury at Reeves ‘lies’ over £30bn black hole” – will not have been pleasant reading for ministers.
She now has questions to answer about the chaotic run-up to the budget – of briefing and counter-briefing, which critics say now makes little sense.
Tory leader Kemi Badenoch said on Saturday: “We have learned that the chancellor misrepresented the OBR’s forecasts. She sold her ‘Benefits Street’ budget on a lie. Honesty matters… she has to go.”
Economist Paul Johnson, former director of the respected Institute for Fiscal Studies (IFS), told The Times the chancellor’s 4 November news briefing “probably was misleading. It was clearly intended to have an impact and confirm what independent forecasters like [the National Institute of Economic and Social Research] and the IFS had been saying”.
“It was designed to confirm a narrative that there was a fiscal hole that needed to be filled with significant tax rises. In fact, as she knew at the time, no such hole existed.”
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Ms Reeves is doing a round of morning interviews on Sunday in which she’ll be grilled over which of her budget measures will generate economic growth (which the government claimed was its number one priority), why they have been unable to tackle rising welfare spending and now about why markets and voters were left confused by dire warnings.
She may claim that she never personally said there was a specific £30bn black hole or that the extra headroom generated by the tax rises will ensure she does not have to come back for more next year.
In an interview with The Saturday’s Guardian, Ms Reeves said she had “chosen to protect public spending” on schools and hospitals in the budget.
She confirmed an income tax rise had been looked at, and insisted that OBR forecasts “move around” after the Treasury has submitted its planned measures. There are plenty more questions to come.
Meanwhile, Sir Keir will use a speech on Monday to support Ms Reeves’ budget decisions and set out his long-term growth plans.
He will praise the budget for bearing down on the cost of living, ensuring economic stability through greater headroom, lower inflation and a commitment to fiscal rules, and protecting investment and public services.
Sir Keir will say “economic growth is beating the forecasts”, but that the government must go “further and faster” to encourage it.
Politics
Lammy says justice reforms will reduce victims’ suffering – as right to jury trial set to go in some cases
Victims will be put “front and centre” in reforms to be announced this week, the justice secretary has said, amid reports jury trials will be scrapped in some cases.
Sky News understands ministers have already been briefed on the changes, which would see a judge decide most cases on their own except for murder, rape or manslaughter – or those in the “public interest”.
The Ministry of Justice (MoJ) said the reforms would speed up justice and save victims from “years of torment and delay”.
Nearly 80,000 cases are currently waiting to be heard in crown courts, but a bid to limit the right to jury trial is likely to be divisive.
Shadow justice secretary Robert Jenrick said Mr Lammy should “pull his finger out” to cut the backlog rather than “depriving British citizens of ancient liberties”.
“The right to be tried by our peers has existed for more than 800 years – it is not to be casually discarded when the spreadsheets turn red,” said Mr Jenrick.
Full details are expected in the coming days, but in a statement today Mr Lammy said he had “inherited a courts emergency; a justice system pushed to the brink”.
“We will not allow victims to suffer the way they did under the last government, we must put victims front and centre of the justice system,” he added.
Mr Lammy said thousands of lives were on hold due to the case backlog, a “rape victim being told their case won’t come before a court until 2029. A mother who has lost a child at the hands of a dangerous driver, waiting to see justice done”.
He said he wanted a system that “finally gives brave survivors the justice they deserve”.
The justice secretary will reportedly go further than a review recommended. Pic: PA
.However, it’s been reported Mr Lammy will go further than a review conducted by Sir Brian Leveson.
The retired judge backed the move for juries only in the most serious cases, but also proposed some lesser offences could go to a new intermediate court where a judge would be joined by two lay magistrates.
The Times said Mr Lammy had suggested in an internal memo he would remove the lay element from many serious offences that carry sentences of up to five years.
There are fears such a move could increase miscarriages of justice and racial discrimination.
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Work and pensions secretary speaks to Sky about justice reforms
Speaking to Sky News’ Politics Hub programme this week, work and pensions secretary Pat McFadden did not deny the changes were on the way.
The MoJ has laid the ground for the reforms by saying the court backlog could hit 100,000 by 2028 under the current system.
It said just 3% of cases are currently decided by a jury, with more than 90% already dealt with by magistrates alone.
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