(Bloomberg) -- UK Chancellor of the Exchequer Rachel Reeves should adopt an entirely new set of fiscal rules that span 10 years to free up billions of pounds of headroom, create space to invest and allow the government to support the economy when needed, new Bloomberg Economics research shows.
Jamie Rush, Bloomberg’s chief European economist and a former official at the Office for Budget Responsibility, and Dan Hanson, Bloomberg’s chief UK economist, argue in a note on Thursday that the move would “create the right incentives for the government to think ahead and to invest for the future.” The plan would allow the government to articulate a clear strategy for the public finances anchored in a medium-term perspective, they said.
Reeves has signaled that she wants the fiscal rules to recognize the benefits of investment to end a bias toward short-termism that is undermining efforts to stimulate growth. Gus O’Donnell, the former head of the UK civil service, has described the current rules as “absurd” because they deter long-term planning.
Economists blame the UK’s weak productivity growth largely on a lack of capital spending. Britain invests about 3% of GDP less every year than its closest European rivals and faces an “investment gap” of £700 billion ($929 billion) by 2040 to meet the nation’s infrastructure needs, from hospital building to defense, according to research by consultancy EY.
In their paper, Rush and Hanson call for a more radical fiscal overhaul than the Treasury appears to be considering. A longer time frame would catch the growth and tax revenue benefits of investment, improving economic incentives, they argue. Their plans would also release about £30 billion of fiscal headroom to end austerity on public services “without jeopardizing fiscal sustainability.”
Reeves is looking at a change to the debt measure that would release at least £16 billion more borrowing headroom. She is also considering moving public institutions like the National Wealth Fund off balance sheet, which Bloomberg Economics estimates would give her another £12 billion.
Alternative debt measures under review such as public sector net worth or public sector net financial liabilities would release too much headroom and “open Reeves up to accusations of creative accounting and risk an adverse market reaction,” said Ana Andrade, another Bloomberg economist focused on the UK.
Rush and Hanson propose scrapping the current rule that debt must fall as a share of GDP between years four and five of the forecast. Instead, the OBR should establish whether tax and spending plans for the next five years will bring down the ratio over the subsequent five years with a 70% probability, the threshold the European Commission uses to assess debt sustainability in EU countries. Based on OBR economic forecasts, the proposed rule would currently be met with 85% probability, they said.
Reeves’s second rule, to balance the current budget by paying for all day-to-day spending out of taxes, should make way for the principle that any consolidation must be spread evenly over the first five years to prevent the government pushing difficult decisions into the future. If growth drops below 1% of GDP, the consolidation can be delayed.
They calculate that financing 1% of GDP more capital spending would require tax rises or spending cuts of just 0.5% of GDP to be fiscally neutral, with the growth effect from higher investment delivering the rest. At the moment, the ratio is one for one.
The plan “would safeguard fiscal sustainability, create space to invest in the country’s future and allow the government to support the economy in times of stress,” they wrote. It would also help governments prepare for challenges like climate change and population aging by bringing the issues “to the forefront of policymaking.”
©2024 Bloomberg L.P.
