It’s Super Tuesday on the fiscal policy front. Try not to get too excited. Today a lucky world gains not only the Office for Budget Responsibility’s Fiscal Sustainability Report (the ‘FSR’ looks ages over the next 50 years to ask: ‘how bust are we if we carry on as we are’) but also the Treasury’s first Managing fiscal risks report (which is the government’s take on the same sustainability question with added depression from also considering what else might go wrong in the here and now).
Now it’s understandable that attention is currently elsewhere. After all the government is currently shedding ministers and no one can currently set out a way forward on Brexit that reconciles an actual proposal for our future relationship with the EU with the parliamentary arithmetic (let alone the EU’s own negotiating position). But if you’re got any appetite for more politics and policy on top of that fandango, this fiscal duet is well worth paying some attention to. No, no-one is resigning over it yet, but it includes serious food for thought that will be shaping the politics of the UK for decades to come. What are the main messages?
The deficit is yesterday’s story
The big fiscal debate has now well and truly shifted from the deficit, which is now back to pre-crisis norms of around 2 per cent of GDP. Far from boasting about further deficit reductions the Treasury actively make the argument that the pace of deficit reduction has more than halved under Phillip Hammond compared to George Osborne (although I’m not sure I’d be shouting about the still very significant cuts to current spending coming if I were them).
It’s all about debt
The bogeyman is no longer that the UK could end up like Greece because it’s deficit is nearly 10 per cent of GDP, and instead that debt is too high and too expensive. The politics friendly proof points are broadly what you’d expect: yes the deficit is below 2 per cent but public debt remains at a 50-year high of around 85 per cent, and we’re spending £50 billion a year on debt interest – more than on the police and armed forces combined. If those don’t remind you of late 1990s Labour nothing will….
So the debt is the main focus of fiscal policy today – and it is good to hear a clear articulation of the objective because the overall approach to the public finances has felt increasingly unmoored from any sense of strategy in recent years. But what level of debt is the government actually aiming for? Well they don’t really say, although implicitly you could conclude they think something nearer 60 per cent is the way to go. That’s higher than the 40 per cent targeted pre-crisis, but we are in a very very different (lower) interest rate environment.
Reducing debt is harder than you think
Just because the Chancellor thinks something like 60 per cent debt would be desirable doesn’t mean we’ll ever get there. Indeed much more interesting than statements about (currently low) debt interest payments, are what the Treasury and OBR have to say about debt trajectories. The Treasury’s main argument is that getting debt down is much harder than you think, for two key reasons. Firstly because we haven’t abolished boom and bust and an average recession every 12 years will cost us 9 per cent of GDP a go . And second, that slow growth fundamentally changes the arithmetic of debt reduction – meaning that just to stabilise the debt-to-GDP ratio, never mind undo any damage from a recession, we now need to have a deficit of just 1.2% of GDP (compared to 3% pre-crisis). The combination of the two is the underpinning argument for Phillip Hammond’s fiscal objective of an overall budget balance from the middle of the next decade (something he is currently not on track to meet). The Treasury is also keen to show that because of these issues, Labour’s approach (under John McDonnell and Ed Balls) of targeting a current budget balance (ie borrowing for investment spending) would see debt rising not falling (see the light grey line in the chart below). Labour’s understandable response would be that they’d quite like the economy to actually start growing properly at some point – which would in turn transform these debt dynamics – but you can see where the political row is going.
We’re all structural social democrats now, so say hello to tax rises
The OBR’s report comes at this question of debt trajectories rather differently. Rather than a top down approach, asking what happens to debt under a range of policies on borrowing, they provide a bottom up assessment of what might happen to debt if current policies on public spending and taxes are maintained. Their (as always eye catching) headline is that, without policy change, we’re on course for a debt to GDP ratio of nearly 280 per cent of GDP in the 2060s. The costs of ageing and wider pressures on health spending will see the state growing just to continue delivering the public services we currently have.
Now some Conservatives (hello Liz Truss) will argue that there are big political debates to be had about whether those spending paths are something we want to do as a country – and the Conservatives have a rich tradition of arguing for a smaller state. That is clearly right in the sense that there is no god given per cent of GDP that has to go on state spending. But the OBR’s work spells out what the direction of travel is in the decades ahead: up not down. As David Willetts has argued elsewhere, the era of politicians offering tax cuts on the back of demographic tailwinds is behind us. And it isn’t just ex-Cabinet ministers saying that. Fundamentally it is this challenge that Theresa May and Phillip Hammond are wrestling with when they promise £20 billion extra for the NHS and admit that there will be tax rises to pay for it.
Now whether they have the votes in Parliament to deliver those tax rises is another question, but something big has changed in politics when both main parties are committed to tax rises to pay for more public spending (Labour’s 2017 manifesto was mainly notable for a bold goal of increasing tax and spend very significantly indeed – albeit to pay for new areas of public spending like free tuition fees rather than the spending pressures for maintaining the status quo).
The conclusion, if we put together the spending pressures noted by the OBR with the debt focus pushed by the Treasury? We’re all social democrats (of a kind) now.”