Chancellor’s spending plans are likely to break his fiscal rules

The new Chancellor’s plans to increase public spending next week look set to be inconsistent with the fiscal rules he publicly remains committed to, according to a report published today (Saturday) by the Resolution Foundation.

Breaking the rules examines the Chancellor’s options for his Spending Round next Wednesday (4 September) when he will set out spending plans for the next financial year (2020-21).

With the deficit at a 17-year low, and borrowing costs having recently fallen yet again, the report says that the Chancellor is able to borrow more to spend on public services. Significant spending commitments on schools, police, prisons and health already announced by the Prime Minister are likely to be added to next week with further spending on the likes of social care.

This extra spending will mark a major shift in British political and economic debate. The Foundation notes that it could be the first Spending Review since 2007 to include overall departmental spending rising faster than inflation.

The report considers how these plans are likely to match up with the government’s current fiscal rules – and in particular the ‘fiscal mandate’ to reduce public sector net borrowing to below 2 per cent of GDP by 2020-21. While the Chancellor has made a virtue out of confirming that increased spending in “next week’s Spending Round will be delivered within the current fiscal rules”, the analysis shows that this may well not be true in any meaningful sense.

On the basis of the last forecast from the Office for Budget Responsibility (OBR), published in March, the Chancellor would have £14 billion of headroom (down from an initial £27bn because of an estimated £13bn hit from the revised public finance treatment of student loans) against his fiscal mandate. This would be more than sufficient to fund the Prime Minister’s spending commitments, and end austerity in the Spending Round.

However, shifts to the fiscal and economic outlook since that forecast was made mean that announcing a significant increase in spending next week is likely to be inconsistent with being credibly committed to the fiscal mandate.

Breaking the rules shows that a continuation of the higher borrowing already witnessed in the first four months of 2019-20 into next year could conservatively mean borrowing in 2020-21 being around £5bn higher than the OBR expected back in March. This is being driven by higher government spending, rather than weaker tax revenues.

Following recent forecast downgrades by the Bank of England, the report adds that a weaker economy on the back of Brexit uncertainty, and a wider global slowdown, could see borrowing hit by a further £5bn next year. The combination of the two would mean a realistic estimate of the headroom against the fiscal mandate is nearer to £4bn than £14bn.

The Foundation’s analysis shows that with the Prime Minister’s existing commitments totalling £6bn in 2020-21, and significant further spending increases likely to be announced next week, the Chancellor’s headroom is set to be more than used up, and the fiscal mandate broken, even before the costs of promised tax cuts are considered.

The Foundation says that the government can afford to borrow more to boost public spending. However, it is undesirable for the credibility boost that is meant to come from fiscal rules to be turned into a credibility deficit, with policy being announced that is inconsistent with the rules the government says it is committed to.

Torsten Bell, Chief Executive of the Resolution Foundation, said:

“Next week’s Spending Round will mark the end of a decade of spending cuts that have dominated political and economic debates. With the deficit now at a 17-year low, the Chancellor can clearly afford to borrow more to spend on public services.

“But it is far less clear that he can afford to undermine economic credibility by professing to be bound by fiscal rules that are likely to be inconsistent with the scale of spending rises and tax cuts being planned.”

Dan Tomlinson, Policy Analyst at the Resolution Foundation, said:

“While it may feel easy for the Chancellor to plan to increase spending while saying he is committed to his predecessor’s fiscal rules, the reality is more complicated.

“The £14bn headroom the Chancellor intends to spend has already been reduced to around £4bn by changes to the fiscal and economic outlook. What remains is likely to be more than exhausted by existing Prime Ministerial spending commitments, even before any further increases are announced in next week’s Spending Round.”