At the Labour Party conference, Chancellor Alistair Darling proposed a ‘Fiscal Responsibility Act’ to increase confidence that he would reduce government borrowing. Shadow chancellor George Osborne has proposed an ‘Office for Budget Responsibility’ to help increase confidence in his Treasury’s forecasts.
Filling in the details of how they intend to reduce borrowing would likely lead to the largest increase in confidence that they are serious about achieving this. Darling and, to a greater extent, Osborne have provided some details but much remains unspecified by both.
The Treasury’s Budget plans imply cuts in central government spending on public services and their administration averaging 2.9% a year, after economy-wide inflation, over the three years from April 2011.
This would require spending in 2013/14 to be £33bn lower in real terms than in 2010/11. Darling has provided little specific detail of where the axe will fall to date. Perhaps the only significant announcement was the plan to control tightly the pay of 40,000 senior and 700,000 middle-ranking public servants. Further details are expected in this autumn’s Pre-Budget Report.
Osborne has provided more information. He would stop higher-income families with children from being eligible for tax credits or the Child Trust Fund, freeze the pay of most public sector workers in cash terms and make deep cuts to central government spending on administration. The Conservatives estimate that these measures would reduce spending by £7bn by the end of the next Parliament. If they are correct, they would still be a considerable way short of the £33bn needed under the Budget’s plans.
A credible plan to reduce borrowing might help convince international investors that they should continue to lend to the UK government at historically low rates of interest. Darling sought to offer reassurance by stating that ‘we will introduce a new Fiscal Responsibility Act to require that the government reduces the budget deficit year on year, ensuring that the national debt remains sustainable in the medium term’. If such an Act did boost credibility among international investors, it might be worth implementing.
But a sensible commitment to reduce borrowing would need to consider the ups and downs of the economic cycle and contain an opt-out clause in the event of an extreme unforeseen adverse shock, such as another financial crisis. These crucial caveats could diminish the power of such an Act. The same issue arose with Gordon Brown’s two fiscal rules: changes to the Treasury’s dating of the economic cycle diminished the credibility of the golden rule, and the financial crisis shattered the ceiling on debt in the sustainable investment rule.
One of Osborne’s plans to reassure markets is the Office for Budget Responsibility, which would produce forecasts for the public finances independently of the Treasury and government. If it did boost the credibility of the chancellor’s forecasts, it could be a sensible move. But care would need to be taken to ensure that it was not hindered by lack of expertise or information compared with the current Treasury forecasting team.
Neither the Act nor the Office should be seen as a substitute for clarity on how Darling or Osborne would seek to cut borrowing. If individuals are to be made directly worse off financially, then being told sooner rather than later would enable them to plan better for the reduction in their future spending power.
Similarly, setting out their plans for spending on public services would allow managers more time to minimise any adverse consequences.
Providing more information would also help voters make a more informed choice when deciding who they want to elect.
And simply by taking the tough decision to set out the choices they would make might be the best way for both Darling and Osborne to reassure international investors that the rate of interest on our borrowing should remain low.
Carl Emmerson is deputy director of the Institute for Fiscal Studies
