Biting the bullet on fiscal targets

26 Sep 12
C Emmerson & G Tetlow

As the economy still refuses to respond to the chancellor’s policies, should he breach his fiscal rules in the Autumn Statement?

George Osborne might have a feeling of déjà vu as he prepares to release his Autumn Statement on December 5. Last year, downgraded growth forecasts led to the estimates for tax receipts being revised down and those for welfare spending being revised up.

Unfortunately, revisions in the same direction can be expected this autumn: the average of independent forecasts for borrowing in 2015/16 is now more than £10bn higher than it was just six months ago. Last year, Osborne responded by allowing borrowing to rise in this Parliament and extending the planned period of deep spending cuts by one further year. Might he do the same again this year?

The chancellor will need to consider the two fiscal targets that he chose to set himself in June 2010. The first, his ‘fiscal mandate’, requires that by the end of the forecast horizon any remaining expected deficit must be explained only by temporary weakness in the economy or by spending on public sector investment. In other words, he cannot expect to borrow to finance non-investment spending on an ongoing basis.

Even if revisions to the forecast mean that new tax rises or spending cuts are required to bring borrowing back on track, these could still be planned for as late as 2017/18. This could be done without breaching the fiscal mandate, assuming the usual practice of extending the forecast horizon by one year each autumn.

More problematic for the chancellor is his ‘supplementary target’, which states that public sector net debt, as a share of national income, should be lower in 2015/16 than in 2014/15. These dates are fixed. We will not know whether or not this target has actually been met until April 2016 but can assess the likelihood using Office for Budget Responsibility forecasts.

In June 2010, the official forecast was that public sector net debt would climb until 2013/14 and then fall, giving the chancellor some wriggle-room against his target. By March 2012, upwards revisions to forecast borrowing over this Parliament were expected to be enough to erode almost all of this room to manoeuvre, with debt forecast to peak in 2014/15 and then fall by just 0.3% of national income in 2015/16. So even at the time of the last Budget there was little more than a 50/50 chance that the chancellor would meet this target on current plans.

If the OBR does now expect that public sector net debt is more likely to rise than fall in 2015/16 on unchanged policies, how should Osborne respond in his Autumn Statement? Assuming he chooses to accept the OBR’s diagnosis there would be three options: continue with policies where the chances of meeting the target are less than 50/50, change policy so that compliance with his target would be more likely, or change the target.

While the fiscal mandate has much to commend it, not least because it allows the government some time to respond appropriately when faced with shocks, the same is not true of the debt target. Forcing debt to fall between two fixed dates does not ensure long-run sustainability, since it does not constrain the government from allowing debt to rise inappropriately before or after those dates. Also, compliance could require the government to implement bad fiscal policies, since there are circumstances under which it would be more desirable for public sector debt to rise rather than fall over a 12-month period.

Therefore, regardless of whether or not the OBR’s next forecast suggests that debt is more likely to rise than fall in 2015/16, the chancellor should drop the supplementary target in his Autumn Statement. Since the fiscal mandate on its own does not limit the liabilities the government accumulates, it would not be sufficient to ensure long-term fiscal sustainability.

Therefore a replacement for the supplementary target would be needed. While it is important to ensure that other market players retain belief in the government’s commitment to fiscal sustainability, getting such a target right, and the timescale in which it should be achieved, is more important than having it in place straight away. It might also be possible to get a broad political consensus over these issues.

Rather than rushing to announce a replacement for the debt target in this year’s Autumn Statement, the chancellor should instead announce a consultation on the design of a new target to conclude in time for next year’s Budget.

Should the chancellor wish to boost further the credibility of the government’s fiscal consolidation plan, he should commit to holding a Spending Review before the end of next year to clarify how the spending cuts pencilled in beyond March 2015 are intended to be achieved.

Carl Emmerson is deputy director and Gemma Tetlow programme director at the Institute for Fiscal Studies

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