Osborne’s Risky Rule

George Osborne is keen on legislation which ensures Chancellors stick to their promises.

Following on from plans to pass a law to stop tax rates being raised, today the Chancellor will announce a plan to legislate to stop future Governments spending more than they receive in revenues. This is supposed to be a demonstration of prudent behaviour. But there is a danger that it could push the Government into taking risks with taxpayer’s money.

The budget surplus rule itself is not a huge surprise. The Conservative manifesto talked of eliminating borrowing by 2019, and introducing “a new fundamental principle of fiscal policy”. According to the manifesto, the policy was to be monitored by the OBR and would ensure that in normal economic times, when the economy is growing, the Government will always run a surplus in order to reduce our national debt and keep our economy secure, with a state neither smaller than we need nor bigger than we can afford”.

Making this official by changing the OBR’s mandate is – for transparency purposes – a good idea. The OBR’s mandate at the moment is to check that the Government is on course to eliminate the current budget deficit, that is, the deficit excluding investment spending. If the Government instead wants to get all Government spending – including investment – below total revenues, then it makes sense to have the OBR checking progress on this.

But the rule itself is very ambitious. As shown in the chart below, the occasions on which borrowing has been below zero, i.e. Government has been taking in more than it spends, are few and far between.


It is also arguably overly restrictive. The IMF has argued that borrowing for infrastructure investment – if done well – increases economic growth, in turn meaning that debt as a proportion of GDP can be kept down. Eliminating the ability to borrow for investment means that funds must come from current revenues. But capital projects don’t have nice, smooth cost profiles – they often involve a couple of years where costs are very high.

For smaller projects, it may be possible to carefully time them so as to ensure a steady stream of capital costs. For larger projects, this is likely to be harder. Overall, it could mean substantial delays to kick-starting valuable infrastructure projects in order to adhere to the rule.

Alternatively, the Government could rely more on the private sector to deliver investment. But there will always be valuable investments that private sector alone won’t deliver. PFI could become more attractive, because it allows payments to be smoothed over time. Perhaps more likely given recent history, Government may issue more infrastructure guarantees – where the private sector undertakes the investment, but Government underwrites the risk, and pays out to lenders if project can no longer finance its debts. But whilst this can look good on paper, the big danger is that this hides risks to the Government finances. The NAO has recently questioned whether HM Treasury is properly measuring risks to taxpayers of long-term infrastructure guarantees.

More broadly, this approach puts even more importance on the role of the financial system. What is meant by “normal economic times”, and therefore the exceptional circumstances when Government could borrow, is yet to be defined. But any lack of liquidity in financial markets could cause much greater problems if Government is unwilling to invest – potentially leaving more in the hands of monetary policy and the Bank of England.

What looks like a prudent rule could push Governments into some imprudent behaviour.


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