What can be done about the Chancellor gaming his fiscal rules

 

As Chris Giles explains here, Chancellor Hunt is gaming his fiscal rules. He is not the first Conservative Chancellor to do so. In particular, it is now routine for Conservative Chancellors to announce that they are freezing fuel duty, but they then tell the OBR that they will raise them with inflation in every forthcoming Budget. They have repeated this fiction for the last dozen years. The fiction that the duty will be raised in the future, just not now, flatters future revenue projections and makes it easier for the Chancellor to meet his fiscal rules.

This particular problem arises because the OBR is legally obliged to produce a forecast on the basis of what the government claims is its policy. However there is the letter of the law, and there is politics. Suppose the head of the OBR decided next year that it would ignore the government and instead use past data to assume that fuel duty would not be uprated in future, what exactly would the Chancellor do? Fire him? It just wouldn’t happen.

I know the previous head of the OBR thought about doing this. The current head, Richard Hughes, would have his hand strengthened considerably if the Treasury Select Committee stated that in future it expects the OBR to do this. This committee has to approve senior appointments to the OBR. Whether the Committee has the political courage to do this is another matter. In the longer run the legislation governing the OBR should be changed so as to allow it to base its projections on what it believes the government will do in the future. [1]

Much the most difficult and serious element of gaming, that I mentioned myself after the budget, involves the projections for public spending. As was clear from the last Autumn Statement, the Chancellor’s plans involve two things that almost certainly will not happen. The first is that we have a renewed round of public spending cuts, in a public sector that is already cut to the bone. The second is that the relative pay of public sector workers continues to be reduced relative to other workers, in a situation where public sector vacancies are at critical levels and public sector workers are either striking or have won awards that exceed the government’s assumptions. This bit of gaming is more difficult to fix, yet it risks making a mockery of the whole Budget forecast.

Some might say that fiscal rules are a fiction anyway, so who cares about this. I don’t like the particular fiscal rules the Chancellor has chosen [2], but I do think fiscal rules are there for a good reason. I partially disagree with Stephen Bush on why they are important. They are not there to keep the markets happy, and nor are they required to keep departmental spending in place. The purpose of fiscal rules is to stop the Chancellor fooling voters, by for example cutting taxes just before an election and pretending that these cuts are sustainable. Voters deserve to know whether pre-election tax cuts or other bits of fiscal largesse are bribes that will disappear once the government is elected or something that is more permanent. That is why gaming the fiscal rules matters.

If we go into why the rules are currently being gamed, it helps to understand why it’s difficult to stop. Paragraph 4.46 of the OBR report explains why assumed pay growth for the public sector is about 1% lower than that for the private sector, thereby continuing the relative fall in the pay of public sector workers that we have seen since 2010/11. There are two points to make. The first involves implausibility, given the increase in vacancies, quit rates and strikes we are currently seeing in the public sector. But just because something is implausible doesn’t mean it is impossible. The second is visibility - you have to dig deep in the OBR’s report to find this analysis.

On public spending, the numbers the government have pencilled in are broad aggregates, so you have to make some assumptions to see what this means for individual departments. Luckily the IFS post-budget analysis has a go in the chart below.

NHS spending increases are at the past long term average, which is the minimum conceivable in that it does nothing to relieve current pressures. Spending on schools declines as a share of GDP, while it is announced policy that defence spending does the opposite. That leaves an annual real term fall in spending of 3.2% in everything else. We have the same two problems. The government’s assumptions are opaque, so they can always say they don’t ‘recognise these numbers’, and they are highly implausible but it is hard to say they are totally impossible.

So the OBR under its current remit cannot say that these projections cannot happen, but because the detail is hidden (pay) or not spelled out (departmental totals) the Chancellor bears little cost in putting these implausible numbers forward.

One way around this problem is to make fiscal rules apply to the short term rather than medium term, but there are excellent reasons why this cure would be worse than the disease. A much better option is to strengthen the watchdog role of the OBR, to make it more in line with some other fiscal councils. This would require two changes to the legislation that set up the OBR.

First, the OBR needs to be able to do policy variants: simulations/forecasts where policy variables are different from the government’s announced plans. That goes well beyond the minor tweak suggested for fuel duty, because no evidence would be required that this would be what the government might actually do. The Treasury were insistent that the OBR would not be able to do this when it was set up, partly I suspect because it didn’t want to see alternatives to austerity.

Second, the OBR would be mandated to comment on the feasibility of aggregate public spending plans, and if the government’s projected plans were unlikely to be feasible, to prepare an alternative forecast based on plans that were feasible. Very quickly this alternative, more plausible forecast would be the one that everyone quotes.

Of course neither of these things will happen under the current government, so what is to be done next year if, as some have suggested, the government not only cuts taxes but pencils in even more tax cuts, and combines these with even more unlikely paths for public spending than are already there. The IFS and Resolution Foundation will no doubt call the government out on this, and the text in the OBR forecast will provide plenty of hints, but both are likely to pass most voters by.

Ironically the government will see these tax cuts as a ‘trap for Labour’. If Labour say they will not implement these tax cuts if they win the election then they give a real ‘higher taxes under Labour’ weapon to the Conservatives. If they say they will cut taxes then journalists, with some justice, will ask Labour about the clear implications for public spending. A compromise for Labour would be to accept the immediate cuts, but not future cuts, saying the Conservatives couldn’t afford these either. There are no easy answers here, but these dilemmas stem from the government’s ability to game the system. The government’s ability to game the system in turn stems from the weakness of the OBR as a watchdog.

[1] Another example of possible gaming that Giles and others have mentioned is investment allowances for firms. In the OBR projections this is a three year policy, but Hunt announced that he would like to make it permanent if and when resources allow. There is the expectation that the Chancellor probably will make it permanent at some point, but this is based on politics rather than experience. In this case the OBR would have little past evidence on which to warrant overruling what the Chancellor says his current plans are. For that reason I don’t think this is an example of gaming the rules. Chancellors should be able to announce aspirations, but if the fiscal rules don’t allow those aspirations to happen I can see no reason why the OBR should do otherwise than take the Chancellor at his word. I think this is an example of the rules working.

[2] I have always argued that falling debt to GDP is a silly rule, and I’m glad the consensus seems to be shifting that way even if Labour policy is not. In addition, targeting the total deficit rather than the current deficit that excludes private investment is wrong both in principle and in practice.

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