More power to the OBR?

The new bill to ensure that a UK government obtains the OBR’s analysis for any fiscal event is largely symbolic, because the reaction to the Truss fiscal event will be enough to ensure that happens anyway. However there does seem to be a more general concern that the OBR’s analysis has come to dominate fiscal policy making. In this post I want to explore this concern in more detail.

Before the OBR was established, the Treasury published its own forecasts of what the consequences of any budget would be for the public finances and the UK economy as a whole. The obvious problem with that arrangement was that politicians may lean on Treasury forecasters, and secrecy ensures we will probably not know if this has happened. It clearly makes sense that fiscal decisions are made on the basis of an independent forecast rather than the forecast politicians would like to see.

Why does it often appear as if the OBR’s forecast is determining fiscal decisions? The reason is the fiscal rules chosen by politicians to constrain what they can do. If, for example, a Chancellor wants to cut taxes by as much as possible while staying within their own fiscal rules, then the OBR forecast will determine by how much taxes can be cut. Exactly the same would happen if the Treasury rather than the OBR did the forecast, with the only difference being that politicians could lean on the Treasury to produce a biased forecast.

Is some of the concern about the OBR’s role really a concern about fiscal rules? I have written a great deal about fiscal rules, but I think it is important to remember the underlying principle behind them. The principle is that fiscal decisions should be sustainable, by which we mean that tax or spending decisions described as permanent today do not have to be reversed at some point because the path of the public finances or the economy is unsustainable, and that this lack of sustainability is clear given the information we have today.

Fiscal rules, like an independent budget forecast, are designed to protect the public from being misled by politicians trying to gain political advantage. Fiscal rules make it harder for politicians to cut taxes or raise public spending just before an election, only for whoever wins that election to have to raise taxes or cut spending to restore sustainability.

When some talk about the OBR having a veto on fiscal decisions, in reality they may simply have a complaint about how well fiscal rules capture the idea of sustainability. Suppose, for example, that you thought tax cuts would, over a decade, generate sufficient extra growth to help pay for themselves. These tax cuts would be sustainable in terms of the public finances, but fiscal rules that only looked five years ahead might suggest that they were not sustainable. The same argument could be used for some public investment projects, for example. In both cases the problem is not the OBR, but the fiscal rules that governments have chosen.

A more interesting case is where politicians have a particular view about how the economy works, which is not shared by the OBR. For example politicians might believe in a Laffer curve where tax cuts pay for themselves because they incentivise people to work more (generating higher tax receipts). The OBR, drawing on the evidence and the consensus view of economists, might think these incentive effects are much weaker, and so in their forecast tax cuts would not pay for themselves.

Does the OBR have a veto in that case? No, because it is open to the politicians to ignore the OBR’s forecast and go ahead with their tax cuts. All the OBR forecast forces them to do is be explicit about why they are ignoring that forecast. This is surely a good thing, because it allows voters to eventually judge who was correct. Of course politicians might not be prepared to put their beliefs on the line, which is why this option has never been used since the OBR was established.

For these reasons, saying that the OBR has a veto on fiscal decisions, or that the OBR reduces democracy, is just wrong. Indeed the opposite is the case, because by making judgements more transparent the OBR increases democratic accountability.

However I do think there is a legitimate concern that recent budgets have become rather mechanical, and that this has over-emphasised the role of the OBR’s forecast. Here I think the fault is with the politicians and to some extent the media rather than the OBR. The biggest and most important fiscal issues involve the structure of taxation and spending. Have we got the right balance between direct (e.g. income tax) and indirect (e.g. VAT) taxation? Are we right to exempt so many goods from paying VAT? How does the income tax schedule influence incentives, and is it fair? Should the rich be paying more tax? How do cuts in some areas of public spending increase public spending elsewhere? How much should the biggest area of welfare spending, pensions, be provided by the state? The list of such issues is endless, and these questions are usually much more interesting than a discussion of how much room the latest OBR forecast leaves for tax cuts.

Unfortunately in recent years such questions have played a rather minor role in budget analysis. In part this is because politicians have focused on the distributional aspects of fiscal measures, and whether these might win them votes among those groups they want to attract. This can lead to an overall tax system which is badly distorted, with costs to society as a whole.

The second most important issue in fiscal policy involves the size of the state. How much more spending do we need on the NHS, education, defence etc, and what taxes need to be raised as a consequence. The idea that the OBR forecast determines the scope for tax cuts is only true if you treat spending as given, and similarly the notion that the OBR forecast tells you how much more can be given to the NHS is only true if you think you cannot raise taxes. In recent budgets there has been little discussion of this because the Conservatives adopted spending projections which were already implausibly low, so tax cuts depended entirely on the OBR forecast.

The media may also be partly responsible for the focus on the arithmetic of budget decisions (and therefore the OBR forecasts), rather than these other issues. Any journalist can ask whether a budget adds up in terms of meeting fiscal rules, while it requires a bit of knowledge or prior research to ask about some of these more interesting questions. It means that all too often IFS and other expertise is underused by the media.

All this suggests that the OBR as it currently stands has very little influence over the budget beyond providing an independent forecast, and certainly has no veto power over politicians. The new bill ensures that the OBR, rather than the government, decides whether a new OBR forecast is warranted after a big fiscal event, which also makes sense.

Going beyond this new legislation, there remain areas where the independence of the OBR’s forecast could be improved by allowing them not to take government projections of their spending totals or policy decisions as given when past evidence suggests they are highly unrealistic.

The most obvious example of this for the last government was their repeated freezing of fuel duty, while continuing to pretend that in the future they would raise fuel duty. The legislation setting up the OBR forced it to take the last government’s word on future fuel duty, even though it broke its word continuously. This could easily be changed, and it should be.

I would go further, and give the OBR discretion to look at scenarios based on alternative projections for government spending and taxes. The latest review of the Bank of England’s forecast said it should look at more scenarios, but at present the OBR is not allowed in its budget forecast to look at any scenario that involves an alternative path for government spending and taxes (‘policy simulations’).

Ending this restriction would allow the OBR to avoid being saddled with unrealistic assumptions about government spending, like those bequeathed by the last government. But more generally doing policy simulations alongside its forecast would give the OBR the opportunity to enrich the fiscal debate. The most obvious example was the Coalition’s austerity policy. Indeed I suspect the reason the OBR is not allowed to do policy simulations alongside its forecast is because Osborne did not want the impact of austerity on output exposed in this way.

Such a change to the legislation governing the OBR would give it a tiny bit of political power, because it could choose whether to do policy simulations and what these simulations would be. Experience suggests that it would use that power responsibly, generally reflecting the policy debates in parliament. It could help make the OBR a tool for parliament as a whole, rather than just an instrument of government. The OBR would still have a lot less power than some other fiscal councils around the world, which operate more as fiscal watchdogs directly criticising government policy.

More generally, I normally find complaints by politicians and others about ‘rule by technocrats’ unconvincing and often self-serving. If the choice is between on the one hand having technical work done by civil servants under the direction of politicians, work that may or may not become public, or on the other hand having this work done by independent institutions that always publish their analysis, I prefer the latter. The key is to ensure that these independent institutions are accountable to parliament, as the OBR is to the Treasury Select Committee.