Thursday 1 February 2024

The myth of fiscal headroom


Fiscal rules are magical things which, apparently, every party needs to have. Parties can and do, however, invent their own rules. And change them, if ever they become ‘inconvenient’. It’s easy to see why the Tories, particularly late in a parliament facing an election which they are all but certain to lose, would want to lay down rules which would constrain an incoming Labour government. It’s a lot less easy to understand why the Labour Party would be stupid enough to let them get away with that.

Whatever, the Tory rule is, in essence, a very simple one: it must show that government debt overall is reducing by the end of the current five year period. Effectively, it doesn’t matter what happens in years 1 to 4, as long as the numbers show the right answer by the end of year 5. Although it might sound very difficult, it’s actually quite easy to achieve, all they have to do is make up the numbers. And that, in effect, is exactly what the Office of Budget Responsibility accused them of doing last week. As their head honcho put it, it’s not that the government figures are a work of fiction, because there was no work involved. They are simply invented numbers, with no plan for achieving them and no evidence to justify them, yet statute requires the OBR to pretend they are serious.

But that isn’t the end of it; the rule is even more magical than that. When one year ends, what was year 5 becomes year 4 and a new year 5 gets added on to the end. The rule now only requires a reduction in debt by the end of the new year 5. If they want to, the government can put off debt reduction almost indefinitely and still claim to be meeting the rule which says it’s reducing. By definition, the figures for year 1 will always be firmer and more accurate (or rather, less inaccurate) than the figures for later years, and they become the basis on which the government manages the books for the year. So, if income increases for whatever reason (such as more people being brought into payment of income tax through frozen limits) or expenditure reduces (such as lower interest rates leading to reductions in the cost of debt servicing), the government finds itself with what it and the media like to call ‘fiscal headroom’. Without borrowing any more than they’ve already planned to do, there is suddenly cash available with which they can do one of three things.

They could reduce the planned borrowing for the year, they could increase spending on failing public services – or they could cut taxes. And all the talk at the moment is that the Chancellor will use this apparent windfall to reduce taxes in next month’s budget, in the belief that doing so will be a big enough bribe for people to vote for the Tories. They will still be borrowing the same amount as they’d already planned to borrow (for all their talk about needing to cut borrowing, that’s a task which they’re more than happy to put off until the mythical year 5 and thus leave to an incoming government). They’ll just use some of that borrowing to reduce taxes. That’s right – the policy is effectively the same as that promoted by the previous worst PM on record, Liz Truss, namely borrow money to cut taxes. The only difference is that she alarmed people by planning to exceed the budgeted amount of borrowing without providing a good enough set of fictitious figures for the future, whilst Hunt is promising to stick within the already agreed fiction.

Here are two facts we know. Firstly, cuts in income tax always help higher earners more than low earners. And secondly, when the government borrows money and pays interest thereon, it necessarily borrows from those who have money available to lend, whether that’s directly through NS&I investments or indirectly through pension pots. Heads the better-off win, tails the less well-off lose. Doubly so, in a sense – the less well-off are also more dependent on the failing services in which the government is deliberately choosing not to invest. It’s easy to see why such policies appeal to those who have money: who wouldn’t prefer to pay less tax and then lend money to the government and receive interest on it instead? It’s a lot less obvious why this ploy will appeal to the majority who neither have the money available to lend to the government nor are likely to benefit greatly from any tax cuts. But then, sleight of hand is the secret of a good magician; most people aren’t seeing the full picture.

No comments: