Fixing the roof while the sun is shining – Osborne’s new spending rule

October 9, 2013

The last few days have been interesting for public finance wonks. George Osborne announced a new fiscal rule – to run a surplus during the next parliament (by 2020). At the same time, the United States is witnessing a shutdown of its federal government as the US Congress failed to agree on a government funding bill, shutting down a range of services from the government tax service to a baby panda camera.

Few would favour such a severe rule for the UK. There are many details of the Chancellor’s plan we do not know yet – how it will respond to the economic cycle, account for investment spending, when it will apply and how it will be enforced among others. But it is far from unambitious. Over the last decade the UK borrowed a whopping £811 billion. Despite government spending restraint, over the next five years we are projected to borrow another £395 billion, £107.7 billion – that’s £107,700,000,000: the equivalent of the entire budget of the NHS – this year alone. Reducing this number to below zero will be no easy task. It has only been done in 11 years of the last 67 – the last time between 1998 and 2000 – a legacy of Labour’s commitment to match Conservative spending plans.

George Osborne justified this approach by referring to a past failure to ‘fix the roof when the sun was shining’ – and the evidence for this is well documented. Between 1997 and 2010, the UK saw the largest increase in public spending as a share of national income of any industrialised country for which there is comparable data, from 22nd position out of 28 to 6th: a remarkable rise of some 4.4% per year in real terms. While tax receipts remained relatively stable throughout this period: fluctuating in a fairly narrow band of 36.2% to 38.7% of GDP, public spending rocketed: from 34.6% of GDP in 2000 to 47.4% in 2010, a level not seen since the UK’s IMF bailout in 1976. Just under half this increase (6.2% of the 12.8% of GDP total) had already occurred by 2005: well before the start of the economic crisis. This meant that the UK entered the financial crisis in 2007/8 with an already significant fiscal deficit, limiting its ability to respond with countercyclical fiscal policies.

So any rule should certainly try to avoid the mistakes of the past. And it makes sense to look at new rules to consolidate the benefits of what will likely be a decade of severe budget restraint – we at Policy Exchange will be setting out just how we think this should be done later this year. But whatever the specifics of the policy, the Chancellor’s announcement revealed a real determination to achieve sound public finances few previous governments have mustered. That alone is worthy of praise.

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