Is the purported £22 billion fiscal "blackhole" a legitimate concern?
This question examines the rationale behind the Chancellor’s decision to change fiscal rules to deliver a Budget of massive spending propped up by £36.2 billion of tax rises and £32.3 billion of borrowing. By emphasizing tax increases and increased spending, the Government risks undermining economic growth and national competitiveness.
On 29th July, Rachel Reeves released a House of Commons statement stating that the new Government had “inherited a projected overspend of £22 billion” following a public spending audit conducted by the Treasury. The public was guaranteed a conclusive report on this to accompany the Autumn Statement in October.
Delivering the statement, the Chancellor proposed a series of changes to the rules that permitted such “incompetence” in the first place. Central to these changes were the fiscal rules which had aimed to show fiscal prudence by reducing the incentive to borrow (by ensuring annual borrowing is not more than 3 percent of GDP) and reducing the debt profile (where debt is defined as the Public Sector Net Debt (PSND) and is expected to fall as a percentage of GDP by the fifth year of official forecasts).
Blessed are the children, for they shall inherit the national debt.
Herbert Hoover
By contrast, the new rules aim to balance the budget by matching spending with revenue and, similarly to the previous rules, aim to reduce the debt profile (except that debt would be estimated using a broader definition – the Public Sector Net Financial Liabilities (PSNFL)).
These fiscal rules are flawed on three premises. First, the first rule does not state clearly the time horizon within which day-to-day spending should match government receipts. This creates a loophole that permits erratic spending with no punitive measure for its consequences. Second, the expectation that debt should be falling by the fifth year does not consider short-term debt volatility, which likely will be on an upward trend following the Budget. Third, it relies on a 5-year public finance forecasting, which is uncertain in comparison to the government deficit. The question is whether loosening fiscal rules in this manner creates more avenue for borrowing more money than we may need to.
At the heart of the rationale behind these changes were estimates from the Office for Budget Responsibility (OBR) showing that the previous administration would have been able to borrow an additional £53 billion had it used the PSNFL method to calculate its debt instead of using PSND. Thus, it implies that no black hole would have existed if they had been broader in their definition of debt. The implication is that these rules would be an epoxy injection to fix the foundation of our cracked economy.
In reality, the Budget revealed that these fiscal rules were created for “securonomics”, the name of the Chancellor’s economic philosophy. Securonomics can be described, roughly, as the promotion of an interventionist state that seeks to tilt the scales of the economy towards government, whilst significantly increasing workers’ rights and protections.
The budget includes an increase in public spending by approximately £70 billion a year, over half of which will be met by taxes. Over the course of this Parliament, the OBR forecasts that borrowing will be £28.4 billion per annum more than forecasted following Jeremy Hunt’s March Budget. As a result, the tax burden is projected to be its highest on record by 2029/30, with a value of 38.2 percent of GDP. This means that the UK will surpass the OECD and G7 average tax burden by as early as 2027/28. As the OBR notes, it will also be the largest tax burden the UK has experienced in peacetime, dwarfing the tax burden imposed by the budgets of 2010 and 1997. This likely means that individuals, families and businesses will experience a further cut in disposable income, reducing their ability and incentive to participate in economic activities that boost growth.
According to the OBR, in the medium term (post 2025-26), the proposed increase to public sector spending will crowd out some aspects of the private sector, reducing British competitiveness. It is highly uncertain that there will be enough economic activity to generate the tax revenue required to meet increases in public spending, which has led many to believe that this will mean more borrowing to plug the gap.
Further early effects of this budget continue to manifest. New reports from the Office for National Statistics (ONS) show that government spent more than it raised in taxes in October, by borrowing £17.4 billion. This was the second highest October borrowing since 1993, when records began. It was also £5.1 billion more than forecasted. The damaging effect of massive borrowing is already being felt as monthly central government debt interest rose to £9.1 billion. If this trend persists, the possibility that the government could spend more than budgeted for could become a reality.
So, what about the black hole expected to be revealed? As promised, the OBR released its review of departmental expenditure limits forecasts on 31st October but could not attest to the presumed £22 billion blackhole. The reason for this uncertainty lies in two key aspects of government financial mechanisms. Firstly, when a government legally approves a budget, it can request funding from the Bank of England, which is legally required to provide the necessary funds, regardless of current tax revenue. Secondly, when a government spends new money, it has two primary options for managing this expenditure: it can either raise taxes to cover the spending or offer citizens investment opportunities through depositing savings with the National Savings and Investment (NS&I) accounts or government bonds (gilts).
Thus, more than anything, these proposed changes to fiscal rules seem destined to expand the scope of government intervention yet further into the economy.