£3 trillion government debt weighs heavily on Reeves’ budget choices

The chancellor has announced measures to raise £26 billion in her budget statement. Driving her decision is the need to cap the size of the government’s debt, which, at £2.9 trillion amounts to 95% of the total size of the UK economy.

But also feeding into her choices is the need to abide by her self-imposed fiscal rules. These require her to cut the deficit (the difference between tax revenue and spending) every year for the next five years. An additional challenge is that the cost of paying interest on this huge national debt has gone up sharply in recent years, with the government now paying more in interest that it spends on education.

The fiscal rules are designed to reassure financial markets, which lend the government the money it needs, that the chancellor is prudent with the country’s finances. Tax rises were necessary to meet Reeves’ “ironclad” rules (based on the forecasts of spending watchdog the Office for Budget Responsibility) with the aim of stabilising that huge debt.

The problem is that small changes in any of the forecasts can throw the government off course. As the former head of the Office for Budget Responsibility, Robert Chote, noted: “The chances of any economic or fiscal forecast being accurate in every dimension are infinitesimally small.” However, Reeves has now left herself more “fiscal headroom” (the amount she can increase spending further without breaking her rules) – £21.7 billion.

She has gone some way to acknowledging the problem of predictions by making two changes in the fiscal rules. Last year she exempted investment spending – on building roads, power stations and houses – from the rules, in the hope of encouraging economic growth.

And this year, she has announced that the Treasury will produce a budget forecast only once a year. This will avoid the difficult spring statement she had to present this year.

But neither of these changes are guaranteed to give her the stability she needs to encourage economic growth and security. Relying on a single OBR forecast makes each budget a hostage to fortune. It might be wise to give a range of economic and revenue forecasts, as the Bank of England already does. The very concept of a fixed amount of “headroom” is probably too rigid and leads to continual changes in policies and taxes.

Since 1997 when fiscal rules were introduced, the Treasury has announced ten sets of rules with 28 different specific targets. For example, when once it was prudent to keep the debt below 40% of GDP, now 100% is an acceptable target. So it is clear that the markets themselves do not view the fiscal rules as immutable, and would probably like more stability and predictability in government spending and tax policy.

This article was written by Steve Schifferes, Honorary Research Fellow, City Political Economy Research Centre, City St George's, University of London. This article is republished from The Conversation under a Creative Commons license. Read the original article to read further expert comments.