Debt annihilation is approaching – and neither party is minded to stop it
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Britain needs an entirely new fiscal framework if it is to put an end to the ever-mounting burden of public indebtedness, but neither the presiding Tory government nor its likely Labour successor show any sign of wanting to apply the required restraint.
As things stand, the British state is on a clear and unavoidable path to debt-addled oblivion. Virtually all the pressures on public spending, from defence to social care, the NHS and net zero, are on a strongly rising path.
Yet the politicians seem powerless to stand in their way, prompting the Institute for Fiscal Studies to comment: “It will be more difficult to reduce the debt-to-GDP ratio over the next parliament than in any other parliament since the 1950s.”
Many supposed priorities, moreover, threaten to make the situation even worse. Big challenges and much higher costs lie in wait for the social care and university sectors if, for instance, there are significant cuts to immigration.
Labour is desperate for power, and is seemingly willing to sell its own grandmother to get it. Every time you look, another policy objective has seemingly been abandoned in an attempt to sweet-talk financial markets into believing this is a party they can do business with.
In George Orwell’s Animal Farm, it did at least take a little while before the noble ideals of “animalism” gave way to the pursuit of power for the sake of it, but Labour is moving from “four legs good, two legs bad” to “four legs good, two legs better” at a speed that would impress even the most cynical of demagogues.
If making it safe to vote Labour entails abandoning curbs on bankers’ bonuses, committing to the same rate of corporation tax as the Tories, promising not to raise established rates of income tax and national insurance, or even watering down the £28bn flagship “green prosperity” plan, so be it.
We’ll match or even better the Tories on fiscal discipline, Labour’s high command repeatedly pledges, which is easy enough to commit to in opposition, but a good sight more difficult to deliver once in government.
As a party that likes to tax, spend and borrow, the fact is that Labour is peculiarly unsuited for the task that lies ahead. As things stand, neither the Government’s fiscal rules nor the very similar ones proposed by Labour – both of them supposed to impose a degree of constraint on tax and spend – look equal to the task of getting the debt-to-GDP trajectory back onto a sustainable path.
To the contrary, by providing the illusion of constraint, they merely serve to reduce the market and political pressures for the degree of fiscal discipline that is required, and thereby give cover for persistent deficit spending.
Both of them are a pretence, or a fig leaf that allows St Augustine’s principle of “please make me chaste, but not yet” to reign supreme. Every time the going gets tough, the rules are adjusted to accommodate a softer approach.
As Ethan Ilzetzki, associate professor at the London School of Economics, observed in a paper last week for “UK in a Changing Europe”, the reality is that governments have repeatedly changed the fiscal rules in order to make room for rising debt-to-GDP ratios.
He said: “When times are bad and the economy is hit by a shock, the government relaxes the target; but when things get better the government declares victory and loosens policy.”
The idea that deficits should be restricted to no more than 3pc of GDP originally came from the EU’s Maastricht Treaty to bring about further European integration. It’s a fairly arbitrary number, which the UK is in any case under no obligation to apply now it’s outside the EU.
Yet today it means almost nothing at all, either in the UK or the EU, having been manipulated or otherwise suspended to death.
After repeated economic shocks, 3pc of GDP has “become the effective floor, rather than the ceiling”, Ilzetzki points out. The UK’s fiscal rules are these days easily capable of accommodating much larger ongoing deficits, while the EU has struggled to reimpose one time fiscal constraints.
It was reasonable to assume that the debacle of Liz Truss’s mini-Budget would have finally drawn a line under the practice of repeatedly putting off the fateful day in the hope that, like Wilkins Micawber, something will turn up.
In the event, it has neither put an end to fantasy fiscal policy, nor is there any likelihood of anything turning up to save us.
In seeking to undo the damage of Truss’s short-lived premiership, the Chancellor, Jeremy Hunt, sought to re-establish confidence by raising taxes and taking the axe to planned spending.
Yet the moment the first green shoots of fiscal stability poked their way through the frozen tundra, it was immediately squandered on tax cuts, even though public debt is now virtually 100pc of GDP.
The Government’s stated objective of further tax cuts ahead of the election drew a stinging rebuke last week from the International Monetary Fund, whose chief economist, Pierre-Olivier Gourinchas, said the UK’s focus should be on “trying to rebuild fiscal buffers ... rather than adding to the £20bn of personal and business tax cuts delivered in November”.
I’ve got some sympathy with the offence that Hunt plainly took at Mr Gourinchas’s remarks, and indeed his testy reaction to separate criticism from the head of the independent Office for Budget Responsibility to the effect that forecasts for debt were based on “questionable assumptions” about the scope for spending cuts.
Mr Gourinchas has no idea what Hunt is planning; when dealing with a tax system as labyrinthine as the UK’s, there are lots of tax cuts that can be made which are good for growth, and would therefore largely pay for themselves.
Nor is it the job of the OBR to express a view on the credibility of spending cuts. That’s for markets and commentators like me to judge.
All the same, both make valid points. Rules designed to guard against fiscal profligacy no longer do the job they are supposed to, and are even less likely to provide that constraint in future.
Like the Government, Labour has chosen a target for getting the debt-to-GDP ratio on a declining path that constantly recedes five years into the future. This makes the rule all but meaningless. What’s more, it can be suspended at any point to allow fiscal policy to respond to external shocks.
In an increasingly dangerous world, it is almost certain that we’ll see at least one such shock in the next five years, making it seem equally certain that debt will continue to rise until finally it breaks the bank.
The soft fiscal credibility rules we see today are going to prove powerless before the flood; none of them ensures that the fiscal armoury is recharged between economic shocks with sufficient weaponry to be able to withstand the next onslaught, which will no doubt be with us soon enough.
