UK: Rethinking the UK’s fiscal rules is a key to unlock growth

What you will learn:

• Last week’s Budget highlighted the flaws at the heart of the UK’s dysfunctional fiscal policy, particularly its poorly-designed fiscal rules. We think reforming these rules would help to cut government debt, provide more support to growth, and reduce the scale of austerity that the next parliament will be forced into.
• The current fiscal rules lack credibility, impose scant debt discipline, and allow governments to game the system. The asymmetric treatment of tax and spending plans incentivises governments to assume future, unspecified, spending cuts will reduce borrowing, no matter how implausible. Including investment in the deficit target steers chancellors towards cutting capital spending.
• We propose three changes to the fiscal rules: cutting the time horizon to three years from five; switching the deficit target to the cyclically-adjusted current budget; and removing the distortionary effects of Asset Purchase Facility losses from the debt rule.
• Shortening the timeframe would bolster the credibility of the government’s commitment to reducing the debt-to-GDP ratio. The other changes would create space to raise public investment. A scenario using our Global Economic Model shows these changes could increase GDP by more than 1ppt over 10 years, while still lowering the debt-to-GDP ratio.
• Outcomes could be even better if the government also implemented a coherent supply-side strategy to boost potential output.