Fiscal rules aren’t working – we need a new traffic light system to show the way

The choices the government makes about tax and public spending – the who, what and how much – matter for all of our economic lives. They are rightly at the forefront of our political and economic debate. Behind those choices, playing a major role in determining which ones get made and why, sit the fiscal rules.

The UK has had fiscal rules since 1997. These are numerical constraints governments set for themselves, requiring some measure of borrowing or debt to stay below a particular threshold in a specified year. The precise design has changed over time and since 2010, it has been the Office for Budget Responsibility (OBR), rather than the Treasury, that assesses whether they’re being met. However, for almost three decades these somewhat arcane rules have been at the heart of the policy-making process and government decision making.

There is a reason why the rules have survived for so long, and why more than 100 countries use them in some form. They can help to curb politicians’ proclivity towards excessive borrowing, as well as signalling the government’s intentions to financial markets and voters, and make explicit the financial constraints ministers and MPs are collectively signing up to.

However, the way we use them in the UK has become increasingly dysfunctional. There’s a peculiar and unhelpful fixation on the amount of “headroom” against the government’s pass-fail fiscal rule – the precise amount by which they are being met. This makes for a facile and overly narrow public debate.

Worse still, when the forecast changes, and the headroom changes, policy gets fine-tuned in response. This means that important decisions about tax and spending are taken in a rush, as the Treasury chases a particular number in the OBR spreadsheet. Meanwhile, debt continues to rise inexorably and the rules are changed so often, and abused so relentlessly, that they lack credibility with financial markets.

In short, the current framework isn’t working as well as it should. Other countries don’t make policy like this, and neither should we.

To be clear, the UK should not simply abandon the rules and, with them, fiscal discipline. There are very good reasons why now is not a good time to be borrowing more and why now would be a particularly bad time to relax the rules, given our position vis-à-vis the bond markets. Making changes overnight would be foolish.

But, in future, once the UK is in a stronger fiscal position, it should consider alternatives – a better way of approaching, debating and communicating these decisions of huge economic and political importance.

My suggestion, based on a detailed proposal we’ve developed at the Institute for Fiscal Studies, is that we replace pass-fail fiscal rules with fiscal “traffic lights”.

The core idea is that, rather than have everything hinge on whether a particular measure of borrowing or debt is below a particular threshold in a particular year, we should move to a broader assessment. When you’re behind the wheel of a car, you can’t judge whether or not you’re driving safely solely by looking at the speedometer.

The same is true for chancellors at budget time – they should also be looking at the fiscal equivalent of the rear-view mirror, the weather conditions and the traffic. The government of the day should set out its high-level objectives at the start of the parliament and specify the eight or so indicators against which it wants to be monitored.

Government performance and the state of the public finances would then be assessed using a traffic lights system (only my traffic lights would have six colours, rather than three). While we might always want to include some measure of debt and borrowing, the idea is that the other indicators would vary depending on political priorities.

A government that is particularly keen to reduce the size of the state might want to include that as one of the traffic lights. A government determined to reform public sector pensions might include unfunded pension liabilities, to heighten focus and attention on a generally neglected issue. A government aiming to prioritise growth-enhancing public investment could include that directly as an indicator, and be monitored accordingly.

This would have multiple advantages. It would better reflect the position of the government finances (we’d be looking at more than just the speedometer). It would make more explicit and transparent the multiple objectives the government has in mind when setting tax and spending policy. It would reduce the incentive to contort policy in pursuit of a particular headroom number – and do away with the concept of headroom altogether, given that there wouldn’t be a single threshold to measure headroom against.

It would open up the space for a grown-up conversation with the public about what the government is doing, and why, rather than have everything framed simply in terms of whether the rules would be met.

This approach would present new challenges. It would be more complicated than a pass-fail rule, and perhaps harder to communicate as a result. Politicians might hide behind that, and use it as an excuse to shy away from tough decisions on how to bring down borrowing. These concerns can be assuaged to an extent, but not ignored entirely.

We would also need to make sure that we don’t throw the baby out with the bathwater. The broad division of tasks between the Treasury and the OBR is worth keeping. Robert Jenrick’s commitment this last week that a Reform government would retain the OBR is welcome, not least because of the additional transparency the watchdog brings, and the importance international investors attach to its existence.

Still, the system we have now isn’t delivering, and there is an important conversation to be had about how to improve things.

If we delay that until the next general election, it might be too late.

Ben Zaranko is associate director of the Institute for Fiscal Studies

Photograph by Mike Kemp/In Pictures via Getty Images