Rachel Reeves faces some tough fiscal choices

Rachel Reeves vowed to stick to her fiscal rules yesterday after a rise in UK borrowing costs piled more pressure on the chancellor.

So what? The rules that constrain day-to-day spending and debt levels are designed to keep the government in check. A costly retreat on welfare and expected downgrade in growth by the OBR mean the chancellor is likely to increase taxes to meet them. But there is another approach, a series of careful tweaks by which Reeves could avoid

• an increase in income tax, national insurance or VAT;
• the political backlash that would come from these rises; and
• the market response that may come, alternatively, from fiscal loosening.

Promises broken. Most economists are predicting that the chancellor will be faced with a significant black hole to fill, with estimates ranging from £10 billion to £30 billion. If it is towards the upper end of this range, no combination of continuing to freeze income tax thresholds and increasing wealth taxes, banking taxes or gambling duties will raise enough money. Reeves will have to break a tax pledge. At which point, attention might turn to the fiscal rules.

Beware the market reaction. Gilt yields rose sharply when the markets thought Reeves might be replaced by someone more inclined to loosen these rules. So the Treasury will be advising caution when it comes to the current chancellor doing the same.

What can’t change. This is why the UK can rule out a complete move away from either Reeves’s “stability rule”, which relates to spending, or her “investment rule”, which relates to debt.

Nothing has changed. But there are tweaks that could be made that would increase fiscal headroom and allow the government to argue that it has stuck to the rules – in the same way it said that increasing employer’s national insurance was consistent with its manifesto.

Part one: timing is everything. The current “stability rule” means day-to-day spending must be met by tax revenues.

• It must remain in balance or surplus by 2029/30, until that becomes the third year of the OBR forecast.
• At this point the target year shifts to three years ahead on a rolling basis.
• As this will happen in a couple of years time anyway, the government could make the change now by keeping the same rule but shifting the target year to 2030/31.

This could be worth around £10 billion.

Part two: spending cuts that won’t happen. The government has set out its spending plans up to 2028/29. Crucially it won’t be setting out departmental allocations for the year the fiscal rule has to be met until the next spending review.

In the coming budget, Reeves could make use of the tried and tested tactic of setting the spending growth rate in those two years to save money. This will mean future spending but the chancellor won’t have to say where it will fall. It may upset the Institute for Fiscal Studies, which has previously talked about a “conspiracy of silence” over spending cuts, but could save Reeves another £5 billion a year.

Part three: a surplus could be a deficit. Finally, the chancellor could make use of the emergency buffer currently written into the existing fiscal rules. This states that once the current target year of 2029/30 is three years away the rules are met even if there is still a deficit of 0.5 per cent of GDP that year. Making use of this now would be worth billions in headroom.

The risk. Politically-speaking, these may look like three more attractive options than raising taxes. But even then they may not be enough, and adjusting the fiscal rules is not cost-free.

• They are supposed to be “non-negotiable” so any change would involve the chancellor breaking a promise.
• The point of any change would be to increase borrowing, which risks a bond market reaction that drives up the government’s debt interest payments.
• Higher borrowing could also mean the Bank of England is forced to keep interest rates higher than they otherwise would, impacting mortgage costs.

Borrowing is borrowing. Reeves’s options on fiscal rules involve tinkering around the edges and hoping to get away with it. The markets may not immediately notice these changes but it will quickly become apparent that, however they are dressed up, they mean more borrowing.

What’s more… Many experts will consider this too risky. The government, as it scrambles to fill an expanding budgetary hole, may not.

Photograph by Jack Hill / The Times via PA Wire