Budget Rules: Are They Helping or Hurting?

Many countries have rules to control their spending. These rules are supposed to keep things in check. But sometimes, they can cause more problems than they solve. Take Britain, for example. The country has two main fiscal rules. One says that tax revenues must be higher than day-to-day spending. The other says that debt must fall as a percentage of GDP. These rules sound good in theory. But in practice, they can be tricky. The first rule is based on forecasts, not actual numbers. This means that changes in expectations can cause big shifts in fiscal policy. For instance, if the Office for Budget Responsibility (OBR) downgrades productivity growth, the finance minister may have to cut spending by tens of billions of pounds to comply with the rule. This seems odd, given that economic forecasts are often inaccurate. The second rule can also limit growth. By urging debt to fall relative to GDP, it can discourage investment in things like infrastructure. This is a problem because public investment has been declining in the West since the 1980s. And getting debt to fall as a percentage of GDP may not even be worth the effort, as it does not correlate well with borrowing costs. Britain's finance minister, Rachel Reeves, recently overhauled the fiscal rules. She shortened the compliance horizon and redefined debt by netting liabilities against the state's financial assets. This has allowed her to maintain public sector net investment near 2. 5% of GDP. However, physical assets like infrastructure are still excluded. It would be better to remove all limits on capital spending. At the same time, day-to-day expenditures should roughly match tax revenues within a year. Independent bodies like the OBR could ensure that officials don't disguise current spending as investment. They could also guide a third "countercyclical bucket" so that temporary tax cuts and stimulus can offset downturns. Even if Reeves never embraces such a framework, she should focus on separating growth strategies from the need to fund the welfare state. She should also downplay rigid numerical targets. As Dean Turner, UK economist at UBS Wealth Management, says: "It's fair to have rules, but also for the government to argue against them. " Even the bond market prefers economic policy to be a coherent vision rather than an Excel spreadsheet.