Binding the Hands of Government - a credible fiscal rule for the UK

New fiscal rules needed to control government spending

In a new paper released by the Institute of Economic Affairs, Kwasi Kwarteng and Jonathan Dupont argue that Britain should introduce a debt brake to ensure the Chancellor balances his budget.

Looking at evidence from Switzerland and Germany, the research shows that debt brakes are effective at limiting government spending, while the fiscal rules Britain has followed in the past have not prevented governments from running up huge debts.

The authors propose that if the Chancellor fails to observe the debt brake, there should be a public exchange of letters between him and the OBR explaining why and what action is being taken to rectify the situation. The Chancellor could also face a personal financial penalty of up to 20% of his salary.

The report suggests that:

  • No fiscal rule can predict the future or guarantee the sustainability of the public finances. However, they remain a useful tool to counter the myopic priorities of politicians and voters.
  • From around 2002 Britain stopped reducing its debt and started running deficits. This left the country ill prepared for the arrival of the financial crisis.
  • The Golden Rule, Britain’s first fiscal rule, failed to bring the budget back into surplus. The regime left no room for error and gave politicians too much flexibility. Spending plans were based on over-optimistic forecasts.
  • We should adopt a less flexible and more credible fiscal rule. We do not need discretionary fiscal policy to ‘manage’ the economy. Insofar as demand is actively managed, this can be done through monetary policy.
  • Britain should adopt a fiscal rule similar to Switzerland’s debt brake. We should balance the structural budget every year, rather than over the cycle.
  • The rule should be backwards looking. Forecasts that prove over-optimistic should be compensated for by greater austerity in future years.

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