A framework for fiscal sustainability
Reform's latest report on the state of the public finances proposes a fiscal framework to ensure long-term sustainability. It builds upon the analysis of The Debt Ratchet, which recommended the Office for Budget Responsibility be given greater powers, and lays out the specific changes that would be required to bring debt under control.
The fundamental purpose of fiscal rules is to ensure the spending promises made by the Government are sustainable. On that count, the current framework has comprehensively failed: the Office for Budget Responsibility (OBR) estimates that, unless NHS productivity more than doubles immediately and permanently, debt will exceed 200 per cent of GDP over the coming decades.
The problem is that UK fiscal policy is characterised by a short planning horizon: forecasts for the Budget and Autumn Statement look forward five years. Spending Reviews typically look forward only three years. Yet the demographic challenges the country faces will unfold over decades and the reforms to pension and health provision necessary for fiscal sustainability need to begin early to allow citizens to plan for them. Substantial reforms to entitlements at short notice will jeopardise the wellbeing of many people who have based their retirement plans on current policy.
Enabling politicians to bring the long-term challenges into short-term focus requires reframing the problem. The current fiscal framework provides no incentive to consider costs and benefits beyond a five-year horizon. A better approach to fiscal management would:
- abandon short-run deficit rules that limit the planning horizon, and
- replace them with an explicit long-run debt target.
Long-run debt targets bring the implications of future promises into the realm of current political challenges. The Government might, for example, require that the ratio of debt to GDP fall to 20 per cent within 50 years. Similar rules have been successful overseas when monitored by a strong, independent institution. This is what the OBR has become over the past five years, although this new role would require some key changes to its mandate. It would need to:
- evaluate current Government policies for their consistency with the debt target and for their impact on economic wellbeing,
- conduct all forecasts based on unchanged policy, rather than using Treasury assumptions,
- combine its five-year Economic and Fiscal Outlook forecasts with its 50-year Fiscal Sustainability Report projections so that every official forecast looks out 50 years, and
- define a new headline measure of progress based on the ‘fiscal gap’ to the long-term target, to replace existing short-term measures such as the cyclically-adjusted current deficit.