Tories, taxes and trains...
The HS2 farce highlights the inadequacy of Britain's fiscal rules.
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Two rows have dominated the first day of the Conservative party’s annual conference. One is an argument about tax. Some 33 MPs have pledged to refuse to vote for November’s autumn statement if it leads to any increase in a tax burden which the Institute for Fiscal Studies says is already at its highest level for 70 years and will need to rise further as the population ages. The other concerns Rishi Sunak’s expected plan to scrap the northern extension of HS2 to Manchester - a plan it seems he dare not officially confirm until he is safely out of Manchester.
In fact, these two issues are linked. In what looked to be a well-sourced piece in The Times last week, Sunak was reported to be considering a ruse to assuage Northern anger over the HS2 betrayal that would delay the next phase of construction of the high speed rail line for seven years. According to The Times, “this would help the government to balance the books before the next election as future costs would no longer fall into the financial period assessed by the Office for Budget Responsibility."
What a way to run a country! It appears that a decision regarding the fate of Britain’s biggest infrastructure project in decades may be driven not by an assessment of the likely benefits over an expected lifetime of well over 100 years, but whether scrapping it will open up short-term fiscal space for pre-election tax cuts. You would think that if HS2 is worth doing in 2030 then it is worth doing now. And if it doesn't offer value for money now, then it won’t in 2030. Yet the fate of the project may hinge on what the OBR judges will be the impact on the government debt and deficit in 2028.
Such fiscal legerdemain highlights a serious deficiency in Britain’s fiscal rules. The problem is not, as many Tories argue, that it hands too much power to the OBR. It is that it encourages all spending and borrowing decisions to be viewed through the prism of the government’s short-term cash balances. Worse, the rules make no distinction between borrowing for consumption, such as welfare spending, and investment that may boost long-term revenues.
Brown versus Osborne
The last Labour government had tried to get around this problem with its “golden rule” whereby the government promised to borrow only to invest. This rule was far from perfect since it allowed Gordon Brown as chancellor too much discretion to decide what counted as investment and to define the “economic cycle” over which the rule was to be met. But the principle was surely right.
Yet this principle was swept away when George Osborne became chancellor in 2010 in the wake of the global financial crisis. Having successfully, though unfairly, blamed the crisis on Brown’s profligacy, as if the implosion of the fraudulent US subprime mortgage market could have been avoided if only Labour had balanced the budget, Osborne introduced new rules focused on reducing the headline deficit and debt. With various tweaks, that framework remains in place today.
Of course, a plan to control the debt was, and is, important, particularly in the wake of a series of shocks that have sent overall debt levels soaring to close to 100 per cent of GDP. As the Truss debacle showed, when the former prime minister appeared to dispense with any sense of fiscal responsibility, the confidence of investors cannot be taken for granted. The current rules have the virtue of at least being easy to calculate and widely understood. You cannot mess around with cash.
But on their own, simple cash-based fiscal rules are an inadequate way to gauge the long-term fiscal health of the nation and can lead to poor policy choices. In Britain’s case, they have led to years of growth- and productivity-sapping austerity. Rather than take advantage of over a decade of near-zero interest rates to invest, as global institutions such as the International Monetary Fund (IMF) were imploring governments to do, infrastructure was allowed to crumble. Ironically, it was the Tories who failed to fix the roof while the sun was shining, literally in the case of schools forced to close buildings because of exposure to Raac concrete.
Public Net Worth
What is needed is smarter fiscal rules. Fortunately, a better solution is available. As Ian Ball, Willem Buiter, John Crompton, Dag Detter and Jacob Soll argue in a forthcoming book, “Public Net Worth”, the key is for governments to focus on balance sheets as well as cashflows. In the corporate world, the balance sheet provides important information about a company’s assets and liabilities which is vital to maintain the confidence of employees, customers, suppliers, lenders and shareholders. Focusing on net worth, total assets less total liabilities, can do the same for countries.
Indeed, the IMF has been promoting the adoption of international public sector accounting standards was a way to improve fiscal policymaking since the 2008 financial crisis. It argues that paying close attention to government balance sheets will force governments to think about how to improve the value of the asset side of the balance sheet as well as pay attention to non-debt liabilities such as public sector pensions. That can improve a country’s long-term debt sustainability. It finds that higher net worth can lead to lower government borrowing costs.
Yet currently only 23 countries prepare public balance sheets and few use them in their budgetary processes. New Zealand, so often a pioneer in economic policy, is an exception. Its government is obliged to publish an updated balance sheet ahead of every budget and general election. In contrast, Britain’s most recent “whole of government accounts” was for 2019-2020.
Poor Britain
It is not hard to see why Britain remains resistant. According to the IMF, Britain has a negative net worth equivalent to a remarkable 96 per cent of GDP, second only to Italy with 167 per cent. That is the equivalent of the typical undergraduate debt for every man, woman and child in the country - a debt that on the current trajectory will only grow. Britain has for many years been consuming wealth rather than accumulating it. On IMF numbers, Britain would need a 5-6 per cent improvement in its fiscal position every year for 50 years to bring its net worth back to zero.
It is too much to hope that the Tories will adopt a net worth target since that would all but rule out any prospect of tax cuts. But Labour has said that it is considering such a move. It should - as should other advanced economies. Britain may be an outlier with its negative net worth, but all western democracies face similar political pressures. Indeed, the case for targeting net worth is even greater in eurozone countries which do not have direct national control over their central bank, thereby bringing questions of longer-term debt sustainability into sharper focus.
Smarter fiscal rules are no guarantee that HS2 will get built. But focusing on net worth would at least force the government to ask the right questions about how best to improve the wealth of the nation - and not further immiserate the next generation.
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