Creating certainty

Liz Truss’s 49-day tenure as First Lord of the Treasury provided a painful education in the importance of sound economic policy. From the removal of the Permanent Secretary to the Treasury to the unfunded tax cuts and uncoordinated U-turns of the ‘mini-budget’, we were all collectively witness to a cautionary tale of how not to run an economy.

Given the costs to our credibility, we must ask ourselves how this disaster was allowed to happen. Why, for example, was Kwasi Kwarteng able to announce these unfunded tax cuts without an assessment from the Office for Budget Responsibility (OBR)?

The OBR has been a positive innovation within UK economy policy. It means that chancellors no longer get to ‘mark their own homework’ when it comes to the cost and likely impact of fiscal decisions. The lack of an official OBR forecast alongside the mini-budget made a substantial contribution to the spooking of the markets, and the subsequent fall of the Truss administration. But this was a very costly way to punish the Conservatives for their departure from convention.

The key issue revealed by the series of announcements this autumn is that the system is too flexible, and this flexibility can and has created huge uncertainty. Ministers are able to announce changes to the public finances almost on a whim, with little scope for external oversight. For example, the Treasury can hold a spending review to allocate departmental budgets whenever the chancellor of the exchequer likes – sometimes as late as the December before the financial year in question. This can leave public services and businesses facing a permanent cliff edge of uncertainty.

This state of affairs has allowed decisions on spending to be delayed and our macroeconomic credibility to be undermined. Most worryingly, this flexibility creates huge uncertainty for the delivery of public services, infrastructure projects or for businesses looking to invest.

In this context, Labour is well placed to establish itself as the party of economic credibility by passing reforms that provide fiscal stability, in the same way that Gordon Brown created monetary policy stability with operational independence for the Bank of England back in 1997.

The clearest examples of the negative effects of fiscal uncertainty often involve large infrastructure projects such as nuclear power stations or transport – both of which often feel at permanent risk of cancellation. Given the high cost across multiple years, the Treasury is wary of these major projects, which can ‘tie the hands’ of future chancellors who may have different fiscal targets (or indeed the hands of the current chancellor if circumstances change). For example, in the 2020 spending review, the construction of the High Speed 2 railway line was projected to cost over £5bn a year between 21/22 and 24/25. This equated to approximately five per cent of the chancellor’s investment spending plans, and exceeds the annual capital budget of the Department for Education agreed in 2021.

The Transpennine Route Upgrade project, intended to redevelop the key rail route between Liverpool, Manchester, Leeds and York, has been a long-suffering victim of fiscal uncertainty, as the National Audit Office recently documented. First announced in 2011, work began four years later only to be paused almost immediately pending a review of National Rail’s investment programme. While it restarted in late 2015, even now, the project scope is only just about confirmed, after over £1bn of spending.

To provide greater stability and value for money, four reforms outlined below should be considered by an incoming Labour government. All four changes could be enacted through a new ‘Finance and Expenditure Act’ that would bolster the party’s economic credentials.

Firstly, the fiscal event process gives too much power to chancellors. As the mini-budget showed, this is not necessarily in their interest. To fix this, the timing of the annual budget and biannual OBR forecasts should be fixed by legislation. One OBR forecast should take place in March, and the other in October, with exact dates within each month still at the discretion of the government. The October forecast should also be accompanied by the annual budget, which is normally the only time when taxes may be changed. In an emergency, the government would still be allowed to make fiscal changes outside these times, subject to parliamentary scrutiny and approval.

Secondly, the spending review process used to allocate budgets to departments since 1998 has no statutory basis and is too flexible. This flexibility for chancellors to make spending decisions with little oversight to meet their fiscal rules or short-term political interests means huge uncertainty for government departments, the wider public sector and anyone looking to invest in the UK.

To end this uncertainty, spending reviews should take place every two years alongside the budget, allocating three years’ worth of spending to departments. New legislation would fix this timing, as well as the process to follow, and ensure budgetary allocations for future years are passed into law (which is not currently the case). Flexibility would be allowed to change these allocations (for example, if inflation goes up, or if the government changes), but only subject to parliamentary approval and scrutiny – meaning the Treasury must justify changes and account for whether money has been spent (or not spent) as intended.

Thirdly, the delivery of major projects needs urgent reform. To create greater certainty and encourage debate on the merits of different major projects, parliament should be empowered to consider and approve their scope and monitor their progress. Parliamentary motions would fix the scope and budgets of major projects across future financial years. Changes could then only be made subject to parliamentary consent to ensure stability for such projects and allow for a settled view to emerge from debate rather than spring out of the blue via a government announcement. Some argue that long-term infrastructure decisions should be made by technocrats, but completely removing any democratic oversight is neither tenable nor desirable given the ramifications for different communities.

Finally, decision making is too centralised, as confirmed by the ‘Commission on the UK’s Future’ chaired by Gordon Brown. The uncertainty in the UK’s fiscal architecture, combined with the Treasury’s mandate to meet fiscal objectives on behalf of the chancellor, leads to a perverse centralisation of all decision making. For example, the Barnett formula is currently a convention rather than being set out in statute – in theory, the Treasury could change it with the stroke of a pen. And the Local Government Finance Settlement is often finalised mere weeks before the start of the relevant financial year.

Future devolution to the nations and regions of the UK as envisaged by the commission must set out in law the fiscal powers and responsibilities of devolved administrations and local government, allowing much greater certainty over medium-term budgets aligned to the new fiscal processes set out above. This would allow places to get on with investment and delivery in their areas, in line with the significant evidence base that devolution leads to better decision making.

The trade-off inherent in these reforms is giving chancellors less manoeuvrability. But by having more certainty embedded in the UK’s fiscal policymaking, our public services would be free to focus on long term value, the private sector would feel more confident to invest, and democratic oversight would be much improved. The Treasury would also be liberated to look at longer term cross-cutting problems rather than short term issues and adjustments.

Most importantly, these reforms would secure economic stability and public service delivery for the future. An incoming Labour government must deliver a new fiscal constitution that meets the serious challenges our economy is facing, and in doing so, build a better future for the UK.

Image credit: HM Treasury, OGL 3 via Wikimedia Commons