Jeremy Hunt and Rishi Sunak’s self-imposed fiscal targets are “not fit for purpose” and have led to a series of government spending decisions that have constrained economic growth, three influential think tanks have warned.

Jack Barnett www.thetimes.co.uk

The fiscal targets have incentivised politicians to cut public investment sharply to balance the public finances, worsening the UK’s economic downturn over the past 15 years, according to the Resolution Foundation, the Institute for Public Policy Research (IPPR) and the National Institute for Economic and Social Research (NIESR).

Under the rules, the government must reduce the UK’s debt stock as a share of gross domestic product in five years and keep annual borrowing capped at 3 per cent of output.

After the budget this month, at which the chancellor cut national insurance by 2 percentage points, the Office for Budget Responsibility (OBR) said he had a margin of only £8.9 billion against his fiscal targets: the second smallest margin since the UK fiscal watchdog was set up in 2010. Fiscal rules were first introduced by Gordon Brown when he was chancellor in 1998 and have been tweaked by successive governments since. They are designed to keep government borrowing in check and ensure that the debt stock does not become unsustainable.

Economists have criticised the fiscal regime for stifling growth and steering governments towards implementing austerity policies like those seen after the 2008 financial crisis. The OBR said last week that real-terms day-to-day spending per person would be 8 per cent lower in the coming years compared with when the plans were set out in October 2021.

https://www.datawrapper.de/_/i3iPc/ Carsten Jung, senior economist at the IPPR, a left-leaning economic think tank, said: “Fiscal rules were introduced to constrain politicians from making bad spending decisions. The evidence now suggests they are also constraining them from making good ones.”

Ben Caswell, a senior economist at NIESR, Britain’s oldest independent economic think tank, said: “During economic downturns, these rules disproportionately favour reductions in investment expenditure as they demand improvements in the debt-to-GDP ratio within a relatively short timeframe. This can hinder an economic recovery and limit potential long-run growth.”

James Smith, research director at the Resolution Foundation, an economic think tank focused on living standards, said that the targets had “encouraged £26 billion of growth-sapping cuts to public investment”.

The UK’s debt-to-GDP ratio has risen to nearly 100 per cent from about 35 per cent in 2007, its highest level since the 1960s, largely thanks to a sharp increase in government spending to soften the shock of the financial and Covid-19 crises. Weak economic growth and a sharp rise in debt interest spending caused by central banks globally lifting borrowing costs to tame inflation have crystallised the ratio at that level. Other countries in the G7, including Japan and Italy, have large debt-to-GDP ratios.

The foundation estimates that cuts to public spending in the coming years represent three quarters of the expenditure reductions instituted by David Cameron and George Osborne in the aftermath of the financial crisis. Smith said: “The fiscal rules should not be ditched, but they need to be overhauled. The next government can start by removing public investment from the target and then fixing them for a five-year parliament to stop politicians ‘gaming’ the rules to continually put off the difficult decisions.”

The European Union recently changed its fiscal rules to exclude “quality assured” investment spending.

There is speculation that Labour, if it wins the general election, which must be held by January 2025, will tweak the fiscal rules to release money for public services. Sir Keir Starmer, the Labour leader, has said that every policy in its manifesto would be fully costed.

A Treasury spokesperson said: “The government set a clear fiscal strategy at autumn statement 2022, introducing new fiscal rules to set a credible path to get debt falling. Thanks to our responsible action with the public finances we are on track to meet our fiscal rules, with debt falling in the final year of the forecast with a larger buffer than last spring. Our rules provide sustainable growth and stability, reducing borrowing and debt so the economy can withstand shocks, and we are delivering over £600 billion of planned public investment over the next five years.”