slavishly following fiscal rules is holding back this government and will hold back the next one

The March 2024 budget turned into an exercise in political game playing rather than an attempt to address the UK’s ongoing economic woes. It was dominated by more cuts to national insurance (after a previous drop in January this year), which the chancellor hopes will revive the government’s electoral fortunes ahead of the general election.

To partly fund this, Jeremy Hunt stole Labour’s plans to scrap “non-dom status”, which allows UK-based foreign residents to avoid paying tax on overseas earnings. Removing this loophole is expected to bring in an extra £2.7 billion a year, which Labour had already earmarked for additional NHS funding.

Elsewhere there was another freeze in fuel duty, plus changes to child benefit thresholds. But the chancellor must be hoping that voters will not notice that their incomes have been cut due to “fiscal drag”, where personal tax allowances are not uprated in line with inflation (they have actually been frozen since 2021).

According to the Institute for Fiscal Studies, this means that for every £1 cut in national insurance, the government has effectively taken back £1.30 in income tax. Indeed, the overall tax burden in the UK is at its highest level for more than 75 years, and is set to rise further.

So the backdrop to the spring budget is one of a stagnant UK economy, which is now officially in a “technical recession”. But the true picture is even worse.

For on a “per capita” (per person) basis, the UK economy contracted in every quarter in 2023, and has not grown since the start of 2022. Over the past few years, it has significantly under-performed, especially compared to the US and the eurozone.

And while economic growth should return in 2024, the Office for Business Responsibility forecasts that this will stutter along at 0.8%, before returning to a more respectable 1.9% in 2025. But even these forecasts may be a little optimistic, given the underlying weaknesses of the economy, which include relatively weak business investment, lower trade over the past five years, and sluggish productivity growth.

Add in cash-starved public services, local government bankruptcies, widening regional inequalities and the transition to net zero, and the challenges facing the UK are, quite frankly, enormous.

Missed opportunities

Unfortunately, the budget has done little to change things.

To boost investment, the chancellor announced plans to extend a scheme which allows firms to set their investment expenditures against profits, reducing their corporation tax bill. There were also some tax breaks to stimulate growth in the UK’s creative sector.

Yet on green investment, apart from some relatively small subsidies here and there, the budget was a missed opportunity. The US and the EU have huge subsidy schemes to promote the green transition, and while the UK is reasonably competitive in some green technology, new investment could bring new growth and reduce dependency on overseas energy.

Many of these low carbon industries (such as offshore wind) are based in northern England, so new investment could also assist with “levelling up” – the government’s plan to spread wealth and opportunity more widely across the country.

But when levelling up was briefly mentioned during the budget, the main beneficiary appeared to be Canary Wharf – at the heart of London’s financial centre for – which will receive funding for housing and the development of a life sciences hub. And so far, research suggests that levelling up has failed to meet its aims and has been poorly funded.

The outlook for public services is also dire. The chancellor announced public expenditure will rise by just 1% over the next five years, with slightly higher increases for the NHS (to modernise IT systems) and defence.

This will mean cuts in other essential public services, such as local government, roads, railways, education and policing. Many of these services are already under severe financial pressure and could buckle under a further round of austerity. And depleting the public realm weakens the foundation for economic growth.

Time to break the rules?

Much of the budget narrative has been framed around so-called “fiscal headroom” and “fiscal rules”. The idea here is the chancellor needs to ensure public debt is falling as a percentage of GDP by 2029 to reassure the financial markets.

These rules are set not by external financial bodies, but by the Treasury itself. Indeed, chancellors have often changed the rules – seven times since 2010– to fit shifting political and economic circumstances.

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Yet both the government and Labour maintain that fiscal rules must be kept, and engage in rhetoric that treats the economy as being like a household budget. This does not make any economic sense. Unlike a household, the UK government can tax and borrow indefinitely, and through the Bank of England, can even print money (via quantitative easing).

Abiding strictly by these self-imposed fiscal rules actually constrains the ability of government to undertake worthy public investment projects that can help grow the economy.

This does not mean there are no constraints on public spending, as simply printing too much money will lead to inflation. Nevertheless, many economists, including myself, believe the very notion of fiscal rules needs to be revisited to provide more scope for greater public investment.

If the UK wants to emerge from its current doom loop of slow, stagnant growth, then the next government will need to be brave enough to rewrite the rules that have been holding the country back for so long.