Rishi Sunak and the Future of UK Fiscal Policy

Despite a comfortable Conservative majority in parliament and high praise from his peers, Rishi Sunak, the new Chancellor of the Exchequer, faces a serious problem: he is caught between his predecessor’s stringent fiscal policy and his boss’ drive for increased public spending. This inflammable mix presents a serious political challenge for the new Chancellor, but also a brilliant opportunity to reshape fiscal and public investment policy.

The UK’s fiscal policy, formulated by Sajid Javid during his time as Chancellor, is to eliminate the current (or day-to-day) budget deficit by 2023, and retain public capital investment at 3% of GDP. Unfortunately, these targets are incompatible with Boris Johnson’s ambitious plan to “level up” Britain, which aims to bridge the gap between the country’s less affluent areas and the wealthy south-east through increases in public spending. The problem in this doesn’t lie so much with the 3% capital investment cap, which primarily involves infrastructure spending, but rather the day-to-day budget, which is needed to finance programmes to upgrade the skill-levels of the workforce, as well as improve transport and increase nursing and policing levels, all of which are cornerstones of a successful “levelling up” plan.

So, what should Mr Sunak do? Indeed, what can he do? There are three main routes that he could viably take: firstly, he could opt for a conservative approach, extending the deadline for the current budget balancing to 2025 and introducing a 1% of GDP error margin to the capital investment cap; secondly, he could blur the distinction between current and capital spending, to increase day-to-day investments; lastly, he could scrap Javid’s rules entirely, instead opting for a pledge to reduce government debt over the course of the parliament.

The problem with the first option is that, past 2025, it wouldn’t allow for bigger overall commitments in areas that require ongoing investment (for example policing and nursing, where you have to continue to pay the extra wages); this makes it only a short-term solution. The appeal of the second option is that, because Johnson’s initiatives would rely primarily on current investments, making the 3% of GDP an overall spending cap (rather than a purely capital one) would free up significant funds for his plan. However, the framework separating current and capital investment was set up by the independent Office for National Statistics in line with international practice, so changing it would invite accusations of fiddling the books; that said, the Conservatives are currently enjoying sufficient political dominance to make this gamble worthwhile. Finally, the last option would offer the most freedom for public investment (because the unwinding of a Bank of England stimulus package will reduce government debt by £121bn over the next 5 years), but would also cause the greatest uproar: it would result in a fiscal policy which is weaker than the one Labour proposed during the last elections, and for which they were heavily criticised. As with the second option, however, the Conservatives could just decide to suffer the criticism.

Nevertheless, none of the options alone will be sufficient: the spending pledges the government has already made and an upcoming change in the accounting treatment of student loans, together with an ageing population, mean that national debt will doubtless increase. Consequently, the government will have to raise more funds, with solutions that have already been aired including a new band of council tax for luxury homes (a “mansion tax”) and cuts in pension tax reliefs and entrepreneurs’ tax reliefs, all of which would target higher earners.

In conclusion, although Sunak is confronted with a significant challenge, he is not without viable options, and a bold response on his part may result in an important victory for the country.

 

By Gianluca Carrozzo

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