HM Treasury

The tortured maths behind the chancellor’s fiscal headroom suggest her ‘ironclad’ fiscal rules are having unintended consequences on real-world policy

In the aftermath of last week’s spring statement I want to ask a rather odd question: has this government really cut spending on overseas development assistance (ODA) in order to increase spending on defence? They have certainly said that is what they are doing. And indeed there is a planned cut in ODA spending of 0.2 per cent of national income and a similarly sized increase in defence spending. It looks like an open and shut case.

To see why I am, nevertheless, sceptical you have to understand something about the chancellor’s fiscal rules. In the weird and wacky world of managing public spending not all cash is fungible. In particular Rachel Reeves is tightly constrained by her “ironclad” rule that she will set policy to run a current budget surplus in 2029-30. A current surplus means that borrowing is OK but only for spending on capital — roads, buildings, big bits of kit, that sort of thing. She can aim to borrow for that but not, for example, to pay salaries to the teachers and doctors and soldiers who use the kit.

You can see how much care she takes with this rule by looking at the precise numbers in the spring statement. Back in October she had £9.9 billion of so-called headroom against this rule. That is to say that the Office for Budget Responsibility’s central forecast was that she would get to current budget balance in 2029-30 with £9.9 billion to spare. And guess what? Despite all that has changed since, by adjusting this and fiddling with that, she had exactly £9.9 billion of headroom again last week. In fact the numbers were the same not just to one decimal place — they were a mere £2 million apart. That is genuinely astonishing. Hats off for some seriously impressive spreadsheet work going on in the bowels of HM Treasury.

It is pretty clear, then, that getting back to that level of headroom is what was driving a whole host of policy decisions. You don’t achieve something like that by accident.

If you are wondering why the changes to working age benefits confirmed on Wednesday were just a little bit harsher than those announced only eight days previously, here is your answer. Work and pensions secretary Liz Kendall announced that the health-related element of universal credit was to be halved for new claimants. Rachel Reeves added that once halved it would also be frozen in cash terms for the next four years. In a welcome rebalancing, Kendall also promised to increase the (miserably low) standard rate of universal credit to £107 per week by 2029. Reeves swiped a single pound a week from that sum. It is now due to reach £106 a week. Those additional cuts help to keep the headroom precisely in place.

All of which is a bit of a shame. Let me put my head above the parapet. I think there is a good case to be made for the changes to these benefits, and the plans to make it harder to get the personal independence payment (PIP). I appreciate the hardship they will cause. But there is no getting away from the quite extraordinary increases in the numbers of claimants and the costs of paying these benefits. The cuts, don’t forget, will somewhat slow the rate of increase in spending, not get close to actually reducing it. The trouble with Reeves’s additional cuts is that they rather undermine the government’s case that reform was needed for its own sake and not simply to make the numbers add up. It looks rather as though she has lost the policy wood for the fiscal trees.

What has all that got to do with the supposed transfer of ODA money into the defence budget? The key point here is that, from the fiscal headroom point of view, the composition of the ODA cut and the defence increase are very different. Almost half of the cut to ODA (£3.2 billion) is day-to-day spending that counts towards the fiscal headroom. In contrast, only £0.6 billion of the increase in defence spending is day-to-day spending. That makes balancing the current budget easier by £2.6 billion. In other words just over a quarter of that oh-so-carefully calibrated £9.9 billion of headroom comes about as a result of that switch. This raises two issues.

First, absent this switch, meeting the fiscal rule by the same margin would have required bigger cuts to other departments. So the main thing the cut to the day-to-day ODA budget has achieved, apart from the cut to aid itself, is smaller cuts to other departments than would otherwise have been possible. There has been almost no switch of current spending from ODA to defence.

Second, at present, about 35 per cent of the defence budget goes on capital. Yet the government has decided that more than 90 per cent of the extra spending will do so. That may be the right option militarily; frankly I have no idea. But the difference between the capital/current split in actual defence spending and the split in the intended uplift is stark indeed. That, and the fact that the £2.6 billion “saving” against the fiscal headroom depends entirely on this pronounced focus on capital spending, does rather raise the question of whether the fiscal rules have not only influenced the precise shape of our working age benefit system, but have also been the determining factor in the composition of defence spending.

Let me be clear. I am not someone who thinks we can or should do away with these sorts of fiscal rules. I do not believe we are in a position to borrow a whole lot more. But having the fiscal headroom tail so blatantly wagging the spending policy dog in this way really does not look all that sensible.

This article was first published in The Times, and is reproduced with kind permission.

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