Promises made by Rachel Reeves limit her room for manoeuvre

There has been an awful lot in the news recently focusing on the minutiae of definitions of public debt. It is more than I ever expected to see and more, probably, than is good for any remotely sensible discussion of fiscal policy. But since it seems to be flavour of the moment, I’ll try to provide some explanation of what might be going on.

The chancellor, Rachel Reeves, has a problem. She has committed herself to a rule that public debt should be falling — relative to the size of the UK economy — between the fourth and fifth year of the forecast period. As she knew perfectly well before she assumed office, it is likely that she’ll only be able to achieve that through increasing taxes or squeezing spending so hard that cuts would be inevitable. Hence the search for a new measure of debt.

In one sense definitions shouldn’t matter. But if they drive policy, as to some extent they do, then they become very important indeed. We certainly shouldn’t be chopping investment spending, as is currently pencilled in, just because of a particular quirk of how we measure debt. Luckily for Reeves changing the precise measure of debt being targeted could make a big difference to her room for manoeuvre, at least when it comes to that investment spending.

The measure of debt currently targeted is “public sector net debt excluding Bank of England”. Plain vanilla, public sector net debt is rather bigger, in part because more of the losses the Bank is going to make through its “quantitative tightening” operations are already scored within it. That’s one reason why it rises more slowly going forward. Making a switch to this measure would increase “headroom” by something like £16 billion. That would help the chancellor, would probably be a modest enough change to avoid any risks with credibility, and would actually be a reversion to pre 2021 practice. There seems little reason to constrain fiscal policy according to the specific timing of Bank operations.

Reeves could also choose to exclude publicly owned or underwritten banks, including the new national wealth fund, from her debt rule. They are currently included in the public sector for accounting and statistical purposes, and so their debt counts towards the total. But if they are constrained in their borrowing by government debt targets then their ability to leverage their balance sheet to secure additional investment will be limited, rather undermining their purpose. Not that a change of rules would be risk free. If the Treasury stands behind any debt taken on, then it seems odd simply to ignore it. Certainly, some way would need to be found to limit and regulate their borrowing. We would not want these banks to become over-leveraged, or to take on too many risks which could fall back on the taxpayer. That said, other countries, including Germany, exclude debt taken on by publicly owned or underwritten development banks from their fiscal targets. Done (very) carefully this could allow for more investment.

A more radical change that Treasury seems to be contemplating would be a move to targeting something called public sector net financial liabilities (PSNFL, pronounced persnuffle). Other than a lovely name — who doesn’t want to focus on persnuffle — PSNFL has the delightful characteristic of offering a whacking £50 billion of additional headroom against targets as currently articulated. PSNFL and PSND have diverged in recent years in large part because the former nets off the expected pay back of much of the more than £200 billion of outstanding student debt. Under PSND it just counts as debt like any other government borrowing. That’s what allowed the last government to game the system by selling the debt for less than its value and still appear to improve the public finances. That suggests a case for moving to PSNFL, but these things are never clear cut. It could still create weird incentives — future loan repayments are recognised, future tax payments are not.

A move to PSNFL has other downsides. By opening up so much additional borrowing space it could spook the markets. Using up a lot of that room would see PSND moving swiftly upwards. It also moves around a lot as definitions change, and has little to do with valuing the benefits of investment, which is what the chancellor claims to want to achieve. A further step would be to target public sector net wealth which does account for the supposed value of all those publicly owned roads, hospitals and army barracks. But that takes us so far from any measure which is relevant to government’s capacity to borrow that it surely cannot stand as the key fiscal target.

There is no escaping the fact that debt is high, and not falling sustainably; the scale of debt interest payments is already creating huge pressure on other spending; and population ageing means debt will rise a lot further unless action is taken. There is no free lunch here. If the government does wants to invest more it also needs to make damn sure it invests well, not repeat the fiasco of the tens of billions of investment poured down the HS2 drain.

In any case none of this fiscal fiddling is of much help to Reeves when it comes to pressures on day-to-day spending. For it is not just her debt rule that constrains. She is also up against it on her pledge to borrow only to invest. However many billions she may “free up” for investment by changing her fiscal rules, she is still likely to have raise taxes if she wants to increase, or even maintain, spending on public services. How much easier, on all fronts, if she had not offered such full-throated support for the £20 billion or so of national insurance cuts implemented by her predecessor.

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