The House of Lords Economic Affairs Committee has today published its report ‘National Debt: It’s Time for Tough Decisions’, which follows on from its Inquiry: ‘How sustainable is our national debt?’ As the report’s name suggests, it is not a proclamation that good times lie just around the corner.
Its theme is that UK government debt, currently running at just under 100% of GDP, risks rising uncontrollably and that a new fiscal framework is required to prevent that. Although debts have been higher, relative to GDP, in the past, that was in a very different economy in which there was scope for much more rapid GDP growth (eg, recovering after World War II).
From the early 1970s until the Great Recession of 2008/09, UK government debt was never above 50% of GDP (so, around half the current level). Although debts rose rapidly during the 2010s, that was in the context of historically low interest rates and other countries also having high indebtedness, meaning lenders were willing to provide funds to the UK government at low rates even though debt levels were very high.
With interest rates now back to more normal levels, we face the risk that nominal interest rates exceed the nominal growth rate of GDP, which means that (with debts at around 100%), the government would have to run a primary surplus (raising more in tax than it spent on things other than debt servicing) simply in order for debts not to explode higher. If other countries stop being in as weak a fiscal position as the UK, matters could rapidly get even worse for us.
The situation is even trickier, the report says, because certain key pressures will tend to necessitate higher public spending in the near future anyway, on matters such as our ageing population and the transition to net zero.
If we want to avoid resorting to high inflation or sovereign default, something must be done. The Committee suggests that raising GDP growth is unlikely to be feasible. Trying to do so by encouraging even more immigration would, it thinks, not be an appropriate or sustainable solution. (With recent net immigration of 700,000 per year, one must question whether it would even be feasible.) It believes that raising public sector productivity would be unlikely to be sufficient to offset the impact of the level of spending cuts required on public service quality. So if we want public services to be of no lower quality than now, it says the choice is between higher taxes and the state doing less (i.e. not cutting public spending through cutting service quality but, rather, cutting it by cutting back on the number of things the state does).
The Committee believes the current fiscal framework, based upon a rule that debt must start to fall some years ahead, is inadequate to drive the correction needed. It proposes that instead of the current commitment that debt will start to fall, relative to GDP, some years ahead, there should be a simple commitment that debt in five years’ time will be lower than it is now, along with a plan for spending and taxation to cover that five year period and achieve that effect.
The report makes some strong points. But I disagree in a couple of key ways. First, I don’t believe that ‘fiscal rules’ achieve anything of importance at all. The current one is particularly bad, but it would be better not to have one at all. If you want to cut debt, cut debt. Don’t announce some rule that says ‘cross my heart and hope to die,’ debt will drop some time. You just need to do it.
Second, I don’t believe in five year plans for spending and taxation, other than as vague indicators that are explicitly non-binding. Too much changes from one year to another to make them meaningful. Think of 2019-2024. A five year plan announced in 2019 would not have been stuck to. Governments should announce one-year plans, along with phased plans in specific areas (e.g., a tax rise coming in at a certain date ahead).
Next, I don’t believe there’s scope for aggregate taxes to rise further than already planned. The UK economy has never consistently delivered taxes as high, relative to GDP, as the levels already scheduled. Even the current plans may not be achievable. Raising even further will chase capital and high-income labour out of the country and the extra tax take won’t be achieved.
Finally, I am more optimistic than the report about the scope for faster growth. The UK has grown much slower than many of its peer countries since 2008. If we just stop doing stupid things, there is scope for us to catch up. And with new technologies and the normalisation of interest rates, we should expect faster growth in developed countries over the next decade anyway.
Economy-wide growth and higher public sector productivity should be the Government’s priorities. The Lords are right that debt is a threat, but a new debt rule isn’t the answer.
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