Getting the debt to GDP ratio to fall at some stage is a good idea, but having a target for a specific year is silly. It is not optimal because if some shock hits the economy before 2016/7 which means debt tends to rise relative to GDP, it is crazy to try and counteract that to meet the target in such a short space of time. It is not effective because it can be gamed by the government fiddling the timing of expenditures.
Having a five year rolling target for the deficit allows fiscal policy plenty of time to adjust to shocks. We saw this in action over the last few years, as the Chancellor was able to reduce the pace of fiscal consolidation from 2012 when the economy failed to recover as quickly as he had hoped. Changing this mandate from five to three years gives any Chancellor less time to adjust, which is why it is a backward step.
The first reason is that the current trajectory of public spending is unsustainable, but not in the sense that the Government means it. Sustainability in public spending should be measured over decades, not a single Parliament. The question is whether the current policy settings can be maintained indefinitely.
This is a chart of the UK’s debt-to-GDP over the past three centuries combined with the Office for Budget Responsibility’s latest long-run projections through to 2063-64.[ref]I have not used the OBR’s central projections here, which assume that health productivity more than doubles for the next fifty years. Instead, I have used the scenario that assumes productivity remains at historical levels.[/ref]
This post draws upon a blog I wrote for The Reformer.
A few days ago I wrote about the lessons that can be drawn from the recent history of the UK’s fiscal rules. This post measures the Government’s new Charter for Fiscal Responsibility against them. The Charter sets out the Government’s fiscal rule and requires the Office for Budget Responsibility (OBR) to assess Budgets against it. The new Charter lightly updates the previous version in two ways:
- It requires the Government to forecast a cyclically-adjusted, current account surplus within three years, rather than the previous five years.
- Public sector net debt should fall as a percentage of GDP in 2016-17, a year later than in the previous Charter.
Now compare against the lessons from history.
Earlier this week the UK Government announced its new fiscal rule, which defines the fiscal envelope. For those of you who aren’t British, the deficit exceeded 10% of GDP during the recession and fiscal sustainability has become an important political issue, even for people who aren’t econ junkies! Unfortunately, this new rule is unlikely to encourage the sort of sustainability that the Government is hoping for. To understand why, I’m going to write a short series of posts on fiscal rules. This first post will briefly review the history of fiscal rules in the UK. For people who love technical details, this paper by Simon Wren-Lewis and Jonathan Portes is a great review and I’ll be coming back to it later.
A fiscal rule is simply a set of objectives that guide and constrain the Government as it makes policy. The rule usually comprises targets for debt and the deficit, with many variations in the details. Rules were introduced to the UK in 1997 by the then-Chancellor, Gordon Brown. Since then they have had a rocky history, as the chart shows:
I see that Patrick Nolan has an article in Public Finance talking about UK and New Zealand productivity. Go read it, but come back here to comment as they don’t seem to have a comment system.
As we are a NZ audience, I’ll quote this bit:
While New Zealand faces different challenges, its experience can throw light on the UK’s situation. OECD research recently published by the New Zealand Productivity Commission has shown that the country has good resources – investment in physical capital and average years of schooling are broadly consistent with other countries – and policy settings. It is one of the easiest countries in the world in which to set up a business and its tax and regulation regimes are often seen as world class.
Indeed, the OECD estimates that New Zealand should have GDP per capita 20% above the OECD average. But its productivity performance means it is 20% below. In short, New Zealand poses a real challenge for standard prescriptions for what countries should do to lift their productivity performance.
– See more at: http://www.publicfinanceinternational.org/features/2014/06/solving-the-productivity-puzzle/#sthash.qZST25PS.dpuf
Estimating the impact of tax cuts is a tricky business. You can fairly easily calculate how the revenue from current income and spending will change, but that’s just the beginning. The problem is that people don’t stand still: they change their earning and spending habits in response to your tax changes, which changes the revenues from the taxes. The UK government is pretty good at estimating that but economists have long known that there are a couple more stages before you have a full picture of what’s going on. That’s why HM Treasury has begun to use a dynamic, computable, general-equilibrium (CGE) model to estimate the effect of tax changes.
CGE models bring us closer to reality…
The CGE model accounts for the long-term effect on the economy of changing behaviour. In the case of cuts in the fuel duty it accounts for the growth in production caused by a reduction in transport costs. Increasing production generates more road traffic, which yields more fuel duty revenues and partially offsets the cost of the cut. Using the CGE model to ‘dynamically score’ (as the jargon goes) the cost of the tax cut incorporates effects these effects that are not a part of the traditional approach. Read more