2. Fiscal rules

Since the 2008-09 financial crisis and its aftermath, the UK fiscal framework has consisted of a set of ‘fiscal rules’—set by the government itself—which underpin the government’s choices over tax, spending and borrowing, with the independent OBR assessing the government’s adherence to these rules. As we said earlier, the fundamental idea of such rules is to ensure that the government acts to reduce public-sector debt when they are not faced with large negative shocks so that they will then be able to increase borrowing when they need to act to absorb such shocks.

In 2010, the fiscal rules stipulated that the deficit to GDP ratio should be falling in every year over the 5-year forecast horizon and that it should have fallen to half of its level by the third year, and that the debt to GDP ratio should be falling by the fifth year. Over the past 15 years, the rules have changed eight times, reflecting how difficult successive governments have found it to adhere to the rules (Chadha et al., Reference Chadha, Küçük and Pabst2021; Hourston et al., Reference Hourston, Pope and Sangha2024). In the Budget on 30 October 2024, the Chancellor introduced two fiscal rules: the ‘stability rule’ stipulates that the current budget should be balanced or in surplus by the fifth year of the forecast period, while the ‘investment rule’ stipulates that public debt, as measured by public sector net financial liabilities (PSNFL), should be falling as a share of GDP by the fifth year of the forecast period. We can note that neither of these rules mentions public investment, though the ‘stability’ rule means that net increases in public investment do not require an automatic increase in taxes, since they do not worsen the current budget deficit. Indeed, the increase in public investment announced in the October 2024 budget suggests that moving to a current budget balance was partly to enable this increase to happen.

But there are problems associated with the way UK fiscal rules have been announced and applied. First, the rules are based on a forecast of what will happen over the next 5 years. This makes them subject to electoral calculations or assumptions about the business cycle. Amid both domestic and international uncertainty (Kay and King, Reference Kay and King2020), these assumptions determine to a significant extent what policymakers think the underlying fiscal position might be. Beyond that, it also means that the government can promise ‘Augustinian’ fiscal policy: ‘we will bring the debt down, but not yet.’ Often, the fiscal rules have been met via promised reductions in spending and/or increases in taxes in years four and five of the forecast that are simply not credible. Second, the fiscal rules have not created an incentive for public investment. Indeed, successive governments have tended to postpone or reduce public investment projects rather than cut current spending to meet the budget deficit or public debt targets, given that it is politically easier to do this. The current rules still fail to incentivise public investment since boosting public investment—e.g., on infrastructure—will add to government debt (and PSNFL) immediately but will not increase GDP for a few years. Even though the OBR now includes the positive effects of public investment on GDP in its projections, it is still the case that the current PSNFL rule will not incentivise any investment project taking longer than 5 years to generate higher GDP. Third, the fiscal rules have reduced the fiscal policy debate to speculations about the size of the government’s ‘fiscal space’, rather than whether the government is achieving its objectives or, indeed, whether the public finances are in a sustainable position. In turn, this has diverted attention from a frank assessment of the failures of policymaking, including a persistent structural deficit and deep disparities of wealth, health and living standards (Pabst, Reference Pabst, van Ark, Millard, Pabst and Westwood2025).

We would argue that the UK fiscal rules are arbitrary, have not led to a reduction in debt and have not supported growth-enhancing public investment for four closely connected reasons. First, policymakers have tended to ‘move the goalposts’: since 1997, the fiscal rules have changed frequently, with the changes often coinciding with the prospect of missing targets. Chadha (Reference Chadha2024a), for example, has argued, fiscal rules are ‘more honor’d in the breach than the observance’. Second, there has been an endless churn of both rules and policy. Since 2010, there have been eight different sets of fiscal rules and as many, if not more, ‘growth plans’ (Hourston et al., Reference Hourston, Pope and Sangha2024; Millard, Reference Millard, van Ark, Millard, Pabst and Westwood2025). Arguably, successive governments have fiddled with both rules and policy (Pabst and Westwood, Reference Pabst and Westwood2021). Third, governments keep on making non-credible promises: the 5-year horizon of the UK fiscal rules means that governments can claim to meet targets via unrealistic tax and spending plans in years three to five. During the 2024 General Election campaign, none of the major political parties was transparent with voters or the markets about how it would combine the fiscal rules with tax and spending plans while also generating economic growth (Caswell, Reference Caswell2024). And fourth, the fiscal rules as they stand are ‘gods rather than guides’: from 2026 to 2027 onwards, the fiscal rules will bind in the third year of the forecast rather than the fifth year, further constraining the government’s scope for public investment, especially in the case of adverse conditions linked to domestic or international shocks.

The problem with a rule based on a short horizon is the lag between the decision to undertake a public investment project and the project generating a positive impact on economic growth. Ghaw et al. (Reference Ghaw, Obeng-Osei, Suresh and Wickstead2024) identify three types of lags: (i) between announcing a project and ‘spades in the ground’ when public money is finally spent; (ii) between launching and completing a public investment project; (iii) between investment project completion and the full impact on GDP. According to Ghaw et al. (Reference Ghaw, Obeng-Osei, Suresh and Wickstead2024), 20 per cent of spending on a public investment project has a positive productive impact in the first year after the start of the project, but the full effect usually takes 10 years. In this way, the current PSNFL rule has the effect of disincentivising investment projects whose time horizon to generate higher economic output exceeds 5 years (Millard, Reference Millard, van Ark, Millard, Pabst and Westwood2025).

Lower levels of public investment compared with other advanced economies have been one of the factors driving slow economic growth and flatlining productivity since the 2008 financial crisis (Carreras et al., Reference Carreras, Liadze, Kirby and Piggott2016; Chadha and Samiri, Reference Chadha and Samiri2022; Pain et al., Reference Pain, Rusticelli, Salins and Turner2018). Public investment, particularly public R&D but also infrastructure investment, can generate positive spillovers into the private sector, i.e., ‘crowding-in’ effects. In other words, there is significant potential for increased returns to business investment derived from the public provision of productivity-enhancing projects such as infrastructure, as well as from the government’s proposed planning reforms (Ghaw et al., Reference Ghaw, Obeng-Osei, Suresh and Wickstead2024).

3. Reforming the UK fiscal framework

An overhaul of the fiscal framework should start with a clear definition of objectives, which helps to determine the choice of the right instruments to pursue the goals.

The main objectives of fiscal policy are at least fourfold:

• • Raising living standards through ensuring economic growth.

• • Providing essential public services and infrastructure—i.e., public goods.

• • Helping the economy absorb economic shocks.

• • Reducing inequality.

But these objectives can only be met if the public finances are sustainable. That is, the public debt to GDP ratio is constant or falling in the long run.

To reduce the uncertainty created by an overemphasis on the fiscal rules, and to shift the emphasis towards the objectives of fiscal policy, we have long argued that the government commits to holding only one fiscal event annually i.e., a Budget held on a fixed date (e.g., the fourth Wednesday in October) and it is good to see that the UK government has now done this (though they did not fix the date of their November 2025 budget well in advance, which only added to the uncertainty surrounding this). It is important that the budget is accompanied by an OBR forecast, which we would expect to show that the public finances are sustainable in a way we will define later in this piece. The Chancellor would announce a set of policies specifically aimed at the objectives listed above, making use of all the available instruments. These instruments would include, among others, supporting the development of the supply side of the economy through public investment and other policy tools (e.g., skills formation, regional capital markets, industrial policy), crowding in private investment through targeted public investment projects (e.g., industry and energy policy) and improving the efficiency of the tax and benefit system (e.g., by switching from Council Tax to a Land Value Tax). Finally, the Budget would include an assessment of national progress and how changes to tax, spending and debt will help the country achieve higher welfare.

Between budgets (e.g., in April of each year), we would suggest that the Chancellor provide a ‘State of the Economy’ Speech instead of a quasi-second fiscal event, as with the Spring Statement (Chadha et al., Reference Chadha, Küçük and Pabst2021, Reference Chadha, Millard and Pabst2024). This speech would inject more accountability and transparency into UK fiscal policy by relating it to the economic and social performance of the United Kingdom, including the effectiveness of policy measures in meeting objectives. It would also be accompanied by an OBR forecast that concentrated on long-run fiscal sustainability and the risks to that. To summarise, the ‘State of the Economy’ speech would offer an annual official analysis of the UK economy that provides a reference point for policymakers and the public in their understanding of key economic choices.

Our second proposal concerns the OBR forecast and analysis. Currently, the OBR is charged with forecasting the evolution of public-sector debt (more specifically, public-sector net financial liabilities) and deficits over the next 5 years and then evaluating the likelihood of the government adhering to its (arbitrary) fiscal rules. We believe that the OBR should not only provide this overview of the likely evolution of the government’s balance sheet in the medium run but should also provide an assessment of whether the balance sheet is sustainable. Indeed, the Budget Responsibility and National Audit Act (HMG, 2011) makes this role the overarching duty of the OBR.

When thinking about long-run fiscal sustainability, the obvious place to start is the government’s budget constraint. The evolution of public-sector net debt is given by:

(1) $$ {B}_t=\left(1+{i}_{t-1}\right){B}_{t-1}+{G}_t-{T}_t $$

where B denotes government debt (in nominal terms), i denotes the effective interest rate on government debt, G denotes (nominal) government spending and T denotes (nominal) tax revenue. The primary surplus is defined as T−G.

We can rewrite equation (1) by dividing both sides by nominal GDP (equal to the GDP deflator denoted by P times real GDP, denoted by y) to obtain an equation for the evolution of the debt to GDP ratio:

(2) $$ \frac{B_t}{P_t{y}_t}=\left(1+{i}_{t-1}\right)\frac{B_{t-1}}{P_{t-1}{y}_{t-1}}\frac{P_{t-1}{y}_{t-1}}{P_t{y}_t}-\frac{Primary\ Surplus}{P_t{y}_t} $$

For the debt to GDP ratio to remain constant, we need:

(3) $$ \frac{Primary\ Surplus}{Py}=\frac{B}{Py}\left(\frac{1+r}{1+g}-1\right) $$

where $ \frac{B}{Py} $ denotes the steady-state debt to GDP ratio, r denotes the steady-state real interest rate (equal to the steady-state nominal interest rate less the steady-state rate of inflation and g denotes the steady-state growth rate of GDP. This familiar equation states that if the real rate of interest is greater than the GDP growth rate then the government needs to run primary surpluses if public-sector debt is not going to get out of control.

The analysis above points to a way for the OBR to assess the long-run sustainability of public finances. Given the current debt-to-GDP ratio, and assumptions about the steady-state real rate of interest and growth rate of GDP, the OBR could use equation (3) to calculate the minimum primary surplus that the government needs to run for public debt not to increase. A more detailed approach might be to forecast all the components of equation (1) out for 5 years, say, fix the debt to GDP ratio at that level and interest rates and GDP growth at their assumed steady-state rates, and then use equation (3) to calculate the primary surplus that the government will need to be running from that point onwards. Either way, the OBR will want to consider different scenarios based on different assumptions about the paths of the real interest rate and the GDP growth rate. The OBR can then publish its findings in its Financial Risks and Sustainability Report, as it does currently.

Given the OBR’s estimate of the primary surplus that it needs to run to ensure fiscal sustainability, the government will need to make sure that it is raising sufficient tax revenue to cover its spending. At the budget, the Chancellor could first lay out their spending plans based on the policies they needed to enact to achieve the objectives discussed above. They could then go on to discuss how much tax revenue was needed to achieve the primary surplus suggested by the OBR’s analysis and how, specifically, they would raise this revenue. We would, of course, argue that this should be done in the most efficient—that is, least economically distortionary—way, though the government will likely also want to use the tax system to achieve some of its objectives, e.g., reducing inequality. As such, our proposal for the fiscal framework stops short of imposing the use of specific taxes to achieve fiscal sustainability; rather, our proposal is simply that fiscal sustainability is ensured through running large enough primary surpluses.

4. What about public investment?

One problem with this approach is that, in specifying a particular path for primary surpluses, we run the risk of discouraging public investment. As we said earlier, successive governments have tended to postpone or reduce public investment projects rather than current spending to meet budget deficit targets, given it is politically easier to postpone or cut investment projects (e.g., a new motorway) rather than to cut current spending (e.g., on healthcare). One way we could encourage public investment is to ensure that the OBR accounts for how public investment in physical and human capital affects the growth rate of GDP over the longer run (i.e., beyond the 5-year horizon of the current OBR forecast). This matters for the level of primary surpluses the government needs to be running for the public finances to be sustainable.

But this reform, on its own, might still not encourage sufficient public investment, given the externality generated by public investment that leads to higher GDP. So, we would propose the government set itself a ‘supplementary investment’ rule that specified a minimum level for the public investment to GDP ratio. This is analogous to the case of a positive private-sector externality, where the government would want to subsidise an increase in whatever was giving the positive externality.

Again, this minimum level of public investment could be based on OBR analysis. Suppose GDP is generated by the aggregate production function:

(4) $$ {y}_t={A}_t{k}_{G,t-1}^{\theta }{k}_{B,t-1}^{\alpha }{h}_t^{1-\alpha } $$

where k _G denotes (end-of-period) public capital, k _B denotes (end-of-period) business capital, h denotes employment, A denotes total factor productivity and θ measures the size of the externalities generated by public investment. The social optimum for public investment would be the point at which the real cost of government borrowing (steady-state real interest rate, r) was equal to the marginal product of public capital, $ \frac{\theta \left(1+g\right)y}{k_G}. $ That is, the government should invest to the point where the ratio of public capital to GDP equals $ \frac{\theta \left(1+g\right)}{r} $ . Given the lack of incentive for public investment within the current fiscal rules, together with the currently high level of public debt, reducing the ability of the government to increase spending on public investment, it is likely that the current level of public investment is less than this.

The OBR could consider different long-run scenarios based on different assumptions about the paths of the public investment to GDP ratio, the real interest rate and technological progress and present this analysis as part of its annual Fiscal Risks and Sustainability Report. This would help the government assess whether the public capital stock was too low or too high, relative to where it needs to be. The government could then propose and follow a rule for a minimum level of public investment as a percentage of GDP over its term of office to get the public capital stock in the right place.

5. Avoiding pro-cyclicality in fiscal policy

One problem we have not addressed in our reforms is that, if the government religiously follows a path for its primary surpluses, the result could be pro-cyclical fiscal policy. Suppose the economy were hit by a shock that led to a reduction in activity. Tax revenues would fall as a result. So, to achieve a given primary surplus, the government would then have to cut government spending, potentially worsening the impact of the negative shock. Similarly, if the economy were hit by a shock that led to an increase in activity, tax revenues would rise and, to achieve the same primary surplus, so would government spending, again amplifying the effect of the shock.

To avoid this issue, we would suggest that, at the beginning of its time in office, the government commit itself to a path for government consumption spending that, based on the OBR’s medium-run economic forecast and a set of tax rates that would apply throughout the parliament, would lead to the desired path for primary surpluses. If the economy were then hit by a negative shock, tax revenue would fall, but government spending, importantly including spending on public investment, would hold up; the government would increase borrowing to inject money into the economy at a time when it was needed. Similarly, if the economy were then hit by a positive demand shock, tax revenue would rise but government spending would not rise with it; this would act to push down on demand at a time when this was the right policy to pursue.

The path for government consumption expenditure to which the government committed would make sure that fiscal sustainability does not go way off track, while fiscal policy would still act countercyclically, i.e., in such a way as to stabilise the economy. At the same time, as discussed in Section 4, the government would commit to the path for public investment laid out by the OBR, which would ensure that public investment was not cut to allow for additional government consumption or to make way for existing government consumption that would otherwise need to be cut.