Opinion: Nick Clegg’s fiscal target – splitting the difference

Calculating Taxes Up And DownStephen Tall writes that “in terms of policies, there wasn’t much that was new” in Nick Clegg’s Bloomberg speech. Giles Wilkes and others have suggested that, on the contrary, Nick’s fiscal targets are a welcome change from the excessive deficit reduction the Coalition has pencilled in for the next parliament.

These commentators think that Nick’s deficit target (below) is a continuation of Labour and current Coalition policy – to balance the budget excluding capital spending. My understanding, however, is that what Nick said was entirely new and would mean far more cuts and tax increases.

Here are Nick’s proposed rules:
1) significantly reduce national debt as a percentage of GDP, year on year (when growth is positive)
2) run a cyclically adjusted balanced total budget, excluding capital spending that enhances economic growth or financial stability

It would be good to know what is meant by “significantly” in the first rule, but it seems likely that the stricter of the two is the budget rule. The caveat suggests that this is not the same as Gordon Brown’s ‘golden rule’. Nick is not suggesting excluding all capital spending (as at present), but only that which “enhances economic growth or financial stability”. His (unfair) criticism that Gordon Brown “used to slap the words ‘capital spending’ on anything and everything just so he could get away with borrowing to pay for it” further suggests that this rule differs from Labour’s.

So all three parties now have a balanced budget target, and each is different. The Conservatives want an absolute budget surplus with no exclusions (but with investment rising with GDP), and Labour propose a ‘current budget’ surplus – excluding all capital spending – and falling debt.

Nick Clegg has now created a new target that excludes some but not all forms of capital spending. Ironically, Labour’s chosen measure is what the Coalition has been targeting, while the yellow and blue parties each wish to adopt a new deficit measure.

So what does it mean to exclude “capital spending that enhances economic growth or financial stability”? The Guardian reports that “according to the Lib Dems, Clegg’s proposals would allow borrowing to fund items such as transport, housing, and communications, which promote growth, but not schools and hospitals, which would have to be funded from ordinary tax revenues.”

Clegg’s speech refers to roads, railways, energy, housing, water and waste networks. It’s not easy to transfer these terms into figures and the answer is very sensitive to what’s included, but my estimate is that around 60% of net departmental capital spending would therefore be excluded from the balanced budget requirement.*

Labour’s proposed current budget surplus would exclude capital spending, which amounts to almost £30 billion a year. The Conservatives’ absolute surplus would mean spending cuts (or tax increases) by 2020 of around £30 billion more than Labour – but lower borrowing.

Clegg, despite arguing that this is not a “split-the-difference-party”, is proposing that roughly half of this figure should be excluded, but not the other half. Using my 60% figure, he is seeking fiscal consolidation perhaps £18 billion lower than the Conservatives suggest by 2020, but £12 billion higher than Labour. This is also £12 billion stricter than previous Lib Dem policy (supporting the Coalition’s fiscal mandate) might have suggested.

Given that Nick’s fiscal targets have, I think, been so misunderstood, clarification is needed. Which particular sectors would he exclude? Does BIS capital spending “enhance economic growth”? What of flood defences? And why not new colleges, school facilities, or boosting public sector energy efficiency?

And what is the theory behind such a target? What is wrong with excluding all net capital spending – an objective rule that means large, one-off costs can be spread across the many cohorts that will benefit. Or if we want to move to up-front funding (which in good times is also reasonable), why should we exclude any capital spending at all?

And if the aim is to separate out pro-growth spending that benefits future generations, why should we consider only physical infrastructure? Why not scientific research, teaching and early years support, for example, which will hugely shape the future economy (and indeed are more natural state activities than supplying houses or energy).

Giles Wilkes says that first and foremost “we should consider simply whether the sums of money available for public services will be enough.” Targeting an extra £12 billion of cuts or tax increases (as well as those needed to fund large tax cuts) means Clegg’s rule perhaps fails Giles’s credibility test after all. Given also its lack of a coherent principle, my concern is that Clegg’s target (if not a post hoc justification for the Government’s planned current budget surplus) may have been chosen only as a confusing attempt to ‘split the difference’ between Labour and the Conservatives.

* I used gross capital DEL figures for 2015-16 and included only transport, DCLG communities, DECC, Defra, and GIB (one could also use these classifications). To get net investment I accounted for depreciation (which makes a big difference) using figures available here.

* Adam Corlett is an economic analyst and Lib Dem member

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17 Comments

  • “Given also its lack of a coherent principle, my concern is that Clegg’s target (if not a post hoc justification for the Government’s planned current budget surplus) may have been chosen only as a confusing attempt to ‘split the difference’ between Labour and the Conservatives.”

    I share your concern. Much of what Clegg says on policy these days seems intended to differentiate the party from its rivals, regardless of whether the policy is a good idea.

    Personally, I’m a fan of infrastructure investment. But if we are planning higher infrastructure spending, we should be bold and specific. Detail the investment and list the projects we will progress and the benefits. This would make the policy appear better thought through. It would also give us a real differentiator to sell on the doorstep, if we are promising to build projects that other parties are not.

  • Little Jackie Paper 14th Jun '14 - 12:47pm

    Great article – but one question. In addition to all of the above there is the question of ringfenced spend. Most notably in this Parliament we have seen the Coalition ringfence the NHS, Pensioners and Foreign Aid. Now I make no value judgment on this here, and these are, of course decisions for government. I would however observe that any ringfence in a fiscal consolidation surely implies deeper cuts elsewhere. In this parliament local government, students and defence have particularly been hit hard.

    My point is that all of the above targets will surely have to account for any ringfences. As I understand it the Conservatives appear to be saying that their manifesto will contain a triple locked pension to 2020 which is an eye-watering level of spend. I don’t know if the other parties have said anything specific yet, but my instinct is that all will protect some areas.

  • Tony Greaves 14th Jun '14 - 1:04pm

    Why does anyone think that Nick Clegg knows much about economics? The question is – who has dreamed up this rather silly policy. The Guardian reported that it meant that education and health were excluded. Who in their right mind thinks that capital investment in education and health do not contribute to economic growth? Such a statement is at one level just illiterate, at another it is a repudiation of “supply side” theories! Unless, of course, such spending is to come from the private sector – Vote Liberal Democrat for lots more PFI!??

    Or, as the Guardian actually said, capital schemes in education and health will all have to come from revenue. Does no-one think about what they are writing any more?

    Tony Greaves

  • “His (unfair) criticism that Gordon Brown “used to slap the words ‘capital spending’ on anything and everything just so he could get away with borrowing to pay for it” further suggests that this rule differs from Labour’s.”

    Correct me if I’m wrong, but wasn’t Vince Cable calling for Labour to increase capital spending in 2008 or thereabouts?

  • Frank Hindle 14th Jun '14 - 2:51pm

    I’m still trying to get my head around exactly what is being proposed, but it does seem to be quite a significant new policy with major implications for other policy areas. Did I miss the party conference motion that agreed this?

  • I think the guidelines are a reasonably sensible approach based on a political rather than economic foundation.

    The economic debate leading up to the 2015 GE will be around headline national debt, borrowing, tax and spending plans.

    The Tory’s focus will be on balancing the books with lower spending overall (particularly welfare spending) and lower taxes to incentivise economic growth.

    Labour will not want to be seen as a high tax party and will look to increases in National Insurance instead to meet the growing needs of the NHS and state pensions and continued borrowing for the capital spending budget.

    I would concur with Will Mann and Jedibeeftrix comments that we need an intellectually coherent plan for higher infrastructure spending. Annual capital spending of £30bn is insufficient to deliver the National Infrastructure of circa £450bn over ten years or make any significant provision for social housing development as part of the Libdem commitment to building 300,000 homes per year.

    Increased infrastructure spending can be funded by Land Value Tax to capture revenue streams from uplifts in Land Values accruing as a consequence of new/enhanced infrastructure.

    The caveat of ” capital spending that enhances economic growth or financial stability” is a ideologically appealing but a tricky differentiation to make in practice. Borrowing only to fund net additions to the existing capital stock of public buildings and infrastructure as reflected in the whole of government accounts i.e. net of the sale proceeds of disposals and excluding replacement/repairs/renewals/modifications of existing infrastructure is an easier accounting differentiation to make.

    The projected tax take of circa 37% of GDP in 2018/19 is likely too low to maintain growing pension commitments, Health and Social Care costs, Educational needs, debt service costs, public services and housing/infrastructure investments at the required levels. The merger of income tax and national insurance and the introduction of LVT with a view to getting the tax take somewhat closer to the approx. 40% of GDP needed for stable public spending would seem to be a necessary element of delivering on the fiscal rules outlined in Nick Clegg’s speech.

  • Eddie Sammon 14th Jun '14 - 5:37pm

    I’m sick of economists talking tough on discipline for the poor whilst being weak on the banks.

  • Eddie Sammon 14th Jun '14 - 5:42pm

    It’s not even a belief in freedom either, there’s nothing liberal about manipulating the currency to give to the banks.

  • David Evershed 14th Jun '14 - 6:12pm

    We should never forget that future generations will have to pay the interest on our debts and eventually either repay them or re-finance them .

    As accumulated Government debt becomes a higher proportion of GDP, investors will view the UK as a higher risk and refinancing will have to be at higher interest rates, if investors are prepared to lend to us at all.

    ‘Live now, pay later’ is fast disappearing as an option for the nation. Our credit is all used up.

  • Adam Corlett 14th Jun '14 - 9:18pm

    Thanks for all the comments so far.

    @David, I think we can basically all agree that debt/GDP needs to come down, but even as debt has shot up interest rates have been incredibly low. That does not back up the idea that our credit is all used up. It’s not at all likely that investors will come to see the UK government, which can tax at will and if necessary print money, as at any risk of defaulting.

    We don’t want to burden future generations with a big debt burden, but nor can we skimp on the infrastructure, education and R&D that will determine their standard of living. Nor do we want to do long term harm to the economy – or create too much private debt – by going too far in cutting current spending or raising taxes. Looking only at debt but not at assets is a bit misleading too: does it really harm future generations or our credit risk if we borrow in order to create assets like social housing that will bring in revenue, probably gain in value, and could be sold off if necessary?

    @Joe, completely agree on LVT and other property taxation as a means to recoup some of the cost of new infrastucture, and on the central issue of needing more like 40% of GDP than 37% (which is a much bigger deal than it sounds).

    @Frank – exactly. I don’t think the party should take a vote on exactly what the deficit should be or how fast debt should come down, but one of the reasons I wrote this article is that we definitely need more discussion.

    @Little Jackie Paper – that’s a really important issue. All three parties want higher investment, all will have to protect or increase NHS spending, no-one will touch the state pension, and there are many departments that can’t really absorb any more cuts. Unless growth boosts revenue much more than expected (which I think is quite possible), the trade-off will be between tax increases, continued borrowing or incredibly tough spending cuts outside protected departments.

  • Eddie Sammon 15th Jun '14 - 3:40am

    I want to be nicer towards people who disagree with me, but we shouldn’t forget that lives are at stake and injustice arouses anger. Misunderstanding arouses anger too, but I think I raise some good points and it is frustrating when people don’t seem to want to engage with me on them. People might say they aren’t engaging because I’m being rude, but when I’ve been nice they haven’t addressed my points either. It seems it is something people don’t want to talk about.

    I remain open minded if a slight increase in interest rates would plunge the economy into recession, but where is people’s analysis that this might happen? The conversation never seems to get that far.

    Regards

  • @ Caracatus

    I think you’re right. All this is woefully short of the mark. We should be setting out how we propose to deal with major challenges facing the UK, like rebalancing our economy towards production and export, reducing inequality and driving economic recovery and growth in the regions outside London and the South East. Then, once we have done this, we look at how to secure the necessary resources.

    Proposed fiscal rules, when we are at 7-8% in the opinion polls, aren’t going to do anything to help us reconnect with the voters, regain their trust and save our party from extinction less than a year from now.

  • RC,

    Ed Balls has proposed that all the parties should subject their plans for dealing with the deficit – their tax, spending and borrowing numbers to pre-election audit by the Office for Budget Responsibility, as happens in many other European countries. Independent certification that everyone’s sums add up would offer the prospect that the next election might be a debate about who has the right priorities in balancing the books, and would put UKIP on the spot to deliver a credible economic plan.

    Libdem support for this Labour proposal might do us no harm and steer the debate towards ” dealing with major challenges facing the UK, like rebalancing our economy towards production and export, reducing inequality and driving economic recovery and growth in the regions outside London and the South East.”

  • jedibeeftrix 15th Jun '14 - 4:05pm

    never going to happen joe.

    what may save the tories bacon in 2015 is the ongoing public doubt about the competency of the two eds on economic and leadership matters, they aren’t going to throw that away by having the OBR say; “yes, the sums add up”.

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