MNI INTERVIEW: Fiscal Ratchet Puts UK Debt On Untenable Path

The UK’s debt-to-GDP ratio is unlikely to improve in coming years due to the common government practice of giving away the proceeds of positive fiscal surprises with tax cuts or spending while compensating for negative outcomes with additional borrowing, former senior Treasury and Office for Budget Responsibility official Andy King told MNI.

The so-called “debt ratchet” has become more noticeable in recent years, as increased economic uncertainty has meant forecasts have been more prone to underestimating or overestimating government revenues, resulting in larger giveaways or more dramatic growth in debt, King said in an interview. His warnings coming ahead of the March 6 Budget, which is widely expected to produce tax cuts ahead of a general election later in the year which he anticipated would see further unrealistic fiscal promises made by both main parties.

"When forecasts are revised, if they're revised in the good news direction that's given back to some extent in tax cuts or otherwise. However, when they're revised in the bad news direction that just feeds through to higher public debt. And you really saw that in the last few fiscal events," said King, who left the OBR in August 2023 and is now at political risk consultancy Flint Global.

AUTUMN GIVE AWAY

In the autumn 2022 fiscal event a costly energy cost suppport package meant "debt was revised up really quite dramatically over the medium term," King said.

And last November, when net debt was at 97.5% of GDP, Chancellor Jeremy Hunt chose to use an inflationary boost to nominal tax revenues to cut taxes, while leaving departmental spending broadly unchanged, and therefore significantly reduced in real terms, he noted.

"The good news in November really was the result of allowing the public service budget to fall in real terms because inflation was higher than expected. So in a sense, that was a kind of money illusion form of good news," King said. (See MNI INTERVIEW: Some Help To BOE From UK Budget–OBR's Miles)

If "you have this asymmetric policy response ex-post, then debt will not be on a declining path ... because the gross effect of bad news pushing debt higher is greater than the gross effect of any good news that is saved rather than given back. And why is it a particular concern at the moment? I think it's just because the environment is very volatile," King said.

"Forecasts will typically be revised by larger amounts from one budget to the next. If you have a debt ratchet working in a world of a few billion pounds worth of forecast revisions that's not ideal, but it's not going to put you on an unsustainable path. If you have frequent revisions in the 10s and 20s of billions of pounds then it's clearly much more damaging to have that asymmetric effect," he said.

INGRAINED CULTURE

Tackling the debt ratchet will be tough given the political culture. The 2024 election will be fought on the basis of public finances figures that many will regard as "implausible," with the government proposing unrealistic real spending cuts and the opposition unable to state that spending will have to be higher for fear of being accused of plotting a "tax bombshell".

While for economists better-than-expected public finances can be regarded as "a buffer against future risks,” for politicians, “it's a war chest, it's the Chancellor's money to spend,” King said.

“So if headroom gets revised up the pressure to use that good news for something is very great. And it's really difficult to see how something so ingrained in our political system can be changed.”