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Brown's less than golden rule Samuel Brittan The Financial Times 02/12/04 When the great conjuror Houdini was in his prime, no one asked whether he would perform his next trick. The question was only how he would do it. The same applies to Gordon Brown's pre-Budget report. No one doubted that he would announce himself on track to fulfil his golden rule without overt tax increases. Fortunately he has eschewed the Heath Robinson devices forecast by some financial analysts and relied on a more optimistic estimate of tax revenue than they have. According to CEBR Economics he is depending mainly on a jump in corporation tax receipts and in revenue from tax avoidance measures. Qui vivra verra. But, in setting so much store by the golden rule, Gordon Brown has created a rod for his own back. In truth it does not matter all that much for the economy whether the rule is observed or not. The debate is in any case futile. Official projections show that, even if everything comes right, the tax burden is due to rise over the next couple of years by over two percentage points of gross domestic product due to fiscal drag - that is, the effect of rising real incomes on government revenue. There is a strong case that we have had a Labour government long enough. But I would not base this case on the fiscal balance or indeed any aspect of macroeconomic policy. I would rest it on Labour's control-freak aspects. While they are seen at their worst in the Blair-Blunkett so-called security agenda they are also reflected in Gordon Brown's attempts to micro-manage the economy. Each single tax subsidy, tax penalty, control or new public body set up by the chancellor may be justified on its own. But the sum total of all these measures adds up to a level of complexity and interference that cannot be gauged by looking at each in isolation. But to return from these broader issues to the golden rule. It has little substance. An early rule, was that the Treasury could borrow for projects that would yield a sufficient financial return. In wartime discussions John Maynard Keynes argued against the Treasury for a broader concept of a capital balance, which would cover other projects of long-lasting benefit such as schools, hospitals or art galleries. The Keynes concept eventually won the day and the definition of capital expenditure is now left to the statisticians. But the warnings of the wartime Treasury officials proved to have had some validity. For instance, expenditure on school lavatories is regarded as capital, while expenditure on science and maths teachers is treated as current expenditure. The case for this rule is pragmatic. Now that few believe that budget deficits spell imminent catastrophe, some line has to be drawn in the sand. Saying that the government can borrow only for defined purposes performs this function in a rough and ready way. The oldest fear about budget deficits was that they would lead to inflation. This was valid when governments financed their deficits by literally clipping the coinage or, a little later, by borrowing from the banking system. Under the current monetary framework such financing is ruled out. The Organisation for Economic Co-operation and Development has warned that excessive budget deficits would reduce savings and investment and thereby diminish the future incomes needed to meet the growing pensions burden. But while there might be something in this for the world as a whole, there is much less for an individual country. With liberalised international capital markets, UK investment is not limited by UK savings. The next danger is that if governments borrow too much they will drive up long-term interest rates. But in an international capital market, the borrowings of the government of an individual medium-sized country are not enough to have much perceptible effect on world interest rates. It is only if currency depreciation is expected that government borrowing can push up national interest rates above world levels. American experience has shown it can be a long time before such depreciation fears affect the bond markets. The biggest threat from budget deficits comes from what is called the debt trap. This is that the government's debt servicing burden spirals out of control because of the need to finance past deficits. The relevant rule here is not the golden one, but Gordon Brown's second and less discussed one that public sector net debt must not rise above 40 per cent of GDP over the business cycle. That percentage is itself arbitrary. The principle is that it must not be allowed to rise indefinitely. Public sector net debt is now about 35 per cent of GDP and is expected to rise slowly to 37 per cent by the end of the decade. The deficit relevant to stabilising this ratio here is public sector net borrowing, which is now estimated at 2.9 per cent of GDP and projected to fall gradually towards 1.5 per cent by 2008-09. Over-optimism takes somewhat longer to show up in the debt ratio than in the crude arithmetic of the golden rule. So a little slippage can be tolerated here, but not very much. The crucial assumption on which the Chancellor's "prudence" depends is that the rise in the public spending ratio in the first five years of this century is once-and-for-all (see chart opposite) and that Labour's aims can then be fulfilled without a further rise.
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