A ludicrous rule hands Reeves a free pass to spend recklessly

Loose fiscal rules mean shadow chancellor Rachel Reeves can continue to Britain's debt binge
The shadow chancellor will inherit the ability to borrow more money and rack up debt - Dan Kitwood/Getty Images

Let’s say, hypothetically, it’s the Labour Party forming the next government in six weeks’ time. What will Sir Keir Starmer and Rachel Reeves be inheriting from the Tories?

More bad than good, I’d say. And these are not problems that a simple change of government can turn around.

A record-high NHS waiting list, 5.6 million Britons on out-of-work benefits: this is the legacy of the lockdowns that the Tories ushered in and Labour supported every step of the way.

Addressing these crises will require a willingness to embrace the sorts of radical reform that, again, no party has wanted to admit is needed. Saying such things out loud would mean action would have to be taken. That would use up a lot of political capital, and require some unpopular decisions, too.

But the inheritance won’t be all bad. Plenty of economic indicators suggest that Britain is set for some better times. By no means should we expect to see booming economic growth or skyrocketing living standards. That would require politicians to do things like, goodness forbid, making it easier to build homes. Labour says it wants to do this, but has not explained convincingly how it will make it happen.

Still, there is good reason to think people will have noticed the improvements: inflation will have returned to around its target for a substantial period of time, boosting confidence that the crisis of prices is over. Wages should continue to outpace inflation. The latest data shows pay growth, adjusted for inflation, at 1.7pc – its highest in two years.

This remains the big conundrum of this summer election: while some metrics may have worsened, many of the economic ones might have improved, including the ones that address the fundamental question of an election: are you feeling better off?

There is a very real chance that the Tories are not only going to hand the keys to No 10 over to Labour, but a quietly improving economy, too. This won’t solve anywhere near all the problems Starmer will inevitably face, but it will make his political landing a little bit softer, and those early decisions ever so slightly easier.

But this is by no means the greatest gift the Tories would be handing over to Labour.

The Treasury has been subject to a very loose fiscal rule: that debt must be falling as a percentage of GDP on a five-year rolling basis. This has never been a secret, but it has also escaped serious scrutiny.

This rule may soon tie new hands – but is it actually constricting spending?

When Jeremy Hunt was appointed Chancellor by Liz Truss, he had one job: to restore the fiscal credibility that had been lost almost overnight by the then prime minister. Hunt did so by reversing almost all of Truss’s so-called mini-Budget. Markets responded positively.

By the time Rishi Sunak entered Downing Street, with Hunt by his side, gilt yields and market expectations for rate peaks had both settled. The pair became a symbol (for the markets, anyway) of renewed stability – and this presented an opportunity.

From time to time it’s noted just how relaxed the fiscal rule is, usually around fiscal statements when we are reminded that the chancellor’s spending plans all seem to rely on major spending cuts in (another) five years’ time.

In his last Budget, for example, Hunt was able to make the sums add up, including another 2p off employee National Insurance, based on the idea that in five years he would unfreeze fuel duty. Technically, his numbers added up and he was making good on his fiscal rule to get debt falling in the medium term: but only on the assumption that such a tough political decision would actually be made in five years’ time.

Does anyone think this will really happen? Of course not. But that’s no trouble for the Treasury. Thanks to the rolling aspect of the fiscal rule, the spending cuts (or tax hikes, or whatever is promised to reduce the debt-to-GDP ratio) can be pushed back, year after year, just so long as at the end of this hypothetical five-year spending period, the rule is satisfied.

It was an odd move indeed when the Government made one of its five pledges to “get debt falling”. This was never going to be delivered: with the leeway that the fiscal rule allows for, public sector net debt just keeps increasing.

Despite making good on the fiscal rule, debt figures soar under current forecasts, from £2.5 trillion by the end of this year to more than £3 trillion by March 2029.

This is not some terrible mistake: it is exactly what the rule is designed to do. It’s just not all that often that politicians can get away with it.

It’s no wonder, then, that Rachel Reeves has announced that she will stick with this fiscal rule if and when she enters No 11.

It is not a burden, but a free pass she will be inheriting: to borrow more money and rack up debt while still being able to claim that debt remains a serious concern.

But will this free past last? Regardless of party, the ludicrous nature of this rule was going to be exposed at some point. Plans for discipline can only be pushed back so many times before market confidence starts to wane.

The assessments that will be made of Labour’s economic agenda are likely to include how they are using this fiscal rule. It’s exactly the kind of flexibility a heavy-spending government dreams about. Were Labour to push it to its limits, it could face a market backlash. But that doesn’t mean the party won’t try.

And why wouldn’t it? Starmer and Reeves have made clear the many areas they want to invest in – green infrastructure, the NHS – and yet have been very hesitant to say where the new money will come from.

“Borrow to invest” is a phrase we hear plenty of times from Labour: we know it’s on their minds. The Tory party’s use of a rather reckless fiscal rule means it may well be on the cards, too.