Sir John Redwood is MP for Wokingham, and is a former Secretary of State for Wales.
The UK economy is currently being run on the Maastricht rules as if we had not left the EU. The Office for Budget Responsibility made clear in its March report that whilst it awaits the Government’s conclusions on a new fiscal framework, the economy will be guided by the two familiar requirements that we get the running deficit down below three per cent of GDP, and that state debt as a percentage of GDP is declining all the time it is above the 60 per cent level.
It is clear that the whole five year budget in question is dominated by the perceived need to get state debt falling as a percentage of the economy by the end of the forecast period. This has led to a range of measures to increase the tax take, with a large increase in the Corporation Tax rate, and a big increase in the numbers of people paying higher rate income tax through freezing allowances.
My critics will argue that because we were outside the Euro we never had to follow the Maastricht rules. The truth is we did. We still do because we have never changed the rules, even though now we are free to do so.
We faithfully reported each year on progress with hitting the debt rules, and made clear that policy was primarily steered by the need to control debt. That was the central driver of George Osborne’s so-called austerity economics. The latest Government figures after Brexit continue to report our progress against these EU rules. This quote from the OBR’s March Report shows nothing has yet changed:
“The Chancellor has not set new fiscal targets in this Budget (despite two of the existing ones expiring this month) and is instead proceeding with the review of the fiscal framework proposed in last year’s Budget. But the absence of formal fiscal targets does not mean that the Chancellor has not been guided by particular metrics when selecting his medium-term Budget policies. The tax rises and spending cuts he has announced are sufficient to eliminate all but a £0.9 billion current budget deficit in 2025-26, while they are just enough to see underlying public sector net debt as a share of GDP fall by a similarly small margin of £0.7 billion in 2024-25 and £4.1 billion in 2025-26.”
I rest my case.
Requiring states to keep their overall state borrowing low makes a lot of sense in a single currency area where different governments have the right to borrow in a common currency. They need to avoid the free rider problem, whereby some states run up excessive debts, taking advantage of a low interest rate facilitated by the prudence of others.
The UK has no such problem. The UK as a single state with its own currency and central bank cannot take advantage of others. It does of course have to decide how much to borrow with affordability in mind. Borrow too much, and the interest bill could become unaffordable. Borrow excessively, and lenders could start demanding penal terms.
This means the best type of control over debt build-up for the UK should be a control over the size and growth of the interest burden. The UK has a tradition of borrowing long, and can do so in current markets. This protects taxpayers against sudden rises in rates, and reduces any strain from refinancing the debt. The Government has used debt interest targets, and should draw up a new realistic one. Given the way debt interest has fallen despite the increase in debt, this should not prove difficult.
The idea that we should carry on controlling the economy by state debt as a percentage of GDP is particularly silly given the great monetary experiment the UK along with the USA, the ECB and the Bank of Japan is carrying out.
The state-owned Central Bank is buying up large quantities of the state debt. Claiming that the gross debt is still a real debt is therefore wrong. The Treasury pays interest on nearly £975 billion of the debt to the Bank which it owns. If I had bought in my own mortgage but still kept paying the interest, I would not regard it as a real debt in the way I did before I bought in the loan, since I would be paying myself. Despite this obvious anomaly, the Budget is constructed on the basis that we need to get gross debt down, not the debt net of that owned by the state itself.
So what should we use as guides for economic policy? To a control on state interest payments to others, we should add a growth target and we should keep the important two per cent inflation target as a restraint on excessive credit and money expansion. The growth target should encompass aims to increase employment and productivity. What we need is to promote a higher wage, higher productivity economy. Our economic targets should reflect those aims.
The current state debt target is acting a constraint on faster growth. Offering tax rises and threats of tax rises for the years ahead damages confidence and deters new job creation and new investment. The UK’s productive capacity has been damaged by years in the single market where we lost out in many areas from steel to consumer electronics and from temperate food production to electricity generation.
We now need a favourable tax regime on self employment, investment, enterprise and individual incomes to promote a substantial increase in our productive capacity. The state debt control implies more of the same old policies which we had to follow in the later single market years which did not do enough to boost high paid jobs through industrial investment and higher productivity.