Coronavirus crisis will demand emergency cash but is no excuse for abandoning fiscal prudence

Andrew Marr went a bit far on Sunday when he said that Rishi Sunak faces greater uncertainty than any chancellor in living memory as he approaches the Budget on 11th March. Alistair Darling, who was at the helm of the Treasury through the financial crisis, would no doubt quibble with that. But the spread of coronavirus does create major economic, as well as health, risks and there is considerable uncertainty about how far and how quickly the effects will spread.

Even before the coronavirus outbreak intensified, there had been debate about whether the new chancellor would stick to the fiscal rules laid out in his party’s election manifesto. That document (coupled with the “costings” document that accompanied it) laid out three rules—the most constraining of those was that a Conservative government would ensure that revenues were sufficient to pay for day-to-day spending within three years. Given modest projected growth in tax revenues over the next few years, that rule gives little scope for the government to announce giveaways to public services of the sort Boris Johnson has suggested he would like.

With coronavirus putting pressure on the government to provide emergency cash to the NHS and to offer a lifeline to businesses and the self-employed, it is natural to ask whether the rules ought to be ditched. Does it make any sense to retain borrowing restrictions when the country is in urgent need of fiscal support?

The government certainly should not hold back from offering short-term support simply because it might mean borrowing for day-to-day spending. Failing to offer adequate support to the NHS or to step in with temporary assistance for business could have far worse long-term economic and social consequences than extra public borrowing. What starts out as temporary disruption could turn into permanent economic damage if, for example, businesses go to the wall as a result of cash flow problems or a temporary loss of demand.

But the fiscal rules laid out in the Conservative manifesto do not require the government to behave in such a perverse way. The rules give the government three years to balance the current budget. The basic idea is to ensure the public finances are structurally sound, while allowing flexibility to respond to short-term shocks. If you think the target to balance the current budget is appropriate, the new question in the face of coronavirus is: is three years long enough for the UK economy to recover from the shock? That is as much an epidemiological question as an economic one: if coronavirus returns in subsequent winters, as Spanish flu did a century ago, its impact could last some time.

Writers of most previous sets of fiscal rules in the UK have attempted to make some allowance for governments to provide economic support through temporary downturns. Gordon Brown’s golden rule required him to balance the current budget over the economic cycle. When he first moved into No 11, George Osborne targeted a balanced budget after adjusting for the ups and downs of the economic cycle. But in practice major economic turmoil—notably the financial crisis—tolled the death knell for rules that proved to offer too little flexibility in the face of major economic turbulence.

The coronavirus-prompted question for Sunak is whether the three-year window laid out in the Conservative manifesto offers enough time for the virus-related shock to pass so that tax revenues recover and the government can pull back its additional support for the NHS and businesses. The bigger question that had already been posed about those fiscal rules—that is, whether it makes sense to aim for revenues to pay for all day-to-day spending but to be willing to borrow for investment—is separate and remains.

There is a case to be made for adopting different rules. Why, for example, should the government be happy to borrow (and so ask future taxpayers to contribute to the costs) for a new rail line or hospital, but not for the costs of employing good quality teachers? Future taxpayers will benefit from both.

It is an important question, but the relevant considerations are essentially unchanged since the manifesto was drawn up at the end of last year—coronavirus does not change the picture. At that time, the party said its pledge “not to borrow to fund day-to-day spending” would “ensure that we are always spending what we can afford.” If Sunak takes a different view from his predecessor on what constitutes fiscal prudence, the electorate will be looking on Wednesday for him to explain his reasoning—and this must go beyond the temporary shock of coronavirus.

He should resist the temptation to ditch the rules altogether. The importance of the fiscal rules lies not in their precise details—reasonable people take different views on what level of borrowing is sustainable for the UK and the answer will vary depending on economic growth prospects and prevailing interest rates—but in their existence. Having a rule that limits annual government borrowing strengthens the Treasury’s hand in negotiations with other government departments, which will make compelling cases for the need for more spending but rarely propose how that should be paid for. Fiscal rules help ensure that difficult trade-offs are confronted. As the Office for Budget Responsibility’s long-term fiscal projections indicate, the pressures of an aging population will only intensify the difficulties of maintaining fiscal sustainability. Abandoning the rules now would only delay—not avoid—facing the awkward questions.