Economics: How Brown has opened the budget debate

On the november revolution in fiscal policy
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Public debate about the Chancellor's Green Budget has become so focused on lone parents that the important reforms to the fiscal process which were announced two weeks ago by the Treasury have been largely ignored. This is unfortunate, since in fact Gordon Brown has now revolutionised the UK's budgetary constitution, just as he revolutionised Britain's monetary constitution four days after the general election.

The first element in this fiscal reform is the decision to deliver the Green Budget itself. Each November from now on, we will see the publication of public spending plans for the year ahead, along with an economic forecast, an assessment of the medium-term state of the public finances, and an analysis of options for changes in taxation. And then, in the spring, we will get a conventional Budget Statement, which will include final proposals for changes in the tax system and the fiscal stance for the following year.

The disadvantage of this procedure is that it will spell the end of Norman Lamont's "Unified Budget", under which full tax and spending decisions for the coming fiscal year were all announced on the same day in November. But there never really was a compelling case for making spending and taxation announcements on the same day, since this meant making tax announcements several months earlier than the final date on which they really had to be taken. Furthermore, attempting to finalise tax and spending each November placed a seasonal overload on Treasury ministers and civil servants, and did not permit an open public debate about the contents of the Budget.

The advantage of announcing a provisional Budget in November, with the real thing following in March, is that an open public discussion can now be encouraged. Provided that the Treasury is willing to publish documents which genuinely encourage an open and informed public debate on the main issues, then the new system will be a big improvement on the old one.

How has the Treasury performed this year in this regard? On the macro- economic side, it has done very well. In particular, the analysis of medium-term growth scenarios, the output gap and the state of the labour market is a big improvement on past Treasury practice, since the public can now make much more sense of the official view of the economy, and of the Government's fiscal plans, than has previously been the case. In the past chancellors have pretended that the Treasury roof would fall in if they revealed details of such items to the public. Gordon Brown has now done so, without any noticeable damage to the structure of Great George Street.

On a less positive note, more thinking probably needs to be done about what the Green Budget should mean for the discussion of tax options. On this occasion, some items - like the corporate tax reform and the individual savings accounts - have been spelled out in full detail, with hardly any "green edges" being left for future public debate. Meanwhile, other items - such as capital gains tax reform - have simply been mentioned as future objectives, with no detail given about the options under consideration. It is not easy to get this balance exactly right, but if the Green Budget is to have any real meaning in the area of tax reform, then in future it would be good to see a half-way house, in which various options on tax reform were spelled out for public debate.

More important than the innovation of the Green Budget itself is the announcement that in future budgetary policy will be guided by the Code for Fiscal Stability, which will be enshrined in legislation. In conjunction with the Bank of England reforms already undertaken, this should greatly enhance the transparency and accountability of macro-economic management.

Although the precise objectives of fiscal policy to be included in the code - ie the golden rule of public finance and a stable and prudent public debt level - can be debated, they are perfectly sound medium-term objectives. The golden rule currently implies that the public sector borrowing requirement (PSBR) should be around 1 per cent of GDP over the medium-term, while the stable public debt requirement implies a PSBR of around 2 per cent of GDP.

These requirements are probably a little easier than those which would be required under the Stability Pact for European economic and monetary union (EMU) members, since the latter requires a PSBR outturn of "close to balance or in surplus" over the medium term. The Treasury says that it is deliberately erring on the conservative side in setting fiscal policy over the next five years, so that the terms of the Stability Pact are likely to be met, but there is some ambiguity here.

More important is the fact that any significant deviations from fiscal sustainability in future will need to be explained in very clear terms to the public, with the Chancellor being held openly accountable for his decisions. This extra degree of transparency will enable the markets to assess whether any rise in the PSBR is really justified in future.

Some people have criticised the Fiscal Code on the grounds that it will put budgetary policy in an over-rigid straight jacket, preventing the desirable "automatic" fluctuations in the PSBR which may sometimes be needed to dampen the economic cycle. There is no need for this to be the case. The automatic fiscal stabilisers will not be suppressed under the new code - all that will happen is that the public will have an official estimate of exactly how big the Treasury believes these stabilisers really are.

Furthermore, if the Chancellor decides to change fiscal policy over and above the automatic variations in the PSBR driven by the fiscal stabilisers, he can still readily do this, but only in the context of explaining exactly how he intends to return to a sustainable fiscal outturn in the medium- term. By bolstering market confidence, the Fiscal Code may actually increase the flexibility to introduce discretionary variations in the budgetary stance over short periods if this should prove necessary to stabilise the economic cycle.

On the question of whether today's fiscal settings are consistent with the code, the short answer is almost certainly "yes". According to Treasury assumptions, the economy will be working at approximately at its normal capacity in 1997/98, and the PSBR will be around 1.25 per cent of GDP - broadly consistent with the 1 to 2 per cent of GDP range which is encompassed by the twin objectives of the code. Furthermore, additional cuts in public spending relative to GDP over the next 18 months should bring the structural budget deficit to under 1 per cent of GDP next year, which would be well inside both the objectives contained in the code.

However, it should be noted that the Chancellor's tough July Budget, which increased tax receipts by about 0.75 per cent of GDP, was necessary to bring the public finances into line with the requirements of the code. Without this fiscal tightening, the stance of budgetary policy would clearly have been easier than is required under the code in the current year.

The Liberal Democrats' suggestion last week that Mr Brown is deliberately hiding billions of pounds which could be used to bolster the public services is, I am sad to say, just pie in the sky.