Hamish McRae: It's time we had some rules – and stuck to them

It will be future generations that will have to work to pay off these debts
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The Independent Online

Oh dear. It is getting worse. Everything that this Government sought to avoid has happened, for it has managed to stumble into a full-blown financial crisis, the consequences of which will hang over us for a decade at least. It is not just bad luck that has given Britain the worst fiscal deficit of any major economy in the world. It is a systemic failure that we need to be honest about if we are to fix it.

The exercise yesterday was principally about politics rather than economics and others will draw appropriate conclusions from that. But though the politics will almost certainly change next year, I am afraid the economics won't. There are some harsh economic realities embedded in the pre-Budget report that need to be brought out, and then there are some longer-term constitutional consequences that need to be debated. The harsh realities first.

The borrowing mountain has been widely discussed. Even on the Government's own figures debt reaches nearly 80 per cent of GDP. While in relative terms that would be broadly similar to many other countries, the rate of increase is so rapid that it seems likely that the UK will lose its AAA debt rating in the coming months. The effect of that would be that all long-term sterling interest rates – for fixed-rate mortgages as well as government debt – will have to rise. That would not be a catastrophe but it would be an additional headwind in the path of recovery. Obviously the higher the debt, and the higher the interest rate, the greater the proportion of tax revenues will go to servicing and paying back debt, leaving even less for providing public services.

The background to the debt is however even more troubling than the debt itself. Under these plans taxes are shooting up to such an extent that they are meeting stiff resistance. But in reality the overall tax burden, even under these projections, is not that high. If you look at page 186 of the report you see a nice little chart showing that in 2014-15 taxes will be just over 35 per cent of GDP, almost exactly the same as when Labour took office in 1997 and rather below the peak a couple of years ago.

So we have all this anguish, the 50 per cent top rate that they promised they would never do, this latest rise in National Insurance contributions and so on, and yet they are not going to get much money in. The problem, in a nutshell, is that you can't raise that much money from the so-called rich because there are not enough of them. The maths do not work.

There is a parallel problem on the spending side. We don't have much detail on the plans beyond next year and we were not given much more yesterday. However, embedded in the figures are really savage cuts. Take public investment. The Chancellor boasted how high public investment was this year and said he was determined "to build on these strengths by... boosting investment in our national infrastructure and skills".

Well, on page 189 there is indeed a table that shows that net public investment this year is 3.5 per cent of GDP. But by 2013/14 it falls to just 1.3 per cent of GDP. That is brutal, particularly so since the burden actually falls on the private sector, the construction and engineering that carry out the investment. I don't think people have any idea quite how serious the squeeze on spending will be, even on this government's own plans.

No government wants to put itself into this sort of position. Gordon Brown desperately wanted to avoid the charge that Labour might mismanage the nation's finances, hence the "golden rule" that the government would only borrow for genuine investment and not for current spending and the sustainable finances rule that debt would be held below 40 per cent of GDP. This has failed. You can have a debate as to why: were they badly framed or were they simply over-ridden by Gordon Brown himself? But something has to be done to stop it happening again.

This leads to a massive constitutional issue: what freedom should an elected government have to determine tax levels, spending levels and public borrowing? For some people the answer might be that a government can do whatever it can get through parliament. Others might say it has the authority to do whatever it puts into its manifesto. But these responses ignore the fact that a government has responsibilities not just to the electorate of the day. It has responsibilities to children, for example, and I would argue it has responsibilities to future generations too. It will be future generations that have to work to pay off these debts.

So what is to be done? Labour announced in the Queen's Speech that it would bring in a fiscal responsibility bill to provide a "firm and binding statutory basis" for reining in the government's deficit. That is one way of doing it and it has been tried elsewhere. Nigeria brought in similar legislation a couple of years ago. But there are limits to what a law can achieve. The Maastricht agreement imposed a deficit ceiling on Eurozone countries of 3 per cent of GDP but that has not stopped Greece running up a deficit almost as big as ours.

In practice it looks as though we will adopt the Conservatives' proposal of an Office for Budget Responsibility, a separate body that will monitor tax and spending decisions. The appointment of the first chairman, Sir Alan Budd, a former chief economic adviser at the Treasury, was announced on Tuesday. This is a really important appointment. I do know Alan well and can say he is wise, forthright, quite apolitical (which is good), and that he will be honourable to the end of time. That will help maintain international confidence, for if anyone can keep Britain's AAA rating it will be him.

But this does not solve the constitutional issue any more than Gordon Brown's golden rule solved it. It may be harder for a Chancellor to over-rule a separate body than to over-rule his own civil servants – if indeed the Treasury put up enough of a resistance to him. But a new and irresponsible government could pack the Office for Budget Responsibility with party hacks. Amazing what the offer of a peerage will do. We have the model of the Bank of England's Monetary Committee and maybe that is the way forward but it has a single objective, hitting an inflation target, that is much simpler than the complexities of fiscal policy.

This is a global issue. All developed countries face huge fiscal pressures, not just from this recession but from the further impact of ageing populations and unfunded pension liabilities. We will all have to find ways within our different constitutional frameworks and histories, to impose a long-term discipline on the governments of the day. The UK simply has a bad incidence of a world-wide epidemic.

There are no easy answers. But one thing is sure. We cannot as a country go on like this. Gordon Brown was right about one thing. We need fiscal rules. Pity he broke them.

h.mcrae@independent.co.uk

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