One of the most significant yet esoteric decisions the chancellor will make in next month’s Budget is how to define the government’s debt rule. This decision will have a profound impact on the country’s ability to invest. Choosing the right measure could release up to £50 billion in extra investment every year, directly shaping how transformative this government can be.
The chancellor is no stranger to the importance of public investment. She has already revised one fiscal rule – the borrowing rule – to safeguard it.[_] But there is still one fiscal rule that needs updating: the government’s debt rule. If left unchanged, this rule could prevent the government from borrowing more to invest, undermining its central mission of driving growth. Ironically, following the existing rule could thus make it harder to improve the country’s fiscal position in the long run.
The previous government’s debt rule required “underlying” debt (public-sector net debt excluding the Bank of England) to fall as a share of gross domestic product (GDP) within five years. This rule became a binding constraint on the previous government’s fiscal plans, leaving only £9 billion of “headroom” in the March Budget. But with the UK’s gross debt among the lowest in the G7, there is some scope to increase debt to fund productive investment without drawing a negative market reaction.
The chancellor has several options for redefining the debt rule. Some have called for a switch to “headline” debt, which includes debt held by the Bank of England. This could free up £16 billion for investment.[_] But this additional space will prove temporary, given headline and underlying debt are set to converge as the Bank of England’s debts are repaid. Both debt measures also share another flaw: they ignore the value of assets created by long-term investments, and thus discourage spending with long-term outcomes in mind.
Another solution would be to adopt a broader measure of the public sector’s balance sheet, such as public sector net worth (PSNW). This measure offsets a wide range of public-sector financial and non-financial assets against debt. While this approach incentivises investment, it presents two challenges: valuing non-financial assets such as infrastructure is difficult, and those assets do not typically generate revenue that can be used to service or repay debt.
A better compromise is to adopt public-sector net financial liabilities (PSNFL). This measure is broader than headline debt, as it takes account of the public sector’s financial assets, but it excludes non-financial assets that are less relevant to the government’s ability to service its debt. PSNFL offers three major advantages:
It aligns with borrowing rules: PSNFL aligns with the definition of public-sector net borrowing. By contrast, under the current debt rule, debt can rise even if the fiscal deficit is zero. For example, if the government advances more student loans or takes equity stakes in companies, those actions will add to debt but not the deficit. The debt rule thus unnecessarily reduces space to borrow to invest and creates perverse incentives to sell valuable assets (such as the student loan book or the government’s equity stake in NatWest Group) to artificially reduce debt. Switching to PSNFL resolves both of these issues.
It allows the government to invest in a National Wealth Fund: The government’s plan to create a National Wealth Fund (NWF) involves borrowing to invest in financial assets, such as taking equity stakes in private companies or providing infrastructure loans. Under the current debt rule, this borrowing would increase the debt stock, while the value of the assets acquired would be ignored. Using PSNFL would account for both sides of the balance sheet and mean that the NWF would be less constrained by the government’s fiscal rules.
It unlocks space for public investment: Most importantly, switching to PSNFL would create an additional £52 billion in headroom for investment each year, based on March forecasts from the Office for Budget Responsibility (OBR). To avoid a negative market reaction and to ensure a sufficient reserve buffer to deal with unforeseen circumstances, not all of this headroom should be used at once. But even just using half of it would allow public-sector net investment to remain at its current level of 2.5 per cent of GDP rather than having to fall back sharply. This would be a transformative sum that could reshape the UK’s economic future. To ensure this money is spent wisely, the government could require the OBR to assess the growth potential of investment plans and ask the Office for Value for Money to evaluate their cost-effectiveness. These measures would further strengthen the government’s fiscal credibility.
A Critical Opportunity
The need for greater public investment in the UK is undeniable. Public services are crumbling, with Lord Darzi’s report revealing a staggering £37 billion capital shortfall in the National Health Service alone. More investment is also vital for achieving the government’s ambitious net-zero targets and deploying cutting-edge technologies to improve public services at lower costs. Additionally, boosting investment is key to driving economic growth; according to the OBR, a 1 per cent sustained increase in public investment can lift GDP by 2.5 per cent over the long term.
The decisions the chancellor announces on 30 October will set the tone for the whole parliament. By making this one crucial adjustment to the UK’s fiscal rules, she has the power to unlock billions in investment – potentially breathing new life into the economy, revitalising public services and setting the country on a path toward sustainable growth. Failure to act would not only constrain the government’s ability to meet its bold ambitions, but it could also keep the UK economy stuck in the doldrums. The opportunity is there to be seized – what remains to be seen is whether the chancellor will take it.