How big is the fiscal hole? Is there really a fiscal hole at all? What even is a fiscal hole? As the Chancellor gears up to give his hair-shirted autumn statement, these are all questions that Labour needs to avoid debating in the weeks and months ahead if it wants to win a much more important political argument - and the election that will be shaped by it.
The economy is in a mess. Just eight months on from the last OBR forecast, the watchdog looks set to significantly downgrade its projections for growth in the short-term and, much more worryingly, its expectations of the size of the economy once the current turbulence is past. An unexpected fall in the size of the workforce and concerns that high energy prices are here to stay are likely to mean that the economy will be smaller by 2027 than the OBR expected in March. Government debt servicing costs, meanwhile, have ballooned. So whatever one thought would be a sustainable level of public borrowing later this decade will now require tax rises or spending cuts to achieve.
Ever since the mini budget, the worsening outlook has triggered concern about the so-called ‘fiscal black hole’: the gap between some definition of fiscal sustainability and where the OBR thinks government borrowing is likely to be once the economic turbulence passes. Leaks suggest it may require the Chancellor to raise taxes or cut spending to the tune of £55 billion per year by 2027. In response, a procession of economists and commentators on the left have been vociferously questioning the whole idea of a ‘fiscal black hole’.
First, they point out, a fiscal hole is only measured relative to some arbitrary definition of what level of borrowing is deemed to be sustainable. But it seems likely Hunt is going to adopt a looser set of fiscal rules than Sunak had as chancellor, stretching the timeframe out to five years to get debt falling and have tax revenues covering all day-to-day spending, rather than three. Indeed such a framework would also be looser than Gordon Brown’s set of rules.
Fiscal hole sceptics also argue that there is simply too much uncertainty around to embark on Austerity 2.0. Forecasts are educated guesswork at the best of times, and right now we are flying especially blind. It wasn’t the borrowing in the Truss-Kwarteng interregnum that spooked markets but the willingness to dismantle institutions, they argue. And in any case we need to avoid swinging wildly towards tightening fiscal policy in the teeth of a recession.
They are right on many of these points. But that’s not the same as refuting the validity a fiscal hole, and they represent a political trap that Labour needs to avoid. By focusing on the arcana of fiscal sustainability and forecasts the left risks losing the bigger argument.
The hue and cry about the legitimacy of ‘fiscal holism’ is really a proxy war for the things the left (and most voters) really cares about – adequately-funded public services and a welfare regime that lifts people out of poverty.
Fiscal policy has three goals. To fund public services and benefits to the level we want as a society. To help minimise macroeconomic volatility. And to ensure the government is not borrowing too much, risking financial instability, pushing up interest rates across the economy and crowding out private activity.
These goals are distinct. It’s possible to combine a view on one of the three tasks with any stance on the other two (see diagram). You could advocate a small state and be fiscally reckless, but seek to stave off recession, like Kwarteng and Truss. You could be a bone-dry fiscal conservative on medium-term borrowing who nevertheless thinks we should take our time on cutting borrowing for the sake of growth, and who thinks that taxes and the role of the state need to expand. Or you could think that the current supply shock means that we should cut borrowing immediately to regain fiscal credibility and slow the Bank of England’s rate hikes, while being agnostic about the ultimate size of the state.
Fig 1: Design your own fiscal consolidation
But conflating different arguments is arguably why Labour lost the political argument in the 2010s. In the original Austerity debate, George Osborne successfully elided the distinction between fiscal conservatism and his preference for a smaller state for political purposes. In the face of any objection to public spending cuts the Coalition government would argue that there was no alternative to getting the public finances back under control. Fiscal conservatism was used as cover for a goal of cutting back public spending. And by implicitly accepting Osborne’s premise that fiscal conservatism necessitated swingeing cuts to public services, progressives were unable to win the argument with voters who also wanted to see borrowing cut.
What should have been a debate over the composition of that consolidation – whether higher taxes should have contributed more – was eclipsed by what sounded like an argument about whether consolidation was required at all.
Eliding these issues is, once again, the Conservatives’ best electoral hope. If Jeremy Hunt opts to fill the fiscal hole with 50% spending cuts this week, the plan would mean unsustainable cuts to public services that are already threadbare. But if the government can keep the political argument focused on whether fiscal consolidation is necessary, rather than his choices about its composition, it’s on much more politically propitious turf.
For Labour and the centre left more broadly, the lesson is clear. Don’t argue the toss about official forecasts. Don’t question reasonable definitions of fiscal sustainability (even if they’re less than ideal). Don’t major on the need to slow the consolidation to support growth at a time of rocketing interest rates. These are important issues for economists. But for the disinterested voter, all of these things sound like excuses for fiscal unreliability.
Rather, to win the argument over Austerity 2.0, Labour needs to burnish its fiscal conservatism, welcome the government’s belated conversion to fiscal responsibility, and focus its fire on the way the government chooses to deliver it this Thursday.