Tighten UK debt rule to prevent it being ‘gamed’, say peers

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The UK needs to tighten its central public debt rule because it is too easily “gamed” and presents a misleading impression of the government’s finances, a House of Lords committee has said, as it called for action to prevent debt from becoming unsustainable.

The House of Lords economic affairs committee said a new fiscal framework was required that ensured the ratio of public debt to GDP would be lower in five years’ time unless there were exceptional reasons.

The government is currently only required to get that ratio to fall between years four and five of a forecast that rolls forward each year — a target that has been criticised as arbitrary and too easily fiddled.

“If we are to tackle the serious risks we face, muddling through is not an option,” said Lord George Bridges, the committee chair. “To put debt back on a gradual, downward path, tough decisions must be taken in this parliament. And we need a revised debt rule that has teeth and holds ministers to account.”

The call comes as chancellor Rachel Reeves prepares to lay out details of her fiscal framework in the Budget on October 30. While she has revised the first of the Tories’ fiscal rules — switching from a fiscal target that strips out investment — she has embraced the existing debt-to-GDP target.

Reeves has not yet set forth the measure of debt she will use in the debt target. Many economists expect her to exclude the negative impact of losses by the Bank of England as it unwinds its quantitative easing programme as she attempts to create extra “fiscal headroom” for government spending.

The Lords committee found the current debt rule was “widely regarded as lacking credibility”. It said the rolling target meant debt could rise for four years, with victory being declared simply because it was predicted to slip back in year five, hiding the need to take “difficult decisions” on the public finances.

As such, the rule needed to be junked and replaced with one that “has teeth”, Bridges said. Lord Terry Burns, a fellow member of the committee, added: “The aim is to get [debt] down steadily over time, so we have a buffer once again.”

Darren Jones, chief secretary to the Treasury, said: “We have inherited a decade of lost economic growth, an economy that isn’t working, a £22bn black hole in our public finances and unsustainable long-term debt. To make sure this reckless overspending does not happen again, we are strengthening the Office for Budget Responsibility and will confirm our robust fiscal rules at Budget.”

Reeves has warned of tough decisions coming in the setpiece Commons speech as she attempts to pare back public borrowing but her options for tax increases are heavily constrained given Labour manifesto pledges not to increase income tax, VAT and national insurance.

A separate report by the Resolution Foundation, a think-tank, calculated that reforms to inheritance tax, capital gains tax and employer national insurance could raise over £20bn a year, while improving tax efficiency, ensuring that rises fall on those with the broadest shoulders while not breaking manifesto commitments.

While the chancellor has limited her revenue-raising options, CGT was “ripe for reform”, said the foundation, as rates were lower than on other forms of income. For example, employment income is taxed at a top rate of 53 per cent, but some capital gains are taxed at a top level of only 20 per cent.

The foundation proposes aligning CGT rates for shares with dividend tax rates, taxing property capital gains like wages, introducing CGT exit charges when moving country, and applying it at death. A full reform of the CGT regime could raise £10bn a year, according to the Resolution Foundation.

Adam Corlett, principal economist at the Resolution Foundation, said: “Long overdue reforms to inheritance tax, capital gains tax and pension contribution reliefs would fit the bill and could raise over £20bn if needed, while also making the tax system fairer and more consistent between different taxpayers.”

The chancellor should also close loopholes in IHT that allow the very wealthy to avoid paying their fair share, and undermine public trust in it, said the think-tank’s report.

Taxation of pensions was inconsistent and unfair and the chancellor’s best option would be to levy employer national insurance on employers’ pension contributions, it said.

Doing this at the same time as abolishing NI on employees’ pension contributions would leave a typical worker saving via auto-enrolment better off, while still raising £9bn overall, and would level out current arbitrary tax biases between different workers’ savings.