It has been described as a millstone around the chancellor’s neck and the reason Conservative MPs could be disappointed by Jeremy Hunt’s budget on Wednesday if he spurns their demands for large pre-election tax cuts.
After coming under intense criticism during Liz Truss’s premiership, the Office for Budget Responsibility (OBR), the Treasury’s tax and spending watchdog, is once again under fire.
What is the OBR and why is it so powerful?
Created by George Osborne in 2010 to “remove the temptation [from politicians] to fiddle the figures”, the OBR’s role is to provide analysis of the UK economy and public finances independent of the Treasury. It is tasked with producing five-year forecasts twice a year, normally alongside a spring budget or autumn statement.
At first the OBR was used by Osborne to signal the Tories’ ironclad commitment to balancing the books, aiming to portray his party as the most trusted stewards of the economy, in opposition to Labour.
However, it is increasingly seen within Tory circles as a roadblock to transformative tax and spending policies, a view also held by some on the left of politics. Truss sidelining the OBR for her mini-budget was one of the reasons cited for the ensuing financial market meltdown, inadvertently strengthening its position further.
Charlie Bean, an ex-member of the independent watchdog and a former Bank of England deputy governor, says: “It’s shooting the messenger. Because the UK’s fiscal context is really very challenging at the moment, which neither party is really recognising.”
So what are these ‘fiscal rules’?
The main constraints on the chancellor are in fact self-imposed, through fiscal rules the government has set. The OBR is tasked with assessing whether these rules are being met, but Hunt could choose to ignore them, or decide a new set of fiscal rules instead.
The primary target is for government debt to be falling as a percentage of GDP in the final year of a five-year forecast. There are also rules for borrowing – the annual budget deficit – not to exceed 3% of GDP over the same time period, and a welfare cap limiting the amount spent on certain benefits.
However, economists say the rules are harder to meet while the UK’s economic growth outlook remains weak; alongside higher borrowing costs, and rising demands on public services from an ageing population. Government debt as a share of the economy is already high, at 96.5% of GDP, having risen sharply after the 2008 financial crisis and Covid pandemic.
Andy King, a former OBR member who is now a specialist partner at the advisory firm Flint Global, says: “My reading of what’s going on at the moment is that the criticism of the OBR is in some respect reflective of the challenging fiscal position, and that comes in part from the weak outlook for growth.”
And what about ‘headroom’?
The margin within which the fiscal rules are met is often termed as the chancellor’s “headroom”. MPs often interpret this as the scope available for tax cuts or higher spending – even if this means the government continually bumping up against its primary fiscal rule.
At last year’s autumn statement, the OBR forecast that Hunt had about £31bn of headroom before any tax or spending decisions were made. Hunt’s policy measures – including a 2p national insurance cut and tax breaks for businesses – reduced his headroom to about £13bn. The OBR warned this was a historically slim margin, with previous chancellors having kept about £29.7bn in reserve on average.
It is understood the OBR has presented Hunt with forecasts showing headroom of about £13bn before any tax and spending decisions are taken at the budget.
David Gauke, a former Conservative chief secretary to the Treasury, says: “The fact is, we are very close to breaking the chancellor’s own rules, but that’s not the OBR’s fault.
“The government sees the edges of the fiscal rules almost as a target, which is why the decisions on the margins by the OBR are having such an important impact on the budget.”
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Economists warn that hard-to-predict changes in the economy could have big impacts on the public finances in future, with the likelihood the headroom can be drastically reduced.
“There is this tendency of chancellors to be responsible in future. But then you never get the debt under control in the medium term, in a sort of mañana strategy,” says Bean.
What are the chancellor’s options?
Hunt could choose to ignore his main fiscal rule, or rip it up and announce new targets instead. The government has changed its fiscal rules nine times since they were first introduced in the 1990s, with seven different sets since 2010.
They were most recently changed by Hunt in November 2022, with the horizon for getting debt falling extended from three to five years. According to the Institute for Government thinktank, the UK’s fiscal rules have the shortest lifespan before being changed out of 35 nations it analysed.
However, it’s most likely the chancellor will stick to the target – reflected in the reports that Hunt is planning to fund his plans using cuts in the public sector, as well as revenue-raising measures such as scrapping the non-dom tax regime.
There are economic and political reasons for doing so. After Truss’s mini-budget meltdown, the chancellor will be wary about signalling to markets a willingness to push up the UK’s debt levels. Meanwhile, sticking to the target throws down a gauntlet to Labour to act within the same rules, which could be helpful ahead of the general election.
However, Hunt could also game the system – as he was accused of doing at the autumn statement – by setting tax and spending policies so that debt falls as a share of GDP in the fifth year, even if the policies are unlikely to be delivered or are not considered to be desirable.
This led Richard Hughes, the chair of the OBR, to criticise Hunt’s plans as a “work of fiction”.
“It’s an invitation for the chancellor to fiddle what’s happening in that final year,” Bean says. “The broad objective is sensible, you want debt to GDP falling in the good times, to build up space for the next bad shock.
“Clearly what’s not sensible is the way it’s being operated. Partly because the rule itself allows this Augustinian approach to public policy: make me chaste, but not today.”