Labour might have more room for manoeuvre

The details of fiscal targets might appear a suitable subject only for economist nerds, but in fact this subject could have crucial political ramifications in the next parliament. If, for example, Labour's budget objectives allowed the PSBR to be around 1 per cent of GDP higher than the Tories' over the medium term, this difference would be equivalent to pounds 8bn off the annual tax burden, giving the next Chancellor room to introduce a permanent 3p cut in the basic rate of income tax. It is quite possible to imagine that a figure of this magnitude could settle the result of the general election after next, so these matters should not be shuffled into the darker spaces of obscure policy texts.

A couple of weeks ago, I wrote in this column that Labour's fiscal objectives would probably turn out to be a little less tough than those of the present Government, and implied that this might leave scope for lower taxes or higher public spending than would be possible under the Conservatives' medium-term policy framework. I was taken to task for this remark by Ed Balls, the very able economic adviser to Gordon Brown, who told me that Labour's objectives were at least as tough as Ken Clarke's, and that there was no intention of allowing scope for an easier fiscal stance if Labour won the election. Since this dispute can now be settled by reference to the precise commitments in Labour's policy document published last Thursday, it is a subject worth revisiting.

Let us start with the present Government's fiscal targets. In the Budget Red Book of 1994 - it is necessary to go back that far for reasons that will soon become apparent - the Chancellor committed himself "to bring the PSBR back to balance over the medium term". Clearly, then, the Government's eventual objective was to eliminate the PSBR altogether, but the reference to "over the medium term" was obviously very vague. It could mean almost anything - three years, five years, 10 - all of which would have totally different implications for the path for the PSBR, and for the steady state levels of taxation and public services in the economy.

However, the 1994 Red Book also contained a concrete path for the PSBR, so it was easy to see what the Government might have meant by its reference to the "medium term". Specifically, the Red Book arithmetic showed the PSBR being eliminated by 1998/99, so it seems sensible to assume that this was the Government's definition of "the medium term".

The situation changed between the Budgets of 1994 and 1995. Last year, the Red Book said that the objective was "to bring the PSBR back towards balance over the medium term". Note that the word "towards" has been substituted for the word "to" in the previous Red Book, thus making the commitment somewhat vaguer. In addition, the budget tables showed that the PSBR would be eliminated in 1999/2000, a year later than previously planned. Nevertheless, the eventual objective of budget balance remained in the document, and the Chancellor has since re-emphasised that he believes this to be an important target which cannot be allowed just to slip around from year to year for the sake of political convenience.

The situation was further complicated, however, by the fact that the 1995 Budget added a new commitment, which was "in particular to ensure that when the economy is next on trend, the public sector borrows no more than is required to finance its net capital spending".

This is a very specific formulation of the golden rule of public finance, which very few people seem to remember appeared in black and white in last year's Budget. And it is not necessarily consistent with the long- standing promise to achieve budget balance over the medium term.

In fact, if the Government were content simply to achieve the golden rule, then they would need to do no more than limit the PSBR to about 1 per cent of GDP over the medium term (i.e. the amount that the Government invests each year), and would not need to achieve the tougher objective of eliminating the PSBR altogether.

Thus, the Chancellor appears to have two targets, involving a PSBR of zero, or of 1 per cent of GDP, and you can take your pick between them. To my knowledge, the Chancellor has never sought to clarify this ambiguity - and, indeed, has never been challenged to do so.

Now what about Labour? Like the Government, it has two separate fiscal objectives, as last week's policy document spells out. One of them is once again to enforce the golden rule - "we will only borrow to invest, and not to fund current expenditure" - so there is no difference on that score from the Tories. However, the second Labour objective is quite different. "Over the cycle," its policy document says, "we will ensure that public debt as a proportion of national income is at a stable and prudent level"

It is hard to be absolutely precise about what this second objective means, since the words "stable and prudent" are not exactly defined. But if we assume that Labour would try to hold the debt ratio at 55 per cent (which is roughly where they would find it), then this would imply that the PSBR could be left indefinitely at around 2 per cent of GDP.

Thus the range of Labour's objectives for the PSBR would appear to be 1 per cent of GDP at the low end and 2 per cent at the high end. This compares with the Tories' range of 0-1 per cent of GDP.

Looked at one way, we might therefore conclude that the main objective of both parties is to hit the golden rule, so there is not the width of a cigarette paper between them. I suspect that this is what Ed Balls had in mind when he disputed the assertion in my previous column. But the subsidiary objectives - budget balance for the Tories, and a stable debt ratio implying a PSBR of 2 per cent of GDP for Labour - are rather different, and would appear to me to give Labour rather more room for manoeuvre than the present Chancellor has allowed himself.

It is far from clear that Gordon Brown would seek to use this objective - in fact, everything he says suggests that he would leave the fiscal framework largely as he would inherit it from Ken Clarke - but nevertheless some extra wriggling room would probably be available if things were to go wrong. And things could well go wrong, since tax receipts are mysteriously melting away, and the Conservatives' plans for public spending will be extremely difficult to achieve. On Thursday, the Cabinet re-affirmed that it will seek to limit the growth in the nominal control total of public spending to only 3 per cent next year, implying that real growth will only be about 1 per cent.

Furthermore, it is quite likely that the Cabinet will agree to cut this total further in the spending round just starting, in order to leave some room for minimal tax cuts in November.

Given these impending problems, Mr Brown may need to use every ounce of the flexibility he has left himself on the PSBR, if Labour should win.