What are Rachel Reeves’s fiscal rules and what does the IFS want to change?

The Institute for Fiscal Studies (IFS) says the chancellor’s fiscal rules are “dysfunctional” – which may come as not much of a surprise even to the lay observer of Rachel Reeves’s time in office. It says the “aggressive ‘gaming’ of rolling targets and frequent changes to the rules have undermined their credibility … nor is the framework delivering on its promise of sustainable public finances”. In short, Reeves has been cheating a bit and the IFS would like to see the rather crude pass/fail system replaced by a more nuanced approach…

The economic watchdog has an eye on 3 March and what is now called the spring statement, made by the chancellor in the Commons in response to the latest forecasts by the official (but operationally independent) Office for Budget Responsibility (OBR). In contrast to past such fiscal events, this was intended to be a low-key occasion. Crucially, the OBR will no longer be asked to say if Reeves is on track to meet her fiscal rules; that will now happen only once a year, at the Budget. This change will ease short-term market pressures and make for an easier life for the chancellor and her colleagues (and the IFS welcomes this). So this time round the OBR won’t be marking her fiscal headroom – though others will give their opinion.

The first concerns “current spending” – teachers’ wages, drugs for the NHS, and so on – which is to be matched by tax revenues by 2029-30.

The second is to ensure national debt starts falling in relation to national income by the same period. That is supposed to give the government more headroom in order to borrow to invest. In 2024, the definition of the national debt was changed to “public sector net financial liabilities” (PSNFL) which offsets debt with certain financial assets such as the student loan book. The effect was to release more funds for infrastructure investment that might otherwise have been crowded out.

There is also a welfare cap, though it is fairly loose and allows for welfare spending to rise during recessions.

Like the rules adopted by Jeremy Hunt, Rishi Sunak and many other predecessors, these were prone to wishful thinking. Thus, huge deficits and a mounting debt were permitted provided that both would be falling in five years’ time and even if the planned decline was imperceptible or based on unspecified future cuts in public spending,

Another problem is that Ms Reeves allowed herself to be locked into a fiscal straitjacket in other ways. Her “original sin” was the manifesto commitment not to raise income tax, VAT and national insurance contributions, which helped win Labour the election but left her with few real options when things went wrong in 2024. Even on her own rules she also gambled and left herself too little room for events outside her control, such as Donald Trump’s tariffs and the unpaid bills left by Sunak and Hunt.

No, but it’s been fashionable since at least the early 1980s when Geoffrey Howe adopted the Medium Term Fiscal Strategy, as designed by Nigel Lawson, then a junior Treasury minister. In 1997, Gordon Brown formulated his “golden rule” of borrowing only to invest and not to fund current spending over an economic cycle. George Osborne and his successors largely followed variations on this.

Such rules, however bogus, tend to improve a chancellor’s credibility and provide reassurance to financial markets – until, that is, the rules become impossible to meet and the markets punish the government, as Kwasi Kwarteng and Liz Truss discovered.

Many more fiscal targets, a more nuanced traffic-light system of measuring success, and more of a medium-term strategic approach (reminiscent of the approach taken in the Thatcher administration’s eventually successful first term).

The IFS suggests time should be taken to frame new rules and present them to voters at the next election, but it doesn’t call for major institutional change: OBR and the Bank of England would continue to be operationally independent (even Reform UK’s new Treasury spokesperson, Robert Jenrick, now says he’d retain the status quo in that respect).

In reality, any set of fiscal rules is only really an expression of what investors are prepared to put up with in return for lending Britain money at an affordable rate of interest. Financial markets are the unseen authors of all fiscal frameworks and, as the ultimate watchdogs, they have sharp teeth and powerful jaws.