The myth of the “fiscal black hole” has been exposed

How did a £70bn “hole” become a £30bn “surplus”? The answer is that we’re doing economic policy wrong.

Photo by UK Parliament/Jessica Taylor/Handout via REUTERS

Just over three months ago, as the dust was settling from the implosion of the Liz Truss/Kwasi Kwarteng “mini-Budget”, we were being solemnly informed by “government sources” that a “fiscal black hole” had been discovered in the public finances, of up to £70bn, that needed to be filled with the savings from spending cuts. And yet just a few months later that same hole has mysteriously become a £30bn surplus.

Nothing fundamental about the economy has changed in those three months. We haven’t discovered a £100bn pot of gold. Inflation has come down slightly, but remains unusually high, while growth has been anaemic to the point of disappearance. There is nothing in the underlying economy to justify the incredible lurch in the government’s fiscal position.

As the economists Rob Calvert Jump and Jo Michell argued in a Progressive Economy Forum report at the time, the supposed fiscal hole was always a statistical fiction: the product of the government’s own deficit reduction targets and the assumptions made by official forecasters. Change the target, or change the assumptions, and the hole could shrink or disappear entirely. A tweak to the accountancy rules used by the government in January 2022, for example, was responsible for the entirety of the supposed hole. Changing those rules back again would turn the £60bn “deficit” into a £14bn “surplus”. The issue wasn’t that the government should do this, to give itself an apparent surplus to spend, it was that it could do this, illustrating the arbitrary nature of the figure.

The miraculous £30bn “surplus” now is an example of the same problem. Self-assessment tax receipts came in higher this January than expected by the Office for Budget Responsibility (OBR). This was the product (probably) of a post-lockdown surge in small business revenues, resulting in higher tax payments. This is a hard economic fact, at least, and forecasting errors are a fact of life in economics. The same is true of lower-than-expected energy price guarantee payments over the winter.

But part of the sudden lurch in the figures was the result of a mistake made by the OBR. It had double-counted payments from the Treasury to the Bank of England to cover losses on its quantitative easing programme – a (somewhat obscure) technical error, but one which made a material difference to the government’s supposed fiscal position.

This shouldn’t be how fiscal policy is conducted. Decisions worth billions of pounds, with consequences affecting millions of us, are being made on the basis of projections that oscillate far more, on the basis of accountancy changes, than the underlying economy those projections are trying to describe.

This is damaging because it reinforces the bias against long-term planning that is an endemic feature of the British system. There is little point in trying to plan into the future if the targets being aimed for are lurching around wildly, while supposedly cast-iron fiscal rules are changed every couple of years to suit. (We have had seven different sets of such supposedly binding rules for government in the last decade.)

The result has been persistent economic underperformance, as governments chase volatile fiscal targets, typically via austerity, instead of real economic outcomes. Breaking the cycle will require an overhaul of how economic policy is conducted: forcing the Treasury to prioritise wider economic goals, such as household living standards, over the longer term, while asking the OBR to be clearer about the uncertainties that are necessarily built into its forecast.