Making a National Fiscal council work: A five point plan

Last week, I argued that Labour should avoid what I see as a ‘stupidity trap’ being set in the Spending review by committing to create a National Fiscal Council, which would have the job of producing the outline deficit/surplus numbers that any government would then build their spending plans around.

Reaction to this idea was mixed.

The criticism ranged from the creation of an NFC being a fundamentally undemocratic proposal, to distrust of placing such institutional strength in a body of experts with a less than perfect record of predictions, to an argument that as the ‘correct’ fiscal balance at any given time is not a clearly settled technical question, it is inappropriate to ask an unelected body to resolve these questions.

These are all perfectly legitimate challenges, but I think they are resolvable. The key  lies in careful examination of what we would and would not want a National Fiscal Council to do and what part we want it to play in our national policy debate and in our policy decision-making.

Below I try to set out how such a body might work in practice. Since this is politics, and we don’t count up to six in politics, I’ve done it in the form of a five point plan.

1. The National Fiscal Council should be genuinely independent from Government.

One of the current problems for the OBR is that it has very little role to play beyond government. OBR members are exclusively appointed by the government, report only to the government, and have their fiscal role entirely dictated by government.

It is therefore no surprise that the OBR has become an essentially passive body.

In order for the NFC to generate real political legitimacy, it needs to be physically, institutionally, politically and culturally separate from government. I’d envisage a council with a tripartite structure. A number of members would be proposed by a body of academic economists, Another group nominated by political parties, and a third group would be nominated together by a selection of national and international institutions (I’m thinking here of IMF, OECD, CBI, TUC etc). These nominees would then choose their own chair, and appoint their own staff. Appointments would be time staggered, so that there would be no chance of single party dominance.

Culturally, the key would be total transparency of information. With wide ranging opinions within the council, there would rarely be total agreement on the ‘right decision’. However, I don’t see this as a weakness.

Uncertainty is essential in both economic prediction and in politics. The key is not to get it right 100% of the time, but to increase the chance of more or less getting it right more of the time. An open, evidence based, rigorously evaluated process is more likely to deliver this than a closed one.

Finally, scrutiny of the NFCs work should lie with parliament, not government.

2. The development of the Government’s fiscal targets should be a process of negotiation between the Treasury and the NFC, with parliament having the key role of scrutinising the process by which the Fiscal Target is agreed.

The most obvious objection to having an NFC setting an overall deficit target for the government to meet is that this is undemocratic. On one level this could be responded to by pointing out that merely setting out that the deficit in a particular year should be X neither dictates the scale of spending nor the level of taxation that delivers X. If the Government say they wish to reach X, however, and their own policies make reaching X less likely, someone should intervene.

However, on reflection, I agree with those who suggest that giving a Fiscal Council that level of power would undermine the cross-party support that is essential for such a body to succeed.

The obvious solution therefore is to see fundamental democratic legitimacy as lying in the power to set an overall fiscal rule by which a Government can then be judged, reducing even the strongest fiscal council to the evaluation of the most effective ways to meet the Government’s own stated objectives.

This leaves an obvious problem. Such a system works well if the Government sets a fiscal rule that makes sense. However, if the proposed ‘Fiscal Rules’ the NFC were to be bound by were themselves flawed  (I’m thinking here of the EU Stability and Growth pact 3% rule, or of the ‘rolling 5 year target’ in the UK), the NFC would be reduced to advising on the great success of driving ever faster to a bad destination. That would inevitably undermine the NFCs own credibility.

The solution here lies in shared authority and transparency.

The Government should set out medium term objectives for economic policy, and propose a Fiscal Rule to support these after consultation with the NFC. As part of that consultation the NFC should be able to set out proposed amendments to the Fiscal Rule, along with supporting rationales as to why their version would be a superior rule to deliver the government’s own medium term objectives.

The final decision will, however lie with government. This said, their choice of rule should be scrutinised by parliament (preferably in the form of a select Committee with an opposition chair) so the government will know it is extremely likely that the operation of alternative fiscal rules will be evaluated, reducing the value of sticking to your guns.

Further, Parliament, government and NFC, all able at any point to propose a change to the Fiscal Rules, and have such a proposal considered. Such a measure would mean that any government that chose to pursue a self-defeating fiscal rule would face challenge from two possible sources, and would have to defend their decision in the court of public and expert opinion.

3. The National Fiscal Council should produce projected annual deficit targets required to deliver the Government’s Fiscal rules.

Out of the process above we should get a Fiscal rule, likely one focused on delivering a structural balance or small surplus over the economic cycle. the NFC should then generate from this the forward deficit/surplus targets needed to reach this.

This is where the independence of the NFC becomes crucial. It should be able to set out its view of the economic cycle, revising it if needed, free of government pressure.

The NFC should also be free to change the annual deficit targets if the evidence is that such is needed to meet the Fiscal rules. As such a step would be politically controversial, the process by which a change in Fiscal targets must be evidence-based, transparent and non-partisan.

For example, it might be required to examine the evidence on the size of the output gap, or the risk level of higher inflation. This should be done publicly.

4. The National Fiscal Council should set out whether the government is likely to meet the identified targets, and if not, set in train a process by which the Government proposes to parliament remedial action to reach the targets.

Once the Fiscal rule is set and annual fiscal targets agreed, the role of the NFC becomes evaluative and triggering. Its job is to calculate what deficit or surplus is needed to meet the Government’s own fiscal rule, evaluate whether the government is reaching that target, and trigger remedial action by government if needed.

If it is clear that the Government is not going to be within the Fiscal targets (within tolerances) the Government should be legally bound to one of two courses of action: First, to propose a revision to their Fiscal Rule that would thus change the targets, or, second,  propose remedial budgetary action. I include the first because it must always be open to the Government to change its fiscal position in light of changing circumstances. However, this should not be politically cost-free.

5. The National Fiscal Council should be empowered to evaluate alternative policy measures proposed to it, to see if, on balance, they would be more likely to help reach the annual deficit targets developed out of the Fiscal rules.

This might be controversial, but I think it is key to the political legitimacy of the NFC.

Politically, the NFC should be able to receive submissions from all interested bodies, including other political parties, on better ways to meet agreed fiscal rules.

In my view, there is very likely to be broad political agreement on the ‘Fiscal Rule’, but very great political disagreement on the economic strategy most likely to meet the fiscal rule. One of the great frustrations for oppositions is that they often feel the government has made a crucial economic error, but they have no basis on which to make that argument credible. Whether they are making the case for ‘sharing the proceeds of growth’ or ‘too far, too fast’ oppositions find they face a credibility gap that is almost unbridgeable. I believe this is bad for policy-making.

So one role of the NFC would be to allow all parties to have their proposed economic strategies evaluated. So, for example, if one party sought a VAT cut, another a spending increase, a third a spending cut, the growth and fiscal effects of this could be evaluated by the NFC.

It might prove difficult for oppositions to make firm proposals without exposing themselves to excessive risks, so I’d also suggest the creation of a Parliamentary Budget office, who could run simulations on the growth and fiscal effects of proposed policies for all political parties in confidence. This would prevent oppositions from being in the uncomfortable position of ‘thinking aloud’ on economic policy.

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