Budget: Capital budget rules change as Treasury unveils new fiscal framework

Departments will get five-year capital budgets, extended every two years at regular spending reviews
Photo: PA Images/Alamy Stock Photo

Rachel Reeves has committed to setting longer-term capital budgets for government departments in a bid to eliminate “funding cliff edges” and provide financial certainty, as part of a new fiscal framework.

The chancellor will set five-year capital budgets and extend them every two years at regular spending reviews, as part of a series of reforms to how capital spending is managed. Departments will also be told to publish business cases for major projects and programmes in a bid to increase transparency.

And the government will publish a 10-year infrastructure strategy in the coming months as the next phase of the spring 2024 Spending Review.

“These changes will provide greater certainty for departments, investors and supply chains, and greater assurance that the investment is high-quality and well delivered,” according to guidance on the new fiscal framework, published by the Treasury this afternoon.

To support these reforms, the government will merge the National Infrastructure Commission and Infrastructure and Projects Authority to create a new National Infrastructure and Service Transformation Authority – plans for which the Labour Party announced in May.

The capital spending reforms are part of a wider fiscal framework set out in a Charter for Budget Responsibility, published alongside the Budget this afternoon.

The Charter for Budget Responsibility promises to support economic growth through decisions that support fiscal sustainability; prioritising investment to support long-term growth and funding high-quality public services while delivering value for money for the taxpayer; and a commitment to fiscal transparency and strong institutions, including the independent Office for Budget Responsibility.

The charter sets out several commitments to create a “stable and predictable fiscal policy environment”. They include holding a spending review every two years, as pledged by Reeves in July, as well as holding one major fiscal event per year. Each spending review will set Departmental Expenditure Limits – which include both capital and day-to-day spending – for a minimum of three years of the five-year forecast period.

The framework will be based on two rules, which Reeves announced earlier this month: the stability rule, to move towards only borrowing for investment; and the investment rule, to reduce debt, defined as public sector net financial liabilities (PSNFL) or “net financial debt”, as a share of the economy.

Documents explaining the new fiscal framework confirm more details of the rules, including that from 2029-30 – the end of the OBR’s forecast period – the budget must remain in balance or in surplus from the third year of the rolling forecast period. Similarly, from 2029-30 onwards, debt should be falling as a share of the economy by the third year of the rolling forecast period.

The rolling approach – targeting the third year in each forecast cycle, rather than a specific financial year – “avoids the need to make sharp policy adjustments in response to small changes in the forecast or economic shocks”, the guidance says.

“With a fixed rule, as the target grows nearer, adjustments like in-year savings or tax rises become more challenging and economically damaging. A rolling target instead provides a medium-term anchor to support stability and sustainable public finances,” it adds.

The guidance gives the government an initial five-year period to create a budget surplus and ensure debt is falling before the rolling deadline comes into force. This phased approach to introducing the rules balances the need to enhance fiscal discipline with the need to manage existing spending pressures, the guidance says. It points to the £22bn “black hole” identified in a review of the public finances commissioned by Reeves in July.

To bolster transparency, the charter commits to affirming the independence of the Office for Budget Responsibility and ensuring that fiscal policy is supportive of monetary policy.

The OBR will independently analyse and comment on fiscal sustainability at each medium-term forecast, referring to metrics including public sector net debt; public sector net financial liabilities; public sector net worth; and general government gross debt.

The charter also commits to welfare reform, including setting a new welfare cap for 2029-30; and an “escape clause” that provides a strengthened role for the OBR when the government assesses there is a need to temporarily suspend the fiscal rules due to economic shocks.

The new fiscal framework also includes measures to improve transparency in public finances, including confirming the detail of the fiscal lock as legislated for in the Budget Responsibility Act 2024 – meaning that every fiscally significant change to tax and spending will be subject to scrutiny by the independent Office for Budget Responsibility. 

Elsewhere in the charter, the Treasury commits to providing the OBR with regular information about spending pressures, and formalises the OBR’s power to forecast overspends against Department Expenditure Limits.

The charter also requires the OBR to analyse and report on long-term impacts of capital investments and other policies at each forecast, which it says will “help demonstrate how the health of the public sector balance sheet is bolstered by good investment decisions”. 

And it commits to annual reporting on government’s contingent liabilities – which are uncertain in timing or cost and don’t appear on most measures of the balance sheet – and financial investments. 

New debt measure

The update meanwhile confirms reports from earlier this month that Reeves has switched her measurement of debt from “public sector net debt” to “public sector net financial liabilities”, allowing for the inclusion of all government financial assets and liabilities, including student loans and funded pension schemes.

The change in definition could allow for around £50bn of extra investment and follows calls from experts to change the fiscal rules to enable the Treasury to up its spending.

Earlier this month, a group of economists including former cabinet secretary Gus O’Donnell said changing the fiscal rules and the Office for Budget Responsibility’s mandate would be a “more responsible approach” than cutting public spending – one that “better reflects the significant long-term benefits of increased public investment”.

The Treasury said using PSNFW as a measure will provide a more complete picture of what the government owes and owns, “improving incentives to manage a broader set of liabilities and drive asset performance”; and recognise the value of financial assets, such as loans that can reduce, rather than increase, debt.

This measure will also support what the Treasury calls “growth enhancing investments”, such as financial investments made by the National Wealth Fund, which will contribute to economic growth .

“Using a debt metric that does not recognise financial assets could create an incentive for the government to forgo profitable and growth enhancing investments,” it says.

Read the most recent articles written by Beckie Smith - DWP and HMRC 'could save 8.12 million hours a year through AI and automation'

Categories

Finance
Share this page