The UK’s deficit is in the news again this week. In this article, IF researcher Conor Nakkan, takes a closer look at whether the UK’s current fiscal rules are fit for purpose.
Over the last few months, barely a week has passed without Chancellor Rachel Reeves being asked whether the government is reconsidering its fiscal rules. Despite mounting pressure on the UK’s public finances, Reeves remains resolute. Even amidst the economic disruption from the Trump Administration’s tariff adventurism, Reeves declared that the current fiscal rules are “non-negotiable” for the duration of this Parliament. Similarly, Prime Minister, Kier Starmer, recently described the rules as “ironclad.”
Given the salience of the fiscal rules within the policy debate, it is worth asking: what, exactly, are the current fiscal rules? What are they meant to achieve? Are they well designed? If not, what are some alternatives? And, importantly, are the current fiscal rules an effective means of protecting the interests of younger and future generations?
What are the current fiscal rules?
Put simply, fiscal rules are budgetary constraints that governments impose on themselves. They typically limit the kinds of decisions that governments can make about borrowing and spending. In the UK, Chancellor Rachel Reeves unveiled an updated set of fiscal rules in the October 2024 Budget. This article focuses on the stability rule and the investment rule, although the government has also adopted an updated welfare cap.
The stability rule
The main fiscal rule, known as the stability rule, requires that the government’s day-to-day (or current) spending be in surplus by 2029-30. In other words, government revenues should fully cover the costs of everyday public spending, with borrowing permitted only for capital investment. Once 2029-30 becomes the third year of the forecast period (i.e. in 2026-27), the rule becomes more flexible. It will then require that the current budget is projected to be in surplus or in deficit by no more than 0.5% of GDP three years ahead, on a rolling basis.
According to the March 2025 forecast from the Office for Budget Responsibility (OBR), the government is on track to meet this rule, but only by £9.9 billion. This figure is the government’s fiscal headroom. Notably, this figure is identical to the headroom projected in October 2024. However, in the intervening months, higher-than-expected debt interest costs and lower-than-expected tax revenue initially resulted in an estimated deficit of £4.1 billion for 2029–30. The headroom was then miraculously (and precisely) restored through the government’s welfare and departmental spending cuts, announced in the March budget.
The investment rule
The investment rule focuses on the sustainability of public debt. Specifically, it requires that public sector net financial liabilities (PSNFL) fall as a share of GDP between 2028–29 and 2029–30. PSNFL is a broader measure than the previously used public sector net debt (PSND). Whereas PSND accounts for gross debt and liquid financial assets (such as cash reserves), PSNFL includes a wider range of liabilities and assets. It includes, for example, the liabilities of funded public sector pension schemes and illiquid financial assets, such as equity stakes in private companies and student loans.
This change was introduced in an attempt to better reflect the government’s full balance sheet and enable more investment (borrowing). The OBR’s March 2025 forecast suggests the government is meeting this rule, with headroom of around £15.7 billion.
What are fiscal rules good for?
Fiscal rules are typically designed to achieve three main objectives.
- Improve the sustainability of public finances
By placing constraints on borrowing and spending, fiscal rules are supposed to limit wasteful expenditure, prevent political opportunism, and reduce the debt burden for future generations. Put differently, they aim to resolve the time inconsistency problem, in which governments have incentives to deviate from optimal long-term plans to achieve irresponsible short-term objectives. For example, in defence of the stability rule, Reeves argued it was designed to ensure that “difficult decisions cannot be constantly delayed or deferred.” Similarly, the Treasury has claimed the rule will prevent future generations from being “burdened with the costs of public services today.”
- Enhance transparency
Because they are generally embedded within official budget processes, fiscal rules should, in theory, make it easier for the public, Parliament, and independent agencies like the OBR to assess whether the government is managing public finances responsibly. By clarifying fiscal objectives and defining success in measurable terms, these rules can serve as a reference point for accountability and (potentially) reduce the scope for creative accounting.
- Reassure the markets
Credible fiscal rules are often thought to help anchor investor expectations, reduce risk premiums on government debt, and prevent financial instability. As the fallout from the Truss–Kwarteng mini-budget showed, perceived fiscal irresponsibility can quickly translate into higher borrowing costs and market volatility, particularly in a high-debt context.
What are the problems with the current fiscal rules?
Despite their intended objectives, the UK’s current fiscal rules face at least five main problems.
- A lot can happen in five years
The current fiscal rules rely on five-year forecasts, which are, by their very nature, quite uncertain. OBR projections, like all economic models, are vulnerable to exogenous shocks. But because the current fiscal rules require a specific budget outcome in a specific year, they are particularly dependent on forecast accuracy.
- Tight headroom results in endless fiscal fine-tuning
With little margin for error, small changes in forecasts can trigger large policy shifts. Consider, for instance, the spending cuts outlined in the March budget. Admittedly, there may be good reasons to consider broader reforms to the UK’s welfare system. However, the seemingly ad hoc changes in the budget don’t appear to advance any clear or compelling reform vision. Rather, they seem more likely to disadvantage some of the UK’s most vulnerable people just to claw back an arbitrary amount of fiscal headroom five years from now. As Ben Zaranko of the Institute for Fiscal Studies (IFS) puts it, the tail ends up wagging the dog – policy follows the spreadsheet, not the strategy.
- They constrain the space for democratic politics
While strict fiscal rules can discipline spending, they can also narrow political choice. By mandating a specific fiscal outcome, the government is less able to debate (let alone implement) policies that might require urgent spending. The recent debate over further raising UK defence spending to 3% of GDP illustrates this tension: it seems unlikely the government can meet that important commitment without either changing the fiscal rules or raising taxes.
- They may not even work
As Martin Sandbu of the Financial Times recently clarified, the evidence on the efficacy of strict fiscal rules is mixed. Governments can (and do) game the system by tweaking assumptions, shifting expenditures off-balance-sheet, or reclassifying spending. And even when they are followed, the focus on relatively short-term targets can lead to underinvestment in long-term priorities.
- They may harm younger and future generations
Despite often being justified in terms of intergenerational fairness, the current fiscal rules may entrench underinvestment in key areas that will benefit younger and future generations. By prioritising short-term targets over improving public services, building human capital, or expanding the long-term productive capacity of the economy, they risk leaving future generations with lower quality services, less productive infrastructure, and greater structural challenges.
An alternative approach
So, given these problems, what could be done differently?
The IFS and others have proposed sensible reforms: targeting structural rather than headline balances and softening year-specific targets. But an even more promising approach might be to move towards a principles-based fiscal strategy – like the one adopted by the Australian government. Rather than rigidly adhering to fixed numerical targets, the Australian government’s Economic and Fiscal Strategy sets out broad, medium-term goals. These include:
- Allowing tax revenues and income support to respond to economic conditions, while directing most revenue upgrades to budget repair;
- Limiting growth in spending until gross debt is on a downward path as a share of GDP;
- Improving the efficiency and sustainability of government spending;
- Prioritising new spending on investments and reforms that build human capital and expand the productive capacity of the economy;
The principles-based approach to fiscal policy allows for greater flexibility, supports long-term investment, and builds market credibility through consistent performance – not by hitting arbitrary and specific targets. Crucially, it also better reflects the principle of intergenerational fairness. Rather than focusing only on what future generations might owe, it also considers what they will inherit, including productive infrastructure, high-quality education and health systems, and a climate-ready economy.
Ultimately, if the UK wants to be fiscally responsible and protect the interests of younger and future generations, it might be time to rethink the fiscal rules.