As the UK approaches the Budget, one phrase is going to be repeated again and again is “fiscal headroom”. Politicians, economists and journalists talk about it as though it represents money the Chancellor has available to spend. In this video, I argue that this is deeply misleading.

Fiscal headroom is not a pot of money sitting at the Bank of England. It is simply the estimated margin by which the government is forecast to meet the fiscal rules it has chosen to impose upon itself.

Those rules are political choices. Change the fiscal rule, change the economic forecast, or change assumptions about growth, tax receipts, spending or interest rates, and billions of pounds of supposed fiscal headroom can appear or disappear without anything changing in the real economy.

I argue that this focus on fiscal headroom distracts us from the questions that really matter. The UK's economic constraints are not numbers on Treasury spreadsheets, but the people, skills, infrastructure, energy and other resources available to meet society's needs.

Instead of asking whether there is enough fiscal headroom for investment, pensions, healthcare, education or tackling poverty, we should ask whether the economy has the capacity to provide them and how that capacity can be expanded.

Economic policy should be judged by employment, investment, public services, inflation, sustainability and people's well-being, not by the margin between a self-imposed fiscal rule and an uncertain economic forecast.

Fiscal headroom does not tell us what government can afford. I argue that it turns political choices into supposed accounting necessities, and that leads to bad economics and bad political decisions.

This is the audio version:

This infographic supports this video:

This is the transcript:

We are in the run-up to a budget in the UK. It's on October 28th, and I suspect I will be in the BBC's Radio 2 studio on the day, talking about the budget as the Chancellor sits down. But there's one phrase that is already being used around this budget, and it's deeply misleading, and that phrase is ‘fiscal headroom'.

Politicians talk about how much fiscal headroom the Chancellor has. Economists speculate about whether the headroom is growing or shrinking. And journalists use this phrase to explain what the government can supposedly afford, but what is fiscal headroom and why does it matter?

That's what this video is about. But if at the end of it you need some more information, do have a look at my blog, where there is much more information about fiscal headroom. And in the case of this video, there should be an infographic summarising the arguments as well.

So what is fiscal headroom? It might sound like money the government has available to spend. It might sound as though the Chancellor has a pot of money waiting to be used, but there is no fiscal headroom account at the Bank of England, and there is no pile of money that becomes available when fiscal headroom increases. Fiscal headroom is simply a calculation. It is just a number on a spreadsheet, and understanding that calculation changes the whole argument.

So what is it really? Fiscal headroom measures whether the government is passing the financial tests, which it calls the fiscal rules, that it has set for itself.

The fiscal rules are just a set of choices that the government has made. There is nothing natural about a fiscal rule. Fiscal rules are not obligatory. Fiscal rules did not exist in the UK before 1997, and we managed very well without them. Fiscal rules are just what the government decides it must do almost invariably with regard to debt.

So, the UK has three fiscal rules at the moment. The first says it will balance its budget by 2029. The second says the ratio of debt to GDP in this country will fall by that same year, 2029, when there is going to be a general election. And the third says the share of welfare spending within total government spending will decline. Those are, in essence, the three fiscal rules we have. There's a little bit of wiggle room around those with regard to investment, but that's it. And what fiscal headroom describes is the margin by which the government may or may not meet those requirements.

So, if the government is going to be able to pay for its current expenditure out of taxation, which is the demand of the first part of the fiscal rules, then it has some fiscal headroom available to it. If it's going to be unable to do so, there is no fiscal headroom.

But let me be clear. This is all about forecasts. It's not about reality. This is all about the data that is produced by the supposedly independent Office for Budget Responsibility, which is staffed by civil servants on loan from the Treasury who still sit inside the Treasury. And this figure is not money available to spend.

Fiscal headroom can, in fact, be created and disappear overnight. Suppose the existing forecast says the government passes its fiscal rule by £10 billion. The forecast for growth, tax revenue, spending, or interest costs then all change. Anything might create that situation, and the government now only passes the same test by, let's say, £3 billion. The headlines will say that £7 billion of fiscal headroom has disappeared as a result. But no £7 billion existed in the first place.

What disappeared was £7 billion from the margin on a forecast calculation. The only thing that changed was a spreadsheet. The world was no different before or after the calculation. There was no reason for anyone to react. The fiscal rules were made up. So were the forecasts. They were all based upon human judgement. They are not based upon reality. And whether or not the test is passed has no real consequence in your life, my life, anyone else's life, or even the government's life because almost nobody can explain, as I just did, what the fiscal rules are.

But it is these fiscal rules that create the headroom that the economists, politicians, and commentators all talk about at present. But they are only referring, and I can't help stressing this enough, that they are only referring to fiscal rules, and these are just choices and not laws of economics.

A different fiscal rule could always change the amount of headroom available, and that is why, since Gordon Brown first introduced fiscal rules 30-odd years ago, nearly now, we've had a great many changes in them. Almost every Chancellor, and there have been a lot of them since 1997, although Gordon Brown occupied the seat for the first 10 of those years, has changed the fiscal rules. And some of them have changed them several times simply because they knew they were failing to create fiscal headroom.

So this is a land of make-believe, and that is why we shouldn't be paying too much attention to fiscal headroom because it relates to a rule that is always flexible.

Some people who are watching this video will remember that there was once upon a time an advert for a credit card, which described itself as ‘Your flexible friend'. Well, that's what fiscal rules are to Chancellors. They're flexible friends that can be altered whenever the Chancellor likes to create the headroom they want. But in the meantime, they are supposed to constrain the spending that the government can undertake, and that's to reflect the real political choices that the government is following.

The fact is that fiscal headroom is created to constrain government activity. There is no other reason for them. The estimates that make up the forecast, which in that sense make up the measure of fiscal headroom, are of things that might happen years from now. But we don't know what is going to happen years from now. Interest rates can change. There could be a war. Government borrowing situations can change. Investment needs can change. There may be a crisis. There may be a pandemic. We just don't know.

But we are supposedly required to manage current government spending on the basis of policy choices, which are dictated by what might happen in the future when the government has no better idea of what that will be than you have or the man down the pub has.

The reality is that the government is simply using these rules to constrain what it can do. And that is a false policy. It is saying we can't afford to invest. It is saying we cannot afford to increase pensions. It is saying we cannot spend on education, the NHS, or relieving poverty or whatever it might be, but that's not true.

The UK government cannot run out of pounds. It creates the pounds it spends. It doesn't need to collect tax before it spends. It doesn't need to borrow from financial markets before spending can happen.

And in that case, the constraints that exist upon the government are not set by finance. But the fiscal rules are all about finance, and fiscal headroom is a term derived from fiscal rules, which are all about finance.

So, we are using false tools to manage the economy. That's the point I'm making. The money is available if we need it, but there's no point creating the money if we haven't got the resources. The resources are what we should be managing. The money will follow if the resources are available.

That fact is disguised by discussion of fiscal headroom. It diverts attention from what is really going on. It prevents discussion of the proper economic issues we should be talking about in this country. It is putting the focus upon the services that can't be supplied rather than the things we can do. If it says money is in short supply, and at the same time we know there are vast numbers of people unemployed, and it says we can't put them to work because the money isn't available, we are creating a false measure. Politics is being presented in that case as an accounting necessity, and that is not true.

So we need to ask a better and a different question about what the government should be doing. We shouldn't be discussing fiscal headroom. We should be discussing the real capacity of the economy. We should be focusing on employment, investment, public services, and environmental sustainability. We should be discussing inflation. We should be discussing how those real resource constraints could create inflationary problems if we don't increase their capacity to meet the demand that we think exists. We should be talking about how tax could control that inflation, redistribute income and wealth, and shape behaviour, not least by eliminating poverty.

Economic policy should then be judged by its real-world consequences and not by the measures on a spreadsheet in the Treasury.

This is why fiscal headroom is not about economic reality. Economic reality is about putting people to work to meet need. Fiscal rules are an estimate of the space between a self-imposed fiscal rule and a forecast, and not even a real outcome.

There is no pot of money that a fiscal rule represents. It doesn't tell us what the government can afford. It doesn't tell us what the real constraints in the economy are, and it therefore leads to economic mismanagement. We should stop confusing a forecast accounting margin with the real limits on what the government can do.

We get bad politics, bad economics, and bad news reporting because people talk about fiscal headroom, which is just a figment of a Chancellor's imagination manipulated by the creators of too many spreadsheets, none of whom will ever have to face the real-world consequences of their actions, unlike the rest of us. It's time for fiscal headroom to go the way that all Chancellors do, which is to the back benches. It's time for us to talk about what is important: that is meeting need.

Now that's what I think. What do you think? There is, of course, a poll down below. Please do let us have your comments. Please do like and share this video. Please do subscribe to our channel. And hitting that bell button means that you will be told if you haven't looked at our videos for a while, because you will be missing out. And if you'd like to support our work, please do. Support us by buying us a coffee, and there's a link to let you do that down below this video.

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