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  • New Chancellor John Healey faces a £5 billion defense funding gap and costs associated with energy bill tax cuts within weeks of his first budget.
  • Economists are divided on whether to exploit existing fiscal rule flexibility or pursue structural changes allowing public corporations to borrow directly from markets.
  • Critics warn that increasing debt, regardless of accounting definitions, raises borrowing costs and future liabilities without guaranteeing substantive economic returns.

With just twelve weeks remaining before his inaugural budget, Chancellor John Healey is confronting a complex fiscal landscape that demands immediate attention to daily government expenditures while simultaneously addressing long-term growth objectives. The former defense secretary has inherited significant financial pressures, including the necessity of funding a value-added tax reduction on energy bills proposed by Prime Minister Andy Burnham. Additionally, Healey must resolve a five billion pound shortfall in the defense investment plan, a gap left by his predecessor Rachel Reeves that contributed to his own resignation earlier this year. These immediate obligations require careful navigation to avoid breaching the Treasury’s established fiscal rules.

Healey has some buffer to work with, as Reeves left behind substantial headroom against fiscal targets, estimated at twenty-four billion pounds during her spring forecast. While the impact of recent geopolitical tensions, including conflicts involving Iran, may have eroded some of this margin, significant room remains for maneuvering. To address the immediate deficits, Healey could implement tax adjustments, such as reintroducing a windfall levy on banks, or direct Whitehall departments to reduce spending in other areas. However, these short-term fixes do not fully address the broader mandate from Burnham, who has emphasized a need for a step-change in long-term investment in infrastructure and housing to fulfill promises of economic growth across all regions.

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One potential avenue for funding this expanded investment involves exploiting flexibility within the current fiscal framework. Reeves previously redefined how debt is calculated under these rules, establishing that borrowing does not count against Treasury targets if it is used to acquire financial assets, such as equity stakes in companies or loans. This metric, known as public sector net financial liabilities, allowed for a significant increase in public borrowing without technically violating the rules. Healey has indicated there is scope for more rapid investment under this framework, aligning with Burnham’s desire to utilize any available flexibility to stimulate economic activity.

Think tanks and economists are urging the government to push further within these existing parameters. A recent analysis by the Resolution Foundation suggests that public financial institutions, including the National Wealth Fund, British Business Bank, and National Housing Bank, could borrow an additional nine billion pounds annually without breaching fiscal rules. Although the Starmer government has already expanded the capital of these bodies, experts argue that greater leverage could be achieved. Lord Jim O’Neill, a former Goldman Sachs chief economist potentially advising Burnham, has also identified opportunities within the rules to increase infrastructure borrowing, suggesting the creation of an independent agency to evaluate and support specific projects.

However, not all experts agree that manipulating fiscal definitions is the optimal strategy. Helen Miller, director of the Institute for Fiscal Studies, cautions against focusing too heavily on technical loopholes in the rules. She argues that maintaining credibility requires strict adherence to fiscal guidelines, regardless of accounting adjustments. From her perspective, any increase in borrowing ultimately raises debt levels and borrowing costs, creating future economic challenges. Miller emphasizes that the more critical question is whether the proposed investments are substantively justified and likely to yield positive economic outcomes, rather than how they are classified within Treasury metrics.

Other specialists advocate for a more structural approach to public financing. Thomas Aubrey from Cambridge University’s Bennett School of Public Policy argues that adjustments to public sector net financial liabilities are insufficient to drive significant change. He proposes allowing public corporations, such as development agencies and utilities, to borrow directly from financial markets. This would apply to sectors including energy, water, large-scale infrastructure, and housing. Aubrey notes that the UK lacks a deep market for public corporation debt compared to other major economies, representing an untapped source of capital.

While direct borrowing by public corporations would likely incur higher interest rates than government-backed loans due to the absence of Treasury guarantees, Aubrey contends the trade-off is worthwhile for the increased scope of long-term investment. He suggests that investors in such debt, particularly pension funds seeking to match liabilities, would differ from those purchasing traditional government bonds. This distinction means the Treasury would not cannibalize existing demand for gilts. Aubrey asserts there is ample capital available for projects with detailed costings and credible revenue streams, provided the regulatory framework allows it.

Despite these proposals, Treasury officials are likely to exercise caution. The UK’s borrowing costs already exceed those of many other large economies, and any move that might unsettle gilt markets could have adverse consequences. Healey must weigh the potential benefits of expanded investment against the risks of financial instability. As he prepares his first budget, the chancellor faces a delicate balancing act between satisfying political demands for growth, managing immediate fiscal deficits, and maintaining market confidence through prudent financial management.

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