The PFI helps government overcome a perceived fiscal dilemma: it enables the government to increase public investment through higher capital spending while maintaining a tight fiscal stance. The 2001 FSBR highlights the two fiscal rules, against which the performance of fiscal policy is currently judged:
the golden rule: over the economic cycle, the Government will borrow only to invest and not to fund current spending; and
the sustainable investment rule: public sector net debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level. Other things equal, net debt will be maintained below 40 per cent of GDP over the economic cycle.34
The golden rule requires the current budget to be in balance or surplus over the cycle, allowing the Government to borrow only for capital spending, that is "borrowing is permitted to finance public investment". It ensures "fairness between generations…" in that:
[…] the Government does not pass on the costs of services consumed today to the taxpayers of the future - each generation is expected to meet the current cost of the public services from which they benefit.35
Under the golden rule today's taxpayer pays for public services provided today. By contrast, if current spending is financed through borrowing tomorrow's taxpayers finance it through the cost of additional capital and interest payments. The sustainable investment rule limits government borrowing to a stable and prudent level: other things equal, lower than 40% of GDP.36 However, a briefing note from the Institute for Fiscal Studies: The Government's fiscal rules, points out:
There is nothing sacrosanct about these two rules, nor are they necessarily optimal. While it is true that meeting them would mean that the public finances were kept in good shape, a failure to do so would not automatically render the public finances unsustainable, and meeting them does not even necessarily imply generational fairness.
The government has provided no justification for a net debt target of 40 per cent of GDP - it could just as easily have chosen 38 per cent or 42 per cent. The Maastricht Treaty, for instance, allows UK gross general government debt of no more than 60 per cent of GDP, which is consistent with net public debt being considerably higher than 40 per cent of GDP. 37
The economic rationale for the fiscal rules is that they promote economic stability by ensuring sound public finances while at the same time allowing flexibility. The fiscal rules are set over the economic cycle, allowing fiscal balances to vary between years in keeping with the cyclical position of the economy. This allows the automatic stabilisers in the economy, such as income tax receipts and unemployment payments, to operate freely, dampening the effects of fluctuations away from trend by boosting or dampening aggregate demand. The interaction of the two rules promotes capital investment while ensuring the sustainability of the public finances in the longer term.38
The golden rule is not broken by funding projects through the PFI, as the capital cost of the project is allocated to the private sector, and is not discussed in detail here.39 However, it is worth noting that supporting a project using conventional methods of public funding does not break the golden rule either, as the borrowing for such a project could count as capital investment and not as funding for current spending.
As for the sustainable investment rule the present state of the public finances could remove any incentive for government to seek private sector finance through the PFI. Since the end of the last economic cycle,40 public sector net borrowing (PSNB), the finance needed to meet current and capital spending over and above that raised in taxes, has been negative in three of the four financial years to the tune of almost £35 billion.41 Over the same period, public sector net debt as a percentage of gross domestic product (GDP) has fallen by 11 percentage points, from 42% in 1997/98 to 31%42 in 2000/01.43 GDP in 2000/01 was £955 billion.44 9%, the unused margin up to 40% of GDP in 2000/01, is £86 billion and capital expenditure under PFI between 1997/1998 and 2000/01 is estimated to have been just over £11 billion.45 This suggests that all the PFI projects signed since the end of the last economic cycle could have been funded by public expenditure in 2000/01, without raising public sector net debt as a percentage of GDP above 40%, thereby not breaking the sustainable investment rule.
The calculations do not include the interest payments on the national debt that would have been incurred had it not fallen over the period or the reduction in payments of interest and capital by the private sector. However, even using a generous estimate of these deductions in the calculations, it is apparent the all the PFI projects that have been signed could have been funded by public sector finance without breaking either the golden rule or the sustainable investment rule.
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34 HM Treasury, Financial Statement and Budget Report 2001, HC 279, 2000/01
35 HM Treasury, Financial Statement and Budget Report 1999, HC 298, 1998/1999
36 HM Treasury, Financial Statement and Budget Report 2001, HC 279, 2000/01
37 Institute for Fiscal Studies, The Government's fiscal rules, Briefing Note No. 16, April 2001
38 HM Treasury, Financial Statement and Budget Report 2001, HC 279, 2000/01
39 For a discussion of the PFI and the golden rule see: IPPR, The Private Finance Initiative: Saviour, Villain or Irrelevance? Working Paper, April 2000.
40 1985-86 to 1996-97, Source: HM Treasury, Fiscal Policy: Current And Capital Spending, HM Treasury website as at 13 December 2001: www.hm-treasury.gov.uk/mediastore/otherfiles/530.pdf
41 National Statistics, Public sector finances October 2001, First Release, 20 November 2001
42 This suggests that the Government could have increased public spending by 9% of GDP in 2000/01, without increasing the public sector net debt above the 40% of GDP over the economic cycle so far, other things being equal.
43 National Statistics, Public sector finances October 2001, First Release, 20 November 2001
44 HM Treasury, Pre-Budget Report, Cm 5318, November 2001
45 IPPR, The Private Finance Initiative: Saviour, Villain or Irrelevance? Working Paper, April 2000