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Designing a UK fiscal framework fit for the climate challenge
Designing a UK fiscal framework fit for the climate challenge
This report proposes changes to the UK’s fiscal framework to help unlock the additional investment required to meet the UK’s net zero targets and adapt to climate change.
Summary
- The speed and scale at which today’s global transition must take place to meet emission reduction targets is unprecedented.
- The Climate Change Committee’s Sixth Carbon Budget estimates that about £50 billion a year of additional investment is required up to 2050 to reduce emissions to net zero, plus a further £10 billion a year to adapt to a warming climate.
- The seismic nature of the net zero transition necessitates a pivotal role for the public sector. However, the UK’s current fiscal framework constrains policymakers’ ability to leverage fiscal policy tools to unlock the additional investment needed.
- The new Government’s proposed fiscal rules require public sector net debt as a percentage of GDP to be falling in the fifth year of the Office for Budgetary Responsibility’s (OBR) five-year forecast, restricting headroom for the necessary public investment.
- The current PSND rule also limits the effectiveness of the UK’s policy banks as well as investment. PSND captures the policy banks’ liabilities but ignores the financial value of their investments. In effect, it treats financial investments as grants, preventing UK policy banks from sensibly leveraging their balance sheets and hampering their ability to invest to address climate change.
- International precedents favour a different fiscal approach to policy banks. In Europe, both the German and French policy banks can deploy financial leverage largely outside of their national fiscal rules, with significantly bigger balance sheets than their UK counterparts, while Australia and New Zealand recognise the value of financial investments as well as liabilities in their key fiscal measures.
- The Government’s plans to bring together the UK Infrastructure Bank and British Business Bank under the new National Wealth Fund provides an opportunity to implement a better approach.
Recommendations
- Recommendation 1 – Reform the UK’s fiscal framework to unlock additional public investment in climate change while retaining fiscal credibility by:
- Explicitly allowing debt to rise over the medium term.
- Reducing the emphasis on public sector net debt as the key ‘stock’ metric in the fiscal framework.
- Extending the medium-term fiscal forecast from five to 10 years.
- Learning lessons from the hypothecation of green revenues and proceeds from green bonds to green expenditures to better manage the risks involved.
- Ensuring the space created by a looser fiscal framework is smaller than the additional climate investment required to demonstrate additional borrowing is not the sole solution.
- Time-limiting these reforms through formal mechanisms in an updated Charter for Budget Responsibility.
- Recommendation 2 – Improve the effectiveness of the UK’s policy banks by removing them from the UK’s fiscal rules, so they can deploy balance sheet leverage to create the fiscal space for loans and equity investments.
- The Government has announced plans to bring together the UK Infrastructure Bank and British Business Bank under the umbrella of the National Wealth Fund.
- The Government should take the opportunity to look at other reforms to improve the effectiveness of this new merged bank, including by taking it outside of the UK’s fiscal rules – in particular, the PSND rule.
- This action would unlock space for the National Wealth Fund to increase its activities to address the climate challenge – and, equally, to address other government priorities, such as a more activist industrial strategy.