In the King’s Speech on July 17, the government announced a new Budget Responsibility Bill, which would ensure that any significant fiscal event would be accompanied by an Office for Budget Responsibility forecast. In turn, via the OBR commenting on the government’s performance against its fiscal rules, this would ensure the sustainability of the public finances. The obvious questions are, though, does it achieve this? Or should the bill go further?

To answer them, it’s worth going back to 2010, when the OBR was set up “to examine and report on the sustainability of the public finances”. It has complete discretion “in the performance of its duties, as long as those duties are performed objectively, transparently and independently and takes into account the sitting government’s policies and not alternative policies”. In practice, this means performing a forecast to show whether the government’s announced tax and spending plans will lead to it meeting its fiscal targets. The result has been a perception, articulated by Simon Wren-Lewis in his Mainly Macro blog, that fiscal policy is determined by the OBR: to avoid spooking the markets, the government needs the OBR to say that it is meeting its fiscal targets.

Leaving aside this perception, there are (at least) two main problems with the system: that the OBR must take government policy as given, even when it is not credible (when the OBR thinks there will be an overspend); and the fiscal rules themselves. The result of both problems is that, when assessing budgets and autumn statements, the OBR is not in fact examining and reporting on the sustainability of the public finances.

To expand on this, we can note that the fiscal rules are arbitrary and are set by the government itself. Whenever it has looked as though the fiscal targets may be missed, the rules have been changed. In addition, the rules have been based around a five-year horizon. This means they can always be met via non-credible promises about spending and taxation in years three to five. Giving the OBR the ability to challenge such forecasts for spending and taxation would be one way in which the system can be improved and this could be done, for example, by allowing the OBR to publish scenario analyses based on (what it considers to be) more realistic assumptions about spending and taxation.

The National Institute for Economic and Social Research has argued that the five-year horizon acts as a strong disincentive for public investment projects. Since such projects typically yield returns over a period longer than five years, they will add to government debt at the five-year target date without having raised GDP. Yet evidence suggests that well-targeted public investment can lead to significant long-run increases in GDP, acting to bring down the debt-to-GDP ratio. Tinkering with the fiscal rules — say, by pushing the debt rule out to ten years or by adopting a rule based around public sector net worth — could partially help to address this problem.

A more radical approach would be to ask the OBR to assess the sustainability of public finances using its own criteria. In this case, the government would present its budget and the OBR could then produce a forecast that was entirely independent. Given that forecast, the financial markets also would be able to assess the sustainability of government finances and to set bond prices accordingly.

The OBR could base its sustainability measure on its long-run projection of the debt-to-GDP ratio.It would need to make clear the assumptions underlying this projection (in particular, the elasticity of output with respect to public investment, trend technology growth and population growth), as well as the precise definition of “sustainable”. It should be noted that the OBR carries out such long-run projections already in its Fiscal Risks and Sustainability Report, so we would not be asking it to do anything it does not do already. And such an approach may even get the government to start thinking in the long term in its budgeting.

Professor Stephen Millard is deputy director at the National Institute for Economic and Social Research