30 June 2026

British fiscal rules leave more room for action than commentators assume, economist argues

Michael Jacobs says the UK government could lower inflation through regulated prices and fund the cost with targeted tax reforms without breaking fiscal commitments.

By Rachel Bennett

British fiscal rules leave more room for action than commentators assume, economist argues

British economic commentary has converged on a pessimistic consensus: whoever succeeds Rachel Reeves as chancellor will have almost no room to spend or borrow beyond her current plans. With the prime minister committed to existing fiscal rules and bond markets nervous, the assumption is that the next occupant of Number 11 Downing Street is effectively boxed in.

That consensus reflects a failure of imagination rather than the reality of policy constraints, argues Michael Jacobs, emeritus professor of political economy at the University of Sheffield and a former member of the Treasury's Council of Economic Advisers. Writing in the New Statesman, Jacobs sets out a series of measures the government could take within current fiscal rules and Labour's tax pledges that would deliver the "change" the leadership has promised.

The real constraint is interest rates, not fiscal rules

The primary limit on government borrowing capacity is not the fiscal framework but the Bank of England's base rate, currently 3.75 per cent, and the resulting gilt yields around 4.7 per cent for ten-year bonds. Both exceed Eurozone equivalents, the European Central Bank's rate sits at 2.4 per cent, with major European sovereign bonds yielding 2.9 to 3.6 per cent. As long as UK rates carry a premium over the continent, borrowing costs will remain elevated.

Orthodoxy holds that inflation is the Bank's responsibility and that government intervention risks triggering further rate hikes. Jacobs argues this is wrong. Several key components of the consumer price index fall in regulated sectors where government policy directly affects prices.

Precedent from the 2022 energy crisis

The Conservative government's Energy Price Guarantee in 2022 capped retail energy prices and compensated suppliers through subsidy. The Office for National Statistics estimated the £23 billion measure reduced headline inflation by approximately 2.7 percentage points in the months after its introduction. Inflation peaked at 9.5 per cent in October 2022 rather than the 11.8 per cent projected without the guarantee.

Reeves replicated the approach in her November budget, shifting green levies from energy bills to general taxation and lowering CPI by 0.4 percentage points. Energy bills are the largest CPI component amenable to direct intervention, but bus and rail fares, water bills, and private rents, now also regulated, offer similar leverage. VAT rates on essential goods could be adjusted, and voluntary supermarket price reductions on basics would also feed through to the index.

Funding the package without breaking tax pledges

Any such "cost of living package" requires funding, but Jacobs identifies tax reforms that would not violate Labour's manifesto commitments against raising income tax rates, National Insurance, or VAT. Equalising capital gains tax rates with income tax rates, a reform first implemented by Nigel Lawson under Margaret Thatcher, would raise roughly £14 billion annually. Aligning tax rates on investment income such as rents would yield another £4 billion.

Because these measures target wealthier households with lower marginal propensities to consume, they would withdraw less demand from the economy than the inflation-reducing measures would inject, creating what Jacobs calls a "balanced budget stimulus."

Chain reaction through borrowing costs

The logic runs as follows: lower measured inflation eases pressure on the Bank of England to raise rates; lower rate expectations reduce gilt yields; cheaper government borrowing frees fiscal space for public service investment. Jacobs counts six distinct wins from a single coordinated package.

Off-balance-sheet investment vehicles

Beyond price interventions, Jacobs points to structural innovations the fiscal rules do not prohibit. The 2023 Levelling Up and Regeneration Act enables public authorities to acquire land at "use value", ignoring the uplift from prospective planning permission. Public development corporations could issue their own bonds, backed by future land sale revenues after infrastructure and planning permission raise site values. This would finance housing and infrastructure without counting against the government's headline deficit or debt metrics.

Similarly, allowing the National Wealth Fund to borrow for infrastructure, as other national investment banks do, would attract new capital for growth-oriented investment without increasing general government borrowing.

Lessons for Canadian policymakers

The argument carries resonance for Canada, where the Bank of Canada's policy rate and federal borrowing costs similarly constrain fiscal choices. Canadian governments at federal and provincial levels also regulate energy, transit, and in some jurisdictions rent, sectors where price interventions could mechanically lower CPI. The Canada Infrastructure Bank already operates on a model comparable to the National Wealth Fund, though its borrowing authority remains limited.

Jacobs's broader contention is that four decades of market-centric orthodoxy have blinded commentators to the state's actual policy toolkit. "The relationship between the state and the private sector is actually much more complex and open to innovation," he writes. Whether the British government chooses to use that toolkit remains an open question.