Is It Possible for Britain to Increase Defence Spending Without Cutting Elsewhere?
Rachel Reeves is limited by fiscal rules governing the UK’s debt levels and the annual spending deficit by the end of the parliament. Given the lower than expected tax receipts and higher borrowing costs in the current financial year, the chancellor is likely to make budget cuts in her next financial statement on 26 March. Last week she stated that increasing defence spending would necessitate “difficult decisions across the board“.
Reeves is anxious about a backlash in financial markets due to increased, unfunded spending, which could lead to higher borrowing costs in a scenario reminiscent of the Liz Truss mini-budget. Many analysts expect a rise in borrowing by international lenders.
A Potential Exemption to Fiscal Rules for Defence?
A defense or security crisis could allow major European nations to increase their defense funding, providing Rachel Reeves with an opportunity to suspend budget rules that economists deem to hinder economic growth.
She could argue that the possibility of an unstable peace deal in Ukraine constitutes an emergency and that defense spending should increase from 2.3% to beyond 2.5% of GDP as planned.
Ed Balls, a former Treasury Minister and ex-shadow chancellor, stated on the Political Currency podcast that a case could be made for borrowing more in exceptional circumstances. He suggested that the Treasury could temporarily carve out defense spending increases from fiscal rules, a plan he deemed more credible than large tax increases or unrealistic spending cuts the markets would not believe.
Could a Defence and Security Levy be Introduced?
The Chancellor has pledged not to increase income tax and national insurance but could consider introducing a defense and security levy as an alternative form of taxation. Levies have been used to boost specific departmental budgets in the past, such as the health levy introduced by Gordon Brown in 2002 to increase NHS funding.
Can the EU Increase Defence Spending Without Breaking Stability and Growth Pact Rules?
The EU could break the stability and growth pact to allow for greater borrowing, as it did during the pandemic back in 2003. Ursula von der Leyen, head of the European Commission, proposed activating a safeguard clause for defense investments at the Munich security conference, arguing that the current crisis is similar to the pandemic.
Newly implemented EU fiscal and debt rules permit a higher deficit for defense spending, which would not trigger disciplinary action if spending exceeds the 3% deficit limit.
Poland, currently holding the EU presidency, advocates for a broader interpretation of defense investment to include support for defense factories.
Are Defence Bonds an Option for the EU?
France and Estonia have proposed using defense bonds, with support growing from other member states including Italy, Spain, and Poland. Russia expert Timothy Ash of Chatham House suggests that Europe should consider using Russian assets frozen in financial exchanges before introducing new bonds.
Germany’s future coalition government will need to address the debt brake clause, which restricts annual budget deficits to less than 0.35% of the country’s annual GDP, particularly focusing on increasing defense spending. Friedrich Merz, expected to become the next prime minister, has expressed a willingness to reform the debt brake, though not as a priority initially.
