The Curious Incident of the Surplus in the Night-Time

One of the challenges in getting to grips with the public finances is that government accounting can be just a little bit weird.  Without the strictures of double entry bookkeeping and balance sheets that (well) balance, it can often appear mysterious.

For example, take the Curious Incident of the Surplus in the Night-Time (or 2019/20 to be more specific).

A £10 billion surplus, according to the official forecasts published published just three weeks ago. If achieved, the Chancellor will have met his objective of balancing income with expenditure for the first time in decades. We will finally be in a position to start paying down some of the national debt, instead of just ‘inflating it away’ as a proportion of GDP.

But, hang on a second. Curiously, the Treasury is actually forecasting in the Budget that we will be £10 billion worse off in 2019/20, not £10 billion better off, with the national debt expected to increase from £1,715 billion to £1,725 billion over the year to 31 March 2020.

Even stranger, there is a forecast for £9 billion in asset sales, the proceeds of which we are told are used to pay off debt. So, a £10 billion increase in public sector net debt instead of the £19 billion reduction in debt that we might expect to see instead.

The Curious Incident of a Surplus in 2019/20.  One that doesn’t result in a positive improvement in the Government’s financial position.

A mystery indeed.

 

Budget surprises can be guaranteed

One of the challenges about trying to predict what will happen in the Budget is that the Chancellor has so many different levers that he can pull.  George Osborne could increase taxes or he could cut them.  He could increase spending or reduce it.  He could borrow more or he could reduce debt.

What makes predicting the Budget so difficult is that the Chancellor can and will do all of the above at the same time.

His existing plans to balance cash inflows with outflows requires tax revenues in 2019/20 to be £73 billion higher than this financial year, with £51 billion coming from economic growth and £22 billion from higher taxes.  With economic growth now expected to be lower he needs to find substantial sums to meet his revenue targets without damaging the economy in the process. This is why radical ideas like abolishing tax relief on pensions have been floated, as they are a way of raising substantial sums now, without (it is hoped) doing too much immediate damage to the economy.

With removing income tax relief on pensions rejected, he will be looking for a different route to raise the money he needs.  One possibility might be charging national insurance on employer contributions into private sector pension funds, while another might be to start cutting away at some of VAT anomalies, such as the lack of VAT on books and newspapers.  Together with rumoured increases in fuel and alcohol duties these measures could help him to meet his revenue target, even assuming phasing in over a number of years.

Of course, no Budget is possible without some form of tax cut or incentive to encourage good behaviour. Even as George takes pounds away with one hand, he will want to give back a few pennies with the other. Of course, this includes continuing the policy of raising personal tax allowances, but I would be surprised if there weren’t some other forms of tax giveaway in the offing. For small businesses, there might be some relief from increases in business rates.

He may need to increase the level of spending cuts he has to deliver, but that is more of an issue for 2018/19 and 2019/20 than it is for the new financial year. Yes, revenues will be lower, but low inflation and the extended period of low interest rates are likely to reduce some of the pressure on costs in the coming year.

If he does have any room to manoeuvre, the smart money is on George trying to increase investment infrastructure. With private infrastructure investment going into reverse following the ending of renewable energy incentives, the Chancellor may decide now is the time to increase the level of direct public investment. Boosting the economy with extra investment now may be the best way to ensure that the Government meets its revenue targets in four years time.

Headlines are likely to focus on whether the Government will achieve its objective of reducing debt as a proportion of GDP in 2015/16. This is dependent on the combination of inflation and economic growth increasing GDP and some £23 billion in asset sales to bring the ratio down. With both inflation and economic growth looking to be lower than expected, and with some of the planned asset sales deferred to the new financial year, this objective may not be met.

Perhaps more interesting will be the position going forward, especially in the three years between now and the 2019/20 financial year that George is committed to going into surplus. With lower deficits in the intervening years, he will have some flexibility in those years to borrow extra to fund investment or, if he chooses, to accept a slightly slower path in cost reductions just as he already has had to do with benefits in the form of tax credits.

So I am looking forward to the Budget on Wednesday. Surprises are guaranteed.

Time to embed Whole of Government Accounts into government

The IFS Green Budget, launched today in association with the ICAEW, contains a chapter on Whole of Government Accounts (WGA), the financial accounts for the UK government. They are prepared on a similar basis to those of millions of companies and other organisations around the world.

The first five years of WGA have covered a dramatic period in Britain’s fiscal history following the global financial crisis. They provide a more comprehensive picture of the public sector’s financial performance over that time than that available from traditional National Accounts reporting by capturing a wider range of financial transactions.

The reduction in the deficit on a National Accounts basis of 35% from £153 billion to £100 billion between 2009–10 and 2013–14 contrasts with a reduction of only 20% in the size of the annual accounting deficit to £149 billion over that same period.

There has been a significant deterioration in the government’s financial position, with net liabilities in the WGA more than doubling in five years, from £0.8 trillion at 31 March 2009 to £1.85 trillion at 31 March 2014. This reflects an increase in public sector pension obligations to £1.3 trillion in addition to the near-doubling of public sector net debt in the National Accounts from £0.7 trillion to £1.4 trillion.

Effective financial management for the longer term involves addressing the balance sheet as well as revenue, expenditure and cash flows reported in the WGA but not in the National Accounts. A relatively high level of asset write-downs, growing pension obligations and increasing charges to cover nuclear decommissioning and clinical negligence exposures are areas of particular concern.

The WGA also provide further insight when considering the vulnerability of the public finances to future economic shocks, with total liabilities at 31 March 2014 of £3.2 trillion, or 177% of GDP. This is substantially higher than public sector net debt, the National Accounts measure typically referred to in this context, which stood at £1.4 trillion, or 78% of GDP, at that date. The former may matter more when thinking about the government’s ability to cope in the event of a future downturn.

Improving financial management within government will become more challenging as further devolution increases the complexity of the public sector in the UK. A necessary first step must be to replace the current complex web of internal financial reporting data collection processes with a modern standardised financial consolidation system for all public sector entities, which should enable the government to obtain and utilise accurate comprehensive financial performance data from across the public sector within days rather than months.

For more information, go to the IFS Green Budget 2016 website and open Chapter 4.

IFS Green Budget 2016 – in association with the ICAEW

This year’s Institute for Fiscal Studies pre-Budget report for 2016, the ‘Green Budget’, will be launched on Monday 8 February.

In association with ICAEW and funded by the Nuffield Foundation, it will analyse the issues and challenges facing Chancellor George Osborne as he prepares for the UK government’s Budget in March.

The areas covered by IFS researchers will include:
– the government’s framework of fiscal rules
– risks to the public finances
– issues coming up for corporate tax policy
– the design of ‘sin taxes’
– the (changing) effects of Universal Credit

Oxford Economics will be giving their view on the prospects for the economy, while I have been working with the ICAEW on their contribution to this year’s report.

For more information go to http://www.ifs.org.uk/publications/8129.

Comprehensive Spending Review approaches

 

Simply UK - deficit reduction plan.001

As the Government works on its plans to cut spending over the next four years, it may be helpful to understand the overall plan.  As ‘Simply UK: A Summary Guide to UK Government Finances 2015/16’ illustrates vividly, the Chancellor’s plan to eliminate the deficit comprises three main components once inflation and population growth are taken account of:

  1. Increase tax revenues by £51 billion a year through growth in the economy;
  2. Increase tax revenues on top of that by £16 billion a year through tax rises and cracking down on tax avoidance; and
  3. Reduce spending by £16 billion.

Reducing spending by £16 billion out of a total annual spend of £742 billion  doesn’t sound too difficult in theory – after all that’s only 2% of the total.  However, once you factor in a £16 billion for higher interest costs because of interest rate rises and £3 billion in additional spending from commitments to protect pensions, health, defence and international development, that means the total cuts needed of £35 billion will be closer to a 5% reduction.

But that’s 5% of the total.  Once you exclude protected areas, the impact on individual areas is much more significant.  Welfare cuts of £12 billion translate into a reduction of around 10% to the current welfare budget of £121 billion, while cuts to unprotected departmental spending of over £20 billion a year will mean cuts of between 25% and 40% in some areas. These including policing, the courts, prisons and emergency services, local services, social care, further and higher education, transport and housing.

And even in the protected departments, there will be a need for savings.  Schools spending is protected only in cash terms, which with increased pupil numbers means a reduction in spending per student.  Health care may be increasing just ahead of inflation and overall population growth, but increased demand from an increasingly long-lived population means that in reality the NHS will need to make significant efficiency savings just to stand still and provide the current level of care, let alone improve it.

So, roll on Comprehensive Spending Review.  It’s going to a be a roller coaster ride for sure.

Simply UK Book Launch – Thursday 24 September

Simply UK: A Summary Guide to UK Government Finances 2015/16 is being launched tonight at the Institute of Chartered Accountants in England & Wales in the City of London.

How much is the Government going to spend this year? How does that compare with the amount raised in tax? What is austerity and how is the deficit being reduced? How much is the national debt and what is happening to it? What is the size of the economy anyway?

Transparency in public finances has frequently meant the provision of ever increasing amounts of financial information, without a focus on the need to make that information understandable. As a consequence, most of us know little about our government and how it is financed.

Simply UK aims to remedy that situation by providing a clear and concise summary of the UK Government’s financial position, using vivid and colourful charts to clearly explain how the national debt has grown by £1 trillion over the last decade and how economic growth, tax increases and austerity spending reductions are contributing to the Government’s objective of eliminating the deficit. It explains where the money comes from and where it goes. It also provides information about the EU Budget for 2015, the overall UK economy, and how the tax and welfare systems work.

Simply UK will be available for sale on Amazon from Monday 28 September 2015.  Click here to order your copy.

Budget 2015 Stop the tinkering – it’s time for a coherent long-term strategy

The past few weeks, ahead of a ‘supplementary’ Budget, have been remarkably exciting

Rumours of major tax changes have abounded, while speculation about how planned cuts in welfare of £12 billion are to be achieved have occupied many headlines. Added to this has been a swarm of lobbying, with both left and right calling for increases in the minimum wage in order to reduce the dependence of the low paid on tax credits and housing benefit, and an apparent U-turn by Labour to say that they now accept the principle of targeting a cash surplus in ‘normal circumstances’.

Interestingly, most of this debate is not about the Government’s financial budget for the current year, the main subject of a Budget announcement. Rather it is focused on the Chancellor’s four-year plan to cut expenditure until there is a surplus in cash terms and about how we can improve the tax and welfare system to make it more effective.

This shifting of the debate is welcome. Although many commentators are still debating the minutiae of the tax and welfare system, such as the intricacies of inheritance tax and benefit caps, or the merits of reducing one of the seven different rates of tax on our salaries, there is an increasing acceptance amongst policy makers across the political spectrum that the complexity of the current system is an obstacle to achieving its objectives of raising money in fair way and supporting those in need effectively.

Perhaps even more welcome is the realisation that our public finances need to be managed much better than they have been in the past. Not only does our Government owe £1.5 trillion in debt, but it has £1.3 trillion in unfunded public sector pension obligations on its whole-of-government accounting balance sheet that will need to be paid for by increased taxes or through further cuts in welfare or public services. And that is even before considering how we find the money to pay for the costs of an increasingly long-lived population, with the future cost of the state pension alone estimated to be more than £4 trillion in a recent report by the Centre for Policy Studies.

Piecemeal tinkering with the tax and welfare system is not going to be enough; we need a plan.

Hence what would be most welcome in this Budget would be an announcement of a comprehensive financial review, as called for by the ICAEW. Considering income, expenditure, cash flow and the balance sheet over the long-term, it would lead to the development of a coherent long-term financial strategy setting out how we can achieve sustainable public finances over the next quarter of a century and beyond.

Such a strategy should include a roadmap to radically restructured system of tax and welfare, with a wholesale replacement of the complex array of inconsistent taxes and welfare benefits with a simple and coherent system of fair taxes and welfare support for those in need, reflecting the following characteristics:

  • Simple – benefiting government just as much as citizens and businesses through clarity, lower administration costs and more effective targeting of support.
  • Sustainable – affordable to both individuals and to the taxpayer over the long-term.
  • Integrated – with a consistent set of rules across taxes and welfare benefits that would mitigate the need for anti-avoidance measures or complex welfare enforcement processes.
  • Joined up – across government, for example with housing policy.
  • Incentivising – making it financial rewarding to work and addressing the poverty trap inherent in the current system that reinforces welfare dependency.
  • Funded – increasing the emphasis on savings, so that we are less reliant on the uncertain ability of future generations to fund our old age.
  • Helpful – establishing a structure that helps people to do the right thing, such as automatic enrolment in pensions, social care insurance and savings plans.
  • Cross-party – sufficient support for core elements of the strategy so that it will survive changes in government over the transition period of ten to twenty years likely to be needed.
  • Fair – and perceived to be fair.

That the focus of a Budget announcement has changed from a one-year time horizon into a more substantive debate about the Government’s medium-term fiscal strategy is positive. But we need to go much further if we are to end the piecemeal tinkering of successive governments applying patches to address the problems caused by an overcomplicated system, while at the same time advancing their own policy goals by adding further complexity.

It is time for a coherent long-term strategy. A plan that not only sets out how we can fund our nation in the future, but that also establishes a path to replacing a failed system of tax and welfare.

Martin Wheatcroft is managing director of Pendan.

This article can also be found on Economia – http://economia.icaew.com/opinion/july-2015/stop-the-tinkering-its-time-for-a-coherent-longterm-strategy

General Election 2015

With all the results in, it is clear that the Conservatives have received just under 37% of the votes and 331 MPs, a majority in the 650 seat House of Commons.

This chart illustrates how the Conservatives, Labour and the SNP have benefited from the first-past-the-post system at the expense of UKIP, the Liberal Democrats and the Green Party.

General Election 2015

It will be very interesting to see how the debate around electoral reform evolves following this election.