Commenting on the public sector finances for February 2019, published today by the ONS, Martin Wheatcroft FCA, advisor to ICAEW on public finances, said:

“The short-term improvement in the public finances means that Philip Hammond has capacity to increase spending on under-pressure public services, while potentially also cutting taxes to provide an economic boost.

However, he, like the rest of us, is waiting to see what happens with Brexit. A ‘Brexit dividend’ from securing an eventual deal – with businesses investing, consumers more confident and an uptick in the market – would help in reducing the public finance deficit further.

In the meantime, the Chancellor continues to give himself as much room as possible to be able to support the economy in the event of a no-deal Brexit.”

Commenting on the public sector finances for January 2019, published today by the ONS, Martin Wheatcroft FCA, advisor to ICAEW on public finances, said:

“The challenge for Government departments is in trying to fight their corner for more money at the same time as dealing with a great deal of Brexit-linked uncertainty. The public finances have already started to be impacted by falling growth and the content of next month’s Spring Statement by the Chancellor will depend on whether or not a deal is concluded within the next three weeks.

Although the Prime Minister has announced that the end of austerity, Phillip Hammond will have to navigate the Spring Statement, the Comprehensive Spending Review and the Budget in the context of a weakening global economy. 

Will the Chancellor take the politically tough decision to raise taxes to increase funding for public services, borrow more to provide an economic stimulus, or will austerity have to continue for a little longer?”

Commenting on the public sector finances for December 2018, published today by the ONS, Martin Wheatcroft FCA, advisor to ICAEW on public finances, said:

“As predicted going into 2019, the public finances are continuing on an improving trend. However, with Brexit looming ever closer and a deal yet to be agreed, there are significant downside risks to the forecasts for the 2019-20 financial year, scheduled to start just two days after the UK plans to leave the EU on 29 March 2019.

The gap between government revenue and public spending is currently expected to narrow to less than £3bn a month in 2019-20, assuming a transition period that maintains the UK’s position in the Single Market until the end of 2020. A disruptive break in the UK’s trading relationship with European markets could adversely affect both tax receipts and expenditures. Some tough decisions would be required in the resulting second Budget that the Chancellor indicated in November 2018 would be necessary if the Brexit deal was not accepted by Parliament.

The attitude of debt investors to the developing situation will also be important as the government needs to refinance £200bn of its existing debt over the course of 2019 and 2020, in addition to raising £100bn in new finance. Higher costs for government borrowing are a real possibility.

Until there is greater clarity from Parliament and the EU on a new plan for Brexit, the outlook for the public finances will remain uncertain.”

Today’s announcement by the Office for National Statistics that expected losses on student loans will be recorded in the fiscal numbers when the loans are issued is a welcome development.

It more closely aligns with economic reality, reflecting the fact that a large proportion of loans will never be repaid, with many students never expected to earn enough above the (current) earnings threshold of £25,000 to repay the full amount before the balance is written off after 30 years.

The previous fiscal treatment, which allowed the government to defer recognition of these losses 30 years into the future, was misleading as well as diverging from the approach adopted under International Financial Reporting Standards (IFRS) in the Whole of Government Accounts (WGA).

The deficit is expected to increase by £12bn this year as a result of the change, narrowing (although not eliminating) the difference between the fiscal deficit, officially known as ‘public sector net borrowing’, and the actual level of net borrowing by the public sector each year.

The main downside is that this is yet another change in the way the fiscal numbers are reported, resulting in prior years’ numbers needing to be restated. This is an all-too-frequent event, with Network Rail being brought onto the balance sheet in 2014, followed by housing associations in 2015, before being taken off again in 2017 and 2018. This change in student loans will affect the numbers from 2019 onwards, causing further instability in the reported fiscal performance of HMG.

Of course, the important thing to understand is that this is a reporting change – the economic reality has not changed. However, by improving the reporting the government will no longer be able to treat student loans as ‘cost-free’ when in reality many of them will never be repaid.

For further information:

ONS announcement: New treatment of student loans in the public sector finances and national accounts

Institute for Fiscal Studies: Better accounting of student loans to increase headline measure of the government’s deficit by around £12 billion

BBC Reality Check: Could student loans ruling mean the system is redesigned?

Ross Cambell of ICAEW and Martin Wheatcroft have co-authored a chapter on defence resources and spending in this year’ IFS Green Budget.

Go to www.icaew.com/technical/economy/ifs-green-budget-2018 to find out more.

In 2017–18, the UK spent £43 billion on defence and security, just meeting the target among NATO members to spend 2% of national income on defence. However, there are growing questions as to whether this level of spending is sufficient to provide for the defence of the UK, with calls from the Defence Committee of the House of Commons and the Secretary of State for Defence to increase spending. These questions reflect the UK’s changing strategic position amid greater international tensions, together with significant cost pressures on the defence budget that could mean cutting existing defence capabilities if not addressed.

This chapter considers how the evolving defence and security position may affect defence resources and spending, and the pressure that this could put on the public finances. We provide an overview of the UK’s defence arrangements in light of the ongoing update to the 2015 National Security Strategy and Strategic Defence and Security Review (the 2015 SDSR) and explore what that might mean for defence spending and for the public finances. We also analyse the finances and financial management of the Ministry of Defence. We highlight several risks going forward, including the management of multi-year complex programmes to procure new equipment and the currency and other risks of multi-year capital programmes.

Key findings

• The UK has enjoyed a substantial post-Cold-War peace dividend that has effectively been used to fund the growing welfare state. The proportion of UK public spending going on defence and security has decreased from 15% fifty years ago to just over 5% today. Over the same period, spending on social security and health has increased from around a quarter to over half of the total.

• Further cuts to the defence budget to fund other spending priorities are no longer possible if the UK is to meet its commitment as a member of NATO to spend 2% of national income on defence. Defence and security spending in 2017–18 of 2.1% of GDP only marginally exceeded the 2% NATO threshold.

• Changing perceptions of potential threats could lead to higher defence spending over the next few years, adding to the pressure on the public finances. The UK’s national security strategy is under review in response to increasing international tensions. The Defence Committee of the House of Commons believes the Armed Forces need to be larger and better equipped for the UK to maintain its leading position within NATO and has called for defence spending to rise by £20 billion a year, or an extra 1% of national income.

• The UK needs to match its aspirations for a global military role to the amount it is willing to spend on defence. UK defence spending of £36 billion in 2017–18 was higher as a fraction of national income than that of most G7 countries, though a smaller share than the US. And, in cash terms, it was less than 8% of the £470 billion spent by the US in 2017 and around a fifth of the amount spent by China.

• There is a significant potential for cost overruns in the procurement budget. The National Audit Office has identified risks that could lead to additional costs of between £5 billion and £21 billion in the 2017 to 2027 Equipment Plan.

• The 10-year Equipment Plan would cost an extra £4.6billion at an exchange rate of $1.25 to £1 instead of the $1.55 to £1 rate originally forecast. This could adversely affect defence capabilities if additional funding is not found. Denominating a proportion of parliamentary funding for defence in dollars would reduce the risk of having to make cuts to personnel or equipment if sterling weakens, or the incentive to spend currency gains if sterling strengthens.

Figure. UK defence and security spending over time

Source: NATO; Office for Budget Responsibility.

Ross Campbell and Martin Wheatcroft have co-authored a chapter in this year’s IFS Green Budget on public sector assets.

To find out more go to https://www.icaew.com/technical/economy/ifs-green-budget-2018.

Public assets are integral to both the government’s balance sheet and the functioning of the UK. Some of these assets, such as schools and hospitals, are essential in delivering public services. Others, such as the road network, are part of the economic, social and legal infrastructure that supports economic activity and hence the tax revenues needed to pay for public services.

The government is undertaking a Balance Sheet Review, considering how it can use public assets in the most effective way to advance its policy priorities, and how it manages its liabilities and other financial commitments. In advance of the progress report expected with the 2018 Autumn Budget, this chapter provides an overview of the assets owned by the UK public sector and discusses how the Balance Sheet Review can be used to improve the utilisation of public assets and the prospects for a comprehensive investment and asset management strategy.

Key findings

• HM Treasury is conducting a Balance Sheet Review that is due to report alongside the 2018 Autumn Budget. This provides an opportunity to develop a comprehensive investment and asset management strategy, going beyond ad hoc initiatives such as the recent establishment of the Government Property Agency to improve the management of offices and other general-purpose central government property.

• Public sector assets are less than half the size of public sector liabilities. At 31 March 2017, the government reported assets of £1.9 trillion (94% of national income), compared with total liabilities of £4.3 trillion (214% of national income). Most public sector assets are not readily saleable and could not easily be used to settle liabilities, although the public sector’s most significant resource – the ability to levy taxes – is excluded.

• Capital investment is a relatively small component of public spending and has declined since 2009–10, although the government plans to increase investment next year and the year after. Capital expenditure in 2016–17 of £55 billion (2.8% of national income) was less than 7% of non-capital expenditure of £819 billion (41.2% of national income) and 9% lower in real terms than in 2009–10. Net additions to fixed assets after depreciation and disposals were just £18 billion (0.9% of national income).

• The government is reliant on future tax revenues to fund its financial commitments, with public debt currently standing at close to £2 trillion. There are no social security or social care funds. No money has been set aside for £1.9 trillion in unfunded public service pensions, nuclear decommissioning or clinical negligence liabilities.

• Labour party proposals for nationalisation would add to public sector assets, but the borrowing required would add considerably to liabilities. Higher revenues would follow, but there is a risk of underinvestment in the future without a change in capital allocation approach. Nationalising utilities, train operations, the Royal Mail and PFI contracts could potentially increase public debt by more than £200 billion.

Figure. Total assets, March 2010 to March 2017 (£ billion and % of GDP)

Source: HM Treasury, Whole of Government Accounts 2016–17 and earlier years.

Martin Wheatcroft, author of Simply UK Government Finances, has co-authored  the ICAEW Better Government Series: ‘The debt of nations’ policy insight published today. It shines a light into public debt around the world.

Ross Campbell, Director, Public Sector at ICAEW says:

“I’m very pleased to present our most recent addition to the Better Government Series: ‘The debt of nations’.

Since 2001 there has been a dramatic increase in borrowing by governments to nearly £30 trillion, a tripling in the level of public debt. Borrowing can be a valuable tool to finance capital investment, e.g. infrastructure, which creates economic and social benefits. However, increasingly governments in developed countries are borrowing to pay day to day running costs.

With the era of ultra-low interest rates coming to an end and the reversal of quantitative easing, there are real questions about whether the cost of public debt will be sustainable. Traditionally governments used inflation as a tool to reduce debt relative to the size of the economy. This policy choice comes at a cost however, eroding the value of saving and investments in the domestic currency and may be harder to implement in an era where central banks are mandated to keep inflation low.

Our report explores these issues and provides analysis and reflections on borrowing by government.

ICAEW believes we need a better public understanding of how public debt is measured and managed to know if borrowing by government is truly under control.”

Click here to read the report.