IFS: deficit to triple as budget contingency increases

30 March 2020: the Institute for Fiscal Studies (IFS) has suggested that the budgeted fiscal deficit for the financial year starting 1 April 2020 of £55bn could more than triple to £177bn due to the coronavirus pandemic.

In a new publication, the economic research institute also stated that there is a chance the 2020-21 deficit could end up exceeding £200bn.

The Chancellor has already stopped reporting financial estimates for a series of emergency measures, such as the funding of 80% of pay for furloughed workers and support for self-employed workers, incurring tens of billions of public money to keep an economy going whilst in lockdown.

The Contingencies Fund Act 2020 (passed by Parliament on 25 March 2020 alongside the Coronavirus Act 2020), increases the amount available for contingencies from a limit of 2% of spending authorised by Parliament in the preceding financial year to a limit of 50%. In effect, this gives the Chancellor the power to spend an additional £266bn in 2020-21 over and above spending plans already announced, a substantial increase from the £11bn that would have been available otherwise.

The IFS’s estimate assumes that a 5% contraction in the economy would reduce tax revenues by somewhere in the region of £80bn in 2020-21, albeit this would be offset by savings in interest costs following the reduction in the base rate to 0.1% and quantitative easing operations by the Bank of England.

Fiscal measures include the £12bn emergency package announced on the day of the Budget and the £20bn announced on 17 March, together with an estimate by the IFS of £18bn for further measures announced up until 25 March 2020.

The effect on the public finances estimated by the IFS is summarised in the table below.

Estimate of coronavirus revisions to the Spring Budget 2020

Financial year 2020-21	Spring Budget £bn	Economic contraction £bn	Fiscal measures £bn	Revised £bn
Taxes and other income	873	(80)	(22)	771
Total managed expenditure	(928)	8	(28)	(948)
Fiscal deficit	(55)	(72)	(50)	(177)
% of GDP	2.4%	+3.4%	+2.3%	8.1%

^{Source: HM Treasury, Spring Budget 2020; IFS, estimates of economic contraction and fiscal measures to date, 26 March 2020; ICAEW, rough estimate of the split of fiscal measures between waiving tax and additional spending.}

The IFS analysis of fiscal measures includes £10bn for the 80% job retention credit for employed workers (for which the IFS have assumed a 10% take-up), but it was prepared for the announcement of support for the self-employed. This could add another £9bn to the deficit for 2020-21.

The IFS has not included the risk of bad debts on the Government’s £330bn programme of financial guarantees and business loans or on the £30bn of second quarter deferred VAT payments. There is also no cost provision for the exposure to additional bank financing and corporate bond purchases by the Bank of England that is being guaranteed by HM Treasury.

Altogether, this would increase the deficit to £177bn, or 8.1% of GDP based on a 5% smaller economy, before taking account of the support package announced for the self-employed. The prospect of further fiscal measures in the weeks and months to come, combined with the risks from loans and guarantees, means that the prospect of a deficit in excess of £200bn is looking increasingly likely.

For more information

IFS, ‘The economic response to coronavirus will substantially increase government borrowing’.

For the latest news and guidance on the ongoing impact of COVID-19 for businesses and accountants, visit ICAEW’s dedicated Coronavirus Hub.

This article was originally published by ICAEW.

The £4.4bn cost of preparing for Brexit

17 March 2020: the NAO has provided an analysis of the spending by government departments on preparing for Brexit, highlighting just how significant an exercise leaving the EU is for the government machine.

A recent report by the National Audit Office (NAO) on the cost of EU Exit preparations analysed the £4.4bn spent by government departments in getting ready for Brexit between June 2016 and 31 January 2020.

The NAO is the independent audit body responsible for scrutinising public spending on behalf of Parliament. In its Brexit report, the NAO identified over 300 workstreams with £1.9bn spent on staff, £1.5bn on building new systems and procuring goods and services, £0.3bn on external advice, and £0.6bn in other costs.

Over half of the costs were incurred by three departments, with £871m, £803m, £748m spent respectively by DEFRA, the Home Office and HMRC. This included preparation for new international trade, immigration and customs processes, as well as implementing domestic regulation in areas currently regulated by the EU.

This spending is not the complete total. It does not include costs incurred, for example, of staff only partially working on Brexit or seconded for less than six months, nor local authority preparations not covered by central government funding. It also does not include the net contributions payable to the EU of £8bn during the transition period between 1 February 2020 and 31 December 2020 nor the net financial settlement payable to the EU after that of an estimated £23bn.

The NAO reported that some of the £1.8bn spent between 1 April and 31 October 2019 was spent on no-deal preparation, but that it is not possible to analyse how much of this was wasted (other than the £92m in losses incurred on terminating ferry and other contracts already identified by Whitehall as ‘fruitless payments’ or ‘constructive losses’). This is because many of the preparations will still be needed for when the UK leaves the Customs Union and Single Market at the end of the year.

Spending on advertising and communication amounted to £77m, including £49m spent on the Cabinet Office’s ‘Get ready for Brexit’ campaign, the subject of a critical NAO report in January 2020.

Alison Ring, Director, Public Sector for ICAEW commented: “The NAO has provided a very helpful analysis of the spending by government departments on preparing for Brexit. It highlights just how significant an exercise leaving the EU is for the government machine, with the need for more staff, new regulatory arrangements and new systems and processes across the public sector.

This effort is far from complete, with a huge amount of work still needed to prepare for leaving the EU Customs Union and Single Market in less than nine months’ time.”

The NAO report: ‘The cost of EU Exit preparations’ is publicly available.

This article was originally published by ICAEW.

Spring Budget 2020: Hey big spender, spend a little infrastructure with me

12 March 2020: Rishi Sunak’s first Budget as Chancellor of the Exchequer provided a sharp change in direction for the public finances – something that will please and surprise many, according to ICAEW’s Public Sector team.

Spring Budget 2020 combined a short-term fiscal stimulus to fight the coronavirus with higher spending on public services and new infrastructure investment to increase borrowing significantly. Fortunately, ultra-low interest rates will keep financing costs down on the more than £330bn in borrowing planned to finance these plans (not including short-term fiscal stimulus measures), with public sector net debt expected to exceed £2.0tn by 2025.

This Budget is particularly important as it sets the spending envelope for the three-year Spending Review expected to be published later this year. With a higher base for spending following the Spending Round 2019 announced by the previous Chancellor in October, this signals an end to the austerity policies of recent administrations.

Key headlines for 2020-21:

Fiscal deficit up from £40bn to £55bn (2.4% of GDP), before coronavirus measures.
No significant tax changes beyond corporation tax remaining at 19%.
£14bn extra current spending and £5bn extra investment before coronavirus measures.
£12bn in tax and spending measures to respond to the coronavirus.
Gross financing requirement of £162bn, including £98bn to cover debt repayments.
No reflection of uncertain adverse economic effect of the coronavirus on tax revenues.

Key headlines for the four subsequent years to 2024-25:

Fiscal deficit of £62bn (2.5% of GDP) on average over the subsequent four years.
Tax policy measures to generate an additional £7bn per year.
Extra current spending of £27bn a year and extra investment of £19bn a year.
Gross financing requirement of £595bn (£149bn a year) including £315bn to cover repayments.
Significant economic uncertainty with coronavirus, global economic conditions and changes in UK trading relationships with the EU and other countries.

The existing plans already incorporated a significant ramp-up in infrastructure and other investment spending with public sector net investment forecast to increase from 2.2% of GDP in 2019-20 to 3.0% by 2022-23. The challenge for the Government will be to deliver and ‘get things done’, especially as capital investment by government departments is expected to increase by 25% in 2020-21 and by a further 35% over the subsequent four years. Will there be sufficient construction capacity and project management expertise to deliver such a rapid expansion and still deliver value for money for taxpayers?

The Budget also contained some important developments in the framework for the public finances, with a specific commitment to review the investment criteria in the Government’s ‘Green Book’ to ensure regions outside London and the South East benefit from the additional infrastructure spend proposed in the Budget. The focus on looking at the effect on investments on the public balance sheet was also welcome with new approaches planned for how to appraise public spending.

One surprise in the Budget announcement was that the OBR did not revise the economic forecasts down as much as had been expected. This was partly because of the economic benefits of higher public spending and investment, but also reflected an improved outlook for productivity. The benefit of this for the Chancellor was that he was able to announce additional current spending on public services, while still remaining within the fiscal rules set out in the Conservative party manifesto.

Unfortunately, the scale of the impact of the coronavirus on the economy is still unclear and so the forecasts for tax revenues may need to be revised downwards, potentially significantly, in the Autumn Budget later this year.

Commenting on Spring Budget 2020, Alison Ring, Director, Public Sector, at ICAEW said: “The Chancellor has announced a major loosening of the taps on spending and investment in his first Budget, with a combination of a short-term fiscal stimulus to fight the coronavirus, higher spending on public services, and a major programme of new infrastructure investment.

Those wondering where all the funding for this planned spending will come from may be surprised to discover that the Chancellor has not followed the custom of post-general election tax rises, but instead has decided to take advantage of ultra-low interest rates to borrow more than £330bn over the next five years. Public sector net debt is expected to exceed £2.0tn by 2025, although the Government hopes that this will then be falling as a ratio to the size of the economy.

Nevertheless, it is a Budget that many will be pleased with, even if a little surprising coming from the traditional champions of small government.”

This article was originally published by ICAEW.

A tax system with 1,190 tax reliefs is difficult to hold accountable

2 March 2020: A recent report by the National Audit Office (NAO) highlighted that there were 1,190 tax reliefs as of October 2019, confirming just how complicated the British tax system is.

The NAO is the independent audit body responsible for scrutinising public spending on behalf of parliament. In a report on how HM Treasury and HMRC manage tax expenditures (tax reliefs that are used to pursue social or economic objectives), the NAO focused on the 362 tax reliefs that fall into this category. HMRC has reported that 111 of these reliefs had a combined annual cost of £155bn in 2018-19.

The NAO was critical of both HM Treasury and HMRC in how they monitor tax expenditures, following on from previous criticism by the Public Accounts Committee in 2018 that HMRC did not know whether a large number of tax reliefs were delivering value for money.

The report highlights how some tax reliefs significantly exceeded their original cost estimates, with HMRC not fully investigating large changes in costs. While HMRC has started to assess tax reliefs, only 15 formal evaluations have been completed since 2015, representing just 7% of the total value. In particular, HMRC has only evaluated five of the 23 tax expenditures estimated to individually cost in excess of £1bn a year.

A major issue highlighted by the report is a lack of sufficient assessments of whether the behavioural changes or other benefits intended by changes to the tax system are being achieved. Guidance from the IMF states that tax expenditures require the same amount of government oversight as public spending and this is not currently the case in the UK.

Poorly designed tax reliefs can skew behaviour in ways that were not originally intended or create opportunities for exploitation or abuse. One example is intangibles relief, which was meant to support innovation. Instead it created multiple opportunities for tax avoidance where taxes were reduced with no true benefit in innovation.

There can also be unintended consequences for the accuracy of company accounts, with financial statement disclosures distorted by the desire to meet the requirements to obtain a particular tax relief.

While the NAO comments that HM Treasury and HMRC have started to improve, it recommends the development of a formal framework for designing and administering tax expenditures, and the introduction of a robust methodology for assessing value for money on a regular basis.

This call echoes the Barber Review on Public Value in 2017, which called for delivery of better outcomes for citizens, noting that the Treasury has historically placed greater emphasis on inputs rather than outcomes. It commented that a public service is more valuable if taxpayers and citizens believe in it, are willing to fund it, and commit to supporting its outcomes more widely.

Alison Ring, Director, Public Sector for ICAEW, commented: “Although this is a fairly technical report from the NAO, it goes right to the heart of the compact between citizens and government. How can we build trust in the tax system if the tax authorities are unable to fully justify the benefits of tax expenditures and confirm that intended outcomes are being delivered?”

Responding to the report, a government spokesperson said: “We want tax reliefs which deliver value for taxpayers and minimise the risk of any avoidance and evasion activity. We will consider the NAO’s recommendations so that we can continue to improve our management of reliefs.”

The NAO report is publicly available here.

This blog post was first published on the ICAEW Insights Hub.

ICAEW Fiscal Insight: General Election 2019

On 12 December 2019, voters have the opportunity to focus on the big challenges of sustainability, technology and the public finances as they elect a government for the next four and a half years.

ICAEW have published a Fiscal Insight on the General Election 2019 manifesto proposals of the Conservatives, the Labour Party, the Liberal Democrats and the Green Party.

All the political parties are promising to increase taxes, public spending and investment. The Conservatives are promising the least, but they have deferred significant decisions. Other parties propose spending a lot more, with Labour planning to nationalise utilities. There are new fiscal rules, but questions about whether they would be adhered to.

This is in the context of public finances that are on a financially unsustainable path and – disappointingly – none of the parties set out a long-term fiscal strategy. There are significant risks around the achievability of all the party manifesto plans, with the projected deficit in 2023–24 of £62bn (Conservatives), £118bn (Labour), £76bn (Liberal Democrats) or £133bn (Greens).

Read the Fiscal Insight on the ICAEW website.

ICAEW Fiscal Insight: Spending Round 2019

Cover photo with link to a pdf - ICAEW Fiscal Insight on the Spending Round 2019: an end to austerity?

Fiscal Insight – Spending Round 2019

On 4 September 2019, the Chancellor of the Exchequer announced the UK Government’s plans for departmental spending in 2020-21 in the Spending Round 2019.

This ICAEW Fiscal Insight analyses the effect of this announcement on the public finances and what this means for public services. Headlines include:

Planned departmental spending of £434.2bn in 2020-21

Departmental current spending up by £13.8bn or 4.1% to £352.3bn
Departmental capital spending up by £3.9bn or 5.0% to £81.9bn
This is £13.4bn more than set out in the March 2019 Spring Statement

Increases in current spending

£4.1bn for health, including £3.9bn for NHS England
£2.2bn for education, including £1.8bn for schools and £400m for further education
£1.3bn for law & order, including £750m for more police
£1.0bn for social care, with the prospect of a further £0.5bn from council tax precepts

Increases in capital investment

£2.2bn for transport, including HS2, Network Rail and Highways England
£1.9bn for international development

Effect on the public finances

Total managed expenditure in 2020-21 of £878.6bn, 2.4% more than this year
With student loan accounting change deficit is £46.2bn or 2.0% of GDP
Economic forecasts not refreshed, updating them would likely increase the deficit further
The government is likely to breach its fiscal targets for 2020-21

An end to austerity?

All departments’ current budgets will increase by at least inflation
Welfare spending is still being cut
The Spending Round is for one year only

The Spending Round marks a turning point for spending on public services, with all departmental budgets increasing by inflation at the very least. This is a significant change after a decade of cuts in most department budgets.

Click here to read the ICAEW Fiscal Insight on the Spending Round 2019.

Fiscal risks report

Last week, the OBR published their second fiscal risks report – 294 pages of detailed economic analysis on risks to the UK public finances.

I am assuming that you will have read it all by now, but on the off-chance you haven’t, can I point you to this (much briefer) ICAEW summary instead?

As I say in the summary:

“The OBR highlights the continuing vulnerability of the UK public finances to economic headwinds and policy risks. Both revenue and spending are under increasing pressure as the population grows older and productivity stubbornly refuses to improve.

The report stresses the short-term risks to the public finances arising from Brexit or a potential global recession, with the ‘mild’ no-deal scenario presented by the OBR suggesting a significant hit to the public finances in the order of £30bn a year, before considering potential policy responses that could cost even more.

Perhaps more concerning is the OBR’s observation that austerity fatigue is leading to a fiscal loosening and less ambitious objectives for the management of the public finances. With the public finances already on an unsustainable path in the longer-term, the temptation to defer necessary decisions even further into the future appears to be proving too difficult to resist.”

https://www.icaew.com/-/media/corporate/files/about-icaew/policy/fiscal-risks-report-2019.ashx?la=en

Chancellor has his chequebook out, but has not opened it yet, says ICAEW

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.”

Government departments will have to fight harder for public money, say ICAEW

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?”

Brexit uncertainty a concern for the public sector finances, say ICAEW

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.”