ONS moves the goalposts with new treatment of student loans

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?

 

IFS Green Budget 2018 – ICAEW: Defence

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

UK defence and security spending over time

Source: NATO; Office for Budget Responsibility.

IFS Green Budget 2018 – ICAEW: Public sector assets

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)

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

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

ICAEW Better Government Series: The debt of nations

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.

Managing the Public Balance Sheet

ICAEW’s latest report is on managing the public balance sheet. As governments around the world start to adopt accruals accounting, they are gaining a wealth of valuable information about their financial position. 

The aim of this policy insight to offer some thoughts about how that information can be used in policy making and financial management.

For more information, visit the ICAEW website by clicking here.  To read the report itself, download it by clicking here.

Analysing the EU Exit Charge

Money will be a critical part of Brexit negotiations. In this report written for ICAEW, we reveal the key components of a deal and estimate the potential EU exit bill.

Key points to highlight:

  • Potential exit charges range from a low cost of £5bn to a maximum cost of £30bn, with the central scenario cost £15bn (based on an exchange rate of €1.20 to £1). This is equivalent to £225 per person expected to be living in the UK in 2019.
  • To put this in context, the UK’s share of the EU budget each year is approximately £20-£21bn, before an estimated rebate of £5-6bn, and spending returning to the UK of £6-£7bn.
  • While the estimated rebate is expected to be received back, the EU could attempt to withhold this if there is no agreement on wider exit charges.
  • Liabilities include EU staff pension and sickness payments which will be close to £63bn when the UK leaves, and of which the UK’s share is £10bn. This could be dealt with through a one-off settlement or the UK could agree to continue to contribute £0.2bn a year for the next 50 years or so.
  • The value of the EU’s fixed assets will also need to be determined, but as these are relatively small compared with other numbers revaluing them is unlikely to have significant impact on the total exit charge.
  • Additional areas for negotiation include the European Investment Bank (EIB), of which the UK has a 16% share. As ownership of the EIB is restricted to EU members, the UK may need to sell its stake to other EU members, or existing rules may need to change.
  • The EU is likely to argue that costs incurred caused by the UK’s decision to leave should be paid for by the UK rather than by other member states.

To find out more and to read the report, visit http://www.icaew.com/en/technical/economy/brexit/analysing-the-eu-exit-charge

Government needs to reverse the trend in infrastructure investment argues ICAEW

In a letter to the new Chancellor, Phillip Hammond, ICAEW has urged Government to take action urgently and reverse the trend by increasing investment in public infrastructure. It also calls for new fiscal rules to support greater private investment.

In its paper ‘Funding UK Infrastructure’, ICAEW argues that for all the new initiatives announced by Government in recent years, public investment in economic infrastructure appears to be static or declining until the end of the decade, while attempts to encourage greater private investment have not been successful. It also reveals:

  • private finance initiative (PFI) contracts have been drying up, with only £0.7bn of projects reaching financial closure during 2014-15
  • although the Government announced that the total National Infrastructure Pipeline had increased from £411bn in 2015 to £425.6bn in 2016, the near term profile of investment grew by less than the overall growth in the economy, with investment in energy infrastructure declining
  • investment in social infrastructure – schools, hospitals and housing – is also static or declining, with claimed increases in social housing investment being offset by expected reductions in capital spending by housing associations

Vernon Soare, ICAEW Chief Operating Officer and Executive Director, said:

“In the past we have seen too much talk and not enough action on infrastructure. The combination of a new Chancellor, low interest rates and Brexit means that now is the time for decisions to be taken and investment to be made. Wavering on projects such as a new runway in the south east of England and a lack of public investment have meant that we are not getting the economic benefits that infrastructure can generate. If Government leads the way, private investment will follow.”

The new Chancellor has already made the decision to change fiscal rules to permit borrowing to fund investment. However, priority now needs to be given to infrastructure investments that provide a positive return to the taxpayer and so pay for themselves, while PFI contracts need to be brought back onto the balance sheet so that they no longer bypass fiscal targets and can be properly evaluated based on whether they provide value for money to the taxpayer.

Vernon Soare adds: “With cost cutting and austerity only getting the UK so far, it is now necessary to generate revenue growth. That will require more investment in key infrastructure projects and spades in the ground. There is now the potential to use borrowing to fund an immediate increase in infrastructure investment.”

Click here to see the full report.

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.