Category: ICAEW article

IFS pre-Budget report warns of difficult choices for the Chancellor

The Institute for Fiscal Studies says that there may be spending cuts in some areas of the Spending Review and Autumn Budget, while the health and social care levy will not be enough to meet spending pressures on the NHS and social care in the medium-term.

The Institute for Fiscal Studies (IFS) has launched its annual Green Budget report, setting out its views on the prospects for the economy and the public finances ahead of the Spending Review and Autumn Budget scheduled for 27 October 2021.

Produced in conjunction with Citi and the Nuffield Foundation, the 427-page report contains detailed chapters on the global and UK economy, the economic and fiscal outlook, the Spending Review, fiscal rules, NHS spending, local government funding in England, tax policies to achieve net zero, and employment and the end of the furlough scheme.

A summary of the key findings in each chapter is set out below, but the key headlines are that COVID has damaged the economy, the fiscal outlook is better than predicted in March but still much worse than pre-pandemic forecasts, and the Chancellor has some very difficult spending choices to make in the Spending Review. 

The IFS cautions that the new health and social care levy will not be sufficient to meet medium-term cost pressures and that ‘unprotected budgets’ continue to be under severe strain, with cuts possible if the Chancellor wants to meet his proposed new fiscal rules.

More detailed analysis goes into spending by the NHS and local government and the implications of net zero for tax policy. A final chapter highlights the mismatch between those losing their jobs and vacancies in a very different employment market following the end of the furlough scheme.

Alison Ring, Director for Public Sector and Taxation at ICAEW, commented: “As ever, the IFS have produced one of the most authoritative analyses of the state of the UK public finances, setting out many of the difficult choices facing the Chancellor in the Spending Review and Autumn Budget.

“The challenge for the Chancellor will be how to address severe spending pressures across central and local government and deliver on ‘levelling up’ and ‘net zero’, at the same time as repairing the public balance sheet and charting a path towards sustainable public finances.”

IFS Green Budget 2021: key points

Citi says the global economy is recovering:

  • Pandemic is not over, but economies are resilient and rebound can become a recovery
  • Supply constraints will restrict growth and higher inflation is likely for some time
  • Risk of fiscal tightening is low and central banks likely to be cautious in exiting monetary support

Citi expects UK economy to be 2.5% smaller in 2024-25 than pre-pandemic forecasts:

  • UK in an imbalanced recovery with fading growth in the winter
  • Profound economic adjustment looms (e.g. less hospitality, more transport and storage). 
  • Brexit leading to supply disruptions and a drop in exports
  • Labour market in process of adjustment, but despite shortage sectors, real-terms pay settlements overall remain broadly in line with pre-pandemic range 
  • Inflation increasing sharply – should be temporary, but there is risk of a wage price spiral
  • Monetary policy constrained, so fiscal capacity needed to stabilise the economy.

IFS says economic and fiscal outlook is better than predicted in March, but still much worse than pre-pandemic forecasts:

  • Deficit in 2021-22 to be £180bn, over £50bn below OBR Spring Budget forecast
  • At 7.7% of GDP deficit remains extraordinarily high – the third highest deficit since WWII
  • Recovery should see current budget be in surplus by 2023-24
  • Upside scenario would see overall deficit eliminated
  • But further lockdowns could see borrowing more than double pre-pandemic forecasts in 2024-25
  • Central scenario would see public debt start to fall, but only gradually
  • Higher interest rates and inflation have increased debt interest costs to around £15bn a year more than expected in March
  • Health and social care levy will need to increase from 1.25% to 3.15% by end of the decade to meet expected health and social care pressures

Fiscal rules are needed, but:

  • Well-designed fiscal rules can help make it harder to borrow for ‘bad reasons’
  • UK has had poorly designed fiscal targets, with 11 new rules in the last seven years – most of which have been missed before being dropped
  • Both Conservatives and Labour appear to favour a current budget fiscal rule
  • Strong case for gilt-issuance to be tilted towards more long-dated index-linked gilts to lock in the current low real cost of more debt
  • Reducing debt should be a long-term target to create more fiscal space for potential future adverse shocks
  • Health, social care and state pensions likely to add 6.1% of national income to costs by 2050
  • Net zero costs likely to peak in 2026-27 at 2.2% of national income
  • IMF says UK has lowest general government net worth of 24 advanced economies
  • A broader focus on wider public balance sheet by government and opposition is welcome
  • Fiscal rules should be seen as rules of thumb and no fiscal target is sacrosanct 

Spending Review 2021:

  • Chancellor faces unpalatable set of spending choices, despite manifesto-breaking tax rise
  • Spending envelope is £3bn a year smaller than pre-pandemic plans, which is a problem when 64% of departmental spending is already protected or otherwise committed
  • Potential cuts in unprotected budgets such as local government, prisons, further education and courts of £2bn in 2022-23
  • More spending room in 2024-25, so potential for Chancellor to re-profile spend to avoid cuts next year with spending more overall
  • NHS and other demands likely to eat into amounts available for unprotected budgets.
  • COVID-19 reserve needed to cover non-NHS virus-related spending
  • Now is time to return to certainty of multi-year budgeting
  • Extending public sector pay freeze risks damaging recruitment, retention and motivation

Pressures on the NHS:

  • NHS already showing signs of strain before pandemic began, with last decade seeing lowest level of spending growth in NHS history
  • NHS entered pandemic with 39,000 nursing vacancies and many fewer doctors, hospital beds and CT scanners per person than in many similar countries
  • NHS funding plans blown out of water by pandemic, with extra £63bn spent in 2020-21 and £34bn in 2021-22
  • Extra funding needed in the next three years of £9bn, £6bn and £5bn – substantial, but manageable, sums. Covered by new health and social levy initial for first two years
  • New funding unlikely to be sufficient in the medium term, with extra money needed from 2024-25 onwards
  • Missed treatments, bringing down waiting lists, demand for mental health services and higher pay all likely to add to spending pressures
  • Some savings from moving to remote outpatient appointments and potential for more from other innovations in the pandemic

Local government funding in England:

  • English councils’ non-education spending almost a quarter lower than 2009-10. 
  • This contrasts with Welsh councils, where spending has fallen by only a tenth
  • £10.4bn in additional funding in 2020-21 covered most in-year COVID-19 pressures
  • But mismatches mean some councils are ‘over-compensated’ while district councils are ‘under-compensated’
  • COVID-19 funding in 2021-22 of £3.8bn expected to be £0.7bn short of what is needed
  • Central government funding currently implies council tax rises of 3.6% a year assuming no further impact on budgets from COVID beyond next April
  • Uncertainties mean that setting firm plans for council funding for the next three years is an impossible task without guarantees from central government
  • Social care funding still allocated based on local populations in 2013 and the delayed ‘Fair Funding Review’ needs to be completed
  • For example, Tower Hamlets’ population is up 21%, Blackpool’s is down 2%.
  • Transition to new system of funding may need extra money to avoid potentially large cuts in some areas
  • Council tax needs reform!
  • More devolution on the agenda – government should develop ‘devolution packages’ rather than have bespoke arrangements for each area
  • Additional £5bn of health and social care levy funding for adult social care is unlikely to be sufficient – an extra £5bn a year could be needed by the second half of the 2020s

Tax policies to achieve net zero:

  • Greenhouse gas emissions fell 38% between 1990 and 2018, the fastest in the G7
  • Emission reductions will have to accelerate from 1.4% a year to 3.1% a year to meet net zero in 2050
  • Many low-cost opportunities to reduce emissions already done, so further reductions will be more difficult
  • Tax rates on emissions vary wildly, so incentives to reduce emissions are highly uneven
  • Renewables attract subsidies paid for by higher electricity prices – may pay-off in long-term but there are risks
  • Carbon footprint higher for higher-income households, but costs take up a bigger share of poorer household budgets
  • Weak incentives to improve energy efficiency
  • International collaboration needed, eg on taxing international aviation

Employment and the end of the furlough scheme:

  • Furlough scheme ended in September at gross cost of £70bn
  • Huge success, but significant challenges remain in the labour market
  • Significant concerns about the employment prospects for the 1.6m on furlough in July
  • Vacancies exceed 1.0m, but mismatch between regions and industries
  • London appears hard-hit on multiple fronts
  • Young people leaving full-time education last year were less likely to get jobs, but employment rates have since fallen back into line with pre-pandemic cohorts

Visit the IFS website to find out more about the IFS Green Budget and to download a copy.

This article was originally published by ICAEW.

Use Spending Review to establish a “financial platform for delivery”

Alison Ring, Director for Public Sector at ICAEW, has written to the Chief Secretary to the Treasury ahead of Spending Review 2021 expressing ICAEW’s view that it should be centred on the three key themes of stable funding, fiscal resilience and financial capability.

The first multi-year Spending Review since 2015 offers the government the opportunity to establish a “firm financial platform” to enable the delivery of its key priorities, including recovering from the pandemic and achieving net zero carbon emissions by 2050, according to the ICAEW Public Sector team.

Alison Ring, Director for Public Sector at ICAEW, has written a letter on behalf of the public sector team to the Rt Hon Simon Clarke MP, the newly appointed Chief Secretary to the Treasury, ahead of the Autumn Spending Review 2021, scheduled to conclude on 27 October.

As set out in the letter, ICAEW’s Public Sector team believes the Spending Review should be guided by three key principles:

  • Stable funding: The Spending Review must provide the certainty that allows bodies across the public sector to plan and invest. The letter argues for the rationalisation of local government funding streams and setting capital budgets over a longer time period.
  • Fiscal resilience: The government needs to establish a strategy for repairing the public balance sheet following the pandemic and ensure the government has the capacity to withstand future fiscal emergencies. It highlights the urgent need to strengthen local authority balance sheets as the costs of not doing so may be even greater.
  • Financial capability: The letter points to recent NAO reports and high profile failures in local government as evidence of the importance of the government using the Spending Review to invest in financial management skills, financial processes, financial reporting and audit.

ICAEW members will be central to ensuring the government can deliver on its priorities. Alison Ring, Director for Public Sector at ICAEW, therefore concludes the letter by offering the Chief Secretary to the Treasury an opportunity to discuss the letter and how ICAEW and its members can support the government in tackling the challenges that the country faces as it recovers from the pandemic. 

Alison Ring commented: “The COVID-19 pandemic has significantly weakened the public finances, which hampers the government’s ability to deliver its priorities and respond to future crises. The upcoming Spending Review gives the government the opportunity to establish a long-term strategy for repairing the public balance sheet and providing the financial capability and certainty public sector bodies need to deliver essential priorities such as the transition to net zero carbon by 2050.”

Read the Public Sector team Representation to the Spending Review

See more commentary from ICAEW on the Autumn Budget and Spending Review.

This article was originally published by ICAEW.

Bad debts hit public finances as last year’s deficit is revised up to £325bn

Manifesto-breaching tax rise does not mean the end of the financial challenges facing the Chancellor in the run up to the Autumn Budget and three-year Spending Review on 27 October.

The public sector finances for August 2021 released on Tuesday 21 September reported a monthly deficit of £20.5bn, better than the £26.0bn reported for August 2020 but still much higher than the deficit of £5.2bn reported for August 2019. This brings the cumulative deficit for the first five months of the financial year to £93.8bn compared with £182.7bn last year and £27.2bn two years ago.

The Office for National Statistics revised the reported deficit for the year ended 31 March 2021 up by £27.1bn from £298.0bn to £325.1bn, principally as a consequence of recognising an estimated £21bn in bad debts on coronavirus loans to businesses.

Public sector net debt increased from £2,201.5bn at the end of July to £2,202.9bn or 97.6% of GDP at the end of August. This is £67.1bn higher than at the start of the financial year and a £416.8bn increase over March 2020.

As in previous months this financial year, the deficit came in below the official forecast for 2021-22 prepared by the Office for Budget Responsibility, which is likely to reduce its projected deficit of £234bn for the full year when it updates its forecasts for the Autumn Budget and Spending Review on 27 October. 

Cumulative receipts in the first five months of the 2021-22 financial year amounted to £347.1bn, £48.4bn or 16% higher than a year previously, but only £12.4bn or 4% above the level seen a year before in 2019-20. At the same time cumulative expenditure excluding interest of £391.8bn was £39.9bn or 9% lower than the first five months of 2020-21, but £69.2bn or 21% higher than the same period two years ago.

Interest amounted to £30.8bn in the five months to August 2021, £10.7bn or 53% higher than the same period in 2020-21. This was principally because of the effect of higher inflation on index linked gilts. Despite the much higher levels of debt than two years ago, interest costs were only £3.8bn or 14% higher than the equivalent five months ended 31 August 2019.

Cumulative net public sector investment in the five months to August 2021 was £18.3bn, including £0.6bn in estimated bad debts on coronavirus lending in the current financial year. This was £11.3bn less than last year’s £29.6bn for the five months to August 2020, which included £15.6bn for coronavirus lending that is not expected to be recovered. Investment was £6.0bn or 49% more than two years ago, principally reflecting a higher level of capital expenditure.

Debt increased by £67.1bn since the start of the financial year, £26.7bn less than the deficit as tax receipts deferred last year were collected and coronavirus loans were repaid.

Alison Ring, ICAEW Public Sector Director, said: “Today’s numbers from the ONS illustrate the significant financial challenges facing the Chancellor as he puts together next month’s Budget and three-year Spending Review while public sector net debt hovers at almost 100% of GDP. The additional billion pounds a month the Chancellor expects to generate from the new tax and social care levy from next April needs to be seen in the context of the £20.5bn shortfall in the public finances recorded in the past month alone.

“Meanwhile, the belated recognition of £21bn in bad debts from coronavirus lending is a reminder of the scale of support the government has provided to keep the economy going during the pandemic. The risk for the next few months is that higher-than-expected inflation, shortages on shelves and disruptions in gas and energy markets may push the post-pandemic economic recovery off course and require further interventions, making the challenge of repairing the public finances even greater than it already is.”

Image of table showing public sector finances for the five months to 31 August 2021 and variances against prior year and two years ago. Click on link at end of post to go to the ICAEW website for a readable version of this table.

Caution is needed with respect to the numbers published by the ONS, which are expected to be repeatedly revised as estimates are refined and gaps in the underlying data are filled.

The ONS made a number of revisions to prior month and prior year fiscal numbers to reflect revisions to estimates. These had the effect of reducing the reported fiscal deficit for April 2021 from £26.0bn to £25.8bn, for May 2021 from £20.2bn to £19.8bn, for June 2021 from £21.4bn to £20.7bn and for July 2021 from £10.4bn to £7.0bn. The deficit for the twelve months ended 31 March 2021 was revised up from £298.0bn to £325.1bn.

Image of table showing summary public sector finances for each of the five months to 31 August 2021. Click on link at end of post to go to the ICAEW website for a readable version of this table.

This article was originally published by ICAEW.

Shadow Chief Secretary joins Fabians-ICAEW roundtable

ICAEW and the Fabian Society recently held a joint roundtable event on how a future Labour government can bring a long-term approach to public sector financial management, infrastructure and investment, amidst a challenging position for the public finances.

While the next General Election is not scheduled until 2024, Labour shadow ministers are already starting to think about how they can both deliver on their policy objectives and ensure sustainable public finances at the same time.

As current and previous administrations have discovered, getting the ‘wiring’ of government right is essential to achieving progress and a joint ICAEW-Fabian Society roundtable on 15 July 2021 explored the challenges with members of Labour’s shadow team including Bridget Phillipson, Shadow Chief Secretary to HM Treasury, and policy experts from academia, ICAEW, the Institute for Government and Reform.

The discussion was focused on how to ensure a joined-up, long-termist approach to government, including strategy and foresight, outcomes and delivery, digital, data and service transformation, financial management, audit and procurement, and infrastructure, investment and major projects. The need for a more effective centre of government to drive policy outcomes at the same time as devolving more powers was a key theme, as was the contribution that effective public audit can make to improving the quality of decision making within government.

The challenges facing any future Labour government are exacerbated not only by the huge amounts of borrowing used to finance the UK’s response to COVID-19, but by public finances that were already challenged by the long-term financial consequences for pensions, health care and social care of more people living for longer. Higher gearing in the public balance sheet increases the vulnerability of the public finances to future economic shocks.

Andrew Harrop, General Secretary of the Fabian Society, commented: “The Fabian Society hopes that this early debate on how to bring a long-termist, coordinated perspective to the centre of government will help equip Labour to critique government inaction; and to start to think through ‘how’ as well as ‘what’ the party wants to achieve if it wins back power. Developing plans to reform the centre of government can also help opposition parties demonstrate their credibility, as the Conservatives proved in 2010 with the Office for Budget Responsibility.”

Alison Ring, director for public sector at ICAEW, commented: “ICAEW believes in engaging across the political spectrum on the importance of strong financial management, high quality financial reporting and a comprehensive fiscal strategy to deliver value for money and sustainable public finances over the long-term. We hope that this event will have helped to advance thinking on how to tackle the many significant challenges facing the UK public sector and public finances in uncertain times.”

This article was originally published by ICAEW.

Public debt hits £2.2tn as Budget delay rumours swirl

A June deficit of £22.8bn resulted in public sector net debt reaching £2,218.2bn or 99.7% of GDP at the end of the first quarter of the 2021-22 fiscal year, fuelling speculation that the Chancellor may delay the Autumn Budget and departmental spending reviews.

The latest public sector finances released on Wednesday 21 July reported a deficit of £22.8bn for June 2021, as COVID-related spending continued to weigh on the public finances, albeit at a reduced rate. This is an improvement from the £28.2bn reported for the same month last year during the first lockdown but was still significantly higher than the £7.0bn reported for June 2019.

Public sector net debt increased to £2,218.2bn or 99.7% of GDP, an increase of £80.8bn since March 2021 and £420.5bn higher than March 2020 just fifteen months ago.

Cumulative receipts in the first three months of the financial year of £201.6bn were £29.5bn or 17% higher than a year previously, but this was only £6.4bn or 3% above the level seen a year before that in the first quarter of 2019-20. At the same time cumulative expenditure of £243.4bn was £26.0bn or 10% lower than the first three months of 2020-21, but £51.6bn or 27% higher than the same period two years ago.

The effect of higher inflation on index-linked gilts drove a jump in interest costs, which at £18.1bn in the quarter to June 2021 were £6.0bn or 50% higher than Q1 in 2020-21, albeit this was still £0.4bn or 2% lower than the quarter ended 30 June 2019 despite much higher levels of debt. 

Net public sector investment was slightly lower than last year with £9.6bn invested in the three months to June, down £0.3bn or 3% from a year before but up £1.7bn or 22% from two years ago. This combined to produce a cumulative deficit for the first three months of the 2021-22 financial year of £69.5bn, £49.8bn or 42% below that of the same period a year previously, but up £46.5bn or 202% from the first quarter of the 2019-20 financial year.

Debt movements reflected £11.3bn of additional borrowing over and above the deficit for the quarter, principally to fund coronavirus loans to businesses. Public sector net debt of £2,218.2bn is £245.5bn or 12% higher than a year earlier and £438.2bn or 25% higher than in June 2019.

The Office for National Statistics revised the reported deficit for the year ended 31 March 2020 down by £1.5bn from £299.2bn to £297.7bn, still a peacetime record. The final total is still expected to exceed £300bn as the ONS has yet to include in the order of £27bn of bad debts on COVID-related lending in this number. Estimates will be refined further over the next few months.

Alison Ring, ICAEW Public Sector Director, said: “Public sector net debt has risen by £420bn since the first lockdown in March 2020, making the public finances more vulnerable to changes in interest rates and reducing the fiscal headroom available to the Chancellor as he seeks to navigate the economy out of the pandemic.

“Rumours that Rishi Sunak is considering cutting investment plans and delaying the Budget and departmental Spending Reviews are concerning. It is important that the baby of borrowing sensibly to fund much-needed investment in infrastructure is not thrown out with the bathwater of post-pandemic spending restraint.

“Central and local government desperately need budget certainty so they can plan, even if there are some adjustments next year when we all hope the pandemic will have run its course. The last full Spending Review was in 2015; it’s important that we end the cycle of deferral and delay and restore financial discipline to the government’s budgeting.”

Public sector finances 2021-22: three months to 30 June 2021

3 months to
June 2021		Variance vs
prior year		Variance vs
two years ago
£bn£bn%£bn%
Receipts201.629.5+17%6.4+3%
Expenditure(243.4)26.0-10%(51.6)+27%
Interest(18.1)(6.0)+50%0.4-2%
Net investment(9.6)0.3-3%(1.7)+22%
Deficit(69.5)49.8-42%(46.5)+202%
Other borrowing(11.3)44.4-80%(19.7)-235%
Change in net debt(80.8)94.2-54%(66.2)+453%
Public sector net debt2,218.2245.5+12%438.2+25%
Public sector net debt / GDP99.7%6.3%+7%19.4%+24%
Public sector finances 2021-22: three months to 30 June 2021

Public sector finances 2021-22: fiscal deficit by month


Receipts		Expend-
iture
Interest		Net
investment
Deficit
£bn£bn£bn£bn£bn
April 202166.2(82.3)(4.8)(5.2)(26.1)
May 202166.3(80.8)(4.5)(1.6)(20.6)
June 202169.1(80.3)(8.8)(2.8)(22.7)
Cumulative to June 2021201.6(243.4)(18.1)(9.6)(69.5)
Public sector finances 2021-22: fiscal deficit by month

Caution is needed with respect to the numbers published by the ONS, which are expected to be repeatedly revised as estimates are refined and gaps in the underlying data are filled.

The ONS made a number of revisions to prior month and prior year fiscal numbers to reflect revisions to estimates. These had the effect of reducing the reported fiscal deficit for April 2021 from £29.1bn to £26.1bn, for May 2021 from £24.3bn to £20.6bn and for the twelve months ended 31 March 2021 from £299.2bn to £297.7bn.

For further information, read the public sector finances release for June 2021.

This article was originally published by ICAEW.

Local authorities need to invest in finance teams

Alison Ring, ICAEW director for public sector, tells Room 151 that local audit reform is not enough on its own.

Alison Ring, ICAEW director for public sector, recently contributed an article to Room 151, an online news, opinion and resource service for local authority section 151 and other senior officers.

Reforms mean local government will soon see a new audit regulator, but investing in local government finance teams and better reporting are priorities too.

The government’s decision to set up a dedicated local audit unit within the new Audit, Reporting and Governance Authority (ARGA) addresses one of the key recommendations of the Redmond Review – that there be a ‘system leader’ for local audit, bringing together many of the different aspects of audit regulation currently dispersed across a variety of bodies, including ICAEW.

Nevertheless, ARGA has a big challenge on its hands.

Problems

The National Audit Office reported recently that 55% of local authorities in England missed the deadline to obtain an audit opinion on their 2019-20 financial statements, despite an extension of four months to take account of the pandemic. While there were significant practical issues facing both local authority finance teams and audit firms that contributed to these delays, they are symptomatic of wider problems in the local audit market and in the preparation of local authority financial statements.

Local audit in England relies on a small pool of eight firms to audit hundreds of NHS trusts and local authorities within a short time frame each year. Audit firms struggle to find sufficient qualified and experienced individuals to deliver local authority audits, an issue that will only grow as the existing cohort of experienced auditors approaches retirement over the coming decade.

Even with the additional £15m in funding provided this year by the government, audit firms highlight how the risk profile of many councils has increased in recent years as reserves have declined and balance sheets have weakened, with many councils borrowing to invest in commercial activities. The impact of the coronavirus pandemic has damaged the financial position of councils even further.

At the same time, more intensive regulation has – quite rightly – put pressure on audit teams to improve the quality of their work, but that has cost implications too, with firms expressing concern about the viability of their local audit practices. There is a real risk that one, or more, firms could withdraw from the market, reducing competition and putting even more pressure on the remaining firms.

There are also significant barriers to entry, starting with a requirement for audit partners to qualify as a key audit partner in addition to being a registered auditor, a requirement specific to the local audit market and not applicable to other sectors requiring equal or much greater sector-specific knowledge and expertise.

This is an obstacle to new firms considering bidding for local audit contracts, even where they have audit partners with experience that would make them eligible to apply and the ability to train and recruit staff with the necessary capabilities. The limited number of key audit partners in each individual firm also makes it more difficult to manage multiple audits within the short time frames needed to achieve audit deadlines.

Stabilising the local audit market and working with the government to ensure there is a viable pool of expertise available to carry out quality audits will be one of the first items on the ARGA agenda.

Priorities

However, audit reform is only part of the story. There is also a need to invest in local authority finance teams and in making the local authority finance profession an attractive career choice. Local authorities need to place a higher priority on the importance of producing high-quality financial statements that meet best practice and how doing so can increase financial understanding among both officers and councillors. Success in this area would also benefit local taxpayers’ understanding of and ability to scrutinise spending decisions, improving accountability and transparency.

There also needs to be investment in the quality of the underlying financial records and the supporting working papers provided to external auditors – a cause of delays in some audits. Not as sexy as many of the budget proposals that go to councillors for approval, but we know that poor financial controls and a lack of financial understanding by decision-makers and those to whom they are accountable can cost a lot more in the long run.

Unfortunately, far too many local authorities appear to treat their annual financial statements and the audit as a compliance exercise, something to be ‘got through’ rather than an opportunity to give a full account of how well they have stewarded public resources on behalf of residents.

Poorly formatted and difficult to read, too many council financial reports and accounts are seemingly designed for depositing in the round filing cabinet, rather than taking their place alongside flagship reports. Such reports are often of much less importance and priority than the hundreds of millions of pounds of public money spent on delivering local services or, in some cases, that have been wagered in speculative commercial investments.

I believe that the new regulator will need to look beyond the audit firms and engage with local authorities and their finance teams to demand and encourage improvements. Although audit firms can, and do, insist on changes to financial statements where they fail to comply with accounting standards or are actively misleading, they can’t insist local authorities follow best practice or that they invest in making the financial statements understandable to elected representatives and to the public. There is a role for the new regulator to bring up reporting quality across the sector.

It is important to realise that the proposed new standardised statement of service information and costs won’t be enough on its own. Readers need to be able to understand the wider financial position of each local authority, such as the level of usable reserves and balance sheet risks—and that requires investment in the entire annual report and accounts to make the financial information presented more understandable.

High standard

The overall package of reforms is positive: a new system leader for local audit and a rationalisation of the regulatory environment; a new audited statement of service information and costs to enable budgets and spending to be compared; a review of audit requirements for smaller bodies; auditors to provide an annual report to full council; an independent member with financial expertise on council audit committees; and a willingness to look again at audit deadlines.

But we should not forget that external audit comes at the end of the process and that solving the problems in the local audit market will only go so far.

Ultimately these reforms will only be successful if the financial statements subject to audit are of a high standard in the first place. That means greater investment in finance teams and—most importantly—council leaders and officers placing a higher priority on the quality and understandability of the financial information they produce.

This article was originally published in Room 151, an online news, opinion and resource service for local authority section 151 and other senior officers covering treasury, strategic finance, funding, resources and risk, and subsequently published by ICAEW.

Fiscal deficit of £24.3bn in May as COVID spending trends downward

COVID-related spending continues to drive borrowing even as receipts approach pre-pandemic levels, with debt up by £24.9bn to £2,195.8bn or 99.2% of GDP in May 2021.

The latest public sector finances released on Tuesday 22 June reported a deficit of £24.3bn for May 2021, as COVID-related spending continued to weigh on the public finances, albeit at a reduced rate. An improvement from the £43.8bn reported for the same month last year during the first lockdown, it was still significantly higher than the £5.5bn reported for May 2019.

The Office for National Statistics revised the reported deficit for the year ended 31 March 2020 down by £1.1bn from £300.3bn to £299.2bn, still a peacetime record. The final total is still expected to exceed £300bn as the ONS has yet to include in the order of £27bn of bad debts on COVID-related lending in this number. Estimates will be refined further over the next few months.

Cumulative receipts in the first two months of the financial year of £128.6bn were £15.9bn or 14% higher than a year previously, but this was still £0.7bn or 0.5% below the level seen a year before that in April and May 2019. At the same time cumulative expenditure of £165.8bn was £20.9bn or 11% lower than the first two months of 2020-21, but £37.2bn or 29% higher than the same period two years ago.

Ultra-low interest rates continued to benefit the interest line, which at £9.1bn in April and May 2021 was £0.1bn or 1% lower than April and May 2020 and £1.5bn or 14% lower than April and May 2019.

Net public sector investment was slightly lower than last year with £7.1bn invested in April and May 2021, down £0.8bn or 10% from a year before but up £0.9bn or 15% from two years ago.

This combined to produce a cumulative deficit for the first two months of the 2021-22 financial year of £53.4bn, £37.7bn or 41% below that of the same period a year previously, but up £37.3bn or 232% from the total for April and May 2019.

Public sector net debt increased to £2,195.8bn or 99.2% of GDP, an increase of £58.4bn since March, reflecting £5.0bn of additional borrowing over and above the deficit, principally to fund coronavirus loans to businesses. Debt is £259.1bn or 13% higher than a year earlier and £427.2bn or 24% higher than in April and May 2019.

Alison Ring, ICAEW Public Sector Director, said: “With numbers for the second month of the financial year now in, we can see tax receipts are starting to approach pre-pandemic levels, while borrowing continues to increase despite COVID-19 spending starting to decrease. 

“The public finances remain in a fragile state, and ongoing debates about education spending, adult social care and the pensions triple-lock highlight the difficult decisions facing Rishi Sunak as he seeks to balance pressures on our public services with still growing levels of public debt. The prospects of the Chancellor raising taxes in the Autumn Budget appear to be increasing.”

Images showing a table of the fiscal numbers for 2 months to May 2021 and variances against the prior year and two years. Click on link at end of this post to the ICAEW website which has a readable version of the table.
Images showing a table of the fiscal deficit by month, including receipts, expenditures interest and net investment. Click on link at end of this post to the ICAEW website which has a readable version of the table.

Caution is needed with respect to the numbers published by the ONS, which are expected to be repeatedly revised as estimates are refined and gaps in the underlying data are filled.

The ONS made a number of revisions to prior month and prior year fiscal numbers to reflect revisions to estimates. These had the effect of reducing the reported fiscal deficit for April 2021 from £31.7bn to £29.1bn and the deficit for the twelve months ended 31 March 2021 from £300.3bn to £299.2bn.

This article was originally published by ICAEW.

NAO: UK ‘lacked playbook’ for emergencies like the pandemic

National Audit Office says the UK government acted at unprecedented speed to respond to the virus, but needs to build resilience and management capabilities if it is to cope better with future emergencies.

The National Audit Office (NAO) issued a report on ‘Initial learning from the government’s response to the COVID-19 pandemic’ on 13 May 2021. This attempts to identify key lessons for the government to take if it is to improve the UK’s ability to respond to future emergencies.

The report sets out six themes where the NAO believes that the government could learn from the experience of the covid-19 pandemic, which has involved measures with estimated lifetime costs of £372bn so far.

Risk management

  • Identifying the wide-ranging consequences of major emergencies and developing playbooks for the most significant impacts.
  • Being clear about risk appetite and risk tolerance as the basis for choosing which trade-offs should be made in emergencies.

Transparency and public trust

  • Being clear and transparent about what the government is trying to achieve, so that it can assess whether it is making a difference.
  • Meeting transparency requirements and providing clear documentation to support decision-making, with transparency being used as a control when other measures, such as competition, are not in place.
  • Producing clear and timely communications.

Data and evidence

  • Improving the accuracy, completeness and interoperability of key datasets and sharing them promptly across delivery chains.
  • Monitoring how programmes are operating, forecasting changes in demand as far as possible, and tackling issues arising from rapid implementation or changes in demand.
  • Gathering information from end-users and front-line staff more systematically to test the effectiveness of programmes and undertake corrective action when required.

Coordination and delivery models

  • Ensuring that there is effective coordination and communication between government departments, central and local government, and private and public sector bodies.
  • Clarifying responsibilities for decision-making, implementation and governance, especially where delivery chains are complex and involve multiple actors.
  • Integrating health and social care and placing social care on an equal footing with the NHS. Balancing the relative merits of central, universal offers of support against targeted local support.

Supporting and protecting people

  • Understanding to what extent the pandemic and government’s response have widened inequalities, and taking action where they have.
  • Providing appropriate support to front-line and other key workers to cope with the physical, mental and emotional demands of responding to the pandemic.

Financial and workforce pressures

  • Placing the NHS and local government on a sustainable footing, to improve their ability to respond to future emergencies.
  • Ensuring that existing systems can respond effectively and flexibly to emergencies, including provision for spare or additional capacity and redeploying staff where needed.
  • Considering which COVID-19-related spending commitments are likely to be retained for the long term, and what these additional spending commitments mean for long-term financial sustainability.

The report does not contain any new substantive recommendations as it in effect brings together insights from 17 individual reports conducted by the NAO into different aspects of the government’s response to the pandemic. However, it is helpful in identifying some of the common strands emerging from the NAO’s work, such as the importance of effective cross-government working.

Perhaps the most significant finding is that the government lacked a playbook for many aspects of its response, with pre-existing pandemic contingency planning not including plans for identifying and supporting a large population advised to shield, employment schemes, financial support to local authorities and managing mass disruption to schooling.

Alison Ring, director for public sector at ICAEW, commented: “The NAO is careful to balance the negatives it saw in the government’s response to coronavirus with positives such as the design and roll-out at speed of large-scale interventions under huge pressure. However, it is clear that the NAO believes that the UK was underprepared for a high-impact low-likelihood event like the pandemic, and the lack of detailed plans in key areas hampered the government’s response.

“While accepting that no plan can cover all the specific circumstances of every potential crisis, the NAO nevertheless believes that more detailed contingency planning can improve the government’s ability to respond to future emergencies.” 

For more information, the full report is available from the NAO website.

This article was originally published by ICAEW.

April fiscal deficit drops to £31.7bn as new financial year gets underway

The latest public sector finances reported a deficit of £31.7bn for April 2021, as COVID-related spending continued to weigh on the public finances.

Although an improvement from the £47.3bn deficit reported for the same month last year during the first lockdown, the figures are still significantly higher than the £10.6bn reported for April 2019.

The Office for National Statistics also revised the reported deficit for the year ended 31 March 2020 down by £2.8bn from £303.1bn to £300.3bn, still a peacetime record. The ONS has yet to include in the order of £27bn of bad debts on COVID-related lending in this number and estimates will be refined further over the next few months.

Receipts in April 2021 of £64.6bn were £7.8bn or 14% higher than a year previously, but this was still £1.1bn or 2% below the level seen a year before that in April 2019. At the same time, expenditure of £83.3bn was £9.3bn or 10% lower than April 2020, but £18.7bn or 29% higher than two years before.

Ultra-low interest rates continued to benefit the interest line, which at £5.3bn in April 2021 was £0.2bn or 4% lower than April 2020 and £1.5bn or 22% lower than April 2019.

Net public sector investment, as planned, has continued to grow with £7.7bn invested in April 2021, up £1.7bn or 28% from a year before and £2.8bn or 57% from two years ago.

This combined to produce a deficit for the first month of the 2021-22 financial year of £31.7bn, £15.6bn or 33% below that of the same month a year previously, but £21.1bn or 199% higher than April 2019.

Public sector net debt increased to £2,171.1bn or 98.5% of GDP, an increase of £33.6bn over the course of April, reflecting £1.9bn of additional borrowing over and above the deficit, principally to fund coronavirus loans to businesses and tax deferral measures. Debt is £304.6bn or 16% higher than a year earlier and £410.2bn or 23% higher than in April 2019.

The net cash outflow (the ‘public sector net cash requirement’) for the month was £34.5bn.

Commenting on the figures, ICAEW’s Public Sector Director Alison Ring said: “It is difficult to read too much into the first month’s numbers in a new financial year, but the Chancellor is likely to be relieved that the gap between receipts and spending is narrower than that seen last year during the first lockdown. But the public finances are not out of the woods, with tax receipts still below pre-pandemic levels and COVID-related spending continuing to drive up borrowing. 

“The focus over the next few months is likely to be on the next Spending Review, which will decide on future public spending and investment with the long-awaited social care funding strategy now anticipated to be announced later this year. However, the need to address the long-term unsustainability of the public finances shouldn’t be forgotten.”

Image showing receipts, expenditure, interest, net investment, deficit, other borrowing, changes in net debt, and net debt for April 2021 public sector finances, together with variances against April 2020 and April 2019. For a readable version of the table click on the link to the ICAEW article at the end of this post.

Caution is needed with respect to the numbers published by the ONS, which are expected to be repeatedly revised as estimates are refined and gaps in the underlying data are filled.

The ONS made a number of revisions to prior month and prior year fiscal numbers to reflect revisions to estimates and changes in methodology. These had the effect of reducing the reported fiscal deficit in the twelve months ended 31 March 2021 from £303.1bn to £300.3bn.

For further information, read the public sector finances release for April 2021.

This article was originally published by ICAEW.

What COVID-19 means for the future of tax

This article features in the May 2021 edition of TAXline, ICAEW Tax Faculty’s monthly magazine. One article is freely available each month.

With the pandemic increasing pressure on public finances, could this prompt overdue discussions on tax reform? ICAEW’s Head of Tax Frank Haskew and independent adviser Martin Wheatcroft reflect on recent announcements and challenges facing the Chancellor.

With the UK’s deficit set to increase to £2.5tn by 2023, the fact that tax revenues do not cover public spending is starker than ever. However, the problem of balancing the books far predates COVID-19. 

An aging population coupled with funding and tax administrative decisions made many decades ago have meant that the gap has been slowly but inexorably widening. Frank Haskew, Head of Tax at ICAEW, says: “Since the turn of the century, we have been running deficits almost every year. The fact is that we’re not raising enough tax meet to our day-to-day spending commitments.”

Martin Wheatcroft, an independent adviser and author on public finances who works closely with ICAEW, explains: “People are living longer which is a good thing, but it has a financial impact. For example, the NHS spends an average of £80 a month on 18-year-olds, while for 80-year-olds that cost is more than £500. The perennial issue is that we don’t have a clear long-term strategy for how the government, or any government, plans to deal with that.”

To balance the books, the primary strategy of governments has been to grow the economy and have a moderate level of inflation to inflate away debt. However, financial crises and recessions have meant that in the past decade growth has been a lot weaker than expected. George Osborne, for example, was forced to leave the Exchequer without fulfilling his pledge of eliminating the deficit due to the underperformance of the economy. “When you combine the demographic pressures with slower economic growth then it’s a difficult situation,” says Wheatcroft.

Paying for coronavirus

Into this strained situation enters a global pandemic and its huge financial repercussions. Alongside the severe and prolonged impact on economic activity, stimulus and support packages are expected to add between £0.5tn–£1tn onto UK debt in the next few years. 

Ahead of the Budget in March, the expectation was that the Chancellor would be looking for ways to raise revenues to help cover the costs of COVID. However, the measures announced will not do so – in the short term at least.

“It’s fair to say that there was no serious attempt to tackle a growing fiscal deficit in the Red Book,” says Haskew. “The 2019 manifesto pledge that there would be no rise in VAT, income tax or national insurance means that the Chancellor is prevented from the most obvious, and quick, ways in which to raise revenues.”

The flagship measure for revenue raising in the Budget was the increase to corporation tax rates. However, as the change will not come into effect until 2023, this will not provide a quick cash injection. Haskew also argues that the fiscal impact may not be significant. “The potential corporation tax revenues over the forecast period are pretty much balanced by the cost of the super deduction. In overall terms any difference is probably loose change,” he says.

Wheatcroft believes the measure gives an indication of the government’s medium-term plans. “One of the more positive things you can do in the medium term to get your public finances under control is encourage stronger economic growth. By taking action on corporation tax the government wants to try and at least stabilise the situation.” 

Reallocating spending

Evidence for where the Chancellor is securing finance in the short term can be seen in the integrated defence review published on 16 March, which confirmed that the size of the army would be further reduced by 2025. “Since the 1950s the UK has cut defence spend from 10% of GDP down to 2%. Reallocating that finance to healthcare that has helped successive governments avoid increasing taxes,” explains Wheatcroft. “However, with defence spend now just above the NATO minimum, there’s no further capacity and taxes are going to have to go up at some point.” 

Haskew agrees: “The measures announced so far are just nibbling at the edges of the problem. The UK has a strategic question as to whether it tackles the deficit and if so how. Since the start of the pandemic there’s been suggestions from some commentators that capital gains tax and inheritance tax might rise, and other have proposed wealth taxes, but we saw none of those suggestions in the Budget. It shows just how hard it is to raise taxes.”

The need for change

There are a number of areas of the UK tax system that have been ripe for reform for many years, including the differences between the taxation of the employed and self-employed. “We’ve had a position of significant difference between these two types of taxpayer for 20 years and more. Successive governments, of every political hue, have identified it as a concern but never successfully addressed it,” says Haskew. 

He cites Philip Hammond’s attempt to make relatively modest changes to national insurance contributions for the self-employed in 2017, which were reversed within a week. 

Wheatcroft, meanwhile, points to the perennial thorny issue of business rates and the interim review published as part of HM Treasury’s Tax Day announcements on 23 March. “Everybody was in total agreement that it’s a bad tax and needs reform, but they were also very unhappy about the main alternative option,” he says. “There’s definitely an inertia bias when it comes to changing taxes because it is so difficult. It’s much easier to stay with the current ones, simply because they already exist and they are collecting revenue, however imperfectly.”

Haskew agrees: “These cases highlight that a lot of the structural problems in the tax system have become so ingrained that trying to change them is almost impossible.”

Catalyst for reform

Decisions on how to balance the books have been getting increasingly difficult year on year, but could the dramatic impact of the pandemic provide the impetus for the government to set out a long-term vision of how to tackle the deficit and for Rishi Sunak to make some brave choices?

“From a public support point of view, this past Budget was politically the best possible time to raise taxes, with everyone understanding the financial impact of the interventions that the government has had to take,” says Wheatcroft. “However, from an economic perspective it would be the worst time. At the moment the government wants to do everything possible to encourage a strong economic recovery. This is probably why the government took the opportunity to pre-announce raising corporation tax rates now, rather in three years’ time immediately prior to a general election.”

Wheatcroft suggests that the Chancellor has potentially another 12 months of political goodwill in which to implement changes and suggests that Tax Day is a good indication of travel. “The very fact of having a Tax Day announcing the consultations and setting out a 10-year strategy, which it did last year, is a positive sign of longer-term thinking,” he says.

Haskew believes that now is the time to start having a national conversation about the future of tax and cites a Treasury Committee report, Tax after coronavirus, published on 1 March as a step in the right direction. “It’s a really interesting report because there was a consensus among the cross-party members about proposals to try and address some of these issues,” he says. 

“The deficit and tax reform are more than political issue, so reaching a consensus was really encouraging,” he says. “We have this growing problem as a nation, so what are we going to do about it? These things need to be debated, to see whether we can reach some consensus about the best way of raising tax without harming productivity.”

This article was originally published by ICAEW.