ICAEW chart of the week – Deficit reduction

Ross Campbell, Director for the Public Sector for the ICAEW, writes:

“After a pause last week while I was behind the Great (fire)wall of China, the ICAEW chart of the week resumes with a look at how the Government has got on with tackling the UK’s current expenditure deficit.

Steady progress was made between 2009-10 and 2016-17 with the numbers mostly going in the right direction and the deficit falling from £152bn to £45bn.  While this is progress it is however still important to remember that we are still spending more than we earn as a nation – a situation that is not sustainable in the long run.

The impact of the chancellor’s decision to ease up on public consolidation in the March 2017 budget is also striking – with the deficit increasing again to £58bn in 2017-18 it has turned dealing with the deficit into a 15 year (or three parliament) problem. Continuing to run a deficit means borrowing money every year to pay the running costs.  With the National Debt at an all time high for peacetime and UK facing a worsening macro-economic position, the cost of that borrowing is only going to put further pressure on public expenditure.

It is time to deal with the deficit once and for all.”

To comment, visit the ICAEW Talk Accountancy Blog.

ICAEW chart of the week – EU Budget 2017

Ross Campbell, Director for the Public Sector for the ICAEW, writes:

“This week’s chart continues the Brexit theme by looking at where the money that we pay to the EU is spent.

It shows how Germany, the UK, France and Italy are the largest contributors, with roughly 79bn euros going into the EU pot, while they receive only about 44bn euros of that back.  The majority of their net contributions go toward post-2000 EU members, principally in eastern Europe, while pre-2000 countries such as the Netherlands, Sweden, Denmark and Austria which also pay in more than they get back are substantially balanced by countries such as Spain, Greece, Portugal and Belgium who are net recipients.

Only a relatively small proportion of the UK’s net contribution goes toward the cost of running EU institutions, agencies and programmes. Instead most of the net contribution actually ends up being spent further east, on economic development programmes in Poland, the Czech Republic, Romania, Hungary and Bulgaria. Consequently the focus on how much the UK is going to contribute to agencies such as Europol or the European Space Agency, or to programmes such as Erasmus, is really missing the point – these are small amounts compared to economic development funding for eastern Europe.

It is worthwhile observing that these countries are now NATO allies and all of them made commitments to increase defence spending on the basis of national budgets that assumed continued funding from the UK via the EU. It is also worth observing that with increased tensions between NATO and Russia – it may well be in the UK’s strategic interest to continue to support increased defence spending in eastern Europe.”

To comment, visit the ICAEW Talk Accountancy blog.

A billion pounds is a lot of money. Or is it?

A billion pounds is a lot of money.

Even when using the now commonly accepted ‘American’ meaning of the word, a billion is a seriously big number. At a thousand million, or 1,000,000,000 (that’s nine zeroes) it is decidedly large.

A pound may not be worth so much these days, but a billion of them? A very large sum of money in any language.

Indeed, for almost everyone apart from those tiny number of people who have that sort of wealth already, the value of a billion pounds is difficult to imagine. The interest in one year alone would be many times the amount most of us might hope to earn in our entire lifetime. To be able to afford thousands of homes, when many struggle to even buy one. Lots of money. Loads.

At the same time, a billion pounds is not a lot of money.

You hear about them on the news all the time. Our government plans to spend 802 of them this year and so one billion is small change, just 0.12% of a year’s spending. So small that the government could decide to spend an extra billion pounds and it might not even show up in the numbers due to rounding.

Of course, the reason for this duality is simple; for a country with tens of millions of inhabitants, even very small amounts for each individual add up to a lot of money.

Thus £1 billion is just £15.10 per person when spread over the 66.1 million people that live in the UK. On a monthly basis, that’s only £1.26 for each of us.

Enough to buy a high street coffee every other month. Not very much at all.

You can start to understand why there are so many of these billions around. A £4 billion cut in spending; that would save each of us about £5 a month. That extra £2 billion on housing? That’s going to cost us an additional £2.50.

So, when you hear that the government intends to spend an extra billion pounds a year on something or other to make our lives better, just remember that it is not a big amount of money at all.

Even so, it is also important to realise something too.

A billion pounds is a lot of money.

ICAEW chart of the week – The EU exit bill

Ross Campbell, Director for the Public Sector for ICAEW, writes:

“With the UK-EU negotiations rumbling on in Brussels, this week’s chart shows the range of likely scenarios that the ICAEW has modelled for the exit charge.

The softening in tone from Downing street following the Prime Minister’s speech in Florence last week, leads us to the conclusion that the ‘high’ scenario now appears to be a more likely outcome.  The speech proposed that UK would seek a transition period after the UK’s departure from the European Union on 30 March 2019. This should run for a period of at least 21 months until the end of 2020, covering the remainder of the EU’s 2014-2020 multi-year financial framework (MFF).

The statement that no country would pay more or less towards the EU Budget indicates that the UK now expects to contribute to the EU on the same basis during the transition period up until the end of 2020 as if it had remained a member. It also implies that the UK has accepted that it will need to contribute towards spending authorised before 2020 that will be paid out in the years after 2020. For example, for years 4 to 10 of a ten-year research grant authorised and starting in 2018.

Our Chart of the Week comes from our report ‘Analysing the EU exit charge’, which sets out the different components of the exit charge in a short digestible summary document. It can be found at:

http://www.icaew.com/technical/economy/brexit/analysing-the-eu-exit-charge.

 One question not yet answered is how much the UK will need to contribute for a longer transition period that extends into 2021 or further, nor to the financial arrangements in order to participate in EU agencies and programmes in the longer-term. So even if both sides can wrap up a deal on the exit charge soon, there remain several more financial negotiations to conduct in the months to come.

Of course, as we all know when it comes to negotiations – nothing is agreed until everything is agreed! “

To comment, please visit the ICAEW Talk Accountancy blog.

Printing money costs money

In a letter to the Guardian, Martin Wheatcroft comments on Professor Richard Murphy’s suggestion that ‘People’s QE’ can be used to finance government spending at no cost.

Professor Richard Murphy (Letters, 27 September) is mistaken when he claims that “QE debt carries no interest cost” and that we can ignore capital markets by using “People’s QE” to finance public spending cost-free. As a chartered accountant, he should know better. No debit exists without a credit, and the purchase of bonds by the Bank of England results in one form of public debt (government securities) being replaced by another (Bank of England deposits). Interest is payable on these deposits at the Bank of England base rate – currently 0.25%. This is not zero.

Quantitative easing swaps the benefit of locking-in the interest rate payable on long-term fixed-rate government securities for variable interest charges. The good news is that the £435bn of QE debt that we have today has been swapped into deposits paying 0.25%, costing the exchequer just £1bn in interest each year on this element of the national debt. However, the base rate could change very quickly depending on economic conditions and the decisions of the Monetary Policy Committee. An increase to 2% – historically still quite low – would cost an extra £8bn a year in interest, while at 5% – the rate in 2006 before the financial crisis – the annual interest cost would be £21bn higher than it is now.

Borrowing to finance public spending can be a sensible policy in the right circumstances, especially if directed at infrastructure and other investments that generate economic growth. But, politicians considering People’s QE as a policy choice should understand that there is no such thing as free finance, even for governments. As it turns out, even printing money costs money.

Martin Wheatcroft
Author of Simply UK Government Finances 2017-18

ICAEW chart of the week – EU contributions

Ross Campbell, Director for the Public Sector for ICAEW, writes:

“With the discussion in politics once again turning to the size of the saving that the UK will make when it stops paying contributions into the EU, this week’s chart is a reminder of what we currently pay and what we get back from the EU.

It is certainly worth noting that while the UK is a net contributor to the EU, both the gross contribution of £290m per week and the net contribution of £165m a week – what actually leaves the UK- are substantially smaller than the £350m a week claimed saving.

What is also worth bearing in mind is that the annual net contribution of approximately £8.6bn is really only about 1% of UK annual government expenditure.”

To comment, please visit the ICAEW Talk Accountancy blog.

ICAEW chart of the week – Public sector net borrowing

Ross Campbell, Director for the Public Sector for the ICAEW, writes:

“This week’s ‘Chart of the Week’ shows two things.

First, that when the government talks about net borrowing, it doesn’t actually include everything that gives rise to an increase in the Government’s debts.  This is a statistical convention, but we accountants tend to think it is misleading as it under-represents the extent to which the country is living beyond its means.

Two, and more importantly, that the UK state is still spending significantly more than it earns in tax and other revenues.  It’s all very well calling for increases in public spending, but as existing spending is not currently covered by revenues, spending more creates an even bigger long term problem (with interest!) in the form of a growing debt burden. All that does is delay the difficult decisions about whether to raise taxes or cut spending to levels we can afford, all the while putting ever more pressure on public spending as the interest bill goes up.

As business people we know that the state is not a business, but in the long run similar rules apply and if it was a business, then it would be running at an ever increasing loss. We really need to improve financial management in government.”

To comment, please visit the ICAEW Talk Accountancy blog.

ICAEW chart of the week – Public debt

Ross Campbell, Director for the Public Sector for ICAEW, writes:

“Here is the latest Chart of the Week from the ICAEW.

This week’s chart shows that public debt has tripled over the last decade.

While economic growth has been at historically low levels over the last decade, reducing tax receipts, government borrowing has rocketed in order to keep paying for public services and social welfare. 

With the average life of borrowing now out to 18 years, as long as the government is still able to borrow, we won’t have to settle our debts anytime soon but we do have to pay the interest on all of this debt.  Let’s hope interest rates stay low!”

To comment, please visit the ICAEW Talk Accountancy blog.

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

Surprisingly, a lower corporate tax rate may actually discourage investment in the UK

The Autumn Statement is tomorrow, and the press is full of speculation that our new Chancellor Philip Hammond will not only hold to previously announced cuts in the corporation tax rate, but will announce a further reduction, despite an expected hit to the public finances from lower economic growth.

A reduction from the current rate of 20% is planned for this April when it is due to come down to 19%, with a further cut to 17% in April 2020. As a consequence it is likely that any new announcement will be in the form of a commitment to reduce the rate to 15% at some point in the next decade.

This definitely sounds attractive – the UK should be an even more rewarding place to base your business than higher tax jurisdictions, such as Germany with its 30%-33% rates, or the US with its combined federal and state tax rates in the order of 40% (albeit Donald Trump is proposing to reduce federal taxes so that the combined rate would come down to around 20%). The UK will perhaps be in touching distance of Ireland with its comparatively low 12.5% rate.

However, a 5% cut in the corporate tax rate is going to cost a lot of money – at least £10 billion a year. Will we really make up for this through increased economy activity and encouraging businesses to invest in the UK?

Perhaps it will. A lower tax regime should encourage businesses to invest in the UK, shouldn’t it? And more investment should mean more jobs, more spending in the UK and and more profits, each generating taxes to offset the cost of the lower corporation tax rate.

But, and there is a but. This change will provide an incentive for international businesses to shift spending out of the UK and into higher tax jurisdictions.

This may sound counterintuitive, but remember that most investment and spending in the UK economy comes from businesses already operating in the UK and internationally. And for them the equation is a little different.

For example, take a business already operating in both the UK and Germany, paying taxes on its profits in each jurisdiction. The lower corporation tax rate will provide an incentive to increase profits in the UK and to decrease them in Germany.

The orthodox answer is to do what the government would like – to prioritise investment in the UK over Germany. But in reality, there is a much easier way to take advantage of this tax differential and that is to do the opposite – to increase spending in Germany and reduce spending in the UK.

After all, this would provide a 30% or so tax deduction on the additional German costs, at the cost of 15% on the higher profits it would generate in the UK – a 15% saving for each pound (or euro) of spending shifted over to Germany.

Of course, life is a bit more complicated than this simple example. In theory the international tax system of “transfer pricing” should offset this sort of cost shifting. But in reality, outside of a straightforward manufacturing or product business, it probably wouldn’t. Especially as this would not necessarily be a clearly linked event, perhaps not even a conscious decision. It would just make financial sense to prioritise cost cutting in the UK over cost cutting in Germany.

There are many arguments for lowering the corporation tax from its current level of 20%; not all of them about the effect on the public finances and on economic activity. Indeed, in years to come, a 20% rate may seem very high, just like the 52% rate that applied in the 1970s seems extremely high to us today. Arguably those historic rate reductions have generated positive returns to the economy, certainly in making the UK an attractive place to do business.

But, I do wonder. Are we getting to the point where cutting the rates below 20% will be effective at stimulating the economy or is this a case of diminishing returns?