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.

Pressure on public services – is it immigration or people living longer?

During the current EU debate a frequent complaint from the Leave side is about the pressure that immigrants put on public services, while the Remain side reply with economic studies indicating that immigrants pay more in taxes than they take out.

Both sides have a point – there are definitely more people living in the UK as a result of migration and so there should in theory be a greater demand on public services. However, it is also true that new migrants are typically young, in good health and generally here to work, likely to be putting more into the system than they take out.

But can it be as simple as just that?  We are also regularly informed that the biggest pressures on public services are coming from an increasingly older population, so which is it: immigration or growing older?

I thought I would start by looking at what has happened over the last twenty years, when the population has grown by seven million people, from 58 million people living in the UK in 1995 to 65 million in 2015.

Of that increase, four million is due to net migration and three million from natural changes. So there you have it, migration is more than half the increase.

But then I looked at how the increase splits between older and younger people, i.e. those older or younger than 40?  It turns out that over the last twenty years, the number of people aged over 40 has increased by six million, while the number of people under 40 has increased by only one million.

And how much of that six million increase in the over 40s is down to migration?  Amazingly, I discovered that the answer is (approximately) zero.  17 million people reached the age of 40 over that time, much more than the just over 11 million people who died, a net increase of six million due to natural changes.

Now, just to be clear, there has of course been immigration amongst the over 40s. But, the numbers suggest that they have either been here for 20 years or more or, if they arrived more recently, that there has been equal and offsetting emigration by Brits over 40 who have left the country to work or retire abroad. For the over 40s, net migration has been effectively nil over the last couple of decades.

But of course now I was puzzled.  Looking at the overall population it appears that more than half the growth is due to migration, but if I just looked at older people of 40 and over, I discover that 6 million of the increase out of 7 million (85%) comes from those older people, with zero migration involved.

This becomes clearer when we look at the younger age group. This has only increased by 1 million people from 32 million to 33 million, an increase of just 3% over the two decades, compared with the 12% increase in the total population.

Where has all the migration gone you ask? Well, it hasn’t gone; there definitely has been a net 4 million increase in the number of people aged under 40 as a consequence of migration. But, this has been mostly offset by a reduction of three million in the number of younger people through natural changes.

Looked at in this way, it appears that three million migrants have replaced younger workers in the economy, with only one million going towards the overall increase in the total population.

A contrasting picture, as shown in this handy chart:

Immigration UK 1995 to 2015

So what is the answer? Is the increased pressure on public services due to the four million migrants arriving here over the last 20 years net of departures. Or is it down to the 6 million extra older people, which would have happened anyway even if there hadn’t been any immigration?

A question that I will leave with you to ponder.

 

Whole-of-Government Accounts for 2014-15 published at last

Yes, today is the day that the Whole of Government Accounts for 2014-15 have been published.  And, although it may be easy to criticise the 14 months it has taken since the end of the financial year to publish them, their publication is further evidence of the (quiet) revolution going on in the staid world of government accounting.

These accounts are the sixth set of financial statements published by the Government in this format, using International Financial Reporting Standards (IFRS), in line with the commercial accounting rules applied to listed companies and many other organisations.

Fourteen months is actually still an improvement over the 15 months it took two years ago when the 2012-13 financial statements were published, but it is a reversal from the twelve months it took last year and is disappointing given the Government’s ambition to reduce the time taken to nine months this time around.

The primary cause of the delays stems from problems in the preparation of the accounts for one of the Government’s major ‘subsidiaries’, namely the Department for Education. It has struggled to cope with the transfer of thousands of local authority schools from to academy chains under the control of central government, causing a knock-on impact on the overall financial reporting programme.

Despite that there have been improvements, with Network Rail now incorporated and further improvements in the quality of the accounts.  And, perhaps just as importantly, the Government has started to realise that it needs to do a lot more if it is cope with the financial implications of devolution.

Unfortunately, there has been a small step backward in terms of the commentary provided on the financial statements. It has been streamlined (something I generally welcome as a matter of principle), but in doing so I think the commentary has lost some of the analysis that would be expected in a listed company’s annual report and so makes it a slightly less useful document than it could be. However, I am sufficiently realistic to accept that there is limited usefulness in a detailed comprehensive financial commentary relating to a period that ended over a year ago.

That demonstrates the reason why it is important for the dedicated team at the Treasury working on the WGA to work with departments such as Education in order to return to the path of more timely reporting. It will only when the Whole of Government Accounts are published within a reasonable time after the end of the financial year that they will be able to come into their own as a vehicle for holding the Government to account for the management of the nation’s finances and to support more effective decision making.

Now to actually read them… mmm… I think the £1.5 trillion in pension liabilities might be worthy of a little further follow up….

https://www.gov.uk/government/publications/whole-of-government-accounts-2014-to-2015

The Curious Incident of the Surplus in the Night-Time

One of the challenges in getting to grips with the public finances is that government accounting can be just a little bit weird.  Without the strictures of double entry bookkeeping and balance sheets that (well) balance, it can often appear mysterious.

For example, take the Curious Incident of the Surplus in the Night-Time (or 2019/20 to be more specific).

A £10 billion surplus, according to the official forecasts published published just three weeks ago. If achieved, the Chancellor will have met his objective of balancing income with expenditure for the first time in decades. We will finally be in a position to start paying down some of the national debt, instead of just ‘inflating it away’ as a proportion of GDP.

But, hang on a second. Curiously, the Treasury is actually forecasting in the Budget that we will be £10 billion worse off in 2019/20, not £10 billion better off, with the national debt expected to increase from £1,715 billion to £1,725 billion over the year to 31 March 2020.

Even stranger, there is a forecast for £9 billion in asset sales, the proceeds of which we are told are used to pay off debt. So, a £10 billion increase in public sector net debt instead of the £19 billion reduction in debt that we might expect to see instead.

The Curious Incident of a Surplus in 2019/20.  One that doesn’t result in a positive improvement in the Government’s financial position.

A mystery indeed.

 

Budget surprises can be guaranteed

One of the challenges about trying to predict what will happen in the Budget is that the Chancellor has so many different levers that he can pull.  George Osborne could increase taxes or he could cut them.  He could increase spending or reduce it.  He could borrow more or he could reduce debt.

What makes predicting the Budget so difficult is that the Chancellor can and will do all of the above at the same time.

His existing plans to balance cash inflows with outflows requires tax revenues in 2019/20 to be £73 billion higher than this financial year, with £51 billion coming from economic growth and £22 billion from higher taxes.  With economic growth now expected to be lower he needs to find substantial sums to meet his revenue targets without damaging the economy in the process. This is why radical ideas like abolishing tax relief on pensions have been floated, as they are a way of raising substantial sums now, without (it is hoped) doing too much immediate damage to the economy.

With removing income tax relief on pensions rejected, he will be looking for a different route to raise the money he needs.  One possibility might be charging national insurance on employer contributions into private sector pension funds, while another might be to start cutting away at some of VAT anomalies, such as the lack of VAT on books and newspapers.  Together with rumoured increases in fuel and alcohol duties these measures could help him to meet his revenue target, even assuming phasing in over a number of years.

Of course, no Budget is possible without some form of tax cut or incentive to encourage good behaviour. Even as George takes pounds away with one hand, he will want to give back a few pennies with the other. Of course, this includes continuing the policy of raising personal tax allowances, but I would be surprised if there weren’t some other forms of tax giveaway in the offing. For small businesses, there might be some relief from increases in business rates.

He may need to increase the level of spending cuts he has to deliver, but that is more of an issue for 2018/19 and 2019/20 than it is for the new financial year. Yes, revenues will be lower, but low inflation and the extended period of low interest rates are likely to reduce some of the pressure on costs in the coming year.

If he does have any room to manoeuvre, the smart money is on George trying to increase investment infrastructure. With private infrastructure investment going into reverse following the ending of renewable energy incentives, the Chancellor may decide now is the time to increase the level of direct public investment. Boosting the economy with extra investment now may be the best way to ensure that the Government meets its revenue targets in four years time.

Headlines are likely to focus on whether the Government will achieve its objective of reducing debt as a proportion of GDP in 2015/16. This is dependent on the combination of inflation and economic growth increasing GDP and some £23 billion in asset sales to bring the ratio down. With both inflation and economic growth looking to be lower than expected, and with some of the planned asset sales deferred to the new financial year, this objective may not be met.

Perhaps more interesting will be the position going forward, especially in the three years between now and the 2019/20 financial year that George is committed to going into surplus. With lower deficits in the intervening years, he will have some flexibility in those years to borrow extra to fund investment or, if he chooses, to accept a slightly slower path in cost reductions just as he already has had to do with benefits in the form of tax credits.

So I am looking forward to the Budget on Wednesday. Surprises are guaranteed.

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.

Simply UK Book Launch – Thursday 24 September

Simply UK: A Summary Guide to UK Government Finances 2015/16 is being launched tonight at the Institute of Chartered Accountants in England & Wales in the City of London.

How much is the Government going to spend this year? How does that compare with the amount raised in tax? What is austerity and how is the deficit being reduced? How much is the national debt and what is happening to it? What is the size of the economy anyway?

Transparency in public finances has frequently meant the provision of ever increasing amounts of financial information, without a focus on the need to make that information understandable. As a consequence, most of us know little about our government and how it is financed.

Simply UK aims to remedy that situation by providing a clear and concise summary of the UK Government’s financial position, using vivid and colourful charts to clearly explain how the national debt has grown by £1 trillion over the last decade and how economic growth, tax increases and austerity spending reductions are contributing to the Government’s objective of eliminating the deficit. It explains where the money comes from and where it goes. It also provides information about the EU Budget for 2015, the overall UK economy, and how the tax and welfare systems work.

Simply UK will be available for sale on Amazon from Monday 28 September 2015.  Click here to order your copy.

Budget 2015 Stop the tinkering – it’s time for a coherent long-term strategy

The past few weeks, ahead of a ‘supplementary’ Budget, have been remarkably exciting

Rumours of major tax changes have abounded, while speculation about how planned cuts in welfare of £12 billion are to be achieved have occupied many headlines. Added to this has been a swarm of lobbying, with both left and right calling for increases in the minimum wage in order to reduce the dependence of the low paid on tax credits and housing benefit, and an apparent U-turn by Labour to say that they now accept the principle of targeting a cash surplus in ‘normal circumstances’.

Interestingly, most of this debate is not about the Government’s financial budget for the current year, the main subject of a Budget announcement. Rather it is focused on the Chancellor’s four-year plan to cut expenditure until there is a surplus in cash terms and about how we can improve the tax and welfare system to make it more effective.

This shifting of the debate is welcome. Although many commentators are still debating the minutiae of the tax and welfare system, such as the intricacies of inheritance tax and benefit caps, or the merits of reducing one of the seven different rates of tax on our salaries, there is an increasing acceptance amongst policy makers across the political spectrum that the complexity of the current system is an obstacle to achieving its objectives of raising money in fair way and supporting those in need effectively.

Perhaps even more welcome is the realisation that our public finances need to be managed much better than they have been in the past. Not only does our Government owe £1.5 trillion in debt, but it has £1.3 trillion in unfunded public sector pension obligations on its whole-of-government accounting balance sheet that will need to be paid for by increased taxes or through further cuts in welfare or public services. And that is even before considering how we find the money to pay for the costs of an increasingly long-lived population, with the future cost of the state pension alone estimated to be more than £4 trillion in a recent report by the Centre for Policy Studies.

Piecemeal tinkering with the tax and welfare system is not going to be enough; we need a plan.

Hence what would be most welcome in this Budget would be an announcement of a comprehensive financial review, as called for by the ICAEW. Considering income, expenditure, cash flow and the balance sheet over the long-term, it would lead to the development of a coherent long-term financial strategy setting out how we can achieve sustainable public finances over the next quarter of a century and beyond.

Such a strategy should include a roadmap to radically restructured system of tax and welfare, with a wholesale replacement of the complex array of inconsistent taxes and welfare benefits with a simple and coherent system of fair taxes and welfare support for those in need, reflecting the following characteristics:

  • Simple – benefiting government just as much as citizens and businesses through clarity, lower administration costs and more effective targeting of support.
  • Sustainable – affordable to both individuals and to the taxpayer over the long-term.
  • Integrated – with a consistent set of rules across taxes and welfare benefits that would mitigate the need for anti-avoidance measures or complex welfare enforcement processes.
  • Joined up – across government, for example with housing policy.
  • Incentivising – making it financial rewarding to work and addressing the poverty trap inherent in the current system that reinforces welfare dependency.
  • Funded – increasing the emphasis on savings, so that we are less reliant on the uncertain ability of future generations to fund our old age.
  • Helpful – establishing a structure that helps people to do the right thing, such as automatic enrolment in pensions, social care insurance and savings plans.
  • Cross-party – sufficient support for core elements of the strategy so that it will survive changes in government over the transition period of ten to twenty years likely to be needed.
  • Fair – and perceived to be fair.

That the focus of a Budget announcement has changed from a one-year time horizon into a more substantive debate about the Government’s medium-term fiscal strategy is positive. But we need to go much further if we are to end the piecemeal tinkering of successive governments applying patches to address the problems caused by an overcomplicated system, while at the same time advancing their own policy goals by adding further complexity.

It is time for a coherent long-term strategy. A plan that not only sets out how we can fund our nation in the future, but that also establishes a path to replacing a failed system of tax and welfare.

Martin Wheatcroft is managing director of Pendan.

This article was originally published in Economia.