Why is cutting public spending so difficult?

Martin Wheatcroft FCA, external adviser on public finances to ICAEW, assesses what options the government has to reduce the gap between receipts and expenditure.

Despite rolling back £32bn out of the £45bn of tax cuts announced in the mini-Budget, Chancellor of the Exchequer Jeremy Hunt is expected to announce tax rises as well as spending cuts when he sets out the Government’s Autumn Statement and medium-term fiscal plan on 17 November. 

The consensus is that he needs to find around £50bn a year to reduce the gap between receipts and expenditure if he wants to get the public finances back under control and provide himself with some headroom in case the situation deteriorates further. This could include extending beyond April 2026 the freeze in personal tax allowances announced by Prime Minister Rishi Sunak when he was Chancellor, as well as scaling back the ‘levelling up’ agenda of former Prime Minister Boris Johnson.

You’d think trimming 3% or so off an annual public spending bill of over a trillion pounds a year wouldn’t be that difficult, but each of the main options for cutting spending in the medium term are unpalatable and politically challenging:

  • Real-terms cuts in pensions and welfare are possible but difficult to deliver politically during a cost-of-living crisis, as previous Prime Minister Liz Truss discovered when she was forced to deny she was planning to abandon the triple-lock mechanism. 
  • Real-terms cuts in public sector pay are likely but come with the prospect of much greater disruption from industrial action and increasing difficulties in recruiting and retaining staff. 
  • Cutting investment in infrastructure and capital programmes is the easiest option to achieve but comes with risks to future economic growth and business investment.
  • Greater efficiency is possible but practically difficult to deliver, with significant project delivery risks and the need for sufficient capital investment to be successful.
  • Higher fees and charges are possible but risk a political backlash.
  • Lowering public service outputs or quality is possible but there are practical limits to how far you can continue to cut funding for many public services without adverse effects.

Forecasts for public spending

Total managed expenditure is budgeted to amount to £1,087bn in the current financial year ending 31 March 2023 (2022/23), equivalent to approximately £1,340 per month for each of the 67.5m people who live in the UK, or £3,220 per month for each of the 28.1m UK households.

Based on inflation assumptions decided on back in March, the Office for Budget Responsibility (OBR) projected that total spending would experience a real-terms cut of 1.2% to £1,100bn in 2023/24, and then real-terms increases of 0.5% to £1,127bn in 2024/25, 1.4% to £1,166bn in 2025/26 and 1.4% to £1,206bn in 2026/27. 

Forecasts for total spending are expected to be revised upwards by the OBR when it reports on 17 November. They will need to reflect higher rates of inflation, significantly higher interest rates, and the cost of the energy support packages announced in May and September 2022 (amended in October). The Institute for Fiscal Studies’ high-level forecast following the mini-Budget suggested that these factors could increase total spending to £1,185bn in 2022/23, £1,201bn in 2023/24, £1,165bn in 2024/25m £1,192bn in 2025/26 and £1,233bn in 2026/27, up £98bn, £101bn, £38bn, £26bn and £27bn respectively from the OBR March forecast.

Fiscal targets

When former Chancellor Kwasi Kwarteng announced on 23 September that he was scrapping the fiscal targets approved by the House of Commons in January this year, he was continuing a pattern of abandoning a succession of fiscal targets as it becomes clear that they have not been, or cannot be, met. Abandoning the existing targets without announcing new ones to take their place is likely to have been one of several contributory factors to the adverse reaction by markets to his proposals.

The latest set of abandoned fiscal targets required each five-year fiscal plan to aim for both a current budget surplus and for a falling debt to GDP ratio by the third year of each forecast period. Kwarteng had been under pressure to replace these with a more realistic fiscal target based on the debt to GDP ratio starting to fall by the fifth year of each forecast period. It is likely that the new Chancellor will adopt this or an even stricter set of targets in the hope of regaining credibility lost by the UK Government over the past few weeks.

Assuming that £43bn of the £45bn annual tax cuts announced in the mini-Budget were implemented, the Institute for Fiscal Studies (IFS) estimated that achieving a falling debt to GDP ratio after 2026/27 would require annual tax rises or public spending cuts of £62bn by 2026/27, equivalent to 5% of total spending that year. On 17 October, the Chancellor brought this estimate down by £27bn, reversing a further £21bn of the mini-Budget tax measures and adding back £6bn a year by cancelling the previously planned one percentage point cut in the rate of basic income tax from April 2024. 

This would suggest that the gap remaining to be filled with other tax and spending measures could be in the order of £35bn a year, equivalent to around 3% of total public spending in 2026/27. Adding in a further £10bn to £15bn of tax rises to provide headroom brings this to around £50bn in total.

The IFS highlighted significant risks in its forecast, which assumes that inflation does not persist in the medium term and that economic growth remains below 2%, consistent with the post-financial crisis trend. The IFS also based its forecast on a relatively shallow recession and highlighted how dependent it was on the level of interest rates, which at that point had spiked in response to the mini-Budget. These risks could easily increase the size of the gap between forecast receipts and spending that the Chancellor needs to fill. The Chancellor will be hoping that government borrowing costs continue to moderate following the appointment of Rishi Sunak as Prime Minister, providing the Government with some headroom in the official fiscal forecast.

What makes up public spending?

Budgeted public spending of £1,087bn in the current financial year ending 31 March 2023 can be broadly split between £295bn (27%) on pensions and welfare, £252bn (23%) on health and social care, £436bn (40%) on public services, and £104bn (10%) on debt and other interest. 

Spending on public services other than health and social care is budgeted to comprise £126bn (12% of total spending) on education, £59bn (5%) on defence and security, £47bn (4%) on transport, £43bn (4%) on public order and safety and £161bn (15%) on all the other services that central and local government provide.

These numbers are on a fiscal basis as presented in the National Accounts, in accordance with statistical standards that include capital expenditure net of depreciation. They exclude long-term expenditures such as accrued public sector pension obligations that are reported in the IFRS-based Whole of Government Accounts. They are also net of approximately £55bn in fees and charges and £5bn from the proceeds of asset sales.

Hands tied on spending

As the Prime Minister and Chancellor look for potential savings, they are finding that their hands are tied by the financial commitments made by successive governments, especially since the second world war. These commitments created the welfare state we know today, with pensions, welfare benefits, health and social care together now making up half of total public spending. Since the last general election this government has added to these commitments, including a significant expansion in eligibility for adult social care and increasing the value of state pensions through the triple lock mechanism. 

Under the long-standing ‘pay-as-you-go’ approach to funding government activities, no money is set aside to meet financial commitments made. Instead, tax receipts, cost savings or additional borrowing are used to pay for financial commitments as they fall due each year. There is no sovereign wealth fund to cushion the blow or to dip into.

The principal challenge for the Chancellor in looking for savings is that more people are living longer. The number of pensioners is expected to increase by 3.3m or 27% from 12.2m to 15.5m over the next 20 years, despite an increase in the state pension age from 66 to 67 over that time. This is driving up the cost of the largest line items within the overall budget: the state pension, the NHS, and social care budgets, over a period when the working age population, the group that pays the most in taxes, is projected to increase by just 4%.

The impact of a growing number of pensioners makes the job of finding savings that much harder, as the savings need to be proportionately larger from other parts of the budget. 

Any savings are also on top of hoped-for efficiency savings that have already been incorporated into departmental budgets to stay within the existing spending envelope, as well as dealing with rising procurement costs, higher energy bills and pressure to increase public sector salaries.

Pensions and welfare – £295bn or 27% of budgeted spending

Pensions and welfare spending can be broken down between £121bn for the state pension and pensioner benefits, £48bn in incapacity and disability benefits, and £126bn in working age, child and other welfare benefits and social protection.

Pensions spending is expected to increase over the next five years from a combination of a 1.1m or 9% increase in the number of pensioners and the ratchet effect of the Government’s triple-lock manifesto commitment to raise the state pension in line with whichever is higher: earnings, inflation or 2.5% .

One option to save money compared with existing forecasts would be to restrict the increase in state pensions to below inflation, either by abandoning the triple lock in this Parliament or not re-committing to it beyond the next general election. However, while Rishi Sunak was able to suspend the triple lock in April 2022 on a one-off basis, it is likely to be extremely difficult to find the political support needed to cut the state’s contribution to pensioner incomes in real terms sufficiently to offset a 9% increase in pensioner numbers over the next five years, or a 27% increase over 20 years.

The government could accelerate planned increases in the state pension age, currently set to go from 66 to 67 by 2028 and to 68 by 2046, although to do so might break a promise to give at least 10 years’ notice to those affected. Another option might be to reformulate the triple-lock mechanism, removing the ratchet effect by making it cumulative. This would see above-earnings rises in one year offset by below-earnings rises in subsequent years, subject to not falling below inflation or 2.5% in any particular year.

Real-term cuts in incapacity and disability benefits would also be politically unpalatable, as would further restricting eligibility criteria, even if pencilled in for subsequent years. Several commentators have suggested that the recent rise in the number of people suffering from health conditions and withdrawing from the workforce is because of NHS treatment backlogs that have been exacerbated by the pandemic. One way of cutting the cost of these benefits would be to provide additional funding to the NHS in the short to medium term, which would add rather than subtract from spending in the next few years, even if there is a positive financial benefit in the longer term.

That leaves welfare benefits for those of working age and children, where the IFS has suggested that indexing the uprating of working-age benefits in April 2023 and April 2024 to earnings rather than inflation could reduce the annual welfare bill by £13bn by 2026/27 when compared with existing forecasts. The risk here is that a recession could see the number of claimants rise significantly even if it were possible to cut the amount paid out to each claimant in real terms. Again, proposing real-terms cuts in the financial support offered to the poorest households of this scale during a cost-of-living crisis is likely to be politically challenging.

Another option would be to increase the minimum wage given that more than half of any wage increase would be recovered from claimants on universal credit. This is likely to be difficult to implement in the next couple of years given the current cost-of-doing-business crisis, but it might be possible to pencil in a rise in the second half of the fiscal period. 

One area where money could be saved is in tackling fraud and error, with the Department for Work and Pensions estimating that overpayments amounted to £8.6bn in 2021/22, partly offset by underpayments of £2.6bn. However, to do so effectively would likely require a significant simplification of the welfare system, a politically challenging task given this would involve both winners and losers.

Health and social care – £252bn or 23% of total spending

The budget for health and social care this year comprises £211bn for the NHS and other health care, and £41bn for social care, which are both driven by the number of pensioners and the level of long-term health conditions in the adult population in particular.

The focus in recent years has been to constrain the rise in spending on health care on a per patient basis through a combination of greater efficiency and constraining staff pay, while social care funding has been restricted to constrain supply. This has seen a decline in service standards in both health and social care, exacerbated by the pandemic. While there are opportunities to find savings by tackling waste and improving efficiency further, this will be difficult without greater capital investment in hospitals, primary care facilities and digital technology.

In practice, staff shortages, rising drug prices, and a weak pound are likely to add to cost pressures on the health budget, at the same time as calls grow to address poor performance across all areas of service delivery, including ambulance waiting times, long waiting lists for treatment and inadequate cancer outcomes, as well as expanding coverage in areas such as mental health.

Social care spending is also under pressure, not only because of rising pensioner numbers but also because of an expansion of eligibility for adult social care announced by former Prime Minister Boris Johnson. His successor, Prime Minister Liz Truss, made a commitment to retain this expansion despite abolishing the health and social care levy that was going to fund it, adding to size of the problem. There are strong arguments for increasing spending on social care in the near-term to relieve pressure on the NHS.

Potential savings in the short-term are likely to be through pay restraint, and in the medium-term through greater use of technology and consolidation of services. Deferring the introduction of the social care cap could ease funding pressures for a time but would not help the Chancellor achieve his targets in the longer-term. He could save some money compared with existing plans by indexing or otherwise increasing eligibility thresholds for social care over time. 

Risks include a further worsening of health outcomes and service standards, a potential collapse in services over this and subsequent winters, and industrial action.

Education – £126bn or 12% of budgeted spending

Education spending this year is estimated to comprise £53bn on secondary education, £34bn or so on primary and pre-school, £27bn on universities and higher education, and £12bn on training, further education, and other education services. 

While the falling birth rate is expected to reduce the numbers attending primary schools by around 10% or so over the next five years, the numbers going through (more expensive) secondary schooling are still increasing. In the near term, primary and secondary schools are already struggling to cope with a national pay settlement this year that was higher than allowed for in their existing budgets.

Restraining staff pay and constraining staff numbers are likely to be the main focuses of any cost savings that might be achievable from the schools’ budget, for example by increasing class sizes or merging schools – particularly at primary level. However, teacher shortages, particularly in science, technology, engineering, and mathematics, may make cutting pay in real terms difficult to achieve. 

University student numbers are expected to grow by around 6% over the next five years, although the per head cost should come down as inflation increases the numbers who earn over student loan repayment thresholds. The changes in student loan terms that extend the period over which repayments are made should also reduce the cost per student, although these are already built into the existing forecasts.

Capping student numbers and reducing the eligibility of some courses for student loans are being explored as one way of cutting the cost of higher education. However, higher inflation also makes the cash freeze in the cap on university student tuition fees increasingly unsustainable, especially as there are limits on how much further universities can continue to recruit sufficient numbers of international students to make up for real-term cuts in funding for UK students.

The challenge for a government looking for economic growth is that the general consensus is that more not less investment in skills is needed. Investment is especially required in technical education at secondary level and in further education and training for adults. There is also a strong case for extending pre-school provision to support parents back into the workforce (in addition to its educational benefits). 

Potential savings in the short term are through pay restraint, in the medium term through school consolidation, and in the longer term as a function of a lower birth rate. Risks and challenges include the competitiveness of the UK economy.

Defence and security – £59bn or 5% of total spending

Defence and security spending in 2022/23 comprises £52bn on defence and armed forces, £5bn on the security services and counter-terrorism policing, and £2bn on war and armed forces pensions.

Over the last fifty years, successive governments have been able to ‘raid’ the defence budget to find money for the rising costs of pensions, health and social care. This is no longer possible given the UK’s commitment to NATO since 2006 to spend a minimum of 2% of national income on defence and security.

In practice, defence spending is expected to increase in the near-term to cover the effect of higher-than-forecast inflation and a weaker pound on the procurement budget, in addition to the costs of providing military aid to Ukraine. These cost pressures are likely to absorb the first stages of the commitment made by former Prime Minister Liz Truss to increase spending on defence and security to 3.0% of national income by 2030.

Pay restraint could help offset some of the rise in spending a little in the short-term but would be politically difficult to sustain over the medium- to long-term, especially if the armed forces continue to struggle to recruit the new soldiers, sailors and aircrew they need. Theoretical savings from better procurement are always discussed, but rarely achieved – at least not in aggregate as cost overruns tend to outweigh any cost savings realised.

There are unlikely to be any potential savings in defence spending. In an increasingly unstable global security situation, most risks primarily relate to not spending enough.

Transport – £47bn or 4% of total spending

Transport spending in 2022/23 is budgeted to comprise £25bn on the railways, £13bn on roads, £6bn on local transport and £3bn in other transport-related expenditures. This includes significant amounts of capital expenditure and is net of passenger fares.

Capital investment in transport infrastructure was a big component of the levelling-up agenda, with a 10% uplift in capital budgets in the 2021 Spending Review. Unfortunately, inflation in construction costs has more than offset this boost in spending, imposing a scaling back of levelling-up ambitions and the potential returns from economic growth unless the government decides to increase the budget to compensate.

Governments looking for spending cuts have often looked at the transport budget as it is relatively easy to defer or cancel capital programmes or cut back on road maintenance in order to achieve a particular financial outcome. With the train companies back in public ownership, cutting back on train services is also an option, as would raising fares on public transport by more than inflation later in the forecast period. 

Further reductions in the scope of HS2 and other rail investment programmes have been mooted as options to save money, or at the very least restrict the level of budget overruns that would otherwise require additional funding. 

The problem with cutting back on investment in transport is that it is one of the key levers available to government to unlock private sector investment and drive economic growth. There is also a risk to business confidence (and hence business investment) if the UK is not able to deliver major infrastructure programmes it has previously committed to.

Potential savings include pay restraint, cutting back on road maintenance, fewer train services, cutting back on road and rail investment programmes, and potentially cutting back or means testing free public transport provided to pensioners. Road charging and higher train fares are also options. Risks are the economic damage of continued industrial action and weaker economic growth, particularly in regional economies outside London and the South East.

Public order and safety – £43bn or 4% of total spending

Spending on public order and safety in 2022/23 is budgeted to comprise £23bn on policing, £8bn on the court system, £7bn on prisons, £3bn on fire and rescue services, and £2bn on border control. 

Cuts in spending on police, courts, prisons and fire services delivered over the past decade were in the context of falling crime and a preceding decade of rising pay and investment. The current context is very different, with crime rising, significant delays in the courts, severe prison overcrowding, and heightened concerns about fire safety since the Grenfell fire. 

The existing budget includes funding for reversing cuts in police numbers since 2010 but significant problems in the court system is likely to need additional funding. Police and prison staff recruitment challenges mean it will be difficult to restrain pay rises into the medium term.

Potential savings include pay restraint, cuts in planned police numbers, and greater use of technology. Risks include rising crime, failed prosecutions, issues with prison safety and the quality of rehabilitation, and underperforming emergency services.

Other public services – £161bn or 15% of total spending

Spending on ‘everything else’ goes across a large number of budget headings, including £30bn on industry and agriculture, £19bn on research and development, £12bn on international development and aid, £11bn on housing, £10bn on waste management, £9bn on the EU exit settlement (which will reduce significantly in future years), £8bn on culture, recreation and sport, £5bn on the BBC and Channel 4, and £2bn on foreign affairs among numerous other public services. These budget headings include most local public services outside of social care and transport, in addition to central government departments, the devolved administrations and around 500 other public bodies.

Despite a decade or so of ‘austerity’ spending restraint, there should be plenty of opportunity to find savings in many public services. Better use of technology could help improve services as well as enable them to be delivered at lower cost. However, delivering services at significantly lower cost typically requires the successful delivery of technology and restructuring programmes that carry significant financial and political risks, as well as requiring additional investment in the short-term. The more that is attempted, the higher the risk of overruns or failed attempts.

There are also significant opportunities to reduce losses incurred from fraud or waste, although this also requires investment in improving governance, processes, and financial controls at all levels of government.

Even where savings are achieved, the impact on overall government spending is limited – even if you could cut every single budget in this category by 5%, this would only reduce total spending by 0.75%.

Some budget headings are discretionary and so could in theory be reduced by much greater amounts, for example spending on research and development or funding for the arts. However, these types of spending tend to be important to delivering on other government objectives, such as fostering economic development, regenerating deprived communities, or supporting key industries such as tourism – in addition to being considered important activities in their own right.

There has been some discussion about cutting the size of the civil service, which at 510,000 is about 9% of the overall public sector workforce. Bringing total numbers down by 91,000 or 18% to the pre-Brexit position as mooted by some in government is likely to be extremely challenging to deliver in practice. Not only does the government need to deliver additional requirements such as for customs and border control, international trade negotiation, and other previously shared responsibilities that have reverted to the UK, but the events of the past few years have highlighted how government has struggled to deliver on its policy priorities. 

The three largest departmental workforces are the Department for Work & Pensions (DWP) at 94,000, the Ministry of Justice (MoJ) at 87,000 and HM Revenue & Customs (HMRC) at 71,000. In theory, the automation of manual processes and the replacement of systems that currently require extensive manual intervention could enable cuts to be made in staff at all three departments, especially the DWP. However, the risks of making major systems changes, a court system under extreme pressure, and the risks to tax revenue of cutting staff significantly in the near-term, as well increased risks of fraud and error, makes this far from a cost-free choice.

There are also political difficulties in cutting non-staff areas of these budgets, such as agricultural subsidies where there are vocal constituencies likely to object to significant reductions in the amounts paid.

One budget heading that has already been cut is spending on international development, which is now set at 0.5% of national income, with a plan to return to the previous level of 0.7% of national income once the public finances are in better shape. Some members of the governing party have suggested reducing this below 0.5%, despite a manifesto commitment to keep to the 0.7% target. There have also been suggestions that the accounting goalposts could be moved to include existing domestic spending in the UK to be classified as international development, enabling the government to reduce the amount spent outside the UK.

Another area where costs are rising are public sector pensions, as former public servants are also living longer, with pensions-in-payment contractually linked to rises in the consumer prices index. Ironically, the switch in the last decade from final salary to average salary calculations reduces the effect that constraining public sector pay has on the eventual bill. Public sector pensions are relatively generous compared with the private sector and cutting the accrual rate for pension entitlements could save substantial amounts in the longer-term, assuming this could be successfully negotiated with the unions. This would allow for higher base salaries, which might help with recruitment given pensions benefits are often undervalued by recipients.

Potential savings again include pay restraint, cutting staff numbers, cutting public sector pension benefits, procurement savings, property consolidation (already underway), technology, cutting discretionary spending, greater use of outsourcing, cutting capital programmes including infrastructure. Risks include a further deterioration in the quality of public services, problems in delivering technology and transformation programmes, failure to achieve key government objectives that depend on effective public services, poor morale affecting the effective delivery of services, and the potential that any cuts in staff numbers will be reversed as governments make new commitments.

Interest – £104bn or 10%

The interest budget in 2022/23 comprises £83bn of debt interest and £21bn of other interest, principally on local authority and other funded public sector pensions. (No interest is recorded in the fiscal numbers on the much larger amount of unfunded pension obligations).

Public sector net debt has more than quadrupled over the last fifteen years from £0.5tn in 2008 to £2.4tn today, but ultra-low borrowing costs over that time has kept the cost of servicing that debt down to historically low levels.

The Debt Management Office within HM Treasury has been able to extend maturities to an average of around 15 years, locking in very low interest rates as it has raised or refinanced debt over the last decade. However, the Bank of England’s quantitative easing programme of gilt purchases has in effect swapped a substantial proportion of this fixed rate debt into variable rate central bank deposits, making the public finances much more sensitive to increases in official interest rates. The Debt Management Office has also been successful in hedging the low levels of inflation we have experienced over the last decade through the issue of bonds that rise in line with the retail prices index. However, this goes the other way in periods of higher inflation, with increasing liabilities on index-linked gilts offsetting the inflationary benefit of a faster growing denominator on the debt to GDP ratio.

The IFS expects debt interest to increase by £23bn to £106bn in the current financial year, primarily as a consequence of higher interest rates and higher inflation on index-linked debt. Even with inflation coming down in the next year or two, it still expects debt interest in 2026/67 to be £106bn, more than double the £51bn forecast by the OBR in March.

The two main levers for restricting rises in the debt interest bill are to keep borrowing down, which implies higher taxes or lower spending compared with the current path and to keep interest rates at the lowest level possible by regaining credibility with the markets, which also implies higher taxes or lower spending. Some commentators have estimated the benefit of the change in Prime Minister as being between £6bn and £12bn in lower annual interest charges than they might otherwise have been the case.

Some commentators have suggested that the Bank of England could implement non-interest paying tiered reserves, in effect arbitrarily ceasing or reducing the base rate payable on a proportion of deposits held by (mostly UK) banks and financial institutions. This would reduce the cost of borrowing on that element of the public debt, but one risk is that the overall interest bill might end up being higher depending on how banks and debt markets responded to such a significant change in monetary policy.

One ‘creative accounting’ approach would be to change the debt measure in the debt to GDP ratio used in fiscal targets. This was amended a few years ago to exclude the rising amounts of debt being taken on by the Bank of England to fund quantitative easing and Term Funding Scheme low-cost loans for high-street banks. Reverting to the headline measure for public sector net debt would contribute to the debt to GDP ratio falling as quantitative easing is unwound and Term Funding Scheme loans are repaid.

Potential savings – none compared with current plans, absent the more radical suggestion of tiered reserves. However, the extent of the cost increase can be limited through improved fiscal credibility and constraining the amount of borrowing.

Other options

More radical options are possible, but these are likely to be extremely difficult without substantial political support from the public, such as that provided by a general election mandate.

For example, privatisation could move responsibility for some taxpayer funded services that are currently provided by public bodies to the private sector. The challenge here is that some public subsidy may still be needed even after privatisation, reducing the amount of any saving to the taxpayer. This would likely increase the burden on those of working age who would have to pay to use any service that was privatised, while still paying through their taxes for pensioners, children and the less well-off to use that service. There is also a risk that the overall cost to the public is higher, given that the bulk purchasing effect of procuring services collectively could be lost depending on the business model chosen.

Historical precedence is not helpful here, in particular the privatisation of the railways in Great Britain in 1996. This ended up being renationalised unintentionally following track-owner Railtrack’s collapse in 2002 and the failure of the train operating company franchise system in 2020. Trying again would be a ‘brave’ choice politically even if it might be possible to reduce the level of public subsidy required with a different financial model.

Other radical options include ending the provision of some public services or scaling them back significantly, but in most cases the political backlash could be significant in comparison with the level of savings that might be possible.

Long-term reform

One of the reasons the UK is in a difficult fiscal situation is the short-term focus of successive governments that have continued to add to the nation’s financial commitments without setting aside funding to pay for them. This has made the public finances increasingly less resilient to face economic shocks such as that seen in the financial crisis a decade and a half ago, the pandemic over the past two and a half years, and the cost-of-living crisis that we are currently going through.

While finding savings in the short-term is likely to be extremely difficult, over a long period there are more options to reduce the cost of the state. A good example is social care, where it might be possible to establish long-term insurance arrangements for those currently in their 20s and 30s that would eventually – in 40 to 50 years’ time – significantly reduce the level of public funding required. Similarly, the state pension could be replaced for those now entering the workforce by collective defined contribution pension funds such as those seen in other countries.

For example, Australia has strengthened its public finances significantly with reforms such as replacing unfunded defined benefit pension schemes for federal employees with defined contribution pension funds, and the establishment of a sovereign wealth fund to support the payment of pensions and welfare benefits.

Conclusion

Prime Minister Rishi Sunak and Chancellor of the Exchequer Jeremy Hunt have a difficult task in trying to reduce the gap between receipts and expenditure. Politically it will be difficult to raise taxes, but there will also be political, financial and operational consequences and risks in how they choose to cut spending. And with an increased focus by the markets on the credibility of their plans, there will be less room to pencil in optimistic ‘anticipated’ savings into the later years of the five-year forecast period.

The first challenge they face will be in how to reengineer the energy support schemes for both households and businesses from April 2023 onwards. As these are time limited, this won’t help bridge the gap in later years, but it will enable them to be more targeted in how support is provided over the next couple of years, as well as potentially reducing the overall cost that needs to be funded by long-term borrowing.

Each of the main options for cutting spending in the medium-term are unpalatable and politically challenging:

  • Real-terms cuts in pensions and welfare are possible but difficult to deliver politically during a cost-of-living crisis, as previous Prime Minister Liz Truss discovered when she was forced to deny she was planning to abandon the triple-lock mechanism. 
  • Real-terms cuts in public sector pay are likely but come with the prospect of much greater disruption from industrial action and increasing difficulties in recruiting and retaining staff. 
  • Cutting investment in infrastructure and capital programmes is the easiest option to achieve but comes with risks to future economic growth and business investment.
  • Greater efficiency is possible but practically difficult to deliver, with significant project delivery risks and the need for sufficient capital investment to be successful.
  • Higher fees and charges are possible but risk a political backlash.
  • Lowering public service outputs or quality is possible but there are practical limits to how far you can continue to cut funding for many public services without adverse effects.

Over the last fifteen years, successive governments have been able to borrow their way out of trouble even as debt has mounted, and the resilience of the public finances has weakened. That era is no more, with providers of finance to the UK Government now asking much more challenging questions about how the government can pay its way.

Tough choices will need to be made.

Martin Wheatcroft FCA is a strategy consultant, adviser on public finances, and the author of Simply UK Government Finances 2022/23.

This article was originally published by ICAEW.

EU fiscal consultation

Input into ICAEW’s response to the future of the EU Economic Governance Framework.

I recently contributed to ICAEW’s response to a consultation on the future of the EU Economic Governance Framework by Dr Susanna Di Feliciantonio, ICAEW’s Head of European Affairs.

To read more see Susanna’s article about the consultation response.

Getting public finances under control will not be easy

The Spending Review and Autumn Budget will mark the first step in the Chancellor’s plan to bring the public finances back under control following the pandemic. There are significant challenges to be overcome if he wants to do so.

Area chart showing fiscal pressures from 2025-26 to 2050-51, with health going up to around 3½% of GDP, with adult social care adding another half a percent, the state pension another 1½% and tax at risk from decarbonisation adding a further 1½% to reach approximately 7% in total in 2050-51.


Tucked away on page 91 of HM Treasury’s Net Zero Review Final Report published on 19 October is a chart illustrating the main long-term pressures on the public finances. This describes how fiscal pressures from health, adult social care, the state pension and tax at risk from decarbonisation could amount to 7% of GDP by 2050-51, equivalent to over £150bn a year in ‘today’s money’.

The majority of the fiscal pressures identified (5.5% of GDP in 2050-51) relate to structural factors, or what can better be described as more people living longer, sometimes less healthy lives. This will add significantly to the costs of healthcare, adult social care, and the state pension over the coming decades – big drivers of public spending.

The pay-as-you-go nature of the UK welfare state means that the tax and national insurance contributions made by people through their working lives to fund these services are not saved up and invested but are instead spent on previous generations. Consequently, there is (unlike some other countries) no pot of money from which to draw on to fund retiree pensions, health, or social care. Instead, taxpayers will be called on to cover these costs as they arise.

More spending cuts are unlikely to be sufficient to close the gap

One option might be to offset rising costs by cutting public spending in other areas, as has already happened with the defence budget, where cuts from over 10% of GDP half a century ago to under 2% of GDP today have helped to offset increases in the funding allocated to the National Health Service.

However, with defence and security spending together hovering just above the 2% NATO minimum, and a decade of austerity that has seen significant cuts in both public services and welfare budgets, the unfortunate reality is that there are no other significant budget headings that the Chancellor might look to dip into to meet these long-term fiscal pressures. At least not without a very radical restructuring of the state, which does not appear to be on the cards.

In practice, Rishi Sunak will have a hard enough time addressing short-term fiscal pressures in other areas. A key example is the criminal justice system, where cuts in spending in recent years on the police, courts, prosecutors, and legal aid have together contributed to significant delays and lost opportunities to prosecute criminals, just as crime levels rise and it returns to the political agenda. A backlog of cases built up over the course of the pandemic doesn’t help. More money beyond that already allocated to restore police numbers is likely to be needed, but where can it be found?

Everywhere the Chancellor looks there are difficult choices between the spending needed to meet policy priorities such as levelling up (local authorities, education and transport), Global Britain (FCDO and international trade), and Build Back Greener (energy and transport), as well ensuring the day-to-day operations of both central and local government continue – from collecting the bins to repairing the roads to defending the country.

There are opportunities to save money through being more efficient, but it is important to understand that administration costs are a relatively small proportion of overall public spending and that many UK public services such as the NHS are fairly cost-effective when compared with equivalents in other countries. Technological change including AI and medical developments could have a significant impact in reducing costs, but it is unclear that they could produce anywhere near the level of service improvement that would offset the long-term fiscal pressures. Ironically, medical developments could also increase those pressures, with savings in the cost of healthcare treatments being offset by helping us live even longer lives. Good news but adding to the public finance challenge.

The demands from across government for more money are intense, putting the Chancellor under severe pressure to increase the overall spending envelope – not just in the next financial year or three, but permanently adding to budgets forevermore.

Can the long-term fiscal pressures be avoided?

The main driver for most of the long-term fiscal pressures identified by HM Treasury is longevity, with the number of people aged over 70 expected to increase by 58% over the next 25 years at the same time as the number of people under the age of 70 (including those of working age who pay most of the taxes) is expected to increase by only 2% or potentially fall by 7% if inward migration falls.

There are some things that can be done to mitigate these increases to a certain extent, such as permanently abandoning the triple lock that has driven substantial increases in the level of the state pension over the last decade. However, this could be politically difficult, as well as not necessarily achieving the intended goal of saving money if more pensioners end up needing support from the welfare system. A more likely approach would be to further increase retirement ages as recently recommended by the OECD.

Other options that have been suggested include greater rationing of health care or introducing charges for some medical procedures. Such moves could help offset some of the pressures on health care spending but would be politically difficult as well as adding an extra layer of complexity to the welfare state. Those who can afford to pay would not only pay more, but there would still be a need to pay more in taxes to fund those on low incomes who wouldn’t be able to afford the additional costs without help.

One of the long-term pressures identified by the government – the effect of decarbonisation on tax receipts – is not really a pressure and arguably should not be included in the list.

While in theory the £37bn a year raised in fuel duty, vehicle excise duty and other taxes will disappear if transport is successfully decarbonised, this is a tax burden already being incurred by road users. All that is likely to happen is a change in the tax used to collect that money, with road charging the most likely option identified so far. This may be seen as a tax rise by some, particularly those hoping that the low tax status of electric cars and other zero emission vehicles might continue into the future, but the net effect is likely to be a temporary tax rise over the course of the transition as the existing taxes co-exist with the new, hopefully adding to the incentive to decarbonise without having to increase taxes in other areas.

Borrowing has a role, but can’t take all the strain

The benefit of being a sovereign nation is the ability to raise money from debt markets at much lower interest rates than those available to businesses or individuals. This is invaluable, as there are often good reasons to borrow to fund capital investment, which in turn will often generate more economic activity and enhance future tax revenues.

However, governments in developed countries have routinely used borrowing to make up for shortfalls between revenues and current spending in the hope that growth in the size of the economy will inflate away the debts built up this way.

The financial firepower provided by borrowing has enabled the UK to support the economy and fund public services and welfare through the financial crisis just over a decade ago and the pandemic in 2020 and 2021. However, the consequence has been to increase public sector net debt from around less than £0.5tn or 35% of GDP in 2008 to £1.8tn or 80% in 2019 and to £2.2tn or just over 95% of GDP as of today.

This excludes £2.5tn or so of other liabilities in the public balance sheet, such as for unfunded public sector pension obligations, nuclear decommissioning obligations and clinical negligence liabilities. When added to debt these take public sector liabilities to more than double the size of the economy.

Countries such as Japan have even higher levels of debt than the UK which, in theory at least, might indicate that the UK government has headroom to borrow even more, this is dependent on the continued confidence of capital markets. The Chancellor is therefore aiming to bring down the ratio of debt to GDP gradually over time, with new fiscal rules designed to ensure that the government targets a balanced current budget by the middle of the decade so that borrowing is only used to fund investment spending.

A particular concern for the Chancellor will be the increased exposure of the public finances to higher inflation and interest rates, which has the potential to claw back any savings he does manage to find in his search for a more efficient government machine.

This is because the current scale and profile of public debt makes it more difficult for the government to ‘inflate away’ debt over time, with the higher interest rates that would be expected to accompany higher levels of economic growth resulting in higher debt-interest costs. Similarly, the effect of higher inflation in increasing nominal GDP and hence reducing the debt to GDP ratio will be offset by the associated uplift in the amounts owed to holders of index-linked gilts.

Economic growth should generate higher tax revenues, but by how much?

The favoured route to bring in more money through the tax line would be through faster economic growth, and the OBR’s October 2021 forecasts are likely to reflect a sharper rebound from the pandemic than was expected in March – providing the Chancellor with more room for manoeuvre, at least in the short term.

Improving productivity is a challenge for governments across the world, while economists have suggested that the combination of Brexit and COVID-19 will make the UK economy permanently 3% smaller than it would have been otherwise. Despite that, higher levels of capital investment within the existing spending plans should have a positive effect on growth, especially if the substantial additional private investment envisaged as part of the Net Zero Strategy is successfully obtained.

The good news is that even moderate levels of economic growth will help put the public finances in a better place, providing capacity for the Chancellor or his successors to be slightly more generous on spending or perhaps fund some limited pre-election tax cuts. The bad news is that even healthy periods of economic growth tend to be punctuated by recessions every decade or so.

Hence the need for prudence in spending plans – if we don’t know how much we (as a country) are going to earn, it makes sense to be careful in our outgoings.

But, there is a risk that too much prudence could result in cutting back on the spending that is needed to drive future prosperity, whether that be funding for education and apprenticeships to enhance skills, or investment in infrastructure to drive regional economic growth. And spending restraint in other areas, such as policing and the criminal justice system, can have other adverse consequences too.

Economic growth is needed to ensure the public finances are brought back under control. Absent an unexpected economic boom, growth on its own is unlikely to provide sufficient tax receipts to fund all of the long-term fiscal pressures identified by the Treasury.

Can further tax rises be avoided?

The introduction of the health and social care levy on top of the tax rises announced in the March 2021 Spring Budget shouldn’t have been a surprise given the long-term pressures on the public finances. The pandemic may have accelerated the arrival of new taxes, but more funding from taxpayers was always the most likely outcome at some point over the next few years.

This is not just because the pandemic has exacerbated the financial situation, but because only very strong levels of economic growth would have enabled any government to avoid putting up taxes. Indeed, the Institute for Fiscal Studies believes that the health and social care levy may have to be increased further by the end of the current decade from 1.25% to 3.15%.

There are some actions the government can take to delay the inevitable, such as increasing labour participation rates, so increasing the pool of taxpayers. But, in the medium- to long-term, the government needs to acknowledge the pressures on public spending and think about how it should go about increasing taxes in a gradual and stable way rather than the current approach of deferring the problem until the pressures become too great.

One thing the government could do better at is developing a long-term tax strategy setting out how it plans to increase taxes gradually over time, avoiding the need for sudden changes, such as the introduction of the health and social care levy with only six months’ notice or the almost one-third rise in the corporation tax rate from 19% to 25% that comes into force on 1 April 2023.

A long-term fiscal strategy is needed to put the public finances on a sustainable path

Tax is not the only aspect of the public finances that would benefit from a longer-term approach. A fiscal strategy encompassing tax, spending, borrowing, debt, and the wider public balance sheet is essential if the government is to improve resilience of the public finances to future economic shocks and put them on a sustainable path.

Such a strategy should address the long-term pressures on public spending as part of a practical vision for the public finances over the next 25 to 50 years. It would consider how best to fund public services over time and how to strengthen the public balance sheet.

At a more granular level it would look at issues such as the unfunded nature of many public sector liabilities, for example considering whether premiums could be levied to fund investments to cover clinical negligence liabilities, rather than rely on there being capacity in future health budgets to cover these costs. Another example would be to consider whether there is a role for sovereign wealth funds, similar to Australia’s Future Fund or Norway’s Oil Fund. It could be argued that some of the savings to the exchequer from ultra-low borrowing rates might have been better used to fund investments for the benefit of future generations instead of being used to cover day-to-day spending, avoiding difficult decisions that should have been addressed earlier.

More significantly, a fiscal strategy would consider how to introduce more long-term thinking into the public finances, moving beyond short-term fiscal rules that have often been broken and prioritising investment that provides positive economic, social and environmental benefits to all of us. It could also provide a framework within which to tackle some of the structural problems in the public finances, such as tax devolution and the complexity of funding streams within and between central and local government, or in clarifying the often misunderstood financial compact between government and citizens.

Reasons to be cheerful

The challenges facing the public finances are significant. According to the Office for Budget Responsibility they are on an unsustainable path. Public debt has increased from less than £0.5tn to more than £2.2tn in less than a decade and a half. Other public sector liabilities amount to least as much again. Cuts in public spending have affected some public services adversely, and the pressure for more spending is intense. Poverty remains and many families struggle financially, further adding to pressures on the government to help. The productivity puzzle remains unresolved and there are significant uncertainties about the health of both the UK and global economies. Tax rises appear inevitable.

However, government has demonstrated in both the financial crisis and the pandemic just how much it can do to support business, individuals, and public services through difficult times when it needs to. Public investment is increasing. Technological developments are helping to improve public services and increase efficiency. The government now knows what is in the public sector balance sheet and is taking steps to improve how it is managed. There is a strategy for tackling net zero. Borrowing costs remain extremely low even if they are starting to rise. The UK continues to be one of the most prosperous countries in the world. And relatively small changes can have a big impact over a 25 to 50-year timeframe.

Getting the public finances back under control will not be easy. But it can be done.

Alison Ring OBE FCA, Director of Public Sector and Taxation at ICAEW, commented: “The challenges facing the public finances are immense and I don’t envy Rishi Sunak the difficult choices he has to make in balancing the demands on the public purse with the real-world impact of decisions to increase, maintain or cut spending across both central and local government.

“Much of the focus on the Spending Review and Autumn Budget will be on how the Chancellor plans to tackle the immediate challenges facing the country this winter and how he plans to balance competing demands over the three years of the Spending Review. However, setting out a fiscal strategy to address long-term fiscal pressures and put the public finances on a sustainable path will be even more important.”

Martin Wheatcroft FCA, external advisor on public finances to ICAEW, added: “There are signs that the government is starting to think more strategically about the public finances, such as in starting to plan for the tax consequences of decarbonisation, identifying the major pressures on public spending that flow from more people living longer, and biting the bullet by increasing taxes to fund those pressures.

“The Spending Review and Autumn Budget on 27 October provide an opportunity for the government to develop that thinking further and to set out an approach that looks beyond the current parliamentary cycle to strengthening the capacity and resilience of the public finances over the longer term.”

This article was originally published by ICAEW.

Chief Secretary brands Treasury ‘new radicals in government’

3 August 2020: Chief Secretary to the Treasury Steve Barclay delivered his first speech last week, providing fresh detail on the plan for the Spending Review.

Steve Barclay’s first speech as Chief Secretary, delivered to thinktank Onward on Tuesday 28 July 2020, set out how he believes Treasury can be an accelerator of change in government.

He sees the Spending Review as a significant moment in the lifecycle of any government, but with the current review being conducted against the backdrop of the most challenging peacetime economic circumstances in living memory.

Despite that, the Government believes the recovery from this pandemic can be a moment for national renewal, with the Spending Review acting as the mechanism to deliver the Prime Minister’s ambition to ‘level up’ the country.

As a constituency MP, Barclay said he has run up against a system that is slow and siloed. By way of an example, he asked why there is a seven-year gap between funding being agreed for a road scheme and the first digger arriving? Or why it takes a decade to decide to produce a full business case on whether to re-open eight miles of railway track?

The lack of upfront clarity on outcomes, the slow speed of delivery and the variable quality of data within government are all areas the Spending Review provides an opportunity to challenge.

The Chief Secretary stressed that to ‘level up’ the country properly, the Government needs to ensure that Treasury decision-making better reflects the UK’s economic geography, with more balanced judgments taking into consideration the transformative potential of investment to drive localised growth.

He drew on the speed of change during the pandemic, with the furlough scheme taking just one month from being announced to being opened for applications when normally such schemes take months – years even – to deliver.

He asked if the wheels of government can be made to spin this fast in a crisis, with all the added pressures of lockdown, why can’t it happen routinely?

Time to level up

The Chief Secretary stated that the actions being taken to support businesses and jobs during the pandemic are the right thing to do, even though it comes at a cost. The cost of inaction would be far greater, he claimed.

Even though the Prime Minister has made it clear that austerity is not the answer to navigating a much-changed economic landscape, departments will have to make tough choices in the months ahead.

The commitment to reviewing the Green Book investment manual was reiterated with changes planned to allow room for more balanced judgments on investments to reduce inequality and drive localised growth.

During the speech, Barclay listed several priorities for government in the Spending Review:

  • accelerating the UK’s economic recovery;
  • levelling-up opportunity across the country;
  • improving public services; and
  • making the UK a scientific superpower.

Outcomes, speed and data

To achieve these objectives, the Chief Secretary focused on three key approaches: outcomes, speed and data.

On outcomes, the Spending Review would try to tie expenditure and performance more closely together, with Treasury having clearer sight of both intended outcomes and subsequent evaluation of their delivery. 

For some of the most complex policy challenges, this will involve breaking the silos between departments, and pilot projects are currently being used to test innovative ways of bringing the public sector together.

On speed, Barclay noted that this is a ‘hallmark of the digital era’. Programmes need to start with robust goals and the temptation to repeatedly change plans has to be resisted if the UK is to bring down capital costs that are typically between 10% and 30% higher than in other European countries. A new Infrastructure Delivery Task Force (known as Project Speed) will be established to cut down the time it takes to develop, design and deliver vital projects.

This will involve more standardisation and modularisation between projects, for example in speeding housing construction. The Spending Review will seek to accelerate the adoption of Modern Methods of Construction and explicitly link funding decisions to schemes that priorities it.

On data, the Chief Secretary believes that government is behind the curve when it comes to obtaining, analysing, and enabling access to open data. It remains the case that decisions still rely heavily on spreadsheets from departments rather than data directly sourced in real time. Work has already begun to incentivise departments and arms-length bodies to supply higher quality standardised data and to support the Treasury to better interrogate this data.

Building this will involve sorting out the data architecture as well as the data sets, and the Spending Review will focus on addressing legacy IT and investing in the data infrastructure needed to become a “truly digital government”.

The new radicals

Barclay concluded with stressing the importance of taking risks, setting ambitious goals and experimenting with ways of delivery, even if failure is a possibility. He wants to move beyond a simple yes/no approach to public spending and instead bring together people, ideas and best practice from inside and outside government.

He concluded: “This is an opportunity for the Treasury to capture the ‘can do’ attitude shown by civil servants during the COVID pandemic and make it permanent. To be the new radicals, leading change across government.

“Done well, we can move on from an era of spreadsheets. We can create a smarter and faster culture in Whitehall. And we can ensure that Britain does indeed bounce back from this crisis stronger and better than before.”

Speech by Steve Barclay MP, Chief Secretary to the Treasury, on 28 July 2020.

This article was originally published by ICAEW.

OBR: Pandemic worsens long-term outlook for public finances

20 July 2020: The Office for Budget Responsibility suggests tax rises or spending cuts of more than £60bn a year may be needed if the UK public finances are to be put onto a sustainable path.

The Office for Budget Responsibility (OBR) has reported that the public finances are unsustainable over the next 25 to 50 years, given expected levels of economic growth and pressures on public spending from more people living longer. Fiscal risks have also increased significantly with two ‘once-in-a-lifetime’ economic shocks occurring in just over a decade.

Without action to increase taxes or cut spending over the next few decades, the OBR projects that the gap between receipts and public spending before interest will widen from around 1% of GDP in 2019-20 to between 10% and 15% in 2069-70, depending on how quickly the UK recovers from the coronavirus pandemic. Public sector net debt could increase to between 320% of GDP and 520% of GDP, based on the assumptions made.

The OBR has highlighted how the coronavirus pandemic has not only worsened the immediate prospects for the UK and global economies, but ‘economic scarring’ will permanently damage the expected level of tax receipts over the next 50 years. The vulnerability of the public finances to potential future economic shocks has also increased significantly.

The OBR believes that a V-shaped economy is still possible, but this is now considered to be an upside scenario, with the OBR’s central scenario based on a much slower recovery from the pandemic. The downside scenario takes even longer for the economy to recover.

Economic activity, as measured by GDP, and tax receipts are both expected to be lower in all scenarios than in previous forecasts.

Prospects for the public finances in the current financial year have continued to deteriorate with the OBR now forecasting a fiscal deficit between 15% and 23% of GDP, with a central scenario of £372bn (19% of GDP). This reflects a total of £192bn in fiscal interventions in 2020-21 announced by the Government to date to support the UK economy through the pandemic.

The OBR projects that in its central scenario the gap between receipts and expenditure excluding interest will widen to almost 13% of GDP by 2069-70 if no actions are taken, equivalent to almost £300bn in 2019-20 terms. With much higher levels of debt, and interest rates likely to be higher in the medium to long-term, this could cause the fiscal deficit to increase to over 30% of GDP in 50 years time.

The OBR has calculated that ‘fiscal tightening’ in the order of 2.9% of GDP (£64bn a year) would be required based on a target level for public sector net debt of 75% of GDP. This is subject to a number of fiscal risks, including that no further significant changes are made to the planned profile of spending on health and social care – a key source of policy risk.

Closing this gap could require potentially very significant levels of tax increases or cuts in public spending, especially if difficult decisions, such as on how to fund social care, continue to be deferred.

Martin Wheatcroft FCA, adviser to ICAEW on public finances, commented: “The Office for Budget Responsibility has yet again assessed the public finances and concluded that they are not sustainable, even before taking account of the eye-watering levels of borrowing being added to the national debt as a consequence of the coronavirus pandemic.

Although we should expect tax cuts and spending increases in the immediate future as the Government looks to provide stimulus to the economy, the need to reduce the gap between tax receipts and public spending over the medium- to long-term means that tax rises or further cuts in public spending are likely in the years to come.

Despite this, there are actions that could be taken to improve the outlook for the public finances by developing a long-term fiscal strategy to put the public finances onto a sustainable path.”

Table 1 – OBR projections for the public finances: central scenario

CENTRAL SCENARIO2019-20
% OF GDP
2020-21
% OF GDP
2024-25
% OF GDP
2044-45
% OF GDP
2069-70
% OF GDP
Receipts excluding interest36.136.336.636.636.4
Expenditure excluding interest(37.2)(54.4)(40.3)(43.9)(49.1)
Primary deficit(1.1)(18.1)(3.7)(7.3)(12.7)
Net interest(1.5)(0.8)(0.9)(6.2)(17.8)
Fiscal deficit(2.6)(18.9)(4.6)(13.5)(30.5)

Public sector net debt

(88.5)

(106.6)

(102.1)

(173.7)

(418.4)

Source: OBR, ‘Fiscal sustainability report July 2020’.  2020-21 amounts adjusted for £50bn (2.5% of GDP) of additional fiscal interventions announced on 8 July 2020. Subsequent periods not adjusted.

Table 2 – OBR projections for the public finances: upside and downside scenarios

DIFFERENCES FROM     
CENTRAL SCENARIO       
                2020-21
% OF GDP
2024-25
% OF GDP
2044-45
% OF GDP
2069-70
% OF GDP
Upside scenario
Primary deficit3.62.12.22.3
Fiscal deficit3.62.23.86.5
Public sector net debt9.314.145.798.2
Downside scenario
Primary deficit(4.3)(2.2)(2.3)(2.4)
Fiscal deficit(4.3)(2.2)(3.9)(6.9)
Public sector net debt(9.1)(14.5)(47.9)(103.5)

Sources: OBR, ‘Fiscal sustainability report July 2020’; ICAEW calculations.
Positive differences = lower deficit or lower debt in percentage points of GDP; (negative) differences = higher deficit or higher debt.

This article was originally published by ICAEW.

Spending Review suspension sensible, but avoid more delays

2 April 2020: ICAEW has called the delay to the UK Government’s 2020 Spending Review a ‘sensible move’ in the current climate, but warned that any further delays pose a major risk to infrastructure projects and economic recovery.

The 2020 Spending Review, scheduled to be completed by July this year, has been delayed to enable the government to remain focused on responding to the ongoing coronavirus outbreak. It is likely that the 2020 Spending Review will now be moved to November to coincide with the Autumn Budget, adding a further delay of at least four months to the process.
 
The last three-year Spending Review was in 2015, covering the financial years 2016-17, 2017-18 and 2018-19. The anticipated 2018 Spending Review never took place and departmental budgets were instead ‘rolled over’ into 2019-20, while the Spending Review in 2019 was also cancelled and replaced by an interim Spending Round that set out current spending by departments for one financial year (2020-21) and capital investment plans for two financial years (2020-21 and 2021-22).
 
Based on the overall spending envelope set out in the Spring Budget 2020, the Spending Review this year is expected to set out detailed financial budgets for each government department for a three-year period (from 2021-22 to 2023-24) and four years for capital investment (to 2024-25), enabling public bodies to plan ahead and get the best value for money for the taxpayer.
 
Alison Ring, Director, Public Sector for ICAEW said: “The latest delay is completely understandable given the huge ramifications for the economy and the public finances of the coronavirus emergency. It makes sense for the Chancellor and the Treasury to redeploy resources to deal with the coronavirus now and to re-evaluate spending plans later when there is a clearer view on the financial impact.
 
One concern is the risk this further delay poses to infrastructure projects, given how important they will be to a successful economic recovery. The need to plan and design infrastructure well in advance means that delays in authorising funding could have a significant knock-on effect to when projects are eventually delivered, and to the boost they can give to the economy. 
 
The Chancellor should give some thought to providing assurances to departments about capital funding in 2021-22 and 2022-23 so that they have sufficient certainty to green-light projects sooner rather than later.
 
The Chancellor should also consider the Government’s approach to Spending Reviews. There are many arguments in favour of holding five-year Spending Reviews every three years, rather than three-year Spending Reviews every five years.”
 
For more information:

This article was originally published by ICAEW.

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

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

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

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

Key headlines for 2020-21:

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

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

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

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

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

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

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

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

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

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

This article was originally published by ICAEW.