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.

Government borrowing exceeds £100bn in first half of financial year

Upward revisions to GDP bring the debt-to-GDP ratio down to 95.5%, but the Chancellor has a difficult Spending Review and Autumn Budget ahead as spending pressures mount.

The public sector finances for September 2021 released on Thursday 21 October reported a monthly deficit of £21.8bn – better than the £28.7bn reported for September 2020 but still much higher than the deficit of £8.1bn reported for September 2019. 

This brings the cumulative deficit for the first half of the financial year to £108.1bn compared with £209.3bn last year and £35.3bn two years ago.

Public sector net debt increased from £2,205.4bn at the end of August to £2,218.9bn or 95.5% of GDP at the end of September. This is £83.1bn higher than at the start of the financial year and an increase of £425.8bn over March 2020.

As in previous months this financial year, the deficit came in below the official forecast for 2021-22 prepared by the Office for Budget Responsibility (OBR) in March 2021, when the outlook appeared less positive. The OBR is expected to significantly reduce its projected deficit of £234bn for the full year when it updates its forecasts for the Autumn Budget and Spending Review on 27 October 2021. 

Cumulative receipts in the first six months of the 2021-22 financial year amounted to £419.1bn, £57.4bn or 16% higher than a year previously, but only £15.2bn or 4% above the level seen a year before in 2019-20. At the same time cumulative expenditure excluding interest of £468.9bn was £41.2bn or 8% lower than the first six months of 2020-21, but £79.6bn or 20% higher than the same period two years ago.

Interest amounted to £33.5bn in the six months to September 2021, £10.4bn or 45% higher than the same period in 2020-21, principally because of higher inflation affecting index-linked gilts. Despite debt being 24% higher than two years ago, interest costs were only £3.7bn or 12% more than the equivalent six months ended 30 September 2019.

Cumulative net public sector investment in the six months to September 2021 was £24.8bn. This was £13.0bn less than the £37.8bn in the first half last year, which includes over £16bn for bad debts on coronavirus lending that are not expected to be recovered. Investment was £7.1bn or 40% more than two years ago, principally reflecting a higher level of capital expenditure.

Debt increased by £83.1bn since the start of the financial year, £25.0bn less than the deficit. This reflects cash inflows from delayed tax receipts and the repayment of coronavirus loans more than offsetting other borrowing to fund student loans and business lending.

Alison Ring, ICAEW Public Sector Director, said: “Upward revisions by the ONS to GDP brought the ratio of public debt to GDP down to 95.5% at the end of September, which is good news for the Chancellor as he gets ready for a potentially difficult Autumn Budget and Spending Review. September’s numbers continue to track below what now appear to be over-prudent forecasts from the Office for Budget Responsibility back in March, and the OBR will likely improve its projections for the Spending Review period when it reports next week.

“However, at £108.1bn the deficit for the first half of the financial year to September 2021 is almost twice the deficit recorded for the last full financial year before the pandemic, and the Chancellor is a long way from getting the public finances back under control. Difficult decisions await Rishi Sunak in the Spending Review given rising debt-interest costs and existing commitments on health, schools and defence will limit the capacity he has available to address significant spending pressures in many public services.”

Image of table with public sector finances for the six months to 30 September together with variances against prior year and two years ago.

For a readable version, please click the link at the bottom of this email to go the original ICAEW published version.

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

The ONS made a number of revisions to prior month and prior year fiscal numbers to reflect revisions to estimates. These had the effect of reducing the reported fiscal deficit for the five months to August 2021 from £93.8bn to £86.3bn and the deficit for the year ended 31 March 2021 from £325.1bn to £319.9bn.

Image of table with public sector finances by month to 30 September 2021.

For a readable version, please click the link at the bottom of this email to go the original ICAEW published version.

This article was originally published by ICAEW.

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

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

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

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

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

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

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

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

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

IFS Green Budget 2021: key points

Citi says the global economy is recovering:

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

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

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

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

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

Fiscal rules are needed, but:

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

Spending Review 2021:

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

Pressures on the NHS:

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

Local government funding in England:

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

Tax policies to achieve net zero:

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

Employment and the end of the furlough scheme:

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

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

This article was originally published by ICAEW.

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

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

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

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

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

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

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

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

Read the Public Sector team Representation to the Spending Review

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

This article was originally published by ICAEW.

ICAEW chart of the week: capital investment before the Spending Review

Given that capital budgets are often the first to be cut when money is tight, will the planned growth in capital investment survive the Spending Review later this month?

Capital investment before the spending review

Departmental capital budgets from 
2019-20 through 2025-26: £70bn, £92bn, £100bn, £107bn, £109bn, £113bn, £117bn

Local and other capital budgets: £14bn, £10bn, £7bn, £7bn, £11bn, £10bn, £10bn.

Sources: HM Treasury and Office for Budget Responsibility, Spring Budget 2021. Excludes covid and student loans.

Our chart this week is on public sector capital investment, illustrating how central department capital budgets increased from £70bn two years ago to £92bn last year and £100bn this year, with further increases planned up to £117bn in 2025-26. This path was originally set by former Chancellor Philip Hammond who believed boosting capital investment, particularly on infrastructure, would help address the productivity gap that has constrained economic growth over the last decade. Chancellor Rishi Sunak has broadly adopted the same approach of increasing capital budgets in the first half of the 2020s, but with the rather snappier objective of ‘levelling up’ opportunity across the country.

Local and other capital budgets in the public sector are actually significantly higher than those shown in the chart (£14bn, £10bn, £7bn, £7bn, £11bn, £10bn and £10bn in 2019-20 through 2025-26), but that is primarily because a substantial proportion of both local government and public corporation capital investment is funded through central government capital grants, which are already included within departmental capital budgets. The balance, funded by local taxation and non-tax revenues, has actually fallen in the last few years, especially as many local authorities have tightened their belts as social care and other costs have outstripped council tax receipts.

The Treasury announced last month that the envelope for the Spending Review would adopt the capital spending profile already set out in the Spring Budget in March as shown in our chart, with core capital department expenditure limits (Core CDEL) of £107bn in 2022-23, £109bn in 2023-24 and £113bn in 2024-25. It seems likely that the government will stick ahead with these capital plans, unlike the profile for departmental current spending (Core resource department expenditure limits or Core RDEL, not shown in the chart) which increased by £15bn, 12bn and £14bn respectively to £408bn in 2022-23, £422bn in 2023-24 and £441bn in 2024-25 to address the increasing demands being placed on health care as more people live longer and to address the social care crisis. 

While this extra current spending is to be funded by the new health and social care levy, there remain huge pressures on many other public services as well as concerns about the risks to tax receipts from an uncertain economic recovery. The temptation to raid capital budgets to top up current spending, as occurred in the years following the financial crisis, will be there. After all, the benefits of capital investment can often take many years to arrive, while the stresses experienced by public services are much more immediate. In addition, under government fiscal rules, capital expenditure counts towards reported expenditure (total managed expenditure or TME) and the public sector deficit, which perhaps makes it more difficult to treat investment for the long-term differently from day-to-day operating expenditure. 

Assuming the Chancellor sticks to the plan, then the big story of the Spending Review from a capital expenditure perspective will be in the allocation between departments. Transport (£18bn in 2021-22), Business, Energy & Industrial Strategy (£16bn) and Defence & Intelligence (£15bn) are the largest spenders, and each will be fighting hard for more money, especially Defence where governmental ambitions to be a ‘tier 1’ military power have always outstripped the amount of money supplied. Other departments likely to be seeking additional capital funding include the Department for Levelling Up, Housing and Communities on behalf of local authorities in England (£9bn in 2021-22) and the devolved administrations (together £9bn).

Will the Chancellor be able to steer a course through what appear to be some turbulent economic waters to deliver on the government’s infrastructure ambitions?

This chart was originally published by ICAEW.

ICAEW chart of the week: German federal budget 2022

As Germany heads to the polls this weekend to elect a new federal parliament, the topic of the public finances has moved to centre stage. Our chart this week looks at the federal budget for 2022 and the current plan to sharply reduce the deficit from 2023 onwards.

German federal budget 2022

2021: revenue €307bn + borrowing €240bn = expenditure €488bn + investment €59bn

2022: revenue €343bn + borrowing €100bn = expenditure €391bn + investment €52bn

2023: revenue €398bn + borrowing €5bn = expenditure €352bn + investment €51bn

2024: revenue €396bn + borrowing €12bn = expenditure €357bn + investment €51bn

2025: revenue €396bn + borrowing €12bn = expenditure €357bn + investment €51bn

Source: Bundesministerium der Finanzen: 'Draft 2022 federal budget and fiscal plan to 2025'

The coronavirus pandemic has been accompanied by relaxations in both European and German constitutional limitations on the size of the federal deficit for 2020, 2021 and 2022, with Chancellor Angela Merkel of the Union parties (the Christian Democratic Union (CDU) together with Bavaria’s Christian Social Union (CSU)) and Finance Minister and chancellor-candidate Olaf Scholtz of the Social Democratic Party (SPD) setting out a plan earlier this year to reduce federal borrowing significantly by 2023.

As the #icaewchartoftheweek illustrates, the plan is to continue to run a sizeable deficit of €100bn in 2022 with tax and other revenue of €343bn being offset by €391bn in expenditure and €52bn in investment spending. This is a smaller deficit than the €240bn forecast for the current year (revenue €307bn – expenditure €488bn – investment €59bn) and the €131bn recorded in 2020 (not shown in the chart: revenue €311bn – expenditure €392bn – investment €50bn), both of which contained significant amounts of emergency spending in response to the pandemic. 

The hope is that revenues will recover in 2023 to €398bn at the same time as expenditures and investment return to pre-pandemic levels of €352bn and €51bn respectively to leave only a €5bn shortfall to be covered by borrowing. The forecast deficit for both 2024 and 2025 is €12bn, comprising revenue of €396bn in both years, less expenditure of just under €396bn in 2024 and just over €396bn in 2025 and investment in both years of €51bn. It is important to note that this is the budget for the federal government only and excludes the share of joint taxes going to Germany’s states (Länder) as well as expenditures funded from state and local taxation.

The challenge for the three principal candidates for the chancellorship: Olaf Scholtz of the SPD, Armin Laschet of the Union parties and Annalena Baerbock of the Green party, is in how to make promises to spend more on their respective priorities while maintaining the low levels of borrowing required by the constitution outside of fiscal emergencies. 

Major flooding earlier this year has put climate change at the top of the electoral agenda, with the need to increase investment to achieve net zero a key theme of party platforms. Together with promises to invest more in infrastructure and the need to cover the cost of more people living longer, higher defence spending and other financial commitments, there are significant questions about whether the path to near-budget balance can be achieved. Given the economic uncertainty, the prospect of returning to the pre-pandemic policy of paying down government debt seems unlikely, although that policy helped reduce general government debt from a peak of 82% of GDP in 2010 following the financial crisis. Despite the additional borrowing because of the pandemic, general government debt is still below that level at somewhere in the region of 75% of GDP – putting Germany in a much better fiscal position than many of its European neighbours, including the UK.

One candidate to be the next finance minister is Christian Lindner of the liberal Free Democratic Party (FDP), a possible partner in either a ‘traffic-light coalition’ of SPD (red), Greens (green) and FDP (yellow) or a ‘Jamaica coalition’ of the Union parties (black), Greens (green) and FDP (yellow) although this will of course depend on how the parties perform in the election on Sunday 26 September. Alice Weidel and Tino Chrupalla, joint leaders of the hard-right Alternative for Germany (AfD), and Janine Wissler & Dietmar Bartch, joint leaders of the Left Party (Die Linke), are considered unlikely to find their way into the federal cabinet in most scenarios.

Unlike in the UK, where a new prime minister customarily takes up residence in 10 Downing Street the next day, there is unlikely to be an instant change in national leadership. Chancellor Angela Merkel and most of her existing Union/SPD ‘Grand coalition’ cabinet are likely to stay in caretaker positions for several weeks or potentially months as fresh coalition negotiations between the parties elected to the Bundestag are concluded.

This chart was originally published by ICAEW.

Shadow Chief Secretary joins Fabians-ICAEW roundtable

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

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

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

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

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

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

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

This article was originally published by ICAEW.

Public debt hits £2.2tn as Budget delay rumours swirl

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

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

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

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

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

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

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

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

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

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

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

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

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

Public sector finances 2021-22: fiscal deficit by month


Receipts
Expend-
iture

Interest
Net
investment

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

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

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

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

This article was originally published by ICAEW.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

This article was originally published by ICAEW.

March fiscal deficit hits £28bn as departments rush to spend capital budgets

The UK reported a £28.0bn fiscal deficit in March 2021, bringing the total shortfall for 2020-21 to £303.1bn. The last month of the financial year saw net investment of £10.3bn, up from a monthly average of £4.0bn over the previous eleven months.

The latest public sector finances released on Friday 23 April reported a deficit of £28.0bn for March 2021, as COVID-related spending continued to weigh on the public finances. This brought the cumulative deficit for the financial year to £303.1bn, £246.0bn more than the £57.1bn reported for the same period last year.

The combination of receipts down 5%, expenditure up 27% and net investment up 25% has resulted in a deficit for the twelve months to March 2021 that is more than five times as much as the budgeted deficit of £55bn for the whole of the 2020-21 financial year set in the Spring Budget in March, despite interest charges being lower by 25%.

The deficit is smaller than the £354.6bn forecast by the Office for Budget Responsibility (OBR) in March as the economy has been less damaged than was feared, despite the extended lockdown during the final quarter of the financial year. However, some of this difference relates to spending that has been deferred into the following financial year, while the provisional numbers also exclude £27bn of bad debts on COVID-related lending that were included in the OBR forecast.

Falls in VAT, corporation tax and income tax receipts and the waiver of business rates were the principal driver of lower tax revenues over the last twelve months, while large-scale fiscal interventions have resulted in much higher levels of expenditure. 

Net investment is greater than last year (mostly as planned), while the interest expense line has benefited from ultra-low interest rates. March 2021 saw a return to the traditional end-of-financial-year rush to get capital budgets spent, with net investment spending of £10.3bn in March contrasting with an average of £4.0bn over the previous eleven months.

Public sector net debt increased to £2,141.7bn or 97.7% of GDP, an increase of £344.0bn from the start of the financial year. This reflected £40.9bn of additional borrowing over and above the deficit, much of which has been used to fund coronavirus loans to businesses and tax deferral measures. Although net debt was reported as exceeding 100% of GDP at various points during the financial year, slightly improved GDP numbers have kept the ratio below that point.

The cash outflow (the ‘public sector net cash requirement’) for the month was £16.4bn, increasing the cumulative total cash outflow for 2020-21 to £339.0bn. This is a significant increase over the cumulative net cash outflow of £17.2bn reported for 2019-20.

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

The ONS made a number of revisions to prior month and prior year fiscal numbers to reflect revisions to estimates and changes in methodology. These had the effect of reducing the reported fiscal deficit in the first eleven months from £278.8bn to £275.1bn and the reported deficit for 2019-20 from £57.7bn to £57.1bn.

This article was originally published by ICAEW.