Tag: #publicspending

ICAEW chart of the week: UK-EU financial settlement update

This week’s chart is on the UK-EU withdrawal agreement financial settlement. Perhaps surprisingly given recent press coverage, ICAEW’s analysis is that it remains roughly unchanged from the Treasury’s 2018 estimate.

Chart on UK-EU financial settlement. HM Treasury estimate from 2018 of £39bn less £16bn transition = post-transition net payments of £23bn (£19bn approved expenditure not paid + £11bn pension obligations, less £7bn share of EU assets). Changes since 2018: -£2bn approved expenditure not paid +£2bn pension obligations. EU 2020 accounts £42bn less forecast UK receipts of £14bn less EIB and other of £bn = Post-transition net payments £23bn (£17bn approved expenditure not paid + £13bn pension obligations - £7bn share of EU assets).

The €47.5bn (£42bn) receivable from the UK included in the recently published EU 2020 accounts caused a kerfuffle last week, as excitement levels grew over what turns out to be a pretty much unchanged estimate for the post-transition element of the UK-EU financial settlement.

ICAEW’s chart of the week attempts to reconcile the £39bn estimate calculated by HM Treasury back in 2018 with the €47.5bn (£42bn) receivable recorded by the EU in its financial statements on 31 December 2020, the last day of the transition period. Perhaps surprisingly, given recent press coverage, ICAEW’s analysis is that the estimate for the post-transition element of the settlement of £23bn remains unchanged overall.

Much of the confusion arises because the £39bn estimate made by HM Treasury in 2018 was a net number, reflecting forecasts of gross payments to the EU by the UK government less anticipated payments by the EU and EU-related institutions back to the UK.

The chart starts by analysing the £39bn estimate into its four main component parts: Net transition payments of £16bn, the UK’s share of approved expenditure not yet paid of £19bn and pension contributions of £11bn less the UK’s share of EU assets of £7bn, with the last three elements amounting to a net £23bn amount to be settled in the post-transition period.

The transition element of £16bn is now in the past, reflecting membership dues for the then anticipated transition period of 1 April 2019 to 31 December 2020 less money coming back from the EU to the UK over the same period. In the end, this turned out to be a couple of extensions in the UK’s period of membership that resulted in a shorter transition period from 1 February to 31 December 2020 – a switch in classification for some of the £16bn from post-EU transition payments to pre-EU exit net membership cost.

The UK’s share of approved expenditure not yet paid of £19bn was also a net number, reflecting a gross amount payable to the EU for ongoing programmes at the end of 2020 less amounts coming back the other way. The OBR has been working to an estimate of €296bn for the balance of approved expenditure not paid (also known as reste á liquider or RAL), which compares with €294bn in the notes to the EU accounts once adjustments were applied to the overall total of €303bn that the EU was committed to spend as at 31 December 2020. 

The calculated receivable of €35bn or £31bn does not reflect an estimated £14bn of payments by the EU to UK participants in these programmes, for example to British universities and research institutions, giving rise to a net amount in the order of £17bn, a couple of billion below the original estimate.

This slightly smaller net outflow is offset by a larger pension liability in the EU accounts, driven by a lower discount rate than originally anticipated. The UK’s €14bn or £13bn share of the €116bn liability is therefore higher than the €12bn or £11bn share of a €96bn liability that was previously forecast. In practice, the value attributable to this balance will change over time given that payments are expected to continue to 2064 or later.

Another area where the EU accounts do not provide the complete story is in the UK’s share of assets it expects to receive back as part of the withdrawal agreement. The €2bn amount in the EU accounts primarily relates to the UK’s share of fines, but it excludes the return of UK shareholdings in EU-related institutions that are owned by member states outside of the scope of the EU consolidated financial statements. Of the £5bn in this category, €3.5bn or £3bn relates to the return of the UK’s share capital in the European Investment Bank.

Despite the numbers being pretty much as expected, there still remains some uncertainty concerning the £23bn post-transition estimate in relation to the calculation of the amounts coming back to the UK, and HM Treasury and the OBR will no doubt continue to refine these estimates over the next few months and years.

The financial settlement is not the end of the UK’s financial engagement with the EU as the government has agreed to participate in a number of EU programmes from 1 January 2021 onwards, for example in Horizon pan-European scientific research, as well as working with the EU on international development programmes funded from the aid budget.

This chart 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.

What COVID-19 means for the future of tax

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

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

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

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

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

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

Paying for coronavirus

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

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

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

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

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

Reallocating spending

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

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

The need for change

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

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

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

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

Catalyst for reform

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

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

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

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

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

This article was originally published by ICAEW.

Biggest peacetime deficit caps extraordinary year for UK public finances

Huge economic shock combined with unprecedented fiscal interventions results in a provisional fiscal deficit of £303bn or 14.5% of GDP for the year ended 31 March 2021.

The Office for National Statistics today published its first estimate of fiscal history, reporting a provisional fiscal deficit of £303bn or 14.5% of GDP for 2020-21 and a £344bn increase in public sector net debt from £1.8bn to £2.14tn at 31 March 2021, breaking peacetime records for the public finances. This compares with an official forecast for the deficit of £55bn presented by the Chancellor just prior to the start of the financial year last March, admittedly together with the first in a series of mini-fiscal announcements that saw spending soar to tackle the pandemic at the same time as tax revenues collapsed.

The damage is less than had been feared at some points during the past year, with the provisional deficit coming in below the £355bn estimated by the Office for Budget Responsibility (OBR) at the time of the Spring Budget 2021 last month and substantially below their forecast of £394bn in November 2020 at the time of the Spending Review. While some of this is down to better economic performance as lockdowns have been less harmful than anticipated, there has been an offsetting increase in the forecast deficit for the 2021-22 financial year starting this month to £234bn compared with the pre-pandemic projection of £67bn. The provisional deficit of £303bn also excludes somewhere in the region of £27bn for bad debts on covid-related lending that will need to be accounted for at some point.

The deficit is only part of the story, as the government has borrowed significant amounts to finance tax deferrals and lending to business to help them survive. As a consequence, public sector net debt has increased by more than the deficit, with an increase of £344bn to a provisional £2,142bn or 97.7% of GDP at 31 March 2021. Debt is expected to rise over the next couple of years to in excess of £2.5tn.

While the numbers for both the deficit and debt are likely to be revised up or down over the next few months, the big picture won’t change – debt as a proportion of GDP has increased from 35% in March 2008 before the financial crisis to around 80% of GDP a couple of years ago before climbing to in the region of 100% of GDP today. These numbers don’t include other significant liabilities in the government balance sheet such as public sector employee pension obligations, nor do they include future financial commitments such as for welfare benefits. Despite that they still provide an indication of just how significantly the UK’s fiscal position has changed over a period of less than a decade and a half.

Fortunately, interest rates have been coming down even faster than debt has been going up, enabling the Government to reduce its interest bill over the course of the year. However, higher leverage comes with a greater exposure to movements in interest rates going forward, a concern for the Chancellor in mapping out his plans for the next few years.

While the Spring Budget last month provided some indications on how the Chancellor aims to stabilise the public finances through a combination of higher investment spending, short-term economic stimulus and a corporation tax rise, there is as yet no indication of his longer-term fiscal strategy to address the unsustainability of the public finances identified by the OBR before the pandemic.

While the government has been taking steps to set the foundations for better management of the public finances, for example through the National Infrastructure Strategy released last year, the soon to be launched National Data Strategy and actions coming out of HM Treasury’s recent Balance Sheet Review, there is no clear plan for how the government intends to fund pensions, health and social care over the next quarter of a century. These costs will continue to grow as many more people live longer in retirement and the working age population shrinks, just at a time that huge investments are needed to achieve net zero and pressures on public spending are unlikely to disappear. At the same time the government needs to work out how it can ensure the public finances are more resilient and better prepared for future crises – from whatever corner they may come.

Alison Ring, ICAEW Public Sector Director, said: “Today’s numbers cap a dramatic year for the UK’s public finances, and show this is the biggest deficit since the end of World War Two. However, the damage is less than had been feared, with the shortfall lower than the OBR had forecast.

Ultra-low borrowing costs have provided the government with the room it needed to provide unprecedented spending to tackle the coronavirus pandemic, protect jobs and prevent the economy from crashing, as well as the opportunity to invest for growth in the coming years.

However, even as the economy starts to recover, the legacy of higher debt and a greater exposure to changes in interest rates will be with us for years, if not decades to come. The public finances were already on an unsustainable path before the pandemic, and the government will need a long-term strategy for rebuilding them.”

This article was originally published by ICAEW.

ICAEW chart of the week: Canada Budget 2021

Canada Budget 2021 2020-21 Forecast outturn C$635 (£363bn) Budget shortfall C$339bn + Taxes and other income C$296bn Covid-19 C$252bn + Federal spending C$363bn 2021-22 Federal budget C$498bn (£285bn) Budget shortfall C$143bn + Taxes and other income C$355bn Covid-19 C$76bn + Federal spending C$422bn

Monday 19 April 2021 saw Chrystia Freeland, the Canadian deputy prime minister and minister of finance, release her country’s 725-page Budget 2021, setting out the Government of Canada’s plan to “finish the fight against COVID-19 and ensure a robust economic recovery that brings all Canadians along”.

As the #icaewchartoftheweek illustrates, the forecast outturn for the fiscal year ended 31 March 2021 involved spending by the federal government of C$635bn (equivalent to £363bn at an exchange rate of C$1,75:£1), resulting in a budget shortfall of C$339bn after taking taxes and other income of C$296bn into account. Spending comprised C$363bn on ‘normal’ federal government activities – operational spending, welfare payments and transfers to provinces and territories and C$272bn on exceptional measures in response to covid-19.

COVID-19 spending is much lower in 2021-22 at C$76bn, even as other spending increases to C$422bn as the federal government seeks to generate economic growth following the pandemic – total spending of C$498bn (£285bn). Assuming taxes and other income recovers to C$355bn as expected, the budget shortfall should reduce to C$143bn – still much higher than the C$29bn seen before the pandemic in 2019-20.

The federal finances were in a fairly strong position coming into the pandemic compared with many other countries, with debt at 31 March 2020 of C$813bn (31% of GDP) rising to C$1,176bn (49% of GDP) at 31 March 2021 and a forecast C$1,334bn (51% of GDP) at 31 March 2022. This provides Canada with some room for manoeuvre as it navigates its way after the pandemic. 

Fortunately for Canadians, one side-effect of the US government’s stimulus package is that it is expected to not only drive growth in the US economy, but in its Canadian neighbour too.

More (much more) information is available in the Canada Budget 2021.

This chart was originally published by ICAEW.

Fiscal deficit on course to exceed £300bn in 2020-21

The UK reported a £19.1bn fiscal deficit in February 2021, bringing the total shortfall over eleven months to £278.8bn. Public sector net debt is up by £333.0bn at £2.13tn.

The latest public sector finances released on Friday 19 March reported a deficit of £19.1bn for February 2021, as COVID-related spending continued to weigh on the public finances. This brought the cumulative deficit for the first eleven months of the financial year to £278.8bn, £228.2bn more than the £50.6bn reported for the same period last year.

The reported deficit for the eleven months excludes £27.2bn in potential business loan write-offs that the Office for Budget Responsibility (OBR) has included in its forecast deficit of £354.6bn for the full financial year.

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 eleven 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 line has benefited from ultra-low interest rates.

Public sector net debt increased to £2,131.2bn or 97.5% of GDP, an increase of £333.0bn from the start of the financial year and £347.2bn higher than in February 2020. This reflects £54.2bn of additional borrowing over and above the deficit, much of which has been used to fund coronavirus loans to businesses and tax deferral measures.

The cash outflow (the ‘public sector net cash requirement’) for the month was £11.4bn, increasing the cumulative total cash outflow this financial year to £322.3bn. This is a significant swing from the cumulative net cash inflow of £10.9bn reported for the equivalent eleven-month period in 2019-20.

The combination of receipts down 5%, expenditure up 27% and net investment up 21% has resulted in a deficit for the eleven months to February 2021 that is around 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 27%.

Alison Ring, ICAEW Public Sector Director said: “Today’s numbers are in line with expectations, with the deficit for the past 11 months reaching £278.8bn. This means we are on track for public sector net borrowing to exceed £300bn for the full year once a potential £27bn in bad debts that have not yet been recorded are factored in.

“Our eyes are now focused on what possible tax measures, in addition to the planned corporation tax rise, the government might use to start rebuilding the public finances.”

Table: public sector finances month ended 28 February 2021. Analyses deficit of £19.1bn for month and variances from same month last year. Click on link at the end of the post to ICAEW article for a readable version of the table.
Table: public sector finances 11 months ended 28 February 2021. Analyses deficit of £278.8bn and change in net debt of £333.03bn and variances from same period last year, together with net debt of £2,131.2bn or 97.5% of GDP. Click on link at the end of the post to ICAEW article for a readable version of the table.
Table: month by month analysis of receipts, expenditure, interest, net investment and the fiscal deficit for the 11 months to 28 February 2021. Click on link at the end of the post to ICAEW article for a readable version of the table.
Table: month by month analysis of receipts, expenditure, interest, net investment and the fiscal deficit for the prior year. Click on link at the end of the post to ICAEW article for 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 and changes in methodology. These had the effect of reducing the reported fiscal deficit in the first ten months from £270.6bn to £259.7bn and increasing the reported deficit for 2019-20 from £57.1bn to £57.7bn.

This article was originally published by ICAEW.

ICAEW chart of the week: global military spending

19 March 2021: The UK’s Integrated Review is the inspiration for this week’s chart, illustrating the 20 countries around the world that spend the most on their militaries.

Chart showing global military spending in 2019 led by USA (£526bn) and China (£200bn) followed by 18 other countries - see text below the chart for details.

The UK Government launched its Integrated Review of Security, Defence, Development and Foreign Policy on 16 March 2021, setting out a vision for the UK’s place in the world following its departure from the European Union and in the context of increasing international tensions and emerging security threats.

At the core of the Integrated Review is security and defence, and ICAEW’s chart of the week illustrates one aspect of that by looking at military spending around the world. 

The chart shows spending by the top 20 countries, which together comprise in the order of £1.2tn of estimated total military spending of around £1.4tn to £1.5tn globally in 2019 – an almost textbook example of the 80:20 rule in action.

More than a third of the total spend is incurred by just one country – the USA – which spent in the order of £526bn in 2019 converted at current exchange rates. The next biggest were China and India at £200bn and £50bn respectively, although differences in purchasing power mean that they can afford many more soldiers, sailors and aircrew for the same amount of money. This is followed by Saudi Arabia (£45bn), Russia (£41bn), France (£38bn), the UK (£38bn), Germany (£38bn), Japan (£34bn), South Korea (£33bn), Australia (£21bn), Italy (£20bn), Canada (£17bn), Israel (£16bn), Brazil (£14bn), Spain (£13bn), Turkey (£11bn), the Netherlands (£9bn), Iran (£9bn) and Poland (£9bn).

Exchange rates affect the relative orders of many countries in the list, for example between Russia, France, the UK and Germany which can move up or down according to movements in their currencies, while there are a number of caveats over the estimates used given the different structures of armed forces around the world and a lack of transparency in what is included or excluded in defence budgets in many cases.

In addition, the use of in-year military spending does not necessarily translate directly into military strength. Military capabilities built up over many years or in some cases (such as the UK) over many centuries need to be taken into account, as do differing levels of technological development and spending on intelligence services, counter-terrorism and other aspects of security. Despite these various caveats, estimated military spending still provides a useful proxy in understanding the global security landscape and in particular highlights the UK’s position as a major second-tier military power – in the top 10 countries around the world.

Global Britain in a Competitive Age: the Integrated Review of Security, Defence, Development and Foreign Policy sets out some ambitious objectives for security and defence, which it summarises as follows: “Our diplomatic service, armed forces and security and intelligence agencies will be the most innovative and effective for their size in the world, able to keep our citizens safe at home and support our allies and partners globally. They will be characterised by agility, speed of action and digital integration – with a greater emphasis on engaging, training and assisting others. We will remain a nuclear-armed power with global reach and integrated military capabilities across all five operational domains. We will have a dynamic space programme and will be one of the world’s leading democratic cyber powers. Our diplomacy will be underwritten by the credibility of our deterrent and our ability to project power.”

The estimates of military spending used in the chart were taken from the Stockholm International Peace Research Institute (SIPRI)’s Military Expenditure Database, updated to current exchange rates.

This chart was originally published by ICAEW.

Crown Consultancy gains traction as UK government spending soars

19 January 2021: Plans for an in-house government consultancy sound sensible, but will insourcing really deliver value for money for taxpayers?

The UK government spends hundreds of millions of pounds on consultants each year for services ranging from strategic advice to service delivery. While ministers and senior civil servants often comment they feel too much is spent on consultants, there continues to be a stream of new contracts awarded to the major professional service firms and consultancy practices.

This is a particularly high-profile issue in the context of the huge amounts of pandemic-related contracts awarded over the course of the last year.

Recent examples include bringing in procurement specialists and forensic accountants to sort out the audit trail for panic purchases of personal protective equipment or using a range of IT consultants to help rapidly design and build new border and customs systems following the UK’s exit from the EU Customs Union and Single Market.

In practice, there are many reasons why a government department – or any organisation for that matter – might want to engage external consultants. They can provide expertise not available in-house, as well as providing a flexible resource that can be mobilised quickly to achieve critical objectives. After more than a decade of tightening budgets in the public sector, it is unsurprising there is a limit to how many of the existing team can be diverted from day-to-day activities in order to (say) implement a major new IT system, transform the organisation or respond to a global crisis such as a pandemic.

Partly that is sensible human resource management. It does not make sense to employ hundreds, if not thousands, of staff across the civil service ‘just in case’ their expertise might be needed on a future project. At the same time, it also makes sense to bring in experience gained elsewhere from experts who know what works and what doesn’t.

Using external service providers also enables resources to be mobilised quickly and at scale. Again, a capability most organisations will not have – or normally need to have – internally. There are also other benefits, such as the ability to change team members at will, charge contractual penalties for non-performance or the ability to sue over poor service or bad advice: options generally not available when employing in-house teams.

However, those benefits come at a cost. Not only are salaries for consultants generally higher than those of staff in the public sector, but there is a premium on top to cover technical resources, overheads, insurance and margin that together mean than the per-hour rate can be a significant multiple of the cost of in-house staff, even when the civil services’ own overheads are factored in. 

Justifying this premium can be difficult, particularly in major projects involving very large teams of consultants. Another perceived issue can be where individual consultants are former civil servants apparently being re-employed at a much greater cost, even if that comes with technical and other resources not available when they were on the payroll.

A recent report by the Public Accounts Committee argues that the extensive use of consultants is driven by an underlying lack of skills in the civil service, with the development of fourteen cross-government functions (such as the Project Delivery Service and the Government Finance Function) not having had the desired effect of strengthening internal capabilities sufficiently to reduce the need to bring in external consultancy support.

One solution that has often been mooted (and is now being considered more actively) is to establish an in-house consultancy organisation. This would have the scale to be able to employ technical experts and experienced consultants to help deliver priorities across the whole of government, both centrally and locally.

Of course, this is not a new phenomenon and there are a range of consultancy services already in existence inside the government. Examples include the Government Legal Department (originally the Treasury Solicitor’s Department, founded in 1876), the Government Actuary’s Department (founded in 1919) and the consultancy arm of the Government Property Agency (founded 2018). These all provide expert advice and support that government departments and agencies can utilise as needed, with any profit that might be generated coming back to the exchequer to be reinvested in public services.

The proposals for a Crown Consultancy ‘firm’ within government would be different both in terms of scale and also in the range of activities it would cover. Such an organisation would have many benefits in being able to utilise existing expertise within the civil service more effectively, while also bringing in private sector expertise and experience to bear on difficult challenges. There would also be opportunities to provide a wider range and depth of experience for civil servants with secondments as part of their development, providing career opportunities not currently available, particularly in technical specialities.

There are a number of hurdles to be overcome in establishing a Crown Consultancy. One of the more significant will be how to address pay disparities that may make it difficult to recruit individuals with the skills and experience required. Another will be in replicating the tools, techniques and resources that private sector firms have spent decades creating and that enable them to mobilise quickly to meet client needs.

Plans remain at an early stage, but of course, there are a number of external consultants available that can help move them forward!

This article was originally published by ICAEW.

A difficult winter ahead for the public finances

23 December 2020: The UK public sector incurred a £31.6bn deficit in November, bringing the total shortfall over eight months to £240.9bn. Debt reached an all-time high of £2.1tn.

Commenting on the latest public sector finances for November 2020, published on Tuesday 22 December 2020 by the Office for National Statistics (ONS), Alison Ring sector director at ICAEW, said: 

“A slightly more optimistic forecast for GDP from the Office for Budget Responsibility last month resulted in the UK’s debt to GDP ratio being revised downwards, despite public sector debt having reached an all-time high of £2.1tn in November. However, this optimism may prove to have been premature, with reports suggesting another national lockdown in the new year and disruption in international trade foretelling a potentially difficult winter ahead for the economy and the public finances. 

Prospects for the spring will depend on how quickly the vaccine can be rolled out, whether testing and tracing can deliver rapid and reliable results, and the extent to which disruption at borders now and after 1 January can be minimised.”

Public sector finances for November

The latest public sector finances reported a deficit of £31.6bn in November 2020, a cumulative total of £240.9bn for the first eight months of the financial year. This is £188.6bn more than the £52.3bn recorded for the same period last year.

Falls in VAT, corporation tax and income tax drove lower receipts, while large-scale fiscal interventions resulted in much higher levels of expenditure. Net investment is greater than last year, as planned, while the interest line has benefited from ultra-low interest rates.

Public sector net debt increased to £2,099.8bn or 99.5% of GDP, an increase of £301.6bn from the start of the financial year and £303.0bn higher than in November 2019. This reflects £60.7bn of additional borrowing over and above the deficit, most of which has been used to fund coronavirus loans to business and tax deferral measures.

Table of results for the month of November and for the 8 months then ended, together with variances against the prior year. Click on the link at end of post to visit the original ICAEW article for a readable version.

The combination of receipts down 8%, expenditure up 29% and net investment up 26% has resulted in a deficit for the eight months to November 2020 that is over four times 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 26%. The cumulative deficit is approaching five times as much as for the same eight-month period last year.

Cash funding (the ‘public sector net cash requirement’) for the month was £20.7bn, bringing the cumulative total this financial year to £295.8bn, compared with £14.9bn for the same eight-month period in 2019. 

Interest costs have fallen despite much higher levels of debt, with extremely low interest rates benefiting both new borrowing to fund government cash requirements and borrowing to refinance existing debts as they have been repaid.

The deficit remains on track to approach the £393.5bn forecast for the financial year to March 2021 by the Office for Budget Responsibility in the Spending Review once bad debts not yet recognised on coronavirus loans are included.

Upwards revisions to GDP based on the latest Office for Budget Responsibility forecasts have reduced the debt to GDP ratio for this and previous months to below 100% of GDP. However, the likelihood of a further national lockdown in the new year and for disruption in international trade with the end of the EU transition period could depress prospects for GDP growth in 2021.

Table of results each of the 8 months to November 2020. Click on the link at end of post to visit the original ICAEW article for a readable version.
Table of results each of the 8 months to November 2019 and of the 12 months ended 31 March 2020. Click on the link at end of post to visit the original ICAEW article for a readable 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 and changes in methodology. These had the effect of reducing the reported fiscal deficit in the first seven months from the £214.9bn reported last time to £209.3bn and increasing the reported deficit for 2019-20 from £56.1bn to £57.4bn.

This article was originally published by ICAEW.

Test and trace in England falls short despite £22bn budget

11 December 2020: Despite achieving significant increases in testing activity, the Department of Health and Social Care’s test and trace service failed to meet recommended effectiveness rates, according to the NAO.

The rapid scale-up of COVID-19 test and trace service saw 23 million tests carried out, 630,000 of 850,000 people testing positive reached and 1.4 million of their contacts traced up to 4 November. However, at 66% the close contact trace rate is below the 80% needed to be effective.

The National Audit Office (NAO) has issued an interim report on the NHS Test and Trace Service set up by the Department of Health and Social Care (DHSC or the Department) to test for COVID-19 and to trace close contacts of those testing positive. 

The NAO reports that between 28 May and 4 November 2020, only 41% of test results were provided within the target time of 24 hours and only 66% of close contacts of those testing positive were reached and asked to self-isolate, compared with the 80% rate recommended by the Scientific Advisory Group for Emergencies (SAGE) for an effective test and trace system.

Test and trace programmes are a core public health response in epidemics that can be used with other measures, such as social distancing, barriers (such as masks) and handwashing, to reduce infections. At the start of the COVID-19 outbreak, Public Health England carried out comprehensive testing and tracing on the relatively low numbers of initial infections, but this was suspended at the start of the first national lockdown in mid-March. The Department scaled-up testing capacity from April onwards and on 28 May 2020 launched the NHS Test and Trace Service covering England.

The NAO’s key findings include:

  • The Department has achieved significant increases in testing activity, set up a national contact tracing service scratch and has tested millions of people.
  • The delivery model chosen for the national test and trace programme, which excluded local public health teams from the response, was only documented in a retrospective business case written in September 2020.
  • The Department spent £4bn up to October 2020, around £2bn less than forecast, due to underspending on laboratories, machines and mass testing. The total budget for 2020-21 is now £22bn with a significant expansion in mass testing planned in the remaining months of the financial year ending in March 2021.
  • 407 contracts worth £7bn have been signed with 217 public and private organisations, with a further 154 contracts worth £16bn expected to be signed by next March (this includes spend going into the next financial year). An internal government review of test and trace systems in 15 other countries confirmed that the UK approach was atypical, as although some countries had used private sector outsourcing to increase testing capacity, none had done so to increase tracing capacity, which was generally built up from existing public health expertise.
  • Connecting discrete services provided by different organisations into an effective end-to-end process has been challenging, with the initial focus on creating a ‘minimum viable process’ shifting to refining, integrating and stabilising the process so it operates reliably at scale.
  • Accountability is unclear, with the executive chair of the test and trace service reporting directly to the Prime Minister and the Cabinet Secretary, bypassing normal reporting lines within the Department.
  • There are now 593 testing sites and 15 laboratories, with plans to add a further 15 lighthouse laboratories and two high-capacity ‘mega-laboratories’ in January 2021. Testing capacity expanded rapidly in line with the public target of 500,000 available tests per day on 31 October, but the average number of tests since May has been only 68% of capacity, below the 85% expected level. The ambition is to increase testing capacity to 800,000 tests a day by the end of January.
  • Turnaround of test results peaked in June with 93% of community (pillar 2) test results provided in 24 hours, but this had deteriorated to 14% around mid-October before improving to 38% by the beginning of November. Turnaround times for hospital and care homes have consistently been about 90%, albeit measured on a different basis.
  • The Department did not plan for a sharp rise in testing demand in early autumn when schools and universities reopened, resulting in the number of tests available being limited, longer turnaround times and extra assistance being commissioned.
  • Initial problems in sharing data with local authorities have now been largely resolved, but there are a number of significant data risks to be managed pending a planned upgrade of contact tracing software scheduled for January 2021.
  • High reported levels of non-compliance with self-isolation rules represent a key risk to the success of test and trace, and national and local government have been trying to increase public engagement.

The NAO concludes by commenting that although a rapid scale-up in activity has been achieved with new infrastructure and capacity built from scratch, issues with implementation and potentially the initial choice of delivery model mean that the government is not yet achieving its objectives.

The NAO also highlights the most significant risks remaining, including in how to increase utilisation of testing capacity, manage spikes in testing demand and expand the use of local authority public health teams. There are challenges to be overcome in delivering mass testing across the country, increasing public engagement to improve compliance with self-isolation and in ensuring contracts awarded contain sufficient flexibility to respond to changing requirements at reasonable cost.

Finally, the NAO stresses the importance of embedding strong and sustainable management structures, controls and lines of accountability, addressing arrangements where accountability does not clearly align with organisational and strategic objectives in other aspects of the government’s COVID-19 response.

Alison Ring, director for public sector at ICAEW, commented: “While the need to move quickly in response to an out-of-control pandemic was always likely to prove extremely challenging, the NAO has highlighted how consequential the initial decisions made under pressure can be. 

The NAO hints (without being explicit) that the choice to exclude local public health teams and local expertise from the initial roll-out of national test and tracing was a major mistake that the government is still struggling to recover from. They also do not sound entirely comfortable with the governance arrangements for the test and trace service and intend to look at value-for-money and contract management in their second report expected in spring 2021.

Despite an eye-watering £22bn price tag, the investment in test and trace will be worthwhile if it saves lives ahead of the roll-out of vaccines and enables restrictions on our freedom and on economic activity to be lifted as quickly as possible in 2021.”

Read the full report here.

This article was originally published on the ICAEW website.