Tag: #tax

ICAEW chart of the week: Autumn Statement 2023

My chart for ICAEW this week illustrates how Chancellor Jeremy Hunt used almost all of the available upside from inflation and fiscal drag to fund his tax measures and a series of business growth initiatives.

Autumn Statement 2023 Step chart (waterfall diagram) showing the average change to 2023/24 to 2027/28 forecasts since the Spring Budget 2023. Forecast revisions (steps in orange): Inflation +$41bn Fiscal drag +£7bn Other changes +£4bn Debt interest -£21bn Welfare uprating -£13bn = Forecast revisions +£18bn (subtotal in purple) Policy measures (steps in blue): Tax measures -£11bn Spending and other -£6bn = Net changes +£1bn (total in purple) 23 Nov 2023. Chart by Martin Wheatcroft FCA. Design by Sunday. Sources: HM Treasury, 'Autumn Statement 2023'; OBR, 'Economic and fiscal outlook, Nov 2023'.

The Autumn Statement 2023 on Wednesday 22 November featured a surprise tax cut to national insurance and a perhaps less surprising decision to make full expensing of business capital expenditure permanent.

As my chart illustrates, the forecasts for the deficit over the next five years benefited by £41bn a year on average in higher receipts from inflation, £7bn a year on average in additional ‘fiscal drag’ as higher inflation erodes the value of frozen tax allowances more quickly, and a net £4bn in other upward forecast revisions. These improvements to the forecasts were offset by an average of £21bn a year in higher debt interest and £13bn from the expected inflation-driven uprating of the state pension and welfare benefits, to arrive at a net improvement of £18bn a year on average over the five financial years from 2023/24 to 2027/28 before policy decisions.

In theory, these upward forecast revisions should be absorbed by more spending on public services as higher inflation feeds through into salaries and procurement costs. However, the Chancellor has chosen to (in effect) sharply cut public spending and use almost all of the upward revisions to fund tax measures and business growth initiatives instead. These amounted to £11bn a year on average in tax changes and £6bn a year on average in spending increases and other changes to reduce the net impact to just £1bn a year on average over the five-year period.

The resulting net change of £1bn on average in forecasts for the deficit is to reduce the forecast deficit by £8bn for the current year (from £132bn to £124bn) and by £1bn for 2024/25 (to £85bn), with no net change in 2025/26 (at £77bn), an increase of £5bn in 2027/28 (to £68bn), and no net change for 2027/28 (at £49bn).

The main tax changes announced were the cuts in national insurance for employees by 2 percentage points from 12% to 10% and by 1 percentage point for the self-employed from 9% to 8%, reducing tax receipts by an average of £9bn over five years. This is combined with the effect of making full expensing permanent of £4bn – this change mainly affects the later years of the forecast (£11bn in 2027/28), although ironically the average is a better proxy for the long-term cost of this change, which the OBR estimates is around £3bn a year. 

Other tax changes offset this to a small extent. 

Spending and other changes of £6bn a year on average comprise incremental spending of £7bn a year plus £2bn higher debt interest to fund that spending, less £3bn in positive economic effects from that spending and from the tax measures above.

Although the cumulative fiscal deficit over five years has been revised down by £4bn, the OBR has revised its forecast for public sector net debt as of 31 March 2028 up by £94bn from to £3,004bn. This principally reflects changes in the planned profile of quantitative tightening and higher lending to students and businesses.

The big gamble the Chancellor appears to be making by choosing to opt for tax cuts now is that the OBR and Bank of England’s pessimistic forecasts for the economy are not realised – enabling him to find extra money in future fiscal events to cover the effect of inflation on public service spending. Otherwise, while it may be possible to cut public spending by as much as the Autumn Statement suggests, it is difficult to see how he can do so without a further deterioration in the quality of public services given he is not providing any additional investment in technology, people and process transformation to deliver sustainable efficiency gains.

This chart was originally published by ICAEW.

July public sector finances: a mixed set of results

Higher self-assessment tax receipts and end of energy support payments help improve what is otherwise a disappointing set of numbers.

The monthly public sector finances for July 2023 were released by the Office for National Statistics (ONS) on Tuesday 22 August 2023. These reported a provisional deficit for the fourth month of the 2023/24 financial year of £4bn, bringing the total deficit for the four months to £57bn, £14bn more than in the first third of the previous year.

Alison Ring OBE FCA, Public Sector and Taxation Director for ICAEW, said: “These numbers reflect a mixed set of results for the first four months of the financial year, as higher self assessment tax receipts and the end of energy price guarantee support payments led to an improved fiscal situation in July. But debt remains on track to hit £2.7trn by the end of the year, up from £1.8trn before the pandemic, adding to the scale of the challenge facing the government and taxpayers in repairing the public finances.

“Stubbornly high core inflation and the prospect of further interest rate rises will concern the Chancellor as he bears down on public spending in the hope of freeing up the money he needs to both pay for the state pension triple-lock and find room for pre-election tax cuts.”

Month of July 2023

The provisional shortfall in taxes and other receipts compared with total managed expenditure for the month of July 2023 was £4bn, being tax and other receipts of £93bn less total managed expenditure of £97bn, up 5% and 9% respectively compared with July 2022.

This was the fifth-highest July deficit on record since monthly records began in 1993, despite being a £3bn improvement over July 2022, driven by higher self assessment tax receipts and the end of payments under the energy price guarantee.

Four months to July 2023

The provisional shortfall in taxes and other receipts compared with total managed expenditure for the four months to July 2023 was £57bn, £14bn more than the £43bn deficit reported for the first third of the previous financial year (April to July 2022). This reflected a widening gap between tax and other receipts for the four months of £343bn and total managed expenditure of £400bn, up 7% and 10% respectively compared with April to July 2022.

Inflation benefited tax receipts for the four months, with income tax up 13% to £85bn and VAT up 9% to £65bn. The rise in corporation tax, up 17% to £30bn, reflected both inflation and the increase in the corporation tax rate to 25% from 1 April 2023. However, national insurance receipts were down by 3% to £57bn because of the abolition of the short-lived health and social care levy last year, while the total for all other taxes was down by 1% to £69bn as economic activity slowed. Other receipts were up 17% to £37bn, driven by higher investment income.

Total managed expenditure of £400bn in the four months to July can be analysed between current expenditure excluding interest of £334bn (up £26bn or 8% over the same period in the previous year), interest of £51bn (up £7bn or 16%), and net investment of £15bn (up £4bn or just over a third).

The increase of £26bn in current expenditure excluding interest compared with the prior year has been driven by £11bn from the uprating of benefit payments, £8bn in higher central government staff costs, £3bn in central government procurement and £5bn in energy support scheme costs, less £1bn in net other changes.

The rise in interest costs of £7bn to £51bn reflects a fall in the interest payable on index-linked debt of £6bn from £30bn to £24bn as inflation has moderated compared with the same period last year, combined with a £13bn increase in interest on non-inflation linked debt from £14bn to £27bn as the Bank of England base rate rose. 

The £4bn increase in net investment spending to £15bn in the first four months of the current year reflects high construction cost inflation among other factors that saw a £5bn or 17% increase in gross investment to £35bn, less a £1bn increase in depreciation to £20bn. 

Public sector finance trends: July 2023

 Four months toJul 2019 (£bn)Jul 2020 (£bn) Jul 2021 (£bn) Jul 2022 (£bn) Jul 2023 (£bn)
 Receipts270234282320343
 Expenditure(259)(348)(310)(308)(334)
 Interest(24)(15)(23)(44)(51)
 Net investment(10)(26)(13)(11)(15)
 Deficit(23)(155)(64)(43)(57)
 Other borrowing 4 (66) (22) 5 10
 Debt movement(19)(221)(86)(38)(47)
 Net debt 1,7962,0362,2392,4202,579
 Net debt / GDP 80.1% 96.9% 97.7% 96.6% 98.5%
Source: ONS, ‘Public sector finances, July 2023’.


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 latest release saw the ONS revise the reported deficit for the three months to June 2023 down by £2bn as estimates of tax receipts and expenditure were updated for better data, as well as reduce the reported deficit for the 2022/23 financial year by £1bn from £132bn to £131bn for similar reasons. The ONS also revised its estimates of GDP for more recent economic data, resulting in a lower reported net debt / GDP ratio.

Balance sheet metrics

Public sector net debt was £2,579bn at the end of July 2023, equivalent to 98.5% of GDP.

The debt movement since the start of the financial year was £47bn, comprising borrowing to fund the deficit for the four months of £57bn plus £10bn in net cash inflows as loan repayments and positive working capital movements exceeded cash outflows for lending to students, business and others.

Public sector net debt is £764bn or 42% higher than it was on 31 March 2020, reflecting the huge sums borrowed since the start of the pandemic.

Public sector net worth, the new balance sheet metric launched by the Office for National Statistics this year, was -£631bn on 31 July 2023, comprising £1,604bn in non-financial assets, £1,011bn in non-liquid financial assets and £336bn in liquid financial assets less public sector gross debt of £2,915bn and other liabilities of £667bn. This is a £54bn deterioration from the -£577bn reported for 31 March 2023.

This new measure seeks to capture more assets and liabilities than the narrowly focused public sector net debt measure traditionally used to assess the financial position of the UK public sector. However, it excludes unfunded employee pension liabilities that amounted to more than £2trn at 31 March 2021 according to the Whole of Government Accounts, although they are expected to be much lower today as discount rates have risen significantly since then.

For further information, read the public sector finances release for July 2023.

This article was originally published by ICAEW.

ICAEW chart of the week: VAT threshold

The mystery of just why so many businesses sit just below the VAT registration threshold will be a big topic of debate at ICAEW’s VAT at 50 conference on Monday 22 May.

Line chart showing number of businesses plotted against £1,000 turnover intervals. An orange line shows how the number of traders curves down as turnover increases, before increasing sharply before the VAT threshold (a vertical line in the chart at £85,000) and dropping almost vertically. A purple line shows a relatively straight decline to the right of the VAT threshold, with some bumps along the way. A teal-coloured dotted trendline curves through the chart, with businesses all above the trendline to the left of the VAT threshold, and below the trendline to the right up until £130,000.

Our chart this week celebrates the 50th anniversary of the introduction in the UK of Value Added Tax (VAT), the indirect tax on commercial transactions that now generates around 20% of tax receipts. 

One of the big mysteries in the tax system is why so many small businesses and sole traders cluster just below the VAT threshold of £85,000.

As illustrated by our chart, the number of businesses below the threshold gradually falls from almost 31,000 in the turnover band between £50,000 and £50,999 to just under 17,000 in the turnover band between £77,000 and £77,999, before diverging above the trendline to increase up to just over 20,000 in the £84,000 to £84,999 turnover band – immediately below the threshold for registering for VAT. This is almost twice as many as the just over 10,000 traders in the £85,000 to £85,999 turnover band, the first band legally required to register for VAT. 

One explanation may be that there is some gaming (or possibly even misreporting) going on, with business owners approaching the threshold for VAT deciding to spread their business activities across multiple legal entities or keeping ‘cash-in-hand’ transactions off the books to avoid, or evade, adding VAT of 20% in most cases onto their prices.

However, perhaps a more worrying concern is if these businesses are not getting around the rules, but instead deliberately choosing to keep their businesses small given the competitive disadvantage that goes with adding VAT to prices charged to consumers, and the hassles and hazards involved with becoming a tax collector on behalf of the government. 

This is a big issue for a UK economy experiencing weak economic growth. Not only is government income at stake, but also the wider benefits of more prosperous small businesses to the overall economy and what that means for the national economy.

Of course, many businesses do register despite being below the threshold, with around 1.1m traders in 2018/19 with turnover less than £85,000 signed up to VAT.

Other countries take a different approach, with much lower registration thresholds across most of Europe. Domestic thresholds range from nil in Spain, Italy and Greece, NOK40,000 (approximately £3,000) in Norway, €22,000 (£19,000) in Germany and €37,500 (£33,000) in Ireland, up to €50,000 (£43,000) in Slovenia. Switzerland is an exception with a higher registration threshold than the UK at CHF100,000 (£89,000). 

In general, this means that a much greater proportion of actively trading businesses across Europe are registered for VAT compared with the UK, where there are estimated to be more than 3m or so traders with annual revenue of between £10,000 and £84,999 who have not registered for VAT – more than £100bn in total revenue.

Some believe that raising the threshold would provide a boost to the economy, given that many businesses would be more willing to grow (or declare) more of their revenue, while others believe the better option would be to reduce the threshold to capture many more businesses. The former would likely result in lower tax receipts overall, by allowing businesses just above the existing threshold to stop collecting VAT. The latter should in theory generate much more in tax receipts, perhaps as much as £20bn a year, in addition to removing one of the distortions that the tax system creates in this part of the economy.

The irony is that a relatively high VAT threshold in the UK designed to encourage and support small businesses may be one of the factors holding back economic growth. And with an unchanged threshold combined with inflation of more than 10% over the past year, this may be an even bigger drag on the economy/incentive to cheat than it has been in the past.

Click here to find out more about VAT at 50, ICAEW’s celebration (if that is the right word) of the 50th anniversary of VAT, and what the future holds for our most beloved of indirect taxes.

This chart was originally published by ICAEW.

Public sector finances return to red

February fiscal deficit hits £17bn, while the cumulative deficit for 11 months of £132bn doesn’t include backdated public sector pay awards.

The monthly public sector finances for February 2023 released on Tuesday 21 March 2023 reported a provisional deficit for the month of £17bn, which is a return to red after a surplus of £8bn last month in January 2023. 

The deficit was £10bn more than the £7bn deficit reported for the same month last year (February 2022), as higher interest costs, higher inflation on index-linked debt, and the cost of the energy price guarantee for households and businesses incurred during the month drove up the need to borrow. 

The cumulative deficit for the first 11 months of the financial year was £132bn, which is £15bn more than in the same period last year but £155bn lower than in 2020/21 during the first stages of the pandemic. It was £78bn more than the deficit of £54bn reported for the first 11 months of 2019/20, the most recent pre-pandemic pre-cost-of-living-crisis comparative period. 

The reported deficit does not reflect backdated public sector pay settlements that have been or are expected to be agreed in March 2023, although the numbers are broadly in line with the £152bn estimated deficit for the full year in the Office for Budget Responsibility (OBR)’s revised forecasts made at the time of the Spring Budget. This was lower than their previous forecast of £177bn in November, primarily because the energy price guarantee is costing less than anticipated.

Public sector net debt was £2,507bn or 99.2% of GDP at the end of February 2023. This is £692bn higher than net debt of £1,815bn on 31 March 2020, reflecting the huge sums borrowed since the start of the pandemic. The OBR’s latest forecast is for net debt to reach £2,546bn by March 2023 and to exceed £2.9trn by March 2028.

Tax and other receipts in the 11 months to 28 February 2023 amounted to £924bn, £91bn or 11% higher than a year previously. Higher income tax and national insurance receipts were driven by rising wages and the higher rate of national insurance for part of the year, while VAT receipts benefited from inflation in retail prices.

Expenditure excluding interest and investment for the 11 months of £888bn was £52bn or 6% higher than the same period in 2021/22, with Spending Review planned increases in spending, the effect of inflation, and the cost of energy support schemes partially offset by the furlough programmes and other pandemic spending in the comparative period not being repeated this year.

Interest charges of £120bn for the 11 months were £51bn or 73% higher than the £69bn reported for the equivalent period in 2021/22, through a combination of higher interest rates and higher inflation driving up the cost of RPI-linked debt. 

Cumulative net public sector investment to February was £48bn, £4bn more than this time last year. This is much less than might be expected given the Spending Review 2021 pencilled in significant increases in capital expenditure budgets in the current year.

The increase in net debt of £125bn since the start of the financial year comprised borrowing to fund the deficit for the 11 months of £132bn, less £7bn in net cash inflows from repayments of deferred taxes, and loans made to businesses during the pandemic, less funding for student, business and other loans together with working capital requirements.

Alison Ring OBE FCA, Public Sector and Taxation Director for ICAEW, said: “The public finances are back in the red this month as a deficit of £17bn brings the total for the 11 months to February to £132bn, with public sector net debt in excess of £2.5trn. Although broadly in line with the OBR’s improved estimate accompanying the Spring Budget, the numbers don’t reflect the cost of backdated public sector pay settlements to be recorded in the final month of the 2022/23 financial year.

“The chancellor still needs to top up departmental budgets for pay awards in the next financial year, reducing his capacity to address inflationary cost pressures in other areas. HS2 may not be the only capital programme at risk of being scaled back or delayed as he seeks to make savings.”

Table showing fiscal numbers for the last four 11 month periods to February. Receipts - Expenditure - Interest - Net investment = Deficit - Other borrowing = Debt movement. Followed by Net debt and Net debt / GDP. All numbers in £bn, except for percentages. Apr 2019 - Feb 2020: 755 - 720 - 53 - 36 = -54 + 22 = -32. Debt: 1,811, 84.2%. Apr 2020 - Feb 2021: 721 - 906 - 40 - 62 = -287 - 56 = -343. Debt: 2,158, 98.0%. Apr 2021 - Feb 2022: 832 - 836 - 69 - 44 = -56 - 85 = -202. Debt: 2,356, 97.0%. Apr 2022 - Feb 2023: 924 - 888 - 120 - 48 =-132 + 7 = -125. Debt: 2,507, 99.2%.

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 several revisions to prior period fiscal numbers to reflect revisions to estimates. These had the effect of reducing the reported fiscal deficit for the 10 months ended 31 January 2023 by £1bn to £116bn.

This article was originally published by ICAEW.

ICAEW chart of the week: Spring Budget 2023

My chart this week is on the Chancellor’s tax and spending plans for the coming financial year commencing on 1 April 2023.

Column chart showing the final fiscal estimate for 2022/23 and the Budget estimate for 2023/24. Final estimate 2022/23 Deficit £152bn. Receipts £1,020bn = Taxes £922bn + other receipts £98bn. Spending £1,172bn = expenditure £968bn + energy support £30bn + interest £115bn + net investment £59bn. Budget estimate 2023/24 Deficit £132bn. Receipts £1,057bn = Taxes £950bn + other receipts £107bn. Spending £1,189bn = expenditure £1,015bn + energy support £5bn + interest £95bn + net investment £74bn.

Chancellor Jeremy Hunt presented his first Budget to Parliament on Wednesday 15 March 2023, setting out his formal Budget estimate for the financial year ended 31 March 2024 (2023/24) accompanied by fiscal forecasts from the Office for Budget Responsibility (OBR) for the period up to 2027/28 and the OBR’s final estimate for the current financial year ending on 31 March 2023.

Our chart this week starts by summarising the final estimate for 2022/23, highlighting an expected shortfall of £152bn between anticipated receipts of £1,020bn and spending of £1,172bn. This is followed by a similar analysis for the budget year of 2023/24, with a deficit of £132bn resulting from a shortfall between estimated taxes and other receipts of £1,057bn and spending of £1,189bn.

Receipts in 2022/23 and 2023/34 respectively comprise £922bn and £950bn in tax and £98bn and £107bn in other receipts. The increase in tax of 3.0% is perhaps lower than might be expected given the level of inflation and the new higher rate of corporation tax from 1 April 2023, with an anticipated 10% growth in corporation tax receipts (net of full expensing of business investment) offset by flat or relatively small growth in other taxes. Other receipts are expected to increase by 9%, primarily the effect of higher interest rates on investments.

Total managed expenditure in 2022/23 and 2023/24 respectively comprise £968bn and £1,015bn in current expenditure excluding energy support costs and debt interest, £30bn and £5bn in energy support packages, £115bn and £95bn in debt interest, and £59bn and £74bn in net investment.

Current expenditure excluding energy support costs and debt interest is expected to increase by 4.9% in 2023/24 compared with 2022/23, more than the 2.5% ‘whole economy’ measure of inflation used by the government and the 4.1% forecast for consumer price inflation. This partly relates to inflation in the current financial year feeding through into next year’s budgets, as well as spending measures announced by the Chancellor.

The three-month extension of the energy price guarantee is anticipated to cost £3bn in 2023/24, with other energy support measures adding a further £2bn to the forecast.

Debt interest is expected to fall by 17% to £95bn, principally because of the effect of a much lower rate of inflation on index-linked debt more than offsetting higher interest rates overall.

Public sector net investment comprises gross investment of £116bn and £134bn in the two years respectively, net of depreciation of £57bn and £60bn respectively. The increase in gross investment is flattered by a £8bn one-off credit in the current financial year arising from changes to student loans, which if excluded implies an 8% increase in capital expenditure and other public investment overall. This reflects delays in capital programmes that are expected to come in significantly under budget in the current financial year but cost more in the next, relatively high construction price inflation, and an extra £2bn of capital investment allocated to defence.

The final estimate for the deficit in the current financial year of £152bn is £25bn lower than was expected in the OBR’s November 2022 forecast of £177bn, while the Budget estimate for 2023/24 of £132bn is £8bn lower than the £140bn forecast last time. The reduction in 2022/23 reflects the benefit of a slightly improved economic outlook, with policy decisions for the last couple of weeks of the financial year by the Chancellor netting off to close to nil. This contrasts with 2023/24, where forecast upsides amounting to around £27bn have been mostly offset by a net cost of £19bn from tax and spending decisions.

Overall, the chart highlights just how much money the UK raises in tax and incurs in public spending. Tax and other receipts are expected to approach £1.1trn in the coming financial year, while public spending is anticipated to be just under £1.2trn. 

On a per capita basis in 2023/24 this is equivalent to receipts and spending of approximately £1,290 per month and £1,450 per month for each person in the UK respectively, a shortfall of £160 per person per month that needs to be funded by borrowing.

The challenge for the Chancellor is that with the number of pensioners projected to increase by 9% over the next five years (with consequent implications for spending on pensions, welfare, health and social care), there is not much room to invest in public services or in infrastructure at the same time as also reducing taxes as he would very much like to do. 

The Chancellor wasn’t able to square this circle in the Spring Budget 2023, so watch this space to see whether he can be any more successful in future fiscal events.

This chart was originally published by ICAEW.

Public sector net debt tops £2.5trn for the first time

The highest December deficit on record has been driven by higher debt interest costs and the cost of energy support schemes.

The monthly public sector finances for December 2022, released on Tuesday 24 January 2023, reported a provisional deficit for the month of £27bn, the highest December deficit since records began in 1993. This was despite a mild December helping to mitigate some of the cost of energy support schemes.

The deficit for the month of £27bn was £12bn higher than the equivalent month in the previous financial year (December 2021) and £8bn more than the previous month (November 2022).

This brought the cumulative deficit for the first three quarters of the financial year to £128bn, which is £3bn below the Office for Budget Responsibility (OBR)’s revised forecast made at the time of the Autumn Statement last November. This substantially exceeds the budget of £99bn for the entire financial year to March 2023 forecast by the OBR at the time of the Spring Statement as higher interest costs, the effect of higher inflation on index-linked debt, and the cost of the energy price guarantee for households and businesses over the winter all add to public spending.

Public sector net debt was £2,504bn or 99.5% of GDP at the end of December 2022, up £131bn from £2,373bn at the end of March 2022. This is £684bn higher than net debt of £1,820bn on 31 March 2020, reflecting the huge sums borrowed since the start of the pandemic. 

The OBR’s latest forecast is for net debt to reach £2,571bn by March 2023 and to approach £3trn by March 2028, although energy prices falling faster than expected may help improve the outlook somewhat.

The cumulative deficit for the first three quarters of the financial year of £128bn was £5bn lower than this time last year and £143bn lower than in 2020/21 during the first stages of the pandemic. However, it was £67bn more than the deficit of £61bn reported for the first nine months of 2019/20, the most recent pre-pandemic pre-cost-of-living-crisis comparative period. 

Tax and other receipts in the three quarters to 31 December 2022 amounted to £721bn, £73bn or 11% higher than a year previously. Higher income tax and national insurance receipts were driven by rising wages and the higher rate of national insurance, while VAT receipts benefited from inflation in retail prices. Year-to-date receipts included £3.7bn accrued for the energy profits levy ‘windfall tax’.

Expenditure excluding interest and investment for the nine months of £716bn was £30bn or 4% higher than the same period in 2021/22, with Spending Review planned increases in spending, high inflation and the cost of energy support schemes more than offsetting the furlough programmes and other pandemic spending in the comparative period not repeated this year.

Interest charges of £100bn for the three quarters were £46bn or 85% higher than the £54bn reported for the equivalent period in 2021/22, through a combination of higher interest rates and higher inflation driving up the cost of RPI-linked debt. 

Cumulative net public sector investment to December was £33bn. This is £2bn more than a year previously, much less than might be expected given the Spending Review 2021 pencilled in significant increases in capital expenditure budgets in the current year.

The increase in net debt of £131bn since the start of the financial year comprised borrowing to fund the deficit for the nine months of £128bn together with a further £3bn to fund student loans, lending to businesses and others, and working capital requirements, net of cash inflows from repayments of deferred taxes and loans made to businesses during the pandemic.

Alison Ring OBE FCA, Public Sector and Taxation Director for ICAEW, said: “A mild December was not enough to prevent public debt from reaching £2.5tn for the first time, in a disappointing set of numbers for December 2022. However, the Chancellor will take comfort that cumulative borrowing for the first three quarters of the financial year was less than feared when the budget for 2022/23 was updated back in November. Energy prices coming down much faster than expected should also improve the outlook for the final quarter as well as the new financial year.

“The deficit is still on track to be one of the highest ever recorded in peacetime and stabilising the fiscal position is the best that Jeremy Hunt can hope for in the short term. Amid a sea of red ink, sustainable public finances remain a distant prospect for now.”

Table showing trends in receipts, expenditure, interest, net investment, deficit, other borrowing, debt movement, net debt and net debt / GDP for the nine months Apr-Dec 2019, 2020, 2021 and 2022. Click on the link to ICAEW article at the end for a readable version of this 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 several revisions to prior period fiscal numbers to reflect revisions to estimates. These had the effect of reducing the reported fiscal deficit for the eight months ended 30 November 2022 by £5bn to £101bn and reducing the reported fiscal deficit for the year to 31 March 2022 by £2bn to £123bn.

The revisions in the current year principally relate to an increase of £4bn in the estimate for accrued corporation tax receipts at 30 November 2022, while the prior year numbers were updated to reflect a £0.7bn correction to reported VAT cash receipts during 2021/22 and a £1bn increase in the estimate for accrued corporation tax receipts at 31 March 2022.

This article was originally published by ICAEW.

ICAEW chart of the week: UK public finances 2022/23

Our chart this week compares the UK public finances for the current fiscal year with the overall size of the economy, illustrating how taxes are expected to amount to 36% of GDP and expenditure 47% of GDP.

Graphic using circles to illustrate the latest official forecast for UK public finances for 2022/23: 1. A circle for taxes of £910bn (36% of GDP), inside a circle of taxes and other income of £1,005bn (40% of GDP) which in turn is inside a circle of GDP of £2,497bn. 2. A circle for expenditure of £1,182bn (47% of GDP), inside a circle of GDP of £2,497bn. 3. An adjacent circle for the deficit of £177bn (7% of GDP).

The latest official forecast from the Office for Budget Responsibility (OBR) for the current fiscal year ending 31 March 2023 is for a shortfall (or ‘deficit’) of £177bn between receipts of £1,005bn and expenditure of £1,182bn. The largest component of receipts is taxation, which is forecast to amount to £910bn.

Our chart puts these numbers into context by comparing them with the forecast for Gross Domestic Product (GDP) of £2,497bn in 2022/23, highlighting how taxes are expected to amount to 36% of GDP, receipts including other income to 40% of GDP, and expenditure to 47% of GDP, resulting in a deficit amounting to 7% of GDP.

As many commentators have noted, taxes are at a historically high level, with taxation at its highest level as a share of economic activity since 1949. This is unsurprising given the combination of many more people living longer lives and the financial commitments made by successive governments to pay for pensions, health and (to an extent) social care.

Expenditure is also at historically high levels, with energy support packages adding to recurring expenditure of around 43% or 44% of GDP. This is below the peak of 53% of GDP a couple of years ago at the height of the pandemic.

As a consequence, the shortfall between receipts and expenditure of 7% of GDP is elevated compared with the 2% to 3% of GDP ‘normal’ range, although still below the 15% of GDP seen in 2020/21 during the pandemic and 10% of GDP in 2009/10 during the financial crisis.

The increase in the corporation tax rate to 25% from April means that receipts are expected to increase to 37% of GDP over the next few years, leading to the total of taxes and other receipts rising to 41%. At the same time total expenditure is expected to stay at 47% of GDP in 2023/24 before falling back to 45% in 2024/25, 44% in 2025/26 and 2026/27, and 43% in 2027/28. 

Unlike in previous generations, the government is restricted in its ability to cut other areas of spending to cover expected further rises in spending on pensions, health and social care as the number of pensioners continues to grow. Savings in the defence and security budgets are no longer possible now that spending has fallen to not much more than the NATO minimum of 2% of GDP, down from in excess of 10% back in the day, while pressures across many other areas of the public sector will make achieving the cost savings already assumed in the forecasts a significant challenge.

This chart was originally published by ICAEW.

Why is cutting public spending so difficult?

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

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

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

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

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

Forecasts for public spending

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

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

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

Fiscal targets

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

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

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

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

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

What makes up public spending?

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

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

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

Hands tied on spending

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Education – £126bn or 12% of budgeted spending

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

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

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

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

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

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

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

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

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

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

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

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

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

Transport – £47bn or 4% of total spending

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Interest – £104bn or 10%

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

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

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

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

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

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

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

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

Other options

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

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

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

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

Long-term reform

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

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

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

Conclusion

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

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

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

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

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

Tough choices will need to be made.

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

This article was originally published by ICAEW.

ICAEW chart of the week: Provisional tax bands 2023/24

My chart this week illustrates how five or seven different personal tax bands are expected in the coming financial year, despite the top rate of income tax being abolished.

Column chart showing tax rates for 2023/24 by income level, based on the mini-Budget. £0 -> 100% take home pay £12,570 -> 12% national insurance, 19% income tax, 69% take home pay Box for withdrawal of child benefit £50,000 -> 12% NI, 31% income tax, 57% take home pay £50,270 -> 2% NI, 52% income tax, 46% take home pay Box for no children / lower earning parent £50,270 -> 2% NI, 40% income tax, 58% take home pay End of boxes £60,000 -> 2% NI, 40% income tax, 58% take home pay £100,000 -> 2% NI, 60% income tax, 38% take home pay (withdrawal of personal allowance) £125,140 -> 2% NI, 40% income tax, 58% take home pay

Amid market chaos it might be forgotten that the ‘mini’ Budget was primarily about reforming the personal tax system. In abolishing the 45% top rate of income tax from 6 April 2023 onwards, the Chancellor simplified the tax system by removing the personal tax band that currently applies to earnings above £150,000.

Despite that simplification, our chart this week highlights how the personal tax system remains quite complicated, much more than might be assumed based on just two rates of income tax (19% and 40%), two rates of national insurance (12% and 2%) and recent alignment in income tax and national insurance thresholds.

In practice, our chart is an oversimplification, as it does not attempt to incorporate welfare benefits and hence the full complexity of how people are ‘taxed’ as their incomes rise – for example the 55% taper rate at which universal credit is withdrawn from those on the lowest incomes. It also does not attempt to reflect the tax treatment on non-earned income such as dividends, interest and capital gains, nor the intricacies of how pension contributions or other tax reliefs are dealt with. 

Nor does it show the different rates of income tax applicable in Scotland, which currently has three more tax bands than elsewhere in the UK and is likely to continue to do so once the Scottish Budget establishes tax rates for next financial year.

Our chart assumes the thresholds for personal income tax and national insurance remain frozen as currently planned, illustrating how there is no tax to pay on the first £12,570 of earned income – the first band in the UK’s personal tax system.

From this point upwards, income tax of 19% (a 1% cut from the current rate) and employee national insurance of 12% (a reduction from the 13.25% in force until next month) are expected to apply in 2023/24, a combined rate of 31% that reduces take-home pay to 69% of each extra pound earned.

These rates apply to earnings up to £50,000, when a strange quirk of the tax system comes into play if you are a parent with a child or children receiving child benefit. Assuming child benefit is uprated by inflation in April, then the amount clawed back between £50,000 and £60,000 from the higher-earning parent is likely to be equivalent to somewhere in the region of an extra 12% (for one child) or 20% (for two children). The quirk is the misalignment between the £50,000 at which child benefit starts to be withdrawn through the tax system and the £50,270 point at which the 40% higher rate of income tax rate and 2% lower rate of national insurance of £50,270 come into force. 

This creates a small band where the higher-earning parent of one child faces a combined tax rate of 43%, followed by a band between £50,270 and £60,000 where a combined rate of 52% applies. Not shown in the chart is the even higher rates of tax for two children – 39% income tax + 12% national insurance and 60% income tax + 2% national insurance – or even higher for three or more children receiving child benefit.

For those without children, or for the lower-earning parent, there is a more straightforward jump as income exceeds £50,270, with an extra 21% taken as the income tax rate rises from 19% to 40%, partially offset by a 10 percentage-point reduction in national insurance from 12% to 2%.

Those without children and lower-earning parents should retain 58% of each pound of earnings over £50,270, as will higher-earning parents on incomes above £60,000. 

For earnings above £100,000 the personal allowance is withdrawn, creating an extra tax band between £100,000 and £125,140 where there is a marginal income tax rate of 60%, which with 2% of employee national insurance means retaining 38% of each additional pound earned within this band. The new top band is above £125,140, where income tax reverts to 40%, which combined with 2% of national insurance results in 58% being retained for each extra pound earned.

With the current 45% top rate of tax abolished, there is no further band for earnings above £150,000, meaning that all incomes above £125,140 are taxed at a combined rate of 42%, at least before taking account of tax reliefs that might apply.

There have been suggestions that the Chancellor intends to attempt to simplify personal tax bands further, perhaps by abolishing the 60% tax rate between £100,000 and £125,140 by allowing higher earners to retain the personal allowance rather than have it withdrawn. A less expensive option would be to align the child benefit withdrawal threshold with that for the higher income tax rate, getting rid of the mini-tax band for higher-earning parents on incomes between £50,000 and £50,270.

We will no doubt discover whether the government’s new-found zeal to simplify the tax system will continue, or if they will revert to the longer-term trend of adding in new complications to the tax system whenever a little extra money needs to be found.

This chart was originally published by ICAEW.

ICAEW chart of the week: Receipts and spending by age

My chart this week looks at how receipts and spending vary by age, a key driver for public finances that new Chancellor Kwasi Kwarteng will need to factor into his fiscal plans.

Column chart - showing receipts by age group per person per month above the line and spending below the line. 0-9: £150 (receipts) - £550 (public services and interest), £290, (pensions and welfare), £270 (health and social care), £380 (education) 10-19: £210 - £620, £320, £110, £750 20-29: £1,150 - £440, £120, £160, £110 30-39: £1,930 - £430, £150, £180, £30 40-49: £2,200 - £430, £170, £200, £20 50-59: £1,960 - £450, £190, £300, £10 60-69: £1,240 - £480, £340, £370, - 70-79: £800 - £640, £1,170, £600, - 80+: £600 - £730, £1,400 - £1,270 Average: £1,220 - £510, £365, £310, £155

Kwasi Kwarteng’s first Budget will be an emergency one, not only setting out his plans for the financial year commencing on 1 April 2023, but also re-opening the budget for the current financial year. It will be dominated by the emergency support package for individuals and businesses already announced, alongside starting to deliver on Prime Minister Liz Truss’s commitments to cut taxes and ‘shrink the state’.

The new Chancellor is likely to find that cutting public spending is not going to be easy given the increasing financial commitments made by successive governments since the Second World War on education, pensions, health and social care, the areas that now dominate public spending. He supported adding to those commitments only a couple of years ago when then Prime Minister Boris Johnson decided to expand eligibility for social care, and former Chancellor Rishi Sunak re-committed to the ‘triple-lock’ that guarantees increases in the state pension every year.

As our chart this week illustrates, receipts and spending vary significantly across age groups, with spending on education higher on the young, who pay very little in taxes, and spending on pensions, health and social care much higher for older generations who contribute less than the average, especially after reaching retirement age. This contrasts with the profile for those of working age who pay the most into the system while on average taking the least out.

Derived from an analysis from the Office for Budget Responsibility’s fiscal risks and sustainability report published in July, the chart shows how – before the emergency Budget scheduled for 21 September – budgeted tax and other receipts for the current financial year 2022/23 are equivalent to £1,220 per person per month, based on forecast receipts of £988bn and a population of 67.5m. This is below budgeted public spending of £1,340 per person per month (£1,087bn/67.5m people/12 months), with the deficit of £120 per person per month (£99bn in total) funded by borrowing.

Average receipts per person per month by age group are estimated to be in the order of £150, £210, £1,150, £1,930, £2,200, £1,960, £1,240, £800 respectively for those aged 0-9, 10-19, 20-29, 30-39, 40-49, 50-59, 60-69, 70-79 and 80+ respectively. These numbers include £115 per person per month of non-tax receipts spread evenly across everyone. 

Spending on public services and interest in the order of £510 per person per month, or £550, £620, £440, £430, £430, £450, £480, £640, £730 by age group, is less variable across age groups because it much of this spending is incurred on behalf of everyone, including £125 in interest, £73 on defence and security and £53 on policing, justice and safety for example.

Spending on pensions and welfare of £365 per person per month is less evenly spread, with £290 and £320 per month spent on those in their first two decades and £440, £430, £430 and £450 on those in their twenties, thirties, forties and fifties respectively. This increases to average spending per person per month of £480, £640 and £730 on those in their sixties, seventies and eighties or over. 

Health and social care spending of £310 is biased towards older generations, with per person per month spending of £270, £110, £160, £180 and £200 for the first five decades of life contrasting with the £300, £370, £600 and £1,270 spent on average on those in their fifties, sixties, seventies and eighties or over. 

As you would expect, education spending of £155 per person per month on average is mostly spent on the young, with around £380 per person per month spent on the under-10s, £750 spent on those between 10 and 19, £110 spent on those in their twenties, and £30, £20 and £10 respectively spent on those in their thirties, forties and fifties.

The reason this chart is so critical is because demographics are not in a steady state, with the ONS projecting that there will be an additional 3.3m pensioners in 20 years’ time, a 27% increase. This will have significant cost implications for this and future governments over a period when the working-age population – who pay most of the taxes to fund public spending – is projected to grow by just 4% in total. 

While a declining birth rate might relieve some of the pressure on education spending over the next 20 years, spending on the state pension, the NHS and on social care will grow significantly if the commitments made by the current and previous governments to provide for income in retirement, universal free health care and an increasing level of social care provision are to be met, at the same time as running public services to the standard required.

Kwasi Kwarteng’s predecessors have been able to cover the expanding share of public spending going on pensions and health and social care without raising taxes above 40% of the economy by cutting spending on public services, in particular the defence budget, which has declined from in the order of 10% of GDP to around 2% over the last half century. However, with defence already at the NATO minimum, and many public services under significant pressure to improve delivery, there is much less scope to find savings than there has been in the past.

This poses a very big challenge for the Chancellor as he puts together his medium-term fiscal plans. Economic growth needs to be much higher than it has been in recent years, not only to cover the cost of tax cuts that he hopes will generate that growth, but also to generate the extra tax receipts needed to fund pensions and health and social care as more people live longer lives.

This chart was originally published by ICAEW.