ICAEW chart of the week – fiscal forecast

With everything else going on this month, you may have missed today’s publication of the Office for Budget Responsibility’s Fiscal Sustainability Report.  This sets out the government’s official long-term fiscal forecast, projecting tax receipts and public spending over the next 50 years.

The central forecast is startling: public spending is expected to increase from 39% to 57% of GDP by 2068. Without tax increases or a major change in public service provision, public sector net debt is forecast to reach 282% of GDP by 2067-68 and continue rising thereafter. 

The key driver here is an ageing population, with the over 65s increasing from 18% of the population today to over 26% in fifty years’ time. As a consequence, spending on health, adult social care and the state pension are all expected to increase significantly.

While the OBR rightly concludes this is not sustainable on the basis of current fiscal polices, their mandate prevents them from making recommendations about what to do.  Do we want to see European levels of taxation? Or will the public accept lower pensions, fewer public services, and different models for funding health and social care?

Tough choices need to be made. Are we willing to make them?

ICAEW chart of the week – regional imbalances

Ross Campbell, Director Public Sector, writes:

“Tomorrow we are hosting a joint event at Chartered Accountants Hall with the Fabian Society. Our aim is to explore the challenges facing Labour in realising the aspirations it set out in its 2017 manifesto, at the same time as ensuring sound financial stewardship.

The chief executive of the Fabians, Andrew Harrop, and I have set out some thoughts on how the Labour party can achieve higher public spending and fiscal sustainability, how fiscal and accounting rules can be reformed to support investment and public ownership of assets, and on devolution of the public finances.

Our chart this week touches on this latter question, illustrating the significant geographic imbalances in the UK public finances. As the chart shows London, the South East and the East of England are expected to generate £63bn for the exchequer this year while the other English regions are expected to absorb £63bn, with £37bn needed to fund the shortfall in tax vs. spending in Scotland, Wales and Northern Ireland. The shortfall of £37bn will be funded through borrowing.

Visit https://www.icaew.com/en/about-icaew/act-in-the-public-interest/policy/public-sector-finances/fabians-project to find out more about our collaboration with the Fabian Society

Given the events of recent weeks, it might well be worthwhile paying closer attention to HM Opposition’s fiscal proposals.”

ICAEW chart of the week – EU financial settlement

Last year we published a policy insight ‘Analysing the EU exit charge’ explaining the likely elements of an exit charge payable by the UK on leaving the EU.

Our higher scenario of £30bn was based on contributions until the end of the EU budget period in 2020. With a formula similar to this scenario now agreed, the Treasury estimate is that the UK will pay £37bn (plus or minus £2bn). This is £7bn more than we expected, so we decided to look at the reasons for the difference.

As with any negotiation there were some ups and downs, additional commitments of £3bn are due to the transition period. A £1bn concession on EU operating assets was offset by £3bn in timing differences and a net £1bn from revisions to estimates. Nothing like £7bn though.

The difference is the UK’s puzzling agreement to accept the return of its £3bn original investment in the European Investment Bank, rather a share of its £10bn of net assets, including accumulated profits. This results in an increase of £7bn in the net financial settlement. We still don’t know why this was agreed, or what the UK got in return…

To find out more, read our press release (https://bit.ly/2tPM5lQ) and the policy insight update itselft (https://bit.ly/2pWbnL1).

ICAEW chart of the week – Bank of England

On Thursday, the Chancellor Philip Hammond announced a £1.2bn capital injection into the Bank of England, which prompted us to take a look at its balance sheet.

As our chart this week shows, the Bank of England has equity of £4bn. This supports assets of £606bn, including £445bn in quantitative easing investments (principally government securities) and £127bn in Term Funding Scheme (TFS) loans to banks and building societies that are used to provide low cost finance to businesses and individuals.

The injection will increase the Bank of England’s capital from £2.3bn to £3.5bn (not all of the Bank’s equity counts as capital for this purpose). In turn the Treasury will no longer guarantee each TFS loan.

Initially these internal changes won’t alter the risk profile of the overall public finances. But, this will allow the Bank to take on more risk in the future, without needing to ask for permission first.

Fortunately, Treasury is still committed to recapitalising the Bank if it ever gets into trouble, ensuring that a deposit with the Bank the England remains, well, ‘as safe as the Bank of England’.

ICAEW chart of the week – NHS

The announcement of a £20bn increase in funding for the NHS in England means a rise in the NHS England budget from £115bn this year to £149bn in five years’ time once inflation is taken into account. (This excludes £14bn of other health related spending in England in 2018-19 outside the main NHS budget).

This is equivalent to an average annual real-terms increase of 2.4%. As a consequence, per capita spending is expected to rise from £171 a month to £194 a month in five years’ time in 2018-19 prices. When Scotland, Wales and Northern Ireland are included, the total is £25bn.  

Around £8bn is expected to come from growth in the economy and there are indications that another £5bn will be made from savings elsewhere in the overall budget.  This leaves somewhere in the region of £12bn a year still to find, equivalent to a couple of extra pence on income tax. 

We leave you with a cliff hanger. Will the Chancellor put up taxes? Or will he increase his borrowing, moving his deficit reduction even further into the future?  We’ll find out in the November budget!

As an aside this increase is only enough to cope with the expected increase in the numbers of people aged over 60 and to give NHS staff the pay rises they expect…

ICAEW chart of the week – public spending health squeeze

A recent report by the Institute for Fiscal Studies and The Health Foundation concludes that annual real-terms increases of 4% in the funding for UK health and social care is needed, mainly to care for the growing number of older people.

Our chart this week shows that consequently, spending on health and social care is forecast to increase from 22% of the total to 28% over the next 15 years.  With the share taken by pensions and debt interest also expected to increase and ring-fences surrounding defence, international development and education, this means that either taxes must rise or spending on ‘everything else’ has to reduce significantly – from 40% to 30% over the same period.

Will it really be possible to deliver further substantial cuts in working-age benefits or in spending on police, prisons, the courts, transport and the environment? Not to mention to everything else? Can our creaking infrastructure really survive another 15 years of underinvestment?

Given the pressures on this and future governments, we suspect that it is more likely that any increase will have to be funded by higher taxes and greater borrowing. Unless we can come up with some radical alternatives: suggestions on a postcard to the Chancellor!

Chart of the week – 300 years of public spending

Deloitte Chief Economist Ian Stewart’s excellent Monday Briefing last week on ‘300 years of public spending’ made for a fascinating read. Over a relatively short period, we have gone from a very small administration to the highly developed welfare state that we have today.

Ian ends with the reassurance that: “Those who worry about the current level of indebtedness of the UK government might take some comfort from the fact that the UK ran far higher levels of debt through much of the last three centuries.”

Unfortunately, we are not comforted.

As our chart this week illustrates, while debt may have been much higher (as a proportion of GDP) in the past, once other liabilities are added in (the red line) things are less rosy. Accounting data only goes back to 2010, but we know that significant liabilities, such as those for employee pensions, have been built up since the 1940s.

In practice, we think the financial position of government is actually much worse than that shown in the accounts because of the even greater commitments made by government to pay for state pensions and other welfare benefits in retirement. Accurate valuations aren’t available, but it is likely that the UK government’s overall financial position the worst it has ever been.

ICAEW chart of the week – Italy

Last month, the caretaker government in Italy proposed a budget which forecast the elimination of Italy’s fiscal deficit by 2021.

The arrival of a radical new coalition government with plans to cut taxes and increase spending changes all that.

Debt investors have seen their concerns reflected in sovereign debt markets, with the yield on Italian government 10-year bonds jumping to 2.43% compared to 1.79% at the end of April, and a further widening in the premium over German government 10-year bunds, which currently yield 0.50%. 

The real issue is the scale of Italy’s accumulated debts. At €2.3tn, or 132% of GDP, Italy’s gross public sector debt is one of the largest in the developed world and is almost three times annual government revenues. Tackling that debt mountain has been the main focus of recent Italian governments, under the watchful eye of the other Eurozone finance ministers and the European Central Bank.

Although not good news from a public finance perspective, there is a silver lining for the UK. Philip Hammond’s plan to eliminate the UK’s fiscal deficit may have slipped to the ‘mid-2020s’, but at least the prospect of being beaten to that achievement by his Italian counterpart appears to have receded.

ICAEW Better Government Series: The debt of nations

Martin Wheatcroft, author of Simply UK Government Finances, has co-authored  the ICAEW Better Government Series: ‘The debt of nations’ policy insight published today. It shines a light into public debt around the world.

Ross Campbell, Director, Public Sector at ICAEW says:

“I’m very pleased to present our most recent addition to the Better Government Series: ‘The debt of nations’.

Since 2001 there has been a dramatic increase in borrowing by governments to nearly £30 trillion, a tripling in the level of public debt. Borrowing can be a valuable tool to finance capital investment, e.g. infrastructure, which creates economic and social benefits. However, increasingly governments in developed countries are borrowing to pay day to day running costs.

With the era of ultra-low interest rates coming to an end and the reversal of quantitative easing, there are real questions about whether the cost of public debt will be sustainable. Traditionally governments used inflation as a tool to reduce debt relative to the size of the economy. This policy choice comes at a cost however, eroding the value of saving and investments in the domestic currency and may be harder to implement in an era where central banks are mandated to keep inflation low.

Our report explores these issues and provides analysis and reflections on borrowing by government.

ICAEW believes we need a better public understanding of how public debt is measured and managed to know if borrowing by government is truly under control.”

Click here to read the report.

ICAEW chart of the week – public debt

Ross Campbell, Director of Public Sector for ICAEW, writes:

“This week’s chart is on the subject of debt. Public debt.

This is the subject of a forthcoming report in the ICAEW’s Better Government Series, which examines the level of public debt around the world. It is not a pretty picture, with general government net debt (the most widely used measure) tripling since 2001 to reach almost £30tn this year.

According to data provided by the IMF, there are 76 indebted countries that together owe £42tn in gross debt, which nets to £29.4tn once cash and liquid financial assets are taken into account. £26.3tn or 90% of this is owed by just 12 countries – the US, Japan, Italy, France, the UK, Germany, Spain, Brazil, Mexico, Belgium, Canada and the Netherlands.

Proportionately, the UK has borrowed the most of the major developed countries, with an average annual increase over the last 17 years of 9.9%, followed by the US with 9.3%. This compares with more modest increases of 2.3% a year on average for Germany and 0.4% for Canada.

A decade after the corporate debt crisis, public debt is at an all-time high and continues to rise. The next debt crisis may well be one of public debt.

Do watch out for our report – it makes for a fascinating (and sobering) read.”

To comment on the ICAEW chart of the week, visit the ICAEW Talk Accountancy blog by clicking here.