11 July 2018

Unless it raises taxes or loosens its borrowing rules, the Government will have to cut spending on other public services by nearly 4% to pay for the recently announced NHS ‘birthday present’, warns Gemma Tetlow.

The Government set out in the 2015 Spending Review detailed spending plans for each department and for local government grants for this year and next. However – apart from announcing a £20 billion birthday present for the NHS – the Chancellor has not yet said how much he will spend on other public services in 2020/21 or beyond. On current estimates public services are facing cuts of nearly 4% to pay for the promised NHS spending. This will be the subject of next year’s spending review.

How much the Government spends depends in part on how much it borrows. At present public sector borrowing is at 1.8% of national income. The Office for Budget Responsibility (OBR) estimates that it will fall to 0.9% by 2022/23. Thereafter, Chancellor Philip Hammond has a target to eliminate borrowing by the “mid-2020s” but has not said how this will be achieved.

If the OBR’s latest forecast is correct, day-to-day spending by government departments on public services would need to fall by 0.6% in real terms between 2019/20 and 2022/23 to balance the books. That equates to a £5bn cut to annual departmental spending by 2022/23, but is less severe than the 0.9% a year cuts imposed in the ten years to 2020.

On top of this £5bn cut, Hammond also needs to find an extra £16bn to meet May’s promises to the NHS in 2022/23. (This rises to £20bn in 2023/24.)

Over the same period, the OBR forecasts that local authority spending funded by locally-raised council tax and business rates will grow by 1.7% in real terms (or an increase of around £800m a year by 2022-23). Exactly how quickly this element of spending grows will depend on how quickly council tax rates are allowed to increase and how fast revenues from business rates rise.

Extra money could be made available for public services by loosening borrowing targets…

Two of the Government’s current fiscal targets expire in 2020/21. The Chancellor is committed to ensuring that public sector net debt falls as a share of national income between 2019/20 and 2020/21. But he currently has no target for debt after that. He is also committed to ensuring that the Government borrows no more than 2% of national income in 2020/21, but thereafter he set only the rather vague “mid-2020s” objective.

If the Government was content to leave borrowing at 1.8% of national income instead of trying to make progress towards eliminating it, public service spending could be increased by around £20bn a year by 2022/23. This would provide enough money to fund the NHS’ birthday present and avoid the need for real terms cuts to spending across other departments.

But such spending would mean debt rising as a share of national income in 2022/23. If the Government wants to avoid that, without making any other changes to tax and spending plans, it would have only an extra £8-9bn for spending in 2022/23. That would mean a 3.9% real terms cut to non-NHS departmental spending.

…or raising taxes…

Last month, the PM announced that the extra money promised to the NHS over the next five years would in part be funded by raising taxes. It has been reported that she is even considering abandoning some of the explicit pledges made in last year’s Conservative election manifesto not to raise certain taxes. But no details have yet been given about which taxes would be raised or by how much.

There are many options. A one percentage point increase in all rates of National Insurance, for example, would raise about half the money needed for the NHS. Abandoning plans to cut corporation tax from 19% to 17% in April 2020 would raise about £5bn a year.

But could May garner enough support from her own MPs to push new tax rises through parliament in the Autumn Budget? By separating the firm announcement of the NHS spending goodies from any serious discussion of where the money will come from, the Prime Minister has made the job of persuading the public that corresponding tax rises will be needed much more difficult.

…or cutting welfare spending

In each of the past two major spending reviews, extra money has been made available for public services by cutting spending on pensions or welfare.

In 2010, cuts were made to Employment and Support Allowance, child benefit was taken away from higher income parents (ending the long-standing principle of universality), and contribution rates were increased for members of public service pension schemes, helping free up over £10bn a year of extra spending for public services.

In 2015, as promised in the Conservative party manifesto that year, £12bn a year was cut from welfare spending by a number of measures. These included freezing the rate of most working age benefits for four years, limiting eligibility for state support to the first two children in a family, and reducing the amount someone could earn before losing their benefits.

The Government could try to follow similar strategies this time – means-testing previously universal benefits (such as winter fuel payments for pensioners), further limiting eligibility for certain benefits, or continuing to hold down growth in benefit amounts.

But it will be harder to find further savings. Some of the cuts announced in 2015 have already been reversed following a public outcry – including changes to Personal Independence Payments for disabled people and planned cuts to tax credits. The 2015 welfare cuts ultimately led to the resignation of Iain Duncan Smith, then-Secretary of State for Work and Pensions, who objected to the cutting of benefits.

With ministers already jostling to make the case that more money should be spent on their area, the Government has yet to answer some important questions. How quickly does it want to cut borrowing? Which taxes is it willing to raise and by how much? Does it think further savings are possible on pensions and welfare spending? Answers to those questions are needed to help departments and service providers work out what sort of service they will be able to provide within the sort of budgets that will be available.


….. or get the Private Sector to carry some of the burden ……

The acute financial crises at the Ministry of Defence has forced the Government to conclude that, it won’t be able to subsidise the defence industry any longer – certainly not in perpetuity, as vested interests would want!

This has spurred the Government into action, yet again. But this time, instead of giving-in to people who are, as usual, pleading for more money for MoD, it is seeking to elicit input of private sector investment capital into defence equipment programmes, to replace taxpayer funds which will serve to lessen the burden on the public purse and also help the Government cope with the financial fallout from Brexit.

In its latest policy statement on defence procurement expressed in the Defence Industrial Policy document which was published in December 2017, the Government says (on page 32):

“We want to encourage more private venture capital into the defence sector, including from non-traditional defence suppliers. Co-investment (where both industry and Government jointly invest) is commonplace in the civil aerospace and automotive sectors, and we want to see more of this in defence”.

Government policy documents are, almost always, framed in language which is deliberately ambiguous in meaning (to sow confusion and conceal real intent, as seen on evolving Brexit positions), leaving them open to multiple interpretations – indeed, as many times as there are readers. However, on this occasion, the message behind the words cannot be clearer.

After decades of propping up the defence industry with unquestioning support, the Government is realistic in its aims and recognises that the private sector will not willingly put forward or risk its own money. Nevertheless, it has come to the conclusion that industry’s appetite for self-funding will only be boosted when the market-based instrument of competition is applied more rigorously.

Defence procurement officials are famous for sticking to tried-and-failed practices of the past, which is why the Secretary of State for Defence has taken to invoking the oft quoted saying “If you always do what you always did, you will always get what you always got” in relation to the behavioural change he is expecting in people directly underneath him at MoD.

To this end, it would be a mistake for MoD to underestimate the formidable resistance that will be put up by defence contractors, or resort to the failed approach of gentle persuasion and talking, to try to convince them to stake their own money. Nor will the presently applied ‘sudden death’ competition (which reduces the field of bidders from six to one abruptly, thereby removing the incentive for the single Contractor to perform) cut it anymore.

Instead, the Government should select the winning Contractor from a choice of industry teams, by running a multiple-phase winner-takes-all competition (see this illustration pic.twitter.com/RUToAZ6thx) on the basis of a level playing field genuinely open to all-comers, including non-domiciled suppliers, with the rules of the contest declared at the outset – and combine it with use of Government’s considerable power of coercion, exercised judiciously.

Accordingly, each Bidder should be invited to declare that part of the bottom-line Selling Price for the overall programme which is to be paid for, from his own (or third party) funds to advance the developmental status of his starting-point for the Technical Solution – as a separate line item on DEFFORM 47, to enable Abbey Wood Team Leader to make a like-for-like comparison. The more money bidders put in, the less MoD will have to contribute, and the lower the risk that the Team Leader will be censured for exceeding the sanctioned budget. See this illustration pic.twitter.com/UIZFTSayqq on how it works.

Normal commercial pressures and market forces inherent within the context of a multiple-phase winner-takes-all competition will, in themselves, compel defence contractors to take a business decision to voluntarily make a contribution from their own funds – not, because the Government says so, as some people in the pay of the State with inflated egos seem to think, but because of the omnipresent threat from the Competition!

Such a feat has not been achieved on any previous equipment acquisition programme for the UK’s Armed Forces, not least, because no one (including the Secretary of State for Defence) has being able to provide convincing evidence of any private sector capital invested – instead, this issue has been dominated by lies, disinformation and spin.

Another beneficial side-effect of getting bidders to put in their own money is that they will be inclined to take greater responsibility for the way they go about designing, developing, integrating, prototyping, manufacturing and supporting their equipment, instead of constantly plotting to contrive situations which will entice acquisition officials into partaking in detailed design decisions relating to the evolving Technical Solution – as has been the case hitherto, on equipment acquisition programmes wholly funded by MoD.

In staking their own funds, bidders implicitly acknowledge and accept a proportionate share of programme risks, so relieving the strain on public finances and with it, ensuring that MoD gets more for its money than it would otherwise do. Additionally, the long-standing practice of bidders concealing technical risks from MoD will cease immediately.

An added benefit to be derived from compelling bidders to borrow funds from third parties such as Finance Houses or private equity partners to pay for the cost of developing their Technical Solutions is that, the monitoring and scrutinising function will be automatically transferred from MoD to the lending institutions, who are likely to be much more rigorous and demanding regarding day-to-day performance than disengaged, here-today-gone-tomorrow procurement officials – yet another good reason why the headcount at MoD’s arms-length defence procurement organisation at Abbey Wood, Bristol should be cut even further!

It is one thing for elite politicians to make ambitious statements in glossy documents for public consumption, and quite another to get front-line procurement officials to implement this policy so that it delivers the outputs, as promised. The acid test will be the actual figure in pounds sterling quoted by bidders on DEFFORM 47 – any number greater than zero will be clear indication that effective implementation of this policy is under way. The legislative branch has a role to play here. To enable Parliament to hold the Government to account and scrutinise the ongoing effectiveness of this policy, it should insist that data on private sector investment capital committed during each phase of equipment procurement programmes be made available, on a regular basis.

The ultimate aim is to gradually cut the Government’s contribution of funds down to zero, commensurate with achievement of levels of competitiveness in the Defence Industry comparable with that exhibited by world-beating, export-orientated, advanced technology non-defence companies in the UK – which happen to pose a nil cost burden upon the taxpayer.