Finances

The budget deficit fell in 2015/16 but the pace of reduction has been slower than planned. In response to the EU referendum the 2019/20 surplus target has been abandoned. The deficit remains large by historical standards and is under pressure from demands for more spending and falls in key revenue streams. Most departmental budgets will decrease in the next four years, and despite planned budget increases in some major public services, resourcing is vulnerable due to the tight spending settlement.

Departmental budget reductions since 2010 will continue up to 2020 broadly on the same scale, in an effort to bring the deficit down. Government revenue is highly dependent on direct and indirect taxes but tax expenditures create billions of pounds of forgone revenue. Since 2010 the value of liabilities on the Government’s balance sheet has grown more than the value of assets, increasing net liabilities.

The deficit has fallen from £155bn to £76bn since 2010…

Government raised £680bn in 2015/16 but spent £756bn, giving a deficit – what government spends minus what government raises – of £76bn. The size of the deficit currently stands at 10% of total expenditure, a reduction from 22% in 2010. This reduction is due to a combination of increasing revenues, which have grown by 26% since 2010, and controlling expenditure, which has grown by 9% over the same period.

The reduction of the deficit since 2010 has not been as fast as the Government intended. In 2010 the Coalition government set out plans for the deficit to be eliminated by the end of the parliament in 2015. In 2012 this target was pushed back into the following parliament due to the state of the economy. The 2015 Spending Review set out plans for the deficit to be eliminated by 2019/20, with the first surplus – where government receipts are greater than government spending – since 2001 (of £10bn).[1] The surplus target was abandoned by George Osborne, and confirmed by his successor as Chancellor, Philip Hammond, in response to the Leave vote in the EU referendum.[2] New spending figures set out in the Autumn Statement forecast a deficit of £20bn in 2020.[3]

…but the gap between revenue and expenditure remains high by historical standards.

Over the past 60 years the public finances have often been in deficit, but the scale of net borrowing since 2009 has been greater than at any time during this period. The impact on the public finances of the financial crisis beginning in 2007 has been more significant than, for example, the recession in the early 1990s or the IMF bailout in 1976. Increased levels of spending coupled with a sharp collapse in government revenue due to decreased economic activity had left a £155bn (10.1% of GDP) hole in the public finances by 2010. After six years, this is a little over half-repaired.

DWP and DH had the largest total managed expenditure in 2015/16.

In 2015/16, as in previous years, DWP (£179.7bn) and DH (£165.9bn) account for 50% of total departmental spending.[4] The combined budgets of the next three departments (DfE, MoD and HMRC) are still smaller than either of them. This reflects the scale of what each department is responsible for – DWP delivers the welfare and benefits system and DH funds the NHS. The third-largest spending department is DfE (with a budget still less than half the size of either DWP or DH), which reflects its role in providing another major public service.

At the opposite end of the scale, HMT, FCO, Defra, DCMS, MoJ and DfID all have budgets of less than £10bn.

When they were abolished in July 2016, DECC (£15.8bn) and BIS (£17.8bn) were in a middle rank of departments along with DfT and DCLG. Also within this middle rank is HO, which provides the largest portion of funding for the police, another important public service.

Government spending is split into different elements – most of it goes to resource spending on policy programmes and staff.

Total managed expenditure (TME) across Whitehall – the overall amount of spending allocated to departments each year – is split into different types.[5] As part of the strict processes and controls applied to how and where departments spend their money, allocations to one category of spending cannot be used for other types of spending.

Spending can be defined by how the limits are set:

  • Departmental Expenditure Limits (DEL) Cover plans that departments are committed to, announced at Spending Reviews. They are often set for a multi-year period, and spending is limited, meaning departmental leaders cannot overshoot their allocated DEL budget.[6]
  • Annually Managed Expenditure (AME) A spending line is defined as AME spending if it ‘cannot reasonably be subject to firm three-year limits’. AME is harder to predict and often relates to functions that are demand driven, such as pensions or welfare payments.[7]

Or spending can be defined by what it is being invested in:

  • Resource spending Relates to departments’ day-to-day operations, including administration spending to cover running costs such as salaries, and programme spending, which pays for policies and programmes.
  • Capital spending Adds to the public sector’s fixed assets, such as transport infrastructure (e.g. roads and rail) and public buildings.

These two different divisions give four quadrants of spending – Resource DEL (RDEL), Resource AME (RAME), Capital DEL (CDEL) and Capital AME (CAME). Resource AME accounts for nearly half (47%) of total government expenditure, closely followed by Resource DEL, often referred to as day-to-day spending (43%).

Most departments’ budgets are dominated by a single type of spending.[8] For example, expenditure at MoJ (prisons) and FCO (administration, conflict resolution and peacekeeping) is almost exclusively Resource DEL, whereas for DWP (pensions, benefits) and HMRC (tax credits) the predominant type of spending is Resource AME. A department primarily relying on Resource DEL faces more challenges overseeing policies and programmes if these particular budgets are targeted for reductions. For example, prison funding comes out of the MoJ’s RDEL budget, and therefore reductions will affect not just the department in Whitehall but resources available to the prison service as a whole.

For departments with predominantly AME profiles, such as DWP, spending is demand driven and harder to plan for accurately. For example, despite government policy aiming to reduce the welfare bill, total spending on housing benefit has grown from £19.9bn in 2009/10 to £24.2bn in 2015/16.[9]

Departments such as DfT and BIS (before it was abolished) have a greater mixture of different types of spending, including capital, which is not the case for the majority of departments. DfT’s capital budget includes investment in the railway network (£6.7bn in 2015/16) and roads (£1.9bn in 2015/16), while BIS invested in higher education and science and research.

Departments responsible for capital spending oversee large and potentially complex projects such as infrastructure, which are longer-term commitments susceptible to delay and overspend.

A majority of departments had their day-to-day spending budgets reduced in the past five years, some (DfT and DCLG) by more than half.

Since RDEL is set on a multi-year basis at the Spending Review and is the financial envelope in which Whitehall departments have to plan and operate, it should be the area of spending that government can exert most control over.

Departments can be broken down into three groups according to changes in their RDEL budgets since 2011/12:

  • In some departments there has been a real-terms increase over the past five years – in some cases, the Government ring-fenced parts of their budget, such as DH (health, up 9%), DfID (aid, up 9%) and DfE (schools, up 1%).
  • Some departments, such as MoD, HO, Defra and MoJ, had budget cuts of up to 30%.
  • In other departments – BIS, DCLG and DfT – there were larger cuts of between 30% and 60%.[10]

A contrast can be seen between DECC and BIS, both abolished in July 2016 as part of the creation of BEIS – DECC’s RDEL increased by 15%, while BIS had a 39% reduction.

Because of their different spending profiles, these RDEL reductions will have more of an impact on some departments – i.e. those departments where the total budget is primarily made up of RDEL. This includes MoJ (-26%), FCO (-18%) and HO (-17%). Conversely, although DfT has had a greater reduction (more than 60%), RDEL doesn’t form the central part of its TME (capital budgets do). The trend of reductions has also varied. Some departments, such as MoJ and Defra, had sustained yearly decreases of comparable sizes, whereas at DCMS there was a sharp increase before the 2012 London Olympics, and decreases in the following years.

Under current spending plans up to 2020, five departments’ budgets will increase and the rest will continue to fall.

The scale of RDEL reductions over the past five years will continue up to 2020.[11] For departments such as MoJ and DCLG, where there have already been sustained budget reductions, the respective 20% and 60% additional decreases will be particularly challenging to achieve without an impact on the areas the departments are responsible for funding (for example, prisons and local government).

DH and DfE will continue to see a real-terms increase to support the provision of schools and hospitals, but the scale of the increase is 1%-2%. For the NHS this is a smaller real-terms increase than in the previous five years, and for DfE it is a similar amount. Such tight spending settlements for major public services are vulnerable to unforeseen levels of demand, or a sharp increase in inflation, both of which would erode the impact of budget rises.

Some departments have a notably different budget plan up to 2020 compared to the previous five years. This can reflect political pressure, where reductions are seen to have gone as far as possible in certain areas, and the challenge of meeting similar levels of spending reductions is judged to be too great. For example, MoD will go from having an 8% decrease over the previous five years, to a 1% increase by 2020, partly in order to meet the 2% Nato defence spending target. The HO budget, which funds the police (among other things), went down 17% in the five years up to 2015/16, but is planned to go down by only 5% in the next four years, a smaller decrease than in other departments.

Whereas in the past five years DECC and BIS had contrasting budget allocations, both had significant planned reductions to achieve over the next four years, before their abolition. DECC planned to operate with the second-largest percentage RDEL reduction of all departments, at 44%, and BIS had a 17% reduction.

Direct and indirect tax revenue increased between 2010/11 and 2014/15 and stands at £512bn.

For revenue, government relies on taxation and the sale of goods and services.

Direct (e.g. income tax and corporation tax) and indirect (e.g. VAT and excise duties) taxes are the main sources of revenue: income generated from all taxation (including local government taxes) accounted for 86% of total government revenue in 2014/15, an increase of just over 1% since 2010. Receipts increased over the past five years, contributing £512bn to the exchequer in 2014/15, compared to £462bn in 2010/11.

In contrast, over the same five years, revenue from goods and services fell from £50bn to £33bn. Revenue from the sale of services by central government (e.g. entities within the NHS), local government (e.g. social care, leisure provision, fare income from Transport for London) and public corporations (e.g. advertising and broadcasting rights) decreased from 8% to 5% of total government revenue. The notable decrease in revenue from public corporations since 2012/13 is due to the sale between 2013 and 2015 of Royal Mail, which is no longer a government entity.[12]

Specific taxes generate the most money for the exchequer as a percentage of total tax revenue: income tax (28%), VAT (20%) and National Insurance (17%) were the largest contributors in 2014/15. In total, the combined contribution of income tax, VAT and National Insurance contributions (NICs) generated £374bn in 2014/15.

Direct and indirect taxation consistently accounted for around 75%-80% of revenues in each year since 2010. Given how vital revenue increases have been in reducing the deficit, deterioration in tax receipts from these revenue streams would create significant problems for the sustainability of government spending plans. Public finance figures from September 2016 showed receipts were beginning to disappoint relative to forecasts and are on course to be £14bn down on the Office for Budget Responsibility’s forecast for 2016/17 from March 2016.[13]

There are 16 tax expenditures each costing over £1bn and half of them relate to VAT.

Tax expenditures are tax discounts or exemptions that further the policy aims of government. They cover everything from the relief on charitable giving to inheritance tax relief, and can involve politically sensitive issues such as the zero rate of VAT on children’s clothes. There are 16 tax expenditures that each cost more than £1bn in forgone revenue (the money government could have expected to raise if the exemptions were not in place). The largest exemptions concern gains arising from selling a house (£26.8bn), pension schemes (£22.9bn) and VAT on food (£16.8bn). Of the 16 expenditures over £1bn, eight concern VAT.

The total sum of forgone revenue for all tax expenditures (including those costing less than £1bn) across the five revenue streams in the chart above (income tax, corporation tax, NICs, capital gains tax and VAT), plus expenditures applying to inheritance tax and excise duties, was £133bn in 2015/16 – equal to a quarter of total direct and indirect tax revenues in 2014/15, and larger than the total managed expenditure of all departments except DWP and DH. In spite of this, the National Audit Office (NAO) has reported that the Treasury does not control tax expenditures with the same rigour as it does general expenditure; they are not included in HMT’s own budget-formation process and are therefore not subject to appropriate levels of scrutiny. The Institute for Government, along with the Institute for Fiscal Studies and Chartered Institute of Taxation, has recently called for the most spending-like tax reliefs to be treated like spending for accountability and scrutiny purposes.[14]

Net liabilities have risen over the past five years, to £2.14tn.

Just as tax expenditures are underappreciated when considering revenue and expenditure, so the balance between assets and liabilities is a relatively overlooked part of the Government’s overall financial management. The Government oversees a large portfolio of assets (e.g. buildings, roads, loans and deposits, equity investments) and liabilities (e.g. government financing and borrowing, public sector workers’ pensions), and the gap between the value of these two – the net liability – has implications for future generations of taxpayers, who will bear the cost of meeting these obligations.

Liabilities increased from £2.48tn in 2010/11 to £3.6tn in 2014/15. The largest components are pension liabilities (£1.5tn) and government financing and borrowing (£1.2tn). Net liabilities in 2014/15 were 165% of total assets, up from 98% in 2009/10.

The long-term nature of liabilities can make discussions around the Government’s balance sheet feel more remote than more immediate concerns about annual budgets. However, they do have a bearing on current policy choices. The Coalition government justified legislation to accelerate the increase in the state pension age and changes to the pensions of public sector workers, on the grounds that an ageing population was making the pension liability increasingly unsustainable.[15] This is an example of concerns about long-term liabilities on the Government’s balance sheet having a direct impact on public policy.

The cost of some liabilities, such as financing and borrowing, is dependent on moves in long-term interest rates. If the economy moves out of the period of low interest rates that has prevailed since 2008, for example in response to a rise in inflation, borrowing costs could increase, leading to a further widening in net liabilities.

Assets and liabilities are concentrated in HMT, MoD, DfT, DH, DfE and (before they were abolished) BIS and DECC.

Assets are concentrated in six departments – DfT, MoD, HMT, BIS (as was), DH and DfE. DfT, MoD, HMT and DH also hold most of the departmental liabilities, along with DECC (as was).[16] The sharp increase in DfT’s assets and liabilities since 2014/15 is the result of the decision by the Office for National Statistics (ONS) to reclassify Network Rail from the private to the public sector (which took effect in September 2014).[17] The main consequence of this was to bring the company’s debt and any future borrowings on to the public sector balance sheet. In 2015/16 DfT assets were £406bn and liabilities £47bn.

DECC’s large and growing liabilities were due to changes to the value of the provision for nuclear decommissioning costs and the inclusion of Contracts for Difference. (These are designed to encourage investment in new, low-carbon power plants to help decarbonisation targets, and they last for 12 to 15 years.) The liability for decommissioning the nuclear estate was £160bn in 2015/16, up from £70bn in 2014/15. The significant increase in the valuation of nuclear decommissioning provisions was caused by changes to HMT discount rates.[18]

DH’s increasing liability is primarily driven by provisioning for clinical negligence, which was £56.1bn at the end of 2015/16, having increased by £27.8bn over the preceding year. The majority of this increase (£25.4bn) related to the same changes in HMT discount rates that affected DECC’s liabilities.[19] Long-term liabilities, like negligence claims and decommissioning costs, are sensitive to even small fluctuations in the discount rate prescribed by HMT.

It is still more difficult to follow changes to spending plans at HMT and HMRC than anywhere else.

There may be good reasons for departments’ spending plans changing between the original figure set out at a Spending Review and subsequent figures produced at Budgets, and the final outturn in the department’s Annual Report. We can track changes relatively easily through these fiscal publications, but understanding why they were made – whether they represent additional funding, savings or transfers to other departments – is often much more difficult.

For each financial year, we compared the original spending plan (from the most recent Spending Review) with every revised plan for that year (in annual Budget documents and the department’s Annual Report and Accounts). We graded each department according to whether changes were explained and where this explanation appeared (i.e. was this in the document where the change occurred?), and then ranked the departments based on their average transparency rating over the period 2011/12 to 2015/16.

DCMS ranks highest, with no significant differences in spending plans between fiscal documents over the period. DECC comes second: over the course of its relatively short lifespan (created in 2008, abolished in July 2016), it was the only department to explain all spending changes inside the document in which the change was first recorded.

HMRC and HMT – the department responsible for producing Spending Reviews and Budgets – are at the bottom of the table because of inconsistencies in the way their spending is reported. At Spending Reviews and in Annual Reports and Accounts, separate figures are reported for HMT and HMRC, but in Budget documentation, HMT and HMRC are combined as the ‘Chancellor’s Departments’, making it impossible to compare HMT and HMRC spending across different fiscal documents. In Budget 2016, however, the two departments have been accounted separately, a commendable improvement that will be reflected in next year’s Whitehall Monitor rankings.

DfID has not published figures for RDEL depreciation in its Annual Reports since 2011/12, and HMT, HO and DCLG failed to account for it this year; this makes it impossible to compare outturn with the original spending plans and therefore contributes to lower rankings.