The Government’s budget deficit has continued to fall, but it is no longer expecting to achieve a budget surplus before 2022/23, the last year for which a forecast has been published. At every fiscal event since becoming Chancellor, Philip Hammond has needed to give a short-term cash injection to a public service under pressure – first prisons, then social care, and most recently the NHS. A further £3 billion (bn) has been set aside for Brexit contingency planning. Looking ahead, the Chancellor should expect weaker growth in tax revenues, following downgraded productivity forecasts.

Most departments’ budgets are set to continue falling up to 2019/20, but political and public service pressures have resulted in the Government deviating from these plans on several occasions already. While forecasts for tax revenues have been downgraded, the Government also forgoes billions of pounds through tax expenditures that are not subject to rigorous value-for-money assessments.

Since 2010, the value of liabilities on the Government’s balance sheet has grown more quickly than the value of assets, increasing net liabilities.

Devolution – specifically, further devolution of tax powers – continues to change the UK’s fiscal landscape.

The Government’s budget deficit has continued to fall…

Chart government revenue and expenditure

The deficit – the gap between what government spends and what it raises – has fallen significantly in recent years. In 2016/17, government borrowing stood at £46bn, compared with £171bn in 2009/10, meaning that borrowing as a share of total government spending has fallen from 22% at the beginning of the decade to 6% last year. The reduction in the deficit is the result of growth in government revenues of 20% in real terms, combined with controls on spending, which has fallen by 0.7% in real terms in the same period.

The deficit represents the amount of money added to the national debt each year, which – subject to the interest rate – determines the level of interest payments that government needs to make to service its debt. In 2016/17, debt interest payments by central government amounted to £48.4bn, which was 6.3% of the Government’s total managed expenditure.[1]

…but revenue is not expected to overtake spending in the foreseeable future

Chart deficit reduction plans after 2010, 2015 and 2017 elections

While the Government has reduced the deficit, it has not done so as quickly as it originally intended. The Coalition Government’s first budget, in June 2010, outlined plans to almost eliminate the deficit by the end of the 2010–15 parliament,[2] but the timeline was pushed back in 2012 because of the state of the economy.[3] The 2015 Spending Review, overseen by George Osborne, then set out plans to achieve a budget surplus by 2019/20. However, Philip Hammond dropped this target in the 2016 Autumn Statement – his first fiscal event as Chancellor – amid weaker economic forecasts after the Brexit vote.[4] The most recent forecasts show the deficit remaining in place until at least 2022/23, with borrowing expected to increase slightly to £49bn next year.

Chart government revenue and expenditure as a percentage of GDP

It is by no means exceptional for the budget to be in deficit. In fact, a surplus has been achieved in only seven financial years since 1955/56 (1969/70, 1970/71, 1988/89, 1989/90, 1998/99, 1999/2000 and 2000/01). Nonetheless, the gap that opened between spending and revenue in the aftermath of the 2007 financial crisis was larger than at any point in the past 60 years. In 2009/10, net borrowing peaked at 9.9% of GDP, compared with 6.3% at the time of the International Monetary Fund (IMF) bailout in 1976, and 6.6% during the recession of the early 1990s. Borrowing currently stands at 2.3% of gross domestic product (GDP), and is expected to fall to 1.1% by 2022/23.

The largest departmental budgets are for Work and Pensions, Health, and Education

Chart Total managed expenditure by government department

Work and Pensions (DWP, £179bn), Health (DH, £148bn) and Education (DfE, £90bn) have the largest budgets of all government departments, and together they account for two thirds of all departmental spending. DfE’s spending has increased from £70bn in 2015/16, after it took on responsibility for further and higher education policy from the now-defunct Department for Business, Innovation and Skills. At the other end of the scale, with budgets of less than £500m, are the Department for Exiting the European Union (DExEU), the Treasury (HMT) and the Department for International Trade (DIT) – thus, two of the departments with the smallest budgets are among the most powerful and politically important.

Budgets are split into different elements, with most spending going on day-to-day business

Chart composition of total managed expenditure across the whole of government

Total managed expenditure (TME) across Whitehall – the overall amount of spending allocated to departments each year – is split into different types. 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.
  • Annually Managed Expenditure (AME) covers spending that ‘cannot reasonably be subject to firm multi-year limits’.[5] AME is harder to predict and often relates to functions that are demand-driven, such as pensions or welfare payments.

Or, spending can be defined by what it is 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 planned day-to-day spending (43%).

Chart breakdown of total managed expenditure by Resource DEL, Resource AME and Capital DEL and AME

Since 2012/13, the amount government spends as Resource AME has risen from £345bn (44% of total managed expenditure) to £363bn in 2016/17 (47%). This includes spending on social security benefits (£189bn in 2016/17) and tax credits (£27bn). Given that much of this spending is demand-driven – based on the number of people that qualify to receive certain benefits – it can be difficult to control spending levels. Resource DEL has fallen as a share of total spending (from 45% to 43%), while the share dedicated to capital spending has remained at 10%.

…but the composition of budgets varies by department

Chart composition of total managed expenditure by department

Most departments’ budgets are dominated by a single type of spending.[6]

Resource DEL makes up more than half of the budget in 10 departments. Because a single capped budget is used to fund multiple functions or responsibilities, pressure in one area can end up affecting other parts of the budget. For example, when political pressure resulted in the school funding formula being made more generous in September 2017, resources were ‘recycled’ from other parts of the DfE budget.[7]With the approval of the Treasury, departments can also divert some of their Capital DEL budgets to alleviate short-term Resource DEL spending pressures.

Four departments – Department for Work and Pensions (DWP), HM Revenue and Customs (HMRC), the Cabinet Office (CO), and the Department for Digital, Culture, Media and Sport (DCMS) – have budgets that are mostly comprised of Resource AME. Most of this spending is determined by the level of demand, which can be difficult to predict, as in the case of benefits that are closely linked to the economic cycle, such as jobseeker’s allowance.

Most departments have seen their planned day-to-day budgets fall, with reductions of 65% at DfT and DCLG

Chart percentage change in planned 'day-to-day' spending RDEL, real terms

Resource DEL, or planned day-to-day spending, is set on a multi-year basis at the Spending Review, and is the financial envelope within which Whitehall departments plan and operate.

Since 2010/11, Resource DEL budgets have risen in only three departments – International Development (DfID, up 19%), CO (up 13%) and DH (up 11%). Two of these have parts of their budgets ring-fenced, with the NHS budget protected in real terms, and the Government committed to spend 0.7% of GDP on international aid.

All other departments have seen their planned day-to-day spending budgets cut in real terms. At DfE, the Ministry of Defence (MoD), DCMS, the Home Office (HO) and Foreign Office (FCO), cuts have been relatively modest, at less than 20%. The Ministry of Justice (MoJ), the Department for Environment, Food and Rural Affairs (Defra) and DWP have faced cuts of up to 40%. However, the most severe have been at Transport (DfT) and Communities and Local Government (DCLG), whose Resource DEL budgets have been cut by 65%.

Because each department has a different spending profile, the overall impact of Resource DEL reductions will vary. The impact will be greater in departments like MoJ and Defra, where the total budget is made up primarily of Resource DEL. However, the three departments that have faced the deepest Resource DEL cuts – DWP, DfT and DCLG – spend less than half of their budgets in this way.

In some departments, such as DH, DfE and MoJ, spending levels have changed in a relatively consistent way since 2010/11. In contrast, DCMS’s spending increased sharply before the 2012 London Olympics, before falling in subsequent years, and spending fluctuations at CO are driven in part by it bearing the cost of holding general elections.

Several departments are deviating from the plans outlined in the Spending Review

Chart percentage change in planned 'day-to-day' spending

The 2015 Spending Review doubled down on the cuts to Resource DEL budgets that had occurred up to that point. Many departments that have already absorbed significant cuts, including DCLG and MoJ, will have further reductions in their budgets by 2019/20. In contrast, two of the three departments where spending has increased since 2010/11 – DH and DfID – are among the five that will see budgets grow between 2015/16 and 2019/20, alongside HMT, DCMS and MoD.

For the departments facing a second round of cuts, finding further ways to reduce their spending without damaging frontline services is likely to prove more challenging, as many of the short-term ‘belt-tightening’ options, such as wage freezes and staff cuts, have been exhausted. Even departments receiving modest spending increases, such as DH, are vulnerable to changes in demand for public services, or to inflation.

Pressures in public services have resulted in several deviations from the plans outlined in the 2015 Spending Review, with an additional £500m of spending for prisons (MoJ) announced at the 2016 Autumn Statement, an additional £2bn for social care (DCLG) at the 2017 Spring Budget, and an additional £2.8bn for the NHS (DH) at the 2017 Autumn Budget. Altogether, the Institute for Government’s Performance Tracker estimates the Government will spend around £10bn in this way over the five years from 2015/16.[8]

Furthermore, at the 2017 Autumn Budget, the Chancellor committed £3bn (to be spent over the course of 2018/19 and 2019/20) for Brexit contingency planning. While this money has not yet been allocated to departments, it is likely to have an impact on future spending at some of the departments most affected by Brexit, like HMRC, Defra and HO.[9]

Tax revenue has risen since 2010/11…

Chart sources of government revenue

The main source of government revenue is taxation, which accounts for 85% of all government receipts. The government also receives revenue from things like the sale of goods and services, fees and charges, and rental income.[10]

Government revenue relies on three taxes in particular – income tax, National Insurance and VAT. Together, these raised £395bn in 2015/16, which was 72% of all taxes raised by central government. The next largest taxes – corporation tax, fuel duty and excise duties – raised a further £101bn, with other central taxes contributing £50bn, and local property taxes (council tax and business rates) £58bn.

In real terms, revenues from taxes have grown 7% since 2010/11. This is largely the result of:

  • VAT receipts increasing by 22% (partly due to the standard VAT rate increasing from 17.5% to 20% in 2011)
  • National Insurance contributions increasing by 11%
  • revenue from other taxes increasing by 39%. This includes taxes that are highly sensitive to economic cycles, such as stamp duty and capital gains tax, where revenues have recovered from a low (post-financial crash) base in 2010/11.

In contrast, revenue from the sale of goods and services has fallen 34% since 2010/11, contributing £36bn in 2015/16. Most of this (£22.8bn) was raised by local government (e.g. social care, leisure provision and fare income for Transport for London), with the remainder coming from public corporations (e.g. the BBC) or central government (e.g. the NHS). Revenues from other sources – which include fees and charges, and the Government’s rental income – have grown by 25%.

For the 2017 Autumn Budget, the Office for Budget Responsibility (OBR) downgraded its forecasts for productivity growth. This, in turn, has resulted in the outlook for Government revenue being revised downwards. Forecast receipts in 2021/22 have fallen 3.2%, from £869.5bn at the Spring Budget 2017 to £841.6bn at the 2017 Autumn Budget.

…but tax expenditures cost £135bn per year

Chart revenue collected and estimated tax expenditure for selected taxes

Tax expenditures are tax discounts or exemptions that further the policy aims of government. They cover anything from income tax relief for charitable giving (Gift Aid) to VAT discounts for children’s clothing.[11]

There are five tax expenditures that cost more than £10bn in forgone revenue (the money government could have expected to raise if the exemptions were not in place) per year, including:

  • exemptions concerning capital gains tax that arises from the sale of a person’s main or only property (£27.3bn)
  • income tax exemptions for payments into registered pensions schemes (£23.4bn)
  • VAT discounts on food (£17.2bn)
  • employer National Insurance exemptions for payments into registered pensions schemes (£15.2bn)
  • VAT discounts on the construction of new dwellings, including refunds for DIY builders (£11bn).

The total sum of all forgone revenue from tax expenditures across income tax, National Insurance contributions, VAT, corporation tax, excise duties, capital gains tax and inheritance tax was £135bn in 2015/16. This is equal to a quarter of the total central government tax revenue in that year, and is larger than the total budgets of all but two departments (DWP and DH). For capital gains tax, the cost of tax expenditures was more than four times the amount of revenue collected.

In the 2017 Autumn Budget, the Chancellor announced new stamp duty reliefs for first time buyers purchasing properties worth under £500,000. Due to the policy being specifically targeted at first time buyers, this policy resembles a tax expenditure, and in 2018/19 (its first full year) is expected to cost £560m.[12]

Despite their considerable impact on the overall state of national finances, the National Audit Office has reported that the Treasury does not monitor tax expenditures and assess the value for money they offer with the same rigour as it does general expenditure. The Institute for Government, along with the Chartered Institute of Taxation and the Institute for Fiscal Studies, has called for the tax reliefs that most closely resemble spending measures to be treated as spending for accountability and scrutiny purposes.[13]

Net government liabilities are now over £2 trillion

Chart government assets and liabilities

While the deficit has fallen in recent years, the Government’s net liability – the gap between its total assets (e.g. buildings, infrastructure, deposits, equity investments) and liabilities (e.g. government borrowing, public sector workers’ pensions) – has grown. In 2015/16, the net liability was over £2 trillion (tn), based on 2016/17 prices.

The value of the Government’s asset portfolio has grown from £1.4tn in 2009/10 to £1.78tn in 2015/16. This includes infrastructure assets worth £584bn, and land and buildings worth £414bn. Meanwhile, the Government’s total liabilities now stand at £3.8tn, up from £2.77tn in 2009/10, which includes £1.45tn of pension liabilities for public services and £1.29tn of government borrowing.[14]

The Government’s net liability has implications for future generations of taxpayers, who will bear the costs of meeting these obligations, but the long-term nature of such obligations can make discussions around the government balance sheet seem more remote than the immediate choices about how much departments should spend each year. Nonetheless, policy choices have important implications for the Government’s liabilities – for example, the decisions taken by the Coalition Government to increase the state pension age, and to set a triple lock that guarantees annual increases of at least 2.5% in the state pension, are likely to have contrasting effects on the size of the state pension liability. Factors outside the Government’s control, such as the Bank of England’s recent decision to increase interest rates to 0.5%, can also result in changes to certain government liabilities, such as financing and borrowing.

DfT, MoD and HMT have the most assets, while liabilities are concentrated at BEIS and DH

Chart departmental assets and liabilities

Departmental assets and liabilities are concentrated in a handful of departments. Three account for 76% of all assets held by departments:

  • DfT’s assets are worth £422bn, and include the national rail and strategic road network. In 2014/15, the department’s assets and liabilities increased sharply after the ONS reclassified Network Rail as part of the public sector.
  • MoD’s assets are worth £140bn and include military equipment, land and buildings.
  • HMT’s assets are worth £117bn and are mostly made up of various types of financial asset, including Royal Bank of Scotland shares and derivative assets.

Other departments with notable asset holdings are DH (£66bn) and DfE (£65bn).

Together, BEIS and DH account for more than half (69%) of the liabilities held by departments:

  • BEIS’s liabilities are worth £191bn, most of which is provisioning for nuclear decommissioning that was previously held by the now-defunct Department of Energy and Climate Change (£165bn).
  • DH’s liabilities are worth £99bn, most of which is provisioning for clinical negligence (£65bn).

Liabilities outstrip assets at BEIS, DH, DWP, HO, DIT and DExEU.

The Government is still not transparent enough about its spending plans

Chart transparency rankings of departmental spending plans

There are good reasons why departmental spending plans might change after they have been set at a Spending Review. Policy changes, machinery of government changes (where responsibilities move between departments) or classification changes (where accounting methods change) can all result in spending figures being revised in subsequent Budget documents or a department’s Annual Report and Accounts.

Tracking when these changes take place – by comparing different fiscal documents – is relatively straightforward, but it is often more difficult to understand why they have taken place. Without these explanations, it can be difficult to hold the Government to account on its public spending decisions.

For each Spending Review period, we have compared the original spending plans with any revised figures in Budgets and departmental accounts. Each department has been graded according to whether changes have been explained, and how easy it is to find these explanations, with departments then ranked according to their average transparency ranking for the 2010, 2013 and 2015 Spending Reviews.

DCMS ranks the highest, mostly because there have not been many significant changes in its spending plans between fiscal documents. The only significant change (above £100m) was for the 2016/17 financial year, and was explained by the Office for Civil Society moving from CO to DCMS.

HMT – the department responsible for producing Spending Reviews and Budgets – and HMRC have historically scored worst in our ranking because of inconsistencies in the way their spending is reported. At Spending Reviews and in Annual Reports and Accounts, separate figures are reported for the two departments, but until 2016, Budget documents combined HMT and HMRC as the ‘Chancellor’s Departments’, making it impossible to compare HMT and HMRC spending plans across different fiscal documents. Since the 2016 Budget, however, the two departments have been accounted separately, which is reflected in their improved ranking in 2016/17.

Some departments, such as DfID and DCLG, have not published figures for Resource DEL excluding depreciation in their Annual Reports and Accounts. This makes it impossible to compare outturn with original spending plans, and has therefore contributed to their lower ranking.[15]

Some departments’ budgets cover only England, or England and Wales…

Chart percentage of departmental spending responsibility that is devolved to Scotland, Wales, and Northern Ireland

Since 1999, devolved administrations in Scotland, Wales and Northern Ireland have been responsible for certain policy areas. To fund this, each administration receives an annual block grant for Resource DEL and Capital DEL that the UK Treasury calculates using the Barnett formula. Each year, devolved budgets in Scotland, Wales and Northern Ireland are adjusted based on the per capita share of any spending changes that the UK Government makes in areas of devolved responsibility. Devolved administrations, however, are not required to make spending changes in the same areas as the UK Government. For example, if the Government increases spending on health, this will result in additional money for devolved administrations, but they are not required to spend this money on health.

In all three nations:

  • DfE, DCLG, DH and Defra functions are fully or almost fully devolved.
  • Most DfT (e.g. highways, road maintenance) and DCMS (e.g. arts, heritage and sports) functions are devolved.
  • Some BEIS functions (e.g. enterprise) are devolved.

MoJ functions and most HO functions are also devolved in Scotland and Northern Ireland, and DWP’s responsibilities for administering social security are devolved in Northern Ireland, although Northern Ireland is required to replicate most elements of DWP policy.[16]

While the Barnett formula is the main mechanism for funding devolved administrations, the UK Government is not bound by it. After the 2017 general election, the Conservative Government reached a confidence and supply agreement with the Democratic Unionist Party, which included £1bn of additional funding for Northern Ireland. This agreement bypassed the Barnett mechanism, so there was no corresponding increase in spending for Scotland, Wales or England.

…and new tax powers are on the way to Edinburgh, Cardiff and Belfast

Chart timeline of tax devolution measures

Legislation in recent years has initiated a wave of tax devolution to Scotland, Wales and Northern Ireland.

In Scotland:

  • Stamp duty and landfill tax have been fully devolved since April 2015.
  • Income tax rates and bands have been devolved since April 2017 (with the personal allowance and income tax arising from savings and dividends reserved for Westminster).[17]
  • Air passenger duty will be devolved in April 2018.
  • 50% of VAT receipts collected in Scotland will be assigned to the Scottish Government from April 2019.
  • The aggregates levy – a tax on the commercial exploitation of rock, sand and gravel – will be devolved at a date as yet unspecified.

In Wales:

  • Stamp duty and landfill tax will be devolved from April 2018.
  • UK income tax rates will be reduced by 10p for each band, and the Welsh Government will gain the power to set the Welsh rate separately for each of the basic, higher and additional bands.

In Northern Ireland:

  • The Assembly was granted the power to abolish long-haul air passenger duty in 2012.
  • Powers to set corporation tax will be devolved. The UK government has committed to doing this when the Northern Ireland Executive ‘demonstrates its finances are on a sustainable footing’.18 The aspiration of the previous administration in Northern Ireland was for this to happen in April 2018, but with power-sharing suspended the plan is on hold, potentially to be revived if and when devolution is restored.

While some of these taxes, including income tax and VAT, will continue to be collected by HMRC, others, including stamp duty and landfill tax, will be collected by new public bodies established by the Scottish and Welsh governments.