Finances

Whitehall is preparing for the 2019 Spending Review. After almost a decade of spending being squeezed, the Chancellor has declared that “austerity is coming to an end”. There are some signs of this happening with new funding for the NHS announced last year, and more modest giveaways to other departments in the latest Budget. However, with the Government committed not to raise certain taxes, the spending restraint of recent years is likely to continue for much of the public sector.

The Chancellor appears likely to increase total departmental spending in the 2019 Spending Review. Most of this planned increase, however, is already earmarked for the NHS. With some other budgets also protected, including defence and international aid, it is likely that unprotected departments will be required to make further cuts.

These will come after a period of austerity. Spending has fallen in real terms in all but three departments since 2010. Administration budgets – which cover the running costs of departments – have been cut most significantly.

The Government is already finding it difficult to adhere to the spending settlement set out at the last spending review in 2015. Since then, several public services have struggled to meet rising demand (such as for health care) or absorb large spending cuts (such as in prisons), and departments have had to make the necessary preparations for Brexit. In response, the Chancellor has opened his cheque book to supplement departmental budgets.

 

Overall spending will go up

The Government will announce new departmental spending plans this year. This will determine how much money is available for public services and investment.

Since 1998, spending reviews have been an important part of the way government manages spending. They set out annual limits for each department – typically for three to four years – which give departments the certainty they need for medium-term planning. They are also an opportunity for the Government to set out its vision for the country and demonstrate how its policies and spending decisions support that.

It is not yet clear what period the next spending review will cover. It must extend at least to the 2020/21 financial year – the first year not covered by the 2015 Spending Review. It could cover a further three years, up to 2023/24.

Spending reviews since 1998, with planned changes in Departmental Expenditure Limits

The three most recent spending reviews – in 2010 and 2013 under the Coalition Government, and in 2015 under a Conservative government – set out plans to cut spending by an average of 1.6% a year in real terms, in contrast to the previous Labour Government’s five spending reviews, which increased it by an average of 4% a year in real terms. The Prime Minister and Chancellor have both signalled that the 2019 Spending Review will mark the end of austerity, and the latest forecasts – from the 2018 Budget – show departmental spending increasing by an average of 1.2% per year in real terms between 2020/21 and 2023/24.

 

Austerity will not end for all departments

In June 2018, the Government published a new, long-term funding settlement for the NHS – dubbed the health service’s ‘70th birthday present’. The settlement covers a five-year period starting in 2019/20. NHS spending in England will increase by an average of 3.4% a year in real terms, meaning an additional £20bn a year (in today’s prices) by 2023/24.

A few months later, in October 2018, the Prime Minister heralded the end of austerity in her party conference speech, promising that “support for public services will go up”. That same month Chancellor Philip Hammond delivered what was widely described as a ‘giveaway Budget’.[1] Additional funding was announced for Universal Credit over a five-year period, with a boost for schools and roads in 2018/19, and for social care and defence covering 2018/19 and 2019/20.

Planned real-terms change in day-to-day departmental budgets at spending reviewsBut the rhetoric on ending austerity, and the cash injections in the Budget, should not be taken as a sign that spending will increase for all departments. Once the NHS spending settlement is factored in, the forecast increase in overall departmental spending almost completely disappears.

In addition to the commitment made to the NHS in England, the Government will also have to allocate equivalent extra money to the devolved administrations and find the resources needed to meet its existing pledges to spend 2% of GDP on defence and 0.7% of national income on overseas aid. This will limit how much funding is left over for other, unprotected departments. It is likely that some departments that have faced significant cuts since 2010 will find themselves having to make further savings.

 

Spending reviews cover half of total spending, but this varies by department

Composition of total managed expenditure (TME) across the whole of government, 2017/18

The government’s total managed expenditure (TME) breaks down into multiple components.

Spending can be defined in two ways. First, by how budgets are managed:

  • Departmental expenditure limits (DEL) cover the areas of public spending over which central government has a high degree of control and which can reasonably be set several years in advance. DEL totals are set at spending reviews, usually for multi-year periods, and departments cannot overshoot their allocated budget.
  • Annually managed expenditure (AME) covers those areas of public spending that are harder to control and “cannot reasonably be subject to firm multi-year limits”. This includes demand-driven benefits, central government debt interest and local- authority expenditure financed through locally raised taxes.

Or second, by what it is invested in:

  • Resource spending relates to day-to-day operations. This breaks down into administration spending, which covers departmental running costs such as salaries, and programme spending, which covers public services and benefits.
  • Capital spending adds to the public sector’s fixed assets, such as transport infrastructure (e.g. roads and rail) and public buildings. This also includes spending on research and development.

These two different divisions give four types of spending: resource DEL (RDEL), resource AME (RAME), capital DEL (CDEL) and capital AME (CAME). The strict controls applied to how departments spend their money mean that allocations to one category cannot be used for other types of spending (however, with Treasury approval, departments can move money between capital and resource DEL budgets).

Spending reviews are focused on resource DEL and capital DEL – the money spent on running public services like schools and hospitals, and departmental administration, and on certain investments. This makes up just under half of all government spending. AME makes up the other half. While AME is not the main focus of spending reviews, forecast AME does affect how much of total government spending will be available for allocation to departments. Recent spending reviews have made cuts to AME in order to make more money available for public services.

Total managed expenditure (TME) by department, 2017/18The departments with the largest budgets are the Department for Work and Pensions (DWP), which spent a total of £184bn in 2017/18, the Department of Health and Social Care (DHSC), with a budget of £165bn, and the Department for Education (DfE), at £96bn.[2]

However, while about three quarters of DHSC and DfE’s budgets will be formally set at the upcoming spending review, only a tiny portion (3%) of DWP’s spending will be.

Composition of total managed expenditure (TME) by department, 2017/18This is because the composition of departments’ budgets varies significantly. At DWP, most spending relates to pensions and benefits, which is counted within AME. Spending on the NHS and on schools, however, is included within DEL, which means that the 2019 Spending Review will formally set limits covering these services.

The departments with the largest DEL budgets (in descending order) are DHSC, DfE, MoD, DfID and the Ministry for Housing, Communities and Local Government (MHCLG). This means that the three most protected budgets going in to the 2019 Spending Review are among the largest, and that the budgets of smaller departments will therefore have to be squeezed disproportionately.

 

Most departments have faced large day-to-day budget cuts since 2010

Percentage change in planned day-to-day (resource DEL) spending, 2010/11 to 2017/18

Since 2010/11, resource DEL budgets have been cut in real terms for almost all departments. The cuts have been relatively modest at some, for example DfE and MoD, where spending is down by around 10% in real terms. Other departments, including the Home Office and Ministry of Justice (MoJ), have had their budgets cut by about a quarter, while the most severe cuts have been at DWP and the Department for Transport (DfT), where spending has fallen by 41% and 56% respectively.

Only three departments have larger day-to-day budgets now than at the beginning of the decade – the Cabinet Office (up 64%), DfID (up 19%) and DHSC (up 13%). Two of these – DHSC and DfID – have had parts of their budgets ring-fenced, while at the Cabinet Office, spending spiked in the most recent year partly due to the cost of holding the 2017 general election.

Spending on housing and communities at MHCLG has fallen 39%. The department’s total resource DEL budget also includes grants to local authorities, which have been cut by 75% since 2010/11. However, when other sources of local authority revenue are considered, including council tax and business rates, the real-terms reduction in councils’ spending power is a more modest 29%.[3]

Percentage change in administration and programme spending, 2012/13 to 2017/18

At most departments, cuts to administration budgets (which cover the running costs of central government) have been more severe than cuts to programme budgets (which cover the costs of delivering public services and government policies).

The sharpest fall in administration spending has been at DHSC, one of the departments where programme spending has been protected. Since 2012/13, the department’s spending on administration has fallen by 42% in real terms.[4] This means that, while DHSC has a larger budget overall, there has been a fall in what it spends on employing civil servants to oversee its growing programme budget. A similar pattern can be observed for other departments where spending was protected, such as DfID and MoD. Despite the substantial cuts that have been made to working-age benefits, DWP’s administration spending has still fallen more sharply than its programme spending.

Spending on administration has also fallen by about 30% at the Home Office and MoJ.

Cuts to administration spending have been less severe than cuts to programme spending at departments like the Department for Business, Energy and Industrial Strategy (BEIS) and Department for Digital, Culture, Media and Sport (DCMS), and only the Foreign Office spent more on administration in 2017/18 than in 2012/13.[5]

 

The Government has deviated from its 2015 Spending Review plans

Deviation from original spending plans by department (resource DEL), 2016/17 to 2019/20

For many departments, the 2015 Spending Review imposed further cuts. But escalating pressures in several public services have prompted the Government to substantially top up its original spending plans.

In the 2016 Autumn Statement, the Chancellor announced an additional £500m of spending for prisons (MoJ) to combat rising violence. In the Budget the following spring, an additional £2bn was announced for adult social care (MHCLG) to “enable elderly patients to be discharged when they are ready, freeing up precious NHS beds”, and in October 2018 another £240m was pledged for similar purposes. The Chancellor also committed an additional £2.8bn to alleviate pressures in the NHS in the 2017 Autumn Budget, which was followed in July 2018 by the new long-term funding settlement for the NHS (although the latter will only affect the final year of the period covered by the 2015 Spending Review).

In many cases, the story of the 2015 Spending Review was of departments struggling to deliver a second round of savings, having exhausted the easy efficiencies and ‘belt-tightening’ options, such as wage freezes, in the period between 2010 and 2015. This does not bode well for the Chancellor, if he is hoping to find further savings in the budgets of unprotected departments like MoJ and MHCLG at the 2019 Spending Review.

 

Departments are spending to prepare for Brexit

Brexit funding allocated to departments by financial year, 2017/18 to 2019/20

The Government is also deviating from its original spending plans because of Brexit. In early 2018, £1.5bn of additional funding was allocated to help departments prepare for Brexit (covering 2018/19), and a further £2bn was allocated in December 2018 (covering 2019/20). This adds to the £260m already spent in 2017/18 on preparations.

Most of the additional funding will go to a handful of key departments on the front line of delivering Brexit. Together, the Home Office (responsible for visas and immigration), the Department for Environment, Food and Rural Affairs (Defra, responsible for agriculture and environmental protection), HM Revenue and Customs (HMRC, responsible for revenue and customs) and BEIS (responsible for state aid and nuclear safeguards) are expected to spend over £2.8bn by in 2018/19 and 2019/20. Most other departments – with the exception of DfE – will also receive at least some additional Brexit funding. Some public bodies have also been allocated additional funding, including the Competition and Markets Authority (CMA), Food Standards Agency (FSA) and Police Service of Northern Ireland (PSNI).

At the time of the most recent Budget, however, the OBR forecast that there would be a £400m underspend on Brexit preparations in 2018/19, suggesting that departments are struggling to spend the money they have been allocated.[6]

 

Raising taxes is politically difficult

Sources of government revenue (real terms), 2010/11 to 2016/17

The Government could try to meet spending demands by growing its revenue. The most direct way would be to increase taxes, which account for 87% of its income.

After the new NHS funding settlement was announced, the Chancellor indicated that this was exactly what would happen.[7] However he appeared to backtrack in the Budget, stating that “my idea of ending austerity does not involve increasing people’s tax bills”. In fact, the Budget announced that the Government would deliver on the Conservative manifesto pledge to cut income tax by increasing the Personal Allowance and Higher Rate Threshold a year earlier than previously promised.

The Government’s ability to raise additional revenue from several other taxes also appears limited. The Conservatives’ 2017 manifesto included a promise not to increase VAT, while there are plans to cut corporation tax to 17% by 2020/21 and the Government has deferred planned increases in fuel duty every year since 2010/11.[8]

But tax revenue is not only dependent on the rates that government sets. It also depends on the tax base – the size and composition of the economy from which the Government draws its tax revenue. Since the 2008 financial crash, revenues seem to have recovered, with income from all four of the largest taxes increasing in real terms in recent years. Revenue from stamp duty and capital gains tax – which are closely linked to the volume and value of asset sales – have also increased substantially since 2010/11. Overall, government revenue as a percentage of GDP has increased slightly from 36.1% in 2010/11 to 36.6% in 2017/18.[9]

 

Tax expenditures cost more than £110bn annually

Estimated tax expenditures costing more than £2bn annually, 2016/17

Tax expenditures are tax discounts or exemptions that further the policy aims of government. They cover anything from income tax relief for savings accounts to VAT exemptions for food.

In 2016/17, tax expenditures accounted for over £110bn in forgone tax revenue (the money government could have expected to raise if the exemptions were not in place) – about a fifth of all central government tax revenue in that year. The largest of these were:

  • capital gains tax exemptions arising from the sale of a person’s main or only property (£25.5bn)
  • VAT exemptions on food (£17.2bn)
  • employer National Insurance exemptions for payments into registered pension schemes (£16.6bn)
  • VAT exemptions on the construction of new dwellings, including refunds for DIY builders (£13bn).

While tax expenditures have a considerable impact on the overall state of the national finances, a report by the Institute for Government, the Chartered Institute of Taxation and the Institute for Fiscal Studies in 2017 found that the Treasury fails to monitor them or assess the value for money they offer with the same rigour it applies to general expenditure. That report called for the tax reliefs that most closely resemble spending measures to be treated as spending for accountability and scrutiny purposes.[10]

 

It is still too difficult to track the Government’s spending plans

Transparency of spending plans, 2010/11 to 2017/18Clear, accurate and consistent accounts of government spending are important for several reasons. They support effective decision making within departments; allow Parliament, civil society and the public to hold the Government to account for its use of taxpayer money; and provide a reliable historical record of government spending. However, in April 2017, a report by the Public Administration and Constitutional Affairs Committee (PACAC) found that “in most cases [departmental] Annual Reports and Accounts appear to be currently failing in their purpose of explaining to the public and Parliament the effectiveness of Government spending”.[11]

One reason why government accounts can be difficult to make sense of is because spending plans change between years. There are several good reasons why this happens, including policy changes, machinery of government changes – where responsibilities move between departments, or classification changes – where accounting methods change. All too often, however, changes in departmental spending plans are not accompanied by a clear explanation of what has happened, making it difficult to determine whether changes in spending forecasts are substantial (meaning that more or less money will be spent on something) or simply due to changes in accounting methods.

Our analysis of the Treasury’s spending review documents for 2010, 2013 and 2015, and its annual Public Expenditure Statistical Analyses (PESA), show that unexplained changes in spending plans are more common for some departments than others, including DfID and MHCLG. For HMRC and HMT, only a total figure for both departments was reported until 2015/16, which meant that changes in spending plans for an individual department could not be tracked.

In June 2018, the Treasury announced a review of government accounts building on the PACAC report with the intention of improving financial reporting.[12]