Ross Campbell 8 Feb 2017 09:30am

ICAEW calls on government to ensure business is sustainable

For the third consecutive year, ICAEW has joined up with the Institute for Fiscal Studies to provide two chapters for its Green Budget

The IFS Green Budget is a flagship publication that seeks to provide policymakers and other interested parties with valuable insight into the economic impact of policy decisions and some of the central issues that the government faces in devising fiscal policy.

ICAEW’s contribution, now in its third year, provides an accountant’s view of the public finances. Usually seen as something within the jurisdiction of economists, ICAEW provides business insight from professional accountants not often applied to public finances.

In particular, it brings an awareness of the long-term financial consequences of the policy choices that successive governments have made over the years.

All decisions have consequences and it is in the Whole of Government Accounts that the financial consequences of public policy decisions become apparent. In addition to the £1.5trn national debt, the outcomes of policy decisions on areas such as pensions provision for public sector employees, how to manage clinical negligence in the NHS, and the cost of cleaning up the nuclear industry add significant sums. When these items are included from the government’s balance sheet, the total liabilities of the UK state now exceed £3.5trn; roughly £130,000 for every household.

We believe that the government would benefit from taking a more business-like approach to liabilities. For example, what reduction could be made to the £29bn currently set aside to settle clinical negligence claims against the NHS if some of that money was used to increase clinical staff levels in high risk areas? Similarly, when the majority of businesses have moved their employees on to defined contribution pension schemes, why does the government persist in the expense and risk of providing defined benefit schemes for public employees? These pensions now have an estimated future cost to the taxpayer of approximately £1.5trn; as much as the national debt.

There is the matter of the national debt too. Expected to grow to just under £2trn in the next five years, this is the highest level of public indebtedness ever seen other than after of a major war. With debt at such high levels it is imperative that the government has an effective strategy to manage its exposure to the associated risks. While demand for UK public debt is strong and the Debt Management Office (part of HM Treasury) has a strong track record, the UK government last published a debt management strategy in 1995. A lot has happened since then, so a refreshed strategy is long overdue, especially since approximately £650m of government debt will need to be refinanced over the next five years.

Important questions to consider in a strategy review are the length (maturity) of debt and the proportion that is index-linked. For example, UK public debt now has an average maturity of 18 years, much longer than comparable developed countries such as the US (5.3 years), Germany (7.0 years), and France (7.5 years). This approach locks in low interest rates for longer periods and protects the government against interest rate rises but at a cost of higher borrowing costs in the short-term.

However, the current strategy, designed long before the financial crisis, doesn’t address the Bank of England’s quantitative easing programme of gilt purchases. This has had the effect of reversing the some of the effect of lengthening maturities, saving the government money in the short-term, but with the consequence of re-increasing the government’s exposure to interest rate changes.
The government is also benefiting at the moment from the current very low levels of inflation, with over a quarter of the gilts in issue index-linked to RPI. But, with inflation likely to increase in the near future, each percentage point increase will cost the taxpayer an extra £5bn a year.

Accountants add value to business every day; ensuring businesses are sustainable by assisting managers to understand the consequences of decisions and how to manage liabilities. There is just as much need for these skills in government and we are proud to be able to contribute to serving the public interest through the Green Budget.

What are the Whole of Government Accounts?

The WGA are integrated financial statements (accounts that balance). They are prepared in accordance with International Financial Reporting Standards (IFRS), a set of accruals-based financial accounting standards issued by the International Accounting Standards Board. In the UK, the government’s Financial Reporting Advisory Board has made some specific adaptations for public sector use. The latest WGA covered the government’s financial year ended 31 March 2015. They were published on 26 May 2016, 15 months after the balance sheet date, and incorporated the financial results of some 6,000 bodies across central government, the devolved administrations and local government.

Together with an associated commentary and explanatory notes, they provide a more comprehensive picture of the government’s financial performance and position than that available through traditional fiscal reporting in the National Accounts. This is because the WGA capture a wider range of financial transactions than are reflected in the National Accounts, including charges for obligations incurred today that will be settled in the future.

The framework used by the Office for National Statistics for the presentation and measurement of economic activities including public sector finances is known as the National Accounts. It is derived from the European System of National and Regional Accounts, which in turn is derived from the UN System of National Accounts. The current version, ESA10, was implemented in the UK in 2014, replacing ESA95.

The public finance numbers reported within the National Accounts are based on resource accounting, a hybrid between fully accruals-based and cash accounting approaches. This takes some account of assets and liabilities in calculating the “near cash” fiscal deficit (public sector net borrowing), but then reverses those items to get back to a “cash” number for public sector net debt.

Ross Campbell is director, public sector at ICAEW

All the latest ICAEW contributions and news about IFS Green Budget can be found at icaew.com

Key findings on Whole of Government Accounts

The Whole of Government Accounts reflect the financial consequences of decisions made by successive governments, in particular in the increasing level of liabilities being recorded.

The WGA’s effectiveness as a tool to support effective public financial management would be improved by improving the narrative disclosures accompanying the Whole of Government Accounts and by producing them more quickly.

The focus on targeting reductions in the “near cash” fiscal deficit measure in the National Accounts risks less attention being given to controlling costs incurred by the government that will be settled in the longer term.

The most significant non-debt liability is for the pension entitlements of public sector employees. The decision to provide defined benefit pensions to employees exposes the public sector to economic and demographic risk, in particular to increases in longevity.

Better information is needed to allow decision-makers to choose between spending today and increasing long-term liabilities, such as deciding between investing in addressing medical failures versus the cost of clinical negligence claims.

Total liabilities of £3.6trn (191% of GDP) were reported at 31 March 2015, almost two and half times the narrower measure of public sector net debt reported in the National Accounts of £1.5trn (or 83% of GDP).

The WGA are a world-leading development in public sector financial reporting, but progress is needed to reduce the 15 months taken to produce them in 2014/15 and to improve the commentary to the standards expected of private sector financial reports.

The 41% reduction in the fiscal deficit over the five years to 2014/15 was not matched by the 19% reduction in accounting deficit over the same period; a significant divergence from the government narrative about the public finances.

Unfunded pension liabilities amounted to £1.4trn at 31 March 2015, up by £352bn since 2010. Local authority and other funded plans’ liabilities of £377bn were supported by pension fund investments of £257bn, with investment growth offsetting most of the increase in liabilities since 2010.

Liabilities for nuclear decommissioning, clinical negligence and the Pension Protection Fund continue to rise, with long-term liabilities up to £175bn at 31 March 2015. These are obligations to pay cash in the future, reducing the amount available.