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8 Feb 2016 03:37pm

Government needs to improve financial reporting

The government and Treasury need to improve their financial reporting and financial management because “there’s too much at stake”, according to Ross Campbell, ICAEW director of public sector and co-author of two chapters in the Institute for Fiscal Studies (IFS) Green Budget

Speaking today at the launch of the publication in London, Campbell also said that in the event of another financial shock the government “doesn’t have a lot room for manoeuvre. Its capacity to make good choices in that scenario would be constrained.”

The now annual IFS Green Budget highlights economic conditions and the challenges facing the chancellor ahead of his Budget on March 16.

ICAEW recommends focusing on whole of government accounts (WGA) rather than traditional national accounts in order to get a broader insight into government finances.

According to ICAEW's analysis, looking at the WGA – financial accounts for the public sector - provides a more comprehensive picture of the government’s financial performance than that available through traditional national accounts reporting.

The WGA capture a wider range of financial transactions than are reflected in the national accounts, including charges for obligations incurred today that will result in cash outflows in the future, as well as integrating revenue and expenditure with a balance sheet and statement of cash flows.

The accounting deficit was on average £55bn higher than the public finance deficit each year from 2009/10 to 2013/14. On a WGA basis, the accounting deficit fell by just 20% to £149bn between 2009–10 and 2013–14 compared with a fall of 35% from £153bn to £100bn on a national accounts basis over the same period.

The differences between the public finance deficit and the accounting deficit principally arise from the long-term costs of public sector pension schemes, asset write-downs and increases in provisions for nuclear decommissioning and clinical negligence claims, which are incorporated in the WGA but not the national accounts.

ICAEW highlighted that the accounting deficits incurred over the five financial years ended 31 March 2014 added together were equal to 25% of revenues over the period.

The financial position of the UK government has deteriorated dramatically over the last five years, with increases in assets being outpaced by much larger increases in liabilities.

Total liabilities increased from £2.5trn (161% of GDP) at 31 March 2010 to £3.2trn (177% of GDP) at 31 March 2014.

Net liabilities in the WGA more than doubled from £0.8trn at 31 March 2009 to £1.85trn at 31 March 2014. This reflects an increase in public sector pension obligations to £1.3trn and increasing public sector net debt in the national accounts from £0.7trn to £1.4trn.

ICAEW also pointed out that the WGA provide further insight when considering the vulnerability of the public finances to future economic shocks. The weakening financial position of the UK government means there will be significant increases in finance costs as interest rates rise, while pension obligations and other liabilities will absorb increasing amounts of cash as they are settled. As a consequence, there will be less available to spend on other policy objectives out of future tax revenues and potentially less headroom to absorb future economic shocks.

Decision making within the public sector continues to be hampered by a lack of timely comprehensive financial information, according to ICAEW’s analysis.

In addition, effective financial management for the longer term involves addressing the balance sheet as well as revenue, expenditure and cash flows reported in the WGA but not in the national accounts.

Improving financial management within government will become more challenging as further devolution increases the complexity of the public sector in the UK.

ICAEW recommends replacing the current complex web of internal financial reporting data collection processes with a modern standardised financial consolidation system for all public sector entities, which should enable the government to obtain and utilise accurate comprehensive financial performance data from across the public sector within days rather than months. It would contribute to the government’s ability to improve the fiscal position of the country, at the same time as delivering radical change across the public sector.

According to ICAEW, this would involve extending WGA from a supplementary annual external financial report to form the basis for comprehensive internal monthly financial reporting throughout the public sector, including providing consolidated financial reports to the Cabinet.

“If used properly, financial analysis based on WGA can enable more comprehensive scrutiny around how the government plans to deal with its longer-term financial challenges than the narrower focus of the national accounts allows, using the common financial language employed widely outside of government. Holding governments to account using the WGA therefore has the potential to improve the quality of policymaking and wider public debate,” ICAEW said.

Campbell added, “The government was elected on the promise to reduce borrowing. But currently it does not have a comprehensive view of the UK’s financial accounts. Getting the best outcomes for the public finances in challenging times, means being supported by modern financial management as well as having the full economic picture. Without these, the consequences of policies decided cannot be seen in their full context.”

According to the IFS, achieving Osborne’s balancing target could require big tax rises or spending cuts with very little notice.

The UK has only run a surplus eight times in the last 60 years, the IFS pointed out.

In order to reach his target, Osborne is banking on tax revenues rising. However, if average earnings do rise 1% less by 2019–20 than the November forecast (as predicted by the Bank of England last week), he could expect to lose £5bn of income tax and national insurance revenues.

His forecasts also depend on keeping the £150,000 threshold, at which the 45% income tax rate kicks in, frozen. The number of additional-rate taxpayers has already increased by 40% since the additional rate was introduced in 2010. Similarly, current policy implies a 50% increase in the numbers losing some or all of their child benefit within five years, as the point at which this happens stays fixed in cash terms.

Public service spending by central government and local authorities is forecast to be cut by 1% in real terms between 2015/16 and 2019/20, meaning it will reach its lowest share of national income for over 60 years with the exception of 1999/2000 and 2000/01.

Paul Johnson, director of the Institute for Fiscal Studies (IFS) and an editor of the green budget, said, “Uncertainty in the fiscal forecasts means that Osborne may well have to cut spending further or raise taxes to get to surplus in 2019/20. With public spending reaching historically low levels relative to national income, promises on tax cuts to keep and pay for, and pressure on revenues from a number of taxes, there may be more tough decisions to come. How he responds to any further unpleasant fiscal surprises may, more than anything we have seen so far, come to define his period as chancellor.”

The fiscal mandate also rules out borrowing to invest even where low interest rates mean such investment would be economically beneficial and would not otherwise occur.

According to ICAEW government decision-making needs to change in order to protect infrastructure investment

Current accounting measures and the desire to reach a surplus on a relatively narrow measure of government borrowing will favour public–private finance partnerships over simply borrowing to invest, ICAEW said.

The IFS called on the government to consider adjusting the rules to allow borrowing for infrastructure investment where it can be demonstrated there will be a financial return to government in the form of revenues – from additional taxes or charges – that will offset the cost of the investment.

Even with steady growth and the forecasted surplus of 0.5% of national income by 2019/20, it would take until the mid-2030s to get debt back to pre-crisis levels as a share of national income (40%), the IFS found.

Borrowing to cover investment could leave debt still at 60% of national income in the mid-2030s. The faster debt falls, the more room for manoeuvre future governments might have in the face of another recession, according to the IFS.

 

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