Select Committee on Treasury Eighth Special Report


THE GOVERNMENT'S RESPONSE TO THE TREASURY COMMITTEE'S EIGHTH REPORT, 1997-98: THE NEW FISCAL FRAMEWORK AND THE COMPREHENSIVE SPENDING REVIEW

(a) We recommend that any subsequent substantial public spending announcements be accompanied by a two-day debate (paragraph 4).

The Government agrees that there should be adequate parliamentary time to discuss major public spending announcements. The length of any debate would depend on the nature of the announcement. This is a matter for the Business Managers to decide at the time after consultation with the Opposition parties through the usual channels.

(b) We recommend that the Treasury extends the innovation of the pre-Budget Report (PBR) by issuing a consultative document on spending plans prior to each rolling forward of departmental expenditure plans. We further recommend that the Treasury should seek to ensure that Parliamentary time is made available to debate such a consultative document (paragraph 4).

The Comprehensive Spending Review was carried out with a zero-based analysis of priorities and programmes across the whole of government. When the Review was launched, the Government's overall priorities were clear from its election manifesto; and Parliament and outside commentators were free to come forward with suggestions and comments on the details of the policies and programmes that should be pursued. A number of departments consulted during their reviews and numerous representations were received on specific issues. But the zero-based nature of the Review precluded the Government from publishing in advance a full draft set of spending plans for the years 1999-2000 to 2001-02 upon which comments could be invited. In future reviews of spending, the Government will also be open to comments and representations from Parliament and from other interested parties. The next review of spending will coincide with the move to resource-based accounting and budgeting, on which Parliament has been fully consulted through hearings and memoranda.

(c) It is important for Parliament and the public to have advance notice of when major economic policy statements are to be made. We would, therefore, welcome a timetable from the Government setting out the likely date of the PBR and the Budget and the date in the summer of 2000 when the next all-encompassing public spending statement is due (paragraph 6).

The Government agrees that it is important for Parliament to have as much advance notice as possible of major economic policy statements. The Pre-Budget Report will be published on 3 November but it is too early to put a date to the next Budget or the next public spending statement.

(d) We recommend that the Treasury should publish now, and at the time of future Budget and Spending Statements, a set of different possible outturns for key measures of government borrowing based upon a range of scenarios for the growth of gross domestic product. This will increase transparency and allow a better understanding of the risks to official forecasts of the public finances from different growth outturns (paragraph 11).

Documentation of Treasury forecasts of the economy and public finances regularly includes information on average errors from past forecasts and the sensitivity of the public finances projections to the path of the economy. Table A4 of the March 1998 Financial Statement and Budget Report showed average errors in the economic forecasts and paragraph B15 gave average errors in the projections of the budget deficit. Paragraph B16 also indicated the sensitivity of the public finances projections to cyclical changes in GDP and to changes in the average rate of GDP growth over a period of years. While this sensitivity analysis was for the net cash requirement, the results would not be significantly different for net borrowing and the current budget surplus. The Financial Statement and Budget Report (page 32) and the Economic and Fiscal Strategy Report (page 46) also showed the sensitivity of the projections to a more pessimistic assumption about the level of GDP relative to trend. These sensitivity analyses are based on the estimates of the effects of GDP on the public finances described in Treasury Occasional Paper No. 4, September 1995.

(e) We recommend that the Treasury should set out clearly the thinking behind the current level of the reserves, how the decision on their magnitude has been taken, what part is to be played by intra-departmental reserves, and what their size is expected to be (paragraph 11).

The new expenditure planning and control system sets firm three-year plans for all departmental expenditure limits, rather than requiring annual revisions of plans. These DELs are based on the rigorous analysis carried out in the Comprehensive Spending Review. Whereas plans set in the Control Total in previous public expenditure surveys were sometimes unrealistic, and needed to be topped up in later surveys, the DEL plans will not be changed every year. Departments are also considering whether to create unallocated provisions to enable them to deal with unforeseen new spending pressures. The DEL Reserve is therefore set not to fund future injections of cash for departments in spending rounds, but to deal with unforeseeable emergencies, for example, a problem such as BSE. It is consequently appropriate to set the Reserve at a prudent but lower level than the Reserve set within the Control Total, which was kept higher in order to permit a policy of topping up plans in later years. The DEL Reserve has been set slightly higher in later years, but not by a large factor, as it will not need to be called on in successive spending rounds. Hence it has been set at £1.5/2.0/2.5 billion over the three years.

Within Annually Managed Expenditure, the AME Margin has been set to provide some headroom within Total Managed Expenditure to help deal with the inevitable variations of the demand-led programmes in AME. The AME Margin has been set in a "wedge" shape (£1/2/3 billion over the three years), to allow for the possible knock-on impact of any estimating change to later years.

(f) We recommend that the Treasury quantify what is meant by inflation varying "substantially" and state whether if such a deviation occurs the Government does intend to make additional payments to departments (paragraph 12).

The Treasury has agreed with Departments that it will not consider reviewing the cash figures other than in the event of inflation varying by more than 1.5 per cent cumulatively from the projections in the Comprehensive Spending Review. There is, of course, no presumption that any review would lead to any changes at all in Departmental cash plans.

(g) While we understand and welcome the Government's emphasis on the need for public sector capital investment where the returns from this are high, we are concerned that the continuing large differential between public and private sector wage increases, in favour of the latter, could serve over time to undermine the recruitment into key public services of high quality employees (paragraph 13).

The Government recognises that the key considerations in setting public sector pay should include recruitment and retention requirements. This will nevertheless need to be consistent with the need for Departments to meet their CSR output targets for the delivery of services within the three-year spending plans. The Government believes that the CSR provides room for realistic settlements on this basis.

The Government notes, in response to the point raised about large differentials in wage increases, that the Average Earnings Index and its components have been significantly revised this month. The latest figures no longer support the case that there is a large gap in growth rate between pubic and private sector earnings. Also data from the New Earnings Survey shows that, during the 1990s, overall earnings growth in the public and private sectors has been similar.

(h) There is an apparent inconsistency between the Monetary Policy Committee position that unemployment must rise if the inflation target is to be met and the Treasury's assumption that unemployment will be held flat at its April level. We accept that by convention Governments never publicly forecast a rise in unemployment, but we believe that in the interests of transparency the Treasury should now begin to publish its estimates for unemployment when it publishes new spending plans (paragraph 14).

In line with the convention adopted by previous governments, the Government does not publish forecasts for unemployment. However, for the purposes of projecting social security expenditure, it is necessary to make a planning assumption about the level of unemployment. Since the July 1997 Budget, the Government has based its public finances projections on the assumption that unemployment remains flat at its most recent level. Accordingly, the CSR projections assume that unemployment remains flat at its level in May 1998.

The flat assumption follows a long-standing convention used by both Labour and Conservative Chancellors up until the 1996 Budget, and has been audited and approved as reasonable by the National Audit Office. Forecasts of unemployment are highly uncertain—error margins are typically large and, over the medium term, the range of outside forecasts for unemployment is very wide. As well as cyclical effects, the flat assumption also discounts the effects that fraud savings, the New Deals and other labour market policies might have in reducing unemployment (see answer k).

(i) We recognise the benefits of publishing the current budget balance in the interest of transparency, but expect the Public Sector Borrowing Requirement to continue to be published alongside the Public Sector Net Borrowing (paragraph 15).

The Code for Fiscal Stability states that the Financial Statement and Budget Report will continue to include forecasts for the net cash requirement (PSBR), as well as net borrowing and the current budget balance.

(j) We seek clarification as to what "balancing the current budget over the cycle" actually means. Furthermore we recommend that the Chancellor make clear whether the projected increases for Departmental spending, and in particular for health and education, are guaranteed even in the face of a faster than expected rise in social security spending, and if so how they would be funded without breaching the Government's overall spending targets (paragraph 19).

One of the Government's two fiscal rules is the golden rule: over the economic cycle, the Government will borrow only to invest and not to fund current spending. As explained in the November 1997 Pre-Budget Report and most recently in the Economic and Fiscal Strategy Report, the golden rule will be met if the public sector current budget avoids a deficit on average over the economic cycle. For the purposes of the fiscal rules, 1997-98 is taken to be the starting point of the economic cycle, as the economy is thought to have been close to its sustainable level in that year. Table 4.7 of the EFSR set out projections for the average surplus on current budget since 1997-98.

The Government has set its fiscal rules over the economic cycle in recognition of the significant effect of cyclical fluctuations on the public finances. This approach aims to enhance stability by allowing borrowing to fluctuate due to cyclical changes in output (ie by allowing the automatic stabilisers to operate). Meeting the golden rule over the economic cycle would be quite consistent with some borrowing to finance current spending during a downswing, provided that this is at least offset by surpluses on current budget at other stages of the cycle. However, the Government is taking a prudent approach to meeting its fiscal rules and is therefore planning for surpluses on current budget, as set out in the EFSR.

The Government does not anticipate that it should be necessary to revisit the Departmental Expenditure Limits set out in table 1 of the White Paper before the next review of spending plans in 2000. It will keep Annually Managed Expenditure under regular review alongside tax receipts, and ensure that the fiscal rules are met.

(k) We wish the Treasury to be more explicit and give figures for the extent of the saving on fraud, if any, that has already been factored in to the social security spending projections. On the issue of the impact of the New Deal on the social security figures the Chief Secretary stated that "Yes, we have made some fairly prudent assumptions as to what the reduction [in the number unemployed] will be". Again, we wish the Treasury to state what these assumptions are (paragraph 20).

Social security expenditure is projected forward based on recent expenditure and caseload information. Expenditure projections take full account of the anti-fraud programme of work. DSS also estimates what is being saved from anti-fraud activities planned for a given year separately from the projections of benefit expenditure. DSS use the Weekly Benefit Savings approach, which assumes that had the fraud not been discovered it would have continued for another 32 weeks, a figure based on average durations of such claims. This is the same methodology used in accounting for actual fraud savings. It produces an approximate figure as by definition it is impossible to know how long a fraud would have continued had it not been discovered. DSS are currently reviewing their methodology, in particular to reflect the greater emphasis on prevention rather than detection of fraud as set out in the Green Paper "Beating Fraud is Everyone's Business: securing the future".

The savings figures below are based on the programme of anti-fraud work planned for each of the financial years shown:

1997-98£2.0 billion
1998-99£2.5 billion
1999-00£2.5 billion
2000-01£2.6 billion
2001-02£2.5 billion

The Government does not publish forecasts of unemployment, and has based public expenditure projections on the basis of level of unemployment in May 1998 (see answer h). A prudent approach does not take credit for reductions in unemployment through the New Deal until they actually arise.

(l) We will be writing to the Office for National Statistics for confirmation that the Government's method of classifying Working Families Tax Credit (WFTC) is in line with internationally accepted accounting standards; and to increase transparency we recommend in future presentations of the public finances that the cost of the WFTC be set out separately (rather than within "accounting and other adjustments"). We ask the Treasury to explain the implications for costing WFTC if it is decided to raise the amounts (paragraph 21).

We note that the Committee has written to the Office for National Statistics (ONS) concerning the classification of Working Families Tax Credit (WFTC). For national accounts-based presentations of the public finances in the FSBR, and subsequently in the EFSR and CSR, the classification of WFTC has followed the treatment in the national accounts at that time for similar income tax credits, such as mortgage interest relief at source (MIRAS).

At the time the WFTC was first announced in the last Budget, the national accounts followed the international conventions set down in the 1979 version of the European System of Accounts (ESA79). ONS adopted a new version of the European System of Accounts, ESA95, for the UK national accounts in the 1998 Blue Book, published in September. This involves changes in the treatment of income tax credits, such as MIRAS. As WFTC will not begin until 1999, the classification issue the ONS will need to address in respect of WFTC is how it should score in national accounts under ESA95. ONS have no operational need to decide the classification of WFTC under ESA79.

The full cost of WFTC was included in the income tax credits line in Table B8 of the FSBR (Total Receipts). In order to improve transparency, the Treasury will for future projections of the public finances include an additional line in this table showing the cost of WFTC separately from other income tax credits.

Future presentations of the national accounts public finances aggregates will be in terms of ESA95. In these presentations, the Treasury will follow whatever classification ONS decide on for WFTC and other income tax credits. To the extent that part or all of payments of such tax credits are classified in the national accounts as expenditure, figures will be included in AME, in the accounting adjustments line. A full breakdown of the accounting adjustments is presented annually in Public Expenditure Statistical Analyses, which is published in March or April along with Main Estimates and departmental reports. The Treasury has provided a breakdown of the accounting adjustments line in CSR Table A2 in a technical note for this Committee (27 July).[1] Because, when following national accounting conventions then in force, only part of WFTC scored as public expenditure, disaggregating the accounting adjustments did not show the full cost of WFTC.

In the FSBR, and subsequently in the EFSR and CSR, some 80 per cent of WFTC payments have been scored in the national accounts measures of public expenditure. This represents an estimate of the proportion of total payments which will be in excess of the individual recipient's total tax liability. Were the scope of WFTC to be changed, then this proportion would need to be re-estimated. A higher (lower) proportion scored as expenditure would, other things equal, increase (decrease) AME and TME.

Office for National Statistics Response

The WFTC has not yet been introduced, so ONS has not yet had to record it in national accounts since these accounts record outturn only and do not address the future. The FSBR gives forecasts and plans for the future and much of its contents are based on national accounts. So Treasury had to decide how WFTC would be classified under the system of national accounts in force at that time.

That system was specific to the UK. It had evolved over many years along basic principles common to international systems of national accounts. In UK national accounts, tax refunds paid to an individual in excess of tax actually paid are treated as public expenditure. This was consistent with IMF guidance on recording government finances which says that such amounts should not be netted-off tax receipts even if they are called tax refunds or tax credits. The treatment is applied for example to Mortgage Interest Tax Relief at Source (MIRAS). MIRAS is available to people who do not pay income tax, as well as to tax payers. Inland Revenue estimates the amount of MIRAS paid to individuals in excess of tax paid. That amount is included in national accounts as public expenditure. The rest is netted-off income tax receipts.

The treatment of WFTC in the FSBR follows the treatment of MIRAS. The Government has estimated that, when considering taxpayers individually, about 80 per cent of WFTC payments will be in excess of tax actually paid. In the FSBR this amount was recorded as public expenditure and the rest, that which is paid to individuals with a positive net income tax bill, was netted-off income tax receipts.

In September 1998, ONS adopts the European System of Accounts (ESA95) for UK national accounts. In preparing for this system ONS reviewed the treatment of tax refunds. ONS concluded that if the refund is not integral to the tax then it should be recorded as public expenditure. This would apply for example if the assessment of the amount of refund due were independent of the tax assessment. In particular, if refunds can exceed the amount of tax actually paid then it is likely that they arc not integral to the tax. This approach is consistent with ESA95 which does not make any references to splitting refunds between negative taxation and expenditure. ESA95 is clear that the recording of taxes should be restricted to regulations that require payments to government rather than payments by government. Another disadvantage with the old method was that accurate data might not be available to split the payments between two categories.

In October ONS will be publishing its first annual national accounts Blue Book under ESA95 rules and will adopt the new method for tax refunds. For example all of MIRAS will be treated as government expenditure. The new method will be described in publications appearing at the same time as Blue Book.

It is likely that, under the revised rules, all of WFTC would be treated as public expenditure in national accounts. The decision will be made when the exact details of the scheme are known.

(m) We welcome the publication of separate spending figures for capital and current spending, while recognising that there are problems of definition. As the definition actually used is central to the process, it is essential that it should be readily available, by being published in the fiscal documents (paragraph 25).

The Treasury has for a number of years included a section in the Financial Statement and Budget Report that sets out the conventions used in presenting the public finances, and would expect to include similar information in future Budget documents. Paragraphs B.62 and B.63 of the March 1998 FSBR set out the main components of capital spending, based on the distinction between current and capital spending used in the national accounts. Further detail of the precise conventions used in the national accounts is published by the Office for National Statistics.

(n) Although we welcome the Government's clarity in setting out its objective of keeping to the Golden Rule, we believe that it may be possible in the future to refine and improve this necessarily crude fiscal guideline. We recommend that the Government undertakes further work on intergenerational and other issues which might in time lead to refinement of the Golden Rule (paragraph 30).

The Government has acknowledged that approaches such as the golden rule represent an approximate way of matching costs and benefits of public spending across generations, and that some areas of current spending can have important effects on future prosperity.

The Government recognises the need for further work on intergenerational and long-term issues. The Treasury is currently collaborating with the National Institute for Economic and Social Research and the Bank of England to produce a set of generational accounts for the UK. The Government is also developing long-term projections, as required by the Code for Fiscal Stability, which will give a further indication of the sustainability of current fiscal policy settings.

(o) We recommend that data on the new basis should be made available as far back as the fiscal year 1988-89 (paragraph 32).

Data will be made available during the course of the Autumn/Winter. At the time of publication of the CSR, full data on the new basis was only available for a period of nine years starting in 1993-94. Nine years represents the normal length of time period for which data are collected in the Treasury's main public expenditure database; and is the standard timespan for tables in Public Expenditure Statistical Analyses. Treasury staff will be extending the series in CSR Tables A1 and A2 back to the late 1980s, using information from old databases. Once that work is completed, these data will be made available.

(p) We recommend that, for the sake of transparency, in future the Government should refer to annual increases over the previous year rather than a cumulative total (paragraph 33).

The Government believes that it is right to indicate clearly how much new money was provided in the Comprehensive Spending Review on top of the amounts made available for 1998-99. The full documentation provided in the white paper "Modern Public Services for Britain" made clear both the totals of new money, and the components of those totals in each year. It has been common practice for Governments of all persuasions to refer to figures across more than one year. For example, the previous Government's last Red Book ("Financial Statement and Budget Report 1997-98", November 1996) referred, inter alia, to "over £3.5 billion of investment in national roads over the next three years" and "£2.5 billion over three years for the Housing Corporation" (figures which refer not to increases over previous plans, but to totals including money already allocated in previous Public Expenditure Surveys).

(q) We recommend that every year the Government publish sales from the National Asset Register and a list of local authority assets that have been sold, how much capital was raised and for what the funds have been used. As a matter of principle it should be relatively easy to be able to see how "dead" assets are turned into "live" ones and whether asset sales are being used to fund current expenditure and so reduce council tax bills. We also recommend that the National Asset Register, which we warmly welcome, should be updated at least every two years and should be broken down into local geographical areas such as local authority areas or postcode areas (paragraph 35).

In response to a recommendation from the Committee during the last Parliament,[2] the Government has already started publishing aggregate figures both for projected and actual asset sales. These were published both in the March 1998 FSBR and in the June 1998 EFSR. In addition, it has passed a breakdown of asset sales by department for the years up to 1996-97 to the National Audit Office. In response to the Committee's new recommendation, the Government agrees to publish in future such a retrospective breakdown of sales by department. It will also provide a commentary on some of the larger sales.

As regards publication of the National Asset Register, the Government understands the Committee's reasons for recommending publication every two years. The Government will, as part of the Resource Accounting and Budgeting timetable and in the run up to the review of public expenditure allocations in 2000, look into the practicality and cost-efficiency of publishing future editions of the Register, including a breakdown of the results into local geographical areas.

(r) We recommend that the figures on the Private Finance Initiative (PFI) are updated twice a year, at the time of the Budget and for the Pre-Budget Report. We would also welcome details of the estimated payments each department is expected to pay under PFI contracts over the next 25 years, and corresponding figures for exposure to capital liabilities (paragraph 36).

Statistics showing outturn and anticipated investment in PFI projects are collected and published twice a year; for the Budget Financial Statement and Budget Report, and then around the end of September, thereby providing Parliament and the public with regular six-monthly reports showing the latest position. Information showing the estimated annual payments departments are expecting to make over the next 30 years is collected at the same six-month intervals, and published on an aggregated basis (in order to protect commercial confidentiality in those cases where departments have only a small number of such commitments).

(s) We agree with the Procedure Committee that it is essential that progress against the "trigger points" for Resource Accounting and Budgeting is reported regularly to Parliament and that "the decision as to whether the target date for implementation is still viable must not be taken on the basis of information available to the Treasury alone". We welcome the Treasury's assent to this (paragraph 41).

The Government welcomes the Committee's agreement with the Procedure Committee that progress against the "trigger points" against which RAB implementation will be monitored and assessed should be reported regularly to Parliament.

As noted in the Treasury's response to the Procedure Committee report (HC 773), the Treasury and the National Audit Office will monitor departments' performance carefully against the trigger points and will report progress fully to Parliament. The Treasury's Memorandum on RAB to the Parliamentary Committees in July 1998[3] contained a detailed assessment of departments' progress against the first trigger point (Stage 1 approval).[4] This showed that 44 out of 49 departments had already secured Stage 1 approval by the end of July, and that each of the remaining five departments was well on course to do so within the deadline for Stage 1 (end of December 1998), for the reasons given in the Memorandum.

(t) If the agreements have not already been published by the time the Treasury responds to this report, we will expect the Treasury response either to include the date or to give firm publication dates for each agreement. We would expect the publication dates to be before the start of the next financial year (paragraph 43).

The Government will publish the public service agreements for departments later this year.

(u) We share the Government's view that "External scrutiny plays a key part in ensuring that the providers of public services are held accountable." To enable this external scrutiny to take place, not least by select committees, it is vital that regular assessments of performance against the public service agreements—which need not be in the form of Cabinet papers—be put in the public domain. We recommend the Treasury give an undertaking to publish this information and set out the mechanism by which this will be done (paragraph 45).

The Government is giving further consideration to this proposal.

(v) We recommend that the Treasury set out which Minister is ultimately responsible for the expenditure relating to each cross-departmental initiative announced to date and in which vote the relevant expenditure will appear (paragraph 46).

Each of the cross-departmental initiatives will have their own PSA in which Ministers with lead responsibility will be identified.

HM Treasury, 26 October 1998


1  Eighth Report, Session 1997-98, The New Fiscal Framework and the Comprehensive Spending Review, Volume 2, HC 960-II, p 71. Back

2  Third Report, Session 1996-97, The 1996 Budget, HC 129-I, paras 25-30; for Government Response see Second Special Report, Session 1996-97, HC 317, Appendix, paragraph 26. Back

3  See p xiii. Back

4  Stage 1 approval involves the Treasury receiving trom departments: meaningful illustrative Resource Accounts compiled in accordance with the Resource Accounting Manual (RAM); a Departmental Resource Accounting Manual, reflecting discussions on accounting policies with the NAO, that deals with each department's own unique circumstances; a letter from the departmental Principal Finance Officer confirming that the department's accounting systems will be able to provide the necessary resource accounting information; a copy of the NAO's preliminary view on departments' accounting policies and systems; and an updated project implementation plan. Back


 
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