Memorandum submitted by Professor David
Heald, Sheffield University Management School
PRE-BUDGET REPORT 2004: TESTING THE FISCAL
RULES
INTRODUCTION
1. There could not presently be a Pre-Budget
Report or Budget Report without the customary barrage of pre-announcements
and diversions and of Treasury-sponsored reports on a plethora
of topics nominally within the jurisdiction of other departments.
Similarly, at this stage in the electoral cycle, the search for
black holes and election bribes is in full swing. Cutting through
this cacophony indicates relatively little substantive change.
The one safe bet was that the Treasury would not announce that
the fiscal rules were about to be breached.
2. This memorandum concentrates on three
issues:
— Testing the fiscal rules.
— The independent audit of macroeconomic
assumptions.
— The End-of-Year Fiscal Report.
TESTING THE
FISCAL RULES
3. The Treasury (2004b, p 193, Box B1) explicitly
rejects the claim that it has moved the goal-posts, by redefining
how the golden rule is measured. The projected future surpluses
in Table B1 (Treasury, 2004b, p 192) are just large enough to
keep the average surplus since 1999-2000 positive. Observers may
feel that this is too convenient, but the Treasury's recent forecasting
track record means that it would be unwise to bet against it.
The chosen measure is more difficult to explain to a non-technical
audience than that of the cumulative surplus over the economic
cycle being non-negative, but that is not a decisive consideration.
My personal view is that:
— From a public finance viewpoint,
it would have been preferable not to have such high fiscal deficits
when the economy continues to perform strongly; the breach of
the Treaty deficit in 2003-04 is indicative of the lack of fiscal
room for manoeuvre should there be serious economic difficulties
ahead.
— From a macroeconomic viewpoint,
the fact that there have been 49 successive quarters of GDP growth,
notwithstanding the weaker performance of major trading partners,
is impressive and the Treasury might argue that macro-fiscal management
took precedence over this period.
4. Uncertainty about the world economy,
and the margins of error attached to forecasting, means that it
is a matter of judgement whether the golden rule will be met over
the current or next cycle, when safety margins are so small. A
curious paradox comes into play. With one caveat, it is immaterial
from a macroeconomic perspective whether the golden rule is precisely
met ex post; its usefulness is as a guide to fiscal planning.
However, the present Chancellor of the Exchequer has placed such
great store on the golden rule that its breach would be widely
portrayed as a devastating blow to his credibility. This leads
on to the caveat; a loss of credibility by the fiscal rules might
erode their beneficial effects in terms of promoting economic
stability. Such a charged political context emphasises the importance
of Parliamentary monitoring of the fiscal numbers and alertness
to any rechannelling of policy commitments into forms that evade
the scoring mechanisms.
INDEPENDENT AUDIT
OF MACROECONOMIC
ASSUMPTIONS
5. The Treasury always makes extensive reference
to the fact that certain Budget assumptions are audited by the
National Audit Office under the provisions of the 1998 Finance
Act. The level of assurance provided is much less than what is
portrayed in Budget documents. Unlike in its financial audit and
VFM work, the National Audit Office cannot choose which assumptions
to audit. It can only audit (a) those assumptions that are specifically
referred to it by the Treasury, and (b) previously audited assumptions
that come up for review on a three-year cycle. Box B2 (page 199
of the Pre-Budget Report 2004) lists the "Key assumptions
audited by the NAO". However, with reference to Box B2, paragraph
B27 states:
All these assumptions are subject to review by
the NAO under the three-year rolling review process, but none
were due for review in this Pre-Budget Report.
This is consistent with there being no NAO Report
on newly audited assumptions either on the Treasury's Pre-Budget
2004 website or on the NAO's website.
6. Although experience-to-date of the 1998
macro-fiscal framework allows reflected credit to be claimed,
I have always had reservations about this unusual role—the
"client" determines what can be looked at—for
the National Audit Office;
The Treasury relied quite heavily on the assumptions
having been independently audited by the National Audit Office
(NAO), following the practice first established in 1997. The NAO
does not audit the forecasts, its role being to ensure that these
forecasts of the public finances are based on assumptions that
are transparent and widely regarded as reasonable. However, the
NAO can only audit the assumptions that the Treasury puts to it,
though since the March 2000 Budget there has been a rolling review
of previously audited assumptions. Thus far, the assumptions embodied
in earlier macro forecasts have not been seriously tested by events.
In such an eventuality, the NAO could be seen to be implicated
in forecasts that later came under challenge, thus deflecting
some blame from the Treasury and potentially creating difficulties
in its relationship to Parliament and its committees. Although
the NAO only audits certain forecasting assumptions, and not forecasting
systems or methodology, this distinction might be lost in practice
(Heald and McLeod, 2002, para 505).
Although the three-year cycle means that assumptions,
once referred, will in due course be reassessed, the notion that
the NAO's sanction can be claimed for three years, without it
having the opportunity to decide for itself what assumptions now
need to be revisited, is strange at best and manipulative at worst.
7. The Committee's requests for clarification
about the NAO's role have generated only the following non-answer
in the Government's Reply to the Committee's Report on the 2004
Budget, HC 654, Session 2003-04, page 7:
MACROECONOMIC
ASSUMPTIONS AND
THE NAO
15. We ask the Treasury to clarify
how they decide which macroeconomic assumptions, apart from those
automatically revisited, should be referred to the National Audit
Office. This is an issue which we shall be monitoring. (Paragraph
31)
The audited assumptions are referred to
the Comptroller and Auditor General as part of the three-year
rolling review process. In addition, the assumptions are submitted
for audit when they are changed or modified, as set out in the
Code for Fiscal Stability. In addition, the Government asks the
Comptroller and Auditor General to audit significant "spend
to save" compliance packages where these principally affect
operational activity rather than requiring legislative change.
8. The NAO's role in auditing "cautious
assumptions" is credited a remarkable number of times in
Pre-Budget Report 2004, as in previous Budgetary documents.
Moreover, the calls by policy critics for greater audit involvement
seriously underestimate the limitations of audit in the area of
macro-forecasting, where policy expertise and experienced judgement
are paramount. The auditor needs to establish that the assumptions
led to the forecasts, and were not chosen in order to generate
particular forecasts. Alarmingly, the annual costs incurred by
the NAO in this role in 2002-03 were only £65,000 (National
Audit Office, 2003, p 4), which pales into insignificance against
the resources available to the Treasury. A possible reason for
such low spending is that the Treasury delivers its requests for
audits close to the dates on which it requires an answer.[1]
As there is no immediate prospect of the statutory duties imposed
by the 1998 Finance Act being revisited, the Committee may wish
to ask the Treasury and the National Audit Office to provide clarification
about how the system operates and how it might be modified within
the present statutory provisions.
END-OF-YEAR
FISCAL REPORT
2004
9. The Treasury should be commended on the
End-of-Year Fiscal Report (EYFR) (Treasury, 2004c), now
in its third edition. This brings together valuable fiscal data
for the previous two years, this year these being 2002-03 and
2003-04. The provision of reliable and prompt outturn data was
for many years a serious deficiency; the End-of-Year Fiscal
Report can be seen as a reporting counterpart to the invaluable
Public Expenditure: Statistical Analyses. Encouragingly,
the EYFR exhibits the measured tone of PESA, not
the breathless tone into which Pre-Budget and Budget Reports often
lapse.
10. The usefulness of PESA is, in
part, a consequence of the Committee's systematic pressure over
the years for more comprehensive coverage. There is now an opportunity
to press for extensions to the coverage of the EYFR. Some
examples of what might be sought are listed below:
(a) An unexpected characteristic of the post-1998
expenditure planning system has been the build-up for various
reasons of a stock of End-Year Flexibility (EYF) claims. These
are reported, annually in July, in the Public Expenditure Provisional
Outturn White Paper. Table 6 (Treasury, 2004a, p 14) shows
Total DEL carried over to 2004-05 as £11,394 million.[2]
One of the present uncertainties regarding compliance with the
golden rule in circumstances when the margins are small concerns
the speed with which departments holding EYF entitlements will
run these down, thus adding to current year expenditure, as planned
spending growth decelerates and especially if their freezing is
anticipated. Data tracking the evolution of EYF would be a valuable
addition to the EYFR.
(b) The Private Finance Initiative has become
an important form of public procurement, with many PFI assets
falling off the public sector balance sheet and, indeed, often
appearing on the balance sheet of no organisation. The EYFR
is the ideal place for systematic reporting of PFI capital
expenditure and of the stock of future commitments. Without this
information, it is difficult to place in context reported underspendings
of direct public sector capital expenditure.
(c) The accounting numbers for UK central
government are now on a Resource Accounting & Budgeting (RAB)
basis, and the fiscal numbers are on an ESA95 (ie national accounts)
basis. Accordingly, changes to accounting do not necessarily affect
the fiscal numbers. The EYFR is the ideal place for systematic
reporting of important issues such as the outstanding debt of
quasi-public organisations, such as Network Rail, and of liabilities
arising from public sector (employee) pension schemes.
7 December 2004
Question: How much advance notice does the Treasury
give the National Audit Office of the assumptions that it wishes
to be audited before a particular budget or pre-budget?
Answer: For the 2003 Pre-Budget Report, the National
Audit Office staff first met Treasury staff on 5 November 2003
to consider the remit for that audit, and the report was published
on 10 December 2003. In the most recent analyses, for Budget 2004,
the first discussions of the remit took place on 12 February 2004
and the report was published on 17 March 2004. The agenda for
these meetings was circulated in advance, and the Treasury also
sometimes forewarn the Office of the likely extent of the audit
some time before the first meeting. For example an informal meeting
was arranged in the summer to discuss some of the background issues
that would be relevant to the 2003 Pre-Budget Report audit. The
budget assumptions work also includes a rolling review of assumptions
last audited three years ago; as this element of the audit is
carried out on a cyclical basis it is known about well in advance
(National Audit Office, 2004, p 6).
References
Heald, D.A. and A. McLeod (2002) "Public
Expenditure", in The Laws of Scotland: Stair Memorial
Encyclopaedia—Constitutional Law Volume, Edinburgh,
LexisNexis Butterworths, paras 480-551.
National Audit Office (2003) "NAO evidence
to the Public Accounts Commission on 7 July 2003", London,
National Audit Office, 26 September, mimeo (forthcoming in The
Public Accounts Commission (2005), Twelfth Report, London,
Stationery Office).
National Audit Office (2004) "Supplementary
evidence provided by the Comptroller and Auditor General following
the Public Accounts Commission's meeting on 24 February 2004",
London, National Audit Office, mimeo (forthcoming in The Public
Accounts Commission (2005), Twelfth Report, London, Stationery
Office).
Treasury (2004a) Public Expenditure: 2003-04
Provisional Outturn, Cm 6293, London, Stationery Office.
Treasury (2004b) Opportunity for All: The
Strength to Take the Long-Term Decisions for Britain— Pre-Budget
Report, December 2004, Cm 6408, London, Stationery Office.
Treasury (2004c) End of Year Fiscal Report,
December 2004, London, HM Treasury.
Treasury Committee (2004) Government Response
to the Committee's Sixth Report on the 2004 Budget, Fourth
Special Report, HC 654 of Session 2003-04, London, HMSO.
1 The Public Accounts Commission put the following
question to the National Audit Office after its evidence session
on 24 February 2004: Back
2
The composition of the total amount of £11,394,246,000 is
as follows: Administration costs (£1,233,398,000); EC Structural
funds Resources (£93,884,000); Other resources (£7,466,368,000);
EC Structural funds Capital (£12,231,000); and Other Capital
(£2,588,365,000). These amounts are analysed by departmental
group in Table 6 (Treasury, 2004a, p 14). Back
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