Memorandum submitted by Professor David Heald, Sheffield
University Management School
BUDGET REPORT 2005: THE NEED TO REFORM FISCAL INSTITUTIONS
Introduction
(1) The public expenditure changes in Budget 2005 are minimal,
as is clearly demonstrated by Tables C11 and C12 (Treasury, 2005,
pp. 257-58). A Budget delivered under the shadow of an imminent
General Election can be expected to be even more political than
usual, a feature accentuated on this occasion by the narrow margin
by which the golden rule is now forecast to be met. Moreover,
this is an odd-numbered year, so there is not the substantive
content of, for example, Budget 2004 that set the spending envelope
for Spending Review 2004. Accordingly, this memorandum reflects
upon certain institutional issues that the Committee may wish
to address, briefly now, but more substantively in the next Parliament.
Therefore it considers:
· the general tone
of the Budget process
· the independent audit
of macroeconomic assumptions
· the status of the
Office for National Statistics
The general tone of the Budget process
(2) I regard myself as a sympathetic critic of the public
expenditure policy of the Brown Chancellorship, but I have repeatedly
criticised the pretentious titles and pre-written verbiage that
have come to characterise the Budget Report. Sometimes it seems
that the sheer volume is intended to obfuscate rather than render
transparent the Government's fiscal position and plans. Moreover,
the run-up to the Budget is characterised by plants in particular
newspapers, some accurate and others not, in order to control
the agenda. Except in the manipulative sense, Budget secrecy has
become an insider joke. Although I understand the underlying partisan
politics, and the implications of enormous Parliamentary majorities,
these developments undermine the fiscal scrutiny functions of
Parliament. This is undoubtedly part of a wider problem in which
the Executive has little respect for Parliament, and thus not
one for which there are institutional redesign remedies.
Independent Audit of Macroeconomic Assumptions
(3) 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 Finance Act 1998. An
external observer unfamiliar with the UK situation would be wholly
deceived by the Budget Report (Treasury, 2005) as to
the degree of assurance that can be derived from this arrangement.
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. I have explained my objections
to this arrangement in an academic publication:
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).
(4) There are two further points to add to the above exposition.
First, the arrangement clearly breaches one of the fundamental
postulates of auditing, namely that independence implies investigatory
as well as reporting freedom (Porter, Simon and Hatherly, 2003,
Figure 3.1). The auditor must be clearly independent in terms
of both specifying the work programme and in reporting findings.
The former is breached. Although it might be objected that this
postulate was developed with reference to audits that certify
financial statements, the counter is that the use of the language
of audit and the choice of the National Audit Office as auditor
are clearly intended to confer legitimacy upon the exercise.[1]
Second, the external observer might expect that the body responsible
for auditing the Treasury's macroeconomic assumptions would devote
substantial resources to this task, given its technical complexity
and political salience. Instead, the National Audit Office has
advised that the cost in 2002-03 was £65,000 (Tyrie, 2005,
p. 123). In part, this is due to the very short notice that the
National Audit Office is given by the Treasury of new references
of assumptions, though clearly those assumptions coming up for
review on the three-year cycle are predictable. For Budget 2005,
clearly a sensitive time in connection with both the electoral
cycle and performance against the golden rule, there were no new
references. The only assumption reviewed on the three-year cycle
was the unemployment assumption, which does not seem likely to
have been the first choice of an auditor with unrestricted rights
of access and questioning. In my view, the Committee and other
relevant Parliamentary bodies should urgently review the requirements
of the Finance Act 1998. The National Audit Office needs
to be dug out of the trap into which it has walked, in part out
of a desire to be helpful.
The status of the Office for National Statistics
(5) Shortly before the Budget, there was controversy in the
media following the announcement that the Office for National
Statistics would revise its public expenditure figures in a way
that would make it easier for the Treasury to meet the golden
rule in this economic cycle. The way in which this was originally
reported, namely as a discretionary classification change regarding
road maintenance, prompted cynicism that there had been political
interference by the Treasury. Subsequent clarification (Office
for National Statistics, 2005) indicates that the issue related
instead to the correction of double counting rather than reclassification.
This episode illustrates two important points. First, the position
of the Office for National Statistics as an Executive Agency of
the Treasury is perceived to undermine operational independence,
even if that perception is unjustified. If the Treasury is going
to place such reliance on compliance against fiscal rules, the
scorekeeper of those rules must be seen to be independent. Accordingly,
the Office for National Statistics should become an Executive
Agency of Parliament, with suitable protective buffers established.
Second, compliance with the golden rule, either way, should not
be dependent upon chance reclassifications. When private sector
firms take on debt covenants, these are often formulated in terms
of constant (ie unchanged) Generally Accepted Accounting Practice,
in order to protect both parties to the transaction from unexpected
changes in accounting standards. Exactly the same point should
apply here, so that classification changes are adjusted for.[2]
As with cricket batsmen, it is better to have a lucky Chancellor
of the Exchequer than an unlucky one, though it is unwise to let
too much rest upon this. Although most expert observers do not
believe that a minor infringement of the golden rule in this or
another cycle is particularly important economically, the political
stakes in terms of ministerial credibility have been made high
by the amount of credit that has been claimed for past compliance.
Similarly, the definition of the economic cycle should not be
under the sole control of the Treasury.
Conclusion
(6) A confident and competent Treasury is essential for effective
economic performance, as those who remember when it was otherwise
would certainly testify. However, these positive qualities, unless
counter-balanced, can destabilise the relationships both between
the Treasury and functional government departments and between
the Government and Parliament. Therefore resistance to the proposals
contained in this memorandum, on the grounds that the system has
recently worked well, should be surmounted. Such an attitude is
both complacent and under-estimates the institutional design problems
that require urgent remedy.
18 March 2005
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 (2005) Audit of Assumptions for Budget
2005, HC 452 of Session 2004-05, London, Stationery Office
Office for National Statistics (2005) Revisions to Public Sector
Finances - road maintenance and repair, News Release, 28 February,
London, Office for National Statistics
Porter, B., J. Simon and D. Hatherly (2003) Principles of External
Auditing, second edition, Chichester, Wiley, 2003.
Power, M. (1997) The Audit Society: Rituals of Verification,
Oxford, Oxford University Press
Treasury (2005) Budget 2005 - Investing for Our Future: Fairness
and Opportunity for Britain's Hard-Working Families - Economic
and Fiscal Strategy Report and Financial Statement and Budget
Report, March 2005, HC 372 of Session 2004-05, London, Stationery
Office
Tyrie, A. (2005) 'Q. 29', in Public Accounts Commission, Twelfth
Report, HC 216 of Session 2004-05, London, Stationery Office
1 See Power (1997) on the expansion of audit into non-traditional
areas. Back
2
In this specific case of the correction of data error, a case
could be made either way, for adjustment or for non-adjustment. Back
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