House of Commons - Environment, Food and Rural Affairs

Select Committee on Environment, Food and Rural Affairs Second Report

2 FINANCIAL MANAGEMENT

Defra's 2006-07 budget

10. During our two evidence sessions with Defra's Permanent Secretary and Director of Finance, Planning and Resources, we wanted to know: the extent of Defra's 2006-07 budget deficit; the reasons for the deficit; and those areas of Defra's work affected by budget cuts.

EXTENT OF DEFRA'S BUDGET DEFICIT

11. We were told that Defra's deficit for 2006-07 amounted to about £200 million. This relates to about 5% of its overall budget.[13] To cope with this deficit, Defra was having to make in-year adjustments and revisions to its 2006-07 budgetary plans and work programme. £170 million of the £200 million would be found by making in-year cuts to the 2006-07 budgets of core Defra and some of Defra's affiliated agencies and NDPBs. Defra planned to find the remaining £30 million from natural under-spends and flexibility during the rest of the financial year.

12. The budget cuts affect Defra's 2006-07 resource budget and, consequently, the 2006-07 resource budgets of some of its affiliated agencies. They do not directly affect the capital budgets of Defra and its agencies.[14] In total, the £200 million deficit equates to 7% of the total resource budget.

CAUSES OF DEFRA'S BUDGET DEFICIT

13. We wanted to know the reasons for this deficit. The Department stated that the deficit was caused by a variety of factors. Some of these factors were due to financial pressures carried over from the 2005-06 financial year—so-called "legacy cuts".[15] Others had occurred since April 2006 and had added to these existing pressures. In total, these various factors amounted to about £200 million.

14. We have found it difficult to obtain a definitive explanation from the Department about the causes of its budget deficit. The public explanations about this issue have often been unclear, overly complex or inconsistent. (We comment more on Defra's public explanations in paras. 46-50). Responding to a written parliamentary question on 6 November 2006, however, the Department did provide a concise breakdown of the various factors it says contributed to the £200 million budget deficit.[16] These are listed below and set out Figure 1:

costs deferred from 2005-06 (around 45% [of the £200 million deficit]);
surplus capital charge budget no longer being available to fund programme expenditure due to new tighter rules governing public expenditure (around 30%);
Rural Payments Agency's running costs (about 11%), including administration of the single payment scheme for both 2005 and 2006;
Avian influenza (about 5%);
other miscellaneous pressures (about 9%).

We examine below some of the factors that Defra says caused the £200 million deficit in its 2006-07 budget.

COSTS DEFERRED FROM 2005-06

15. About £95 million of the £200 million deficit originates from costs deferred from 2005-06 to 2006-07, according to the Department's written parliamentary answer on 6 November 2006.[17] This represents the largest single contributory factor (about 45%) to the £200 million deficit in 2006-07. Examples of programmes and projects delayed from 2005-06 into 2006-07 include work to be undertaken by the Countryside Agency and English Nature, and work on flood management, waste, IT and R&D.

16. We were told that a number of factors occurred in 2005-06 that contributed to the Department's decision to delay some programmes and projects from that year into 2006-07. First, the Department faced a number of financial pressures early in the year, including TB compensation, structural funds, property rent increases and the final costs of foot and mouth disease.[18] These financial pressures contributed to about £40 million of programmes being delayed into 2006-07.[19]

17. Secondly, the Treasury did not allow Defra to draw down its full near-cash End-Year-Flexibility (EYF) in 2005-06. This meant that £55 million worth of programmes and projects—including work on flood management, waste, IT and Research & Development—was delayed into 2006-07.[20] EYF relates to the amount Government departments underspend the previous year (in this case, 2004-05) which, if the Treasury approves, can then be spent in future financial years. Defra had hoped to draw down its full near-cash EYF of about £120 million in 2005-06, and had budgeted on this assumption.[21] However, in July 2005, the Treasury had placed restrictions on drawing down EYF, after notifying departments to this effect in spring 2005.[22] In October 2005, after negotiations, Treasury allowed Defra to draw down £65 million near-cash in 2005-06, leaving a stock of £55 million which could only be accessed in 2006-07 and 2007-08.[23]

18. A third pressure in 2005-06 was that Defra was operating within a tighter financial environment compared to previous years, partly because the Department had improved certain aspects of its financial management.

19. In the early years of this decade Defra had a reputation as an underspending department, attributed in part to weaknesses in Defra's systems of planning and budgetary control.[24] This meant that Defra was accustomed to some financial flexibility if unexpected budgetary pressures arose during any one year. Over the past four years, however, the Department had improved its budgeting and forecasting systems. So in 2005-06, Defra 'came in' more or less on budget, with a net under-spend of just £1 million out of a provisional total public spending budget of around £3.5 billion.[25] The Permanent Secretary believed this showed that Defra was "not an underspending department any more".[26] Although this signalled that the Department had improved aspects of its financial management, the lack of underspend in 2005-06 meant the Department had less flexibility to address other unexpected budgetary pressures that arose during the year, such as the Treasury restrictions on the amount of 2004-05 EYF the Department could draw down in 2005-06. The Defra board seems to have been slow in picking up this change of behaviour within the Department. The Permanent Secretary told us:

TREASURY ACCOUNTING RULES

20. This factor equates to about £65 million. It represents the second largest single factor for the £200 million deficit, about 30%. Again, the circumstances giving rise to this first occurred in 2005-06 with, said the Permanent Secretary, a "forward impact" in 2006-07.[28]

21. In evidence, the Permanent Secretary said a "Treasury reclassification" of near-cash and non-cash spending had increased the Department's financial pressures in 2005-06 because it meant Defra had "less flexibility" in managing its resources.[29]Treasury guidance permits Government departments to make switches between non-cash "savings" to near-cash, under certain circumstances. Departments like to make such transfers because near-cash budgets are often under greater pressure than non-cash budgets. In 2005-06, Defra had about £85 million worth of non-cash savings and so wished to transfer this amount to near-cash.[30] However, the Treasury allowed Defra to switch only £20 million; the remaining £65 million was not allowed because, Defra says, "switches of this magnitude are not approvable in a tight fiscal climate".[31]

22. We wanted to know when the Department first became aware it was not allowed to switch £85 million from non-cash into near-cash, as it had expected. Defra's Director of Finance, Planning and Resources told us that Treasury Spending Review 2004 (SR04) guidance, issued to Government departments in December 2003, was the first indication that "significant changes" were going to be made, in 2005-06 and 2006-07, in the accounting rules relating to non-cash and near-cash spending, but that this guidance was not specific.[32] The Department only understood the full implications of the rules—that it could only transfer a maximum of £20 million non-cash to near-cash—"during the summer of 2005".[33] On 11 August 2005, HM Treasury clarified the rules when a letter was sent to government departments' finance directors, stipulating that departments could only move "up to £20m a year" of non-cash to near-cash "without reference to the Treasury".[34]

23. We wanted to know whether the Department's assumptions about making such a large transfer between non-cash and near-cash were based on any other existing Treasury guidance—after all, the Department had made switches of £20 million non-cash to near-cash on previous occasions during the SR04 period but never an amount as large as £85 million. The Department confirmed that no other such guidance existed. We were told it was the "lack of clear guidance that led to this assumption, rather than guidance that existed."[35]

24. The original SR04 guidance—issued to Government departments in December 2003—states that departments should discuss with HM Treasury any proposals to make switches "before making any commitments based on this flexibility".[36]

2006-07 PRESSURES

25. By the end of calendar year 2005, Defra was aware that it was deferring a significant amount of costs—perhaps as much as £150 million[37]—from 2005-06 into 2006-07. Budgets for 2006-07 for core Defra and Defra's affiliated agencies and NDPBs were set in January 2006. Senior Defra officials decided not to revise substantially 2006-07 budgets to take account of the deferred 2005-06 costs. In evidence, the Permanent Secretary told us it was "a matter of judgement" that the Department could probably absorb these additional 2005-06 costs within its 2006-07 budget.[38] The expectation within the Department was that "things would be easier this year [2006-07]" and that they could cope with the additional costs they were deferring into that year.[39]

26. However, the Permanent Secretary acknowledged that these initial assumptions were "over-optimistic".[40] In March and April 2006, a combination of the higher than expected running costs of the Rural Payments Agency (RPA) and the cost of managing the avian influenza outbreak in East Anglia further added to Defra's financial problems.[41] These two additional pressures—although only amounting to 16% of the £200 million deficit[42]—meant the Department had "tipped over into a situation where we could not guarantee coming in on budget" for 2006-07.[43] It was at this point that the Department decided 2006-07 budgets would have to be revisited. Revised budgets were confirmed in July 2006.

27. In evidence, the Department told us its experience in 2005-06 and 2006-07 meant it would "consider using more cautious planning assumptions in future years"—such as assuming Treasury would allow Defra to draw down its full EYF.[44]

Conclusions

28. We have considered a substantial amount of evidence about the causes of Defra's £200 million deficit in 2006-07. This deficit ultimately resulted in action to reduce, in-year, the 2006-07 budgets of several Defra executive agencies and Non-Departmental Public Bodies (NDPBs) and disrupt a number of important environmental programmes and projects. The evidence suggests that the Department itself has to take much of the blame for the precarious financial situation it found itself in 2006-07. We regard this whole episode to be a serious failure in the Department's financial management.

29. We acknowledge that some minor factors for the deficit, such as costs related to the Spring 2006 avian influenza outbreak, were largely beyond the Department's control. However, many of the financial problems carried over from 2005-06 occurred because the Department had made budgeting commitments based on unsubstantiated assumptions about the generosity of HM Treasury in a tight fiscal period. We believe the Department was irresponsibly over-optimistic and complacent in budgeting on the assumption that, first, it would be allowed its draw-down its full End-Year-Flexibility (EYF) from the Treasury in 2005-06 and, secondly, that it would be able to switch £85 million from non-cash to near-cash that same year. These two factors alone amounted to £110 million of the £200 million deficit. We are not convinced that the Department explored fully with the Treasury at an early enough stage the possibility of making these kind of transactions, particularly bearing in mind the tight financial climate. This complacency had unplanned-for severe consequences.

30. We are particularly unimpressed with the Department's explanation of how the Treasury "re-classification" of near-cash and non-cash spending impacted on its budget. Our evidence shows that no good reason existed for the Department to assume it could make a transfer of £85 million non-cash into near-cash, and to make budgetary commitments based on this assumption. The Department had never made such a large transfer before. No Treasury guidance existed permitting it to do so. This financial pressure was therefore caused more by the Department's self-deception, as well as its misguided assumptions about Treasury rules. To blame the Treasury was on this occasion incorrect. The result was a sudden, unplanned, poorly explained and highly disruptive mid-year restriction on budgets. Defra's agencies and NDPBs—as well as voluntary groups reliant on Defra funding—found themselves with wholly unanticipated financial problems as a result. In its response, the Department should tell us when Ministers were informed by officials about the rule changes and their financial consequences.

31. We also remain doubtful whether the £23 million figure that Defra says the Rural Payments Agency (RPA) contributed to its budget deficit tells the full story. In its response to this report, the Department should state how much the RPA was within or over budget on a monthly basis throughout the financial year 2005-06. The Department must also indicate what parts of its internal budget were affected during this period by financial transfers to the RPA, and the consequences of these financial movements.

IMPACT OF BUDGET CUTS

Extent of budget revisions of Defra agencies and Non-Departmental Public Bodies

32. The table below shows all those agencies and NDPBs whose 2006-07 resource budgets were changed in-year, in July 2006, in order to help meet Defra's total £200 million deficit. All but two—the Rural Payments Agency and the Centre for Environment, Fisheries and Aquaculture Science (CEFAS)—experienced reductions. Table 1 shows the change in money terms and as a percentage of that agencies' initial 2006-07 resource budget.

Table 1: Extent of Defra agencies and Non-Departmental Public Bodies' 2006-07 in-year resource budget revision

Defra agency/Non-Departmental Public Body	Change in 2006-07 esource budget (£)	Change in 2006-07 resource budget (%)
Environment Agency	£23.7 million REDUCTION	-5%
Natural England	£12.9 million REDUCTION	-7%
British Waterways	£3.9 million REDUCTION	-7%
State Veterinary Service	£3.0 million REDUCTION	-3%
Veterinary Laboratories Agency	£2.4 million REDUCTION	-3%
Marine Fisheries Agency	£1.7 million REDUCTION	-6%
Pesticides Safety Directorate	£0.8 million REDUCTION	-7%
Royal Botanic Garden Kew	£0.6 million REDUCTION	-3%
Food from Britain	£0.4 million REDUCTION	-8%
National Forest Company	£0.3 million REDUCTION	-8%
Veterinary Medicines Directorate	£0.3 million REDUCTION	-7%
Meat and Livestock Commission	£0.02 million REDUCTION	-4%
Rural Payments Agency	£23 million INCREASE	+11%
Centre for Environment, Fisheries and Aquaculture Science (CEFAS)	£1 million INCREASE	+3%

Source: HC Debs, 8 November 2006, cols 1581-82W

33. The Environment Agency and British Waterways both told us that the July reductions represented the second time in quick succession that their 2006-07 budgets had been reduced from the expected amounts. Defra had notified the Environment Agency in April 2006 that it would face a £4.4 million cut in its 2006-07 budget. The in-year revision, in July, resulted in a further £23.7 million cut. The Agency's total budget cut in 2006-07 was therefore £28.1 million.[45] British Waterways was told by Defra in March 2006 that £3.2 million would be cut from its indicative budget allocation for 2006-07, as set in SR04. A further £3.9 million was then cut as part of the in-year review in July. British Waterways says its overall reduction in grant from 2005-06 to 2006-07 has therefore been £7.1 million.[46]

Programmes and projects affected by the cuts

34. Written evidence from Defra agencies and NDPBs provided us with several examples of the impact of the budget cuts on Defra's environmental work. British Waterways described a number of engineering works that have been postponed or cancelled due to the cuts.[47] These disruptions have received considerable public and media attention, with a number of high-profile protests and barge blockades occurring in late 2006 and early 2007.[48] The Environment Agency states that it informed Defra about the likely impacts of the cuts in a letter from the Agency's Chairman dated 3 October.[49] For example, reductions in channel clearing and maintenance, caused by reductions to its budget, "will increase flood risk". A lessened ability to attend to category 3 pollution incidents is "likely to lead to more incidents escalating since they will not be dealt with promptly".[50]

35. Natural England told us that its 7% budget reduction meant a range of core research work would be "slowed down" until 2007-08. There would also be a reduction in the scale of the farm demonstration programme in 2006-07 and in new work in Areas of Outstanding Natural Beauty. Funding for some voluntary groups would also be affected.[51] The Veterinary Laboratories Agency (VLA) told us that the majority of its cuts had affected its scientific surveillance work. In addition to this, not all the research 'concept' proposals on antimicrobial resistance could be taken forward. This, the VLA said, "could leave Defra open to criticism since it is of considerable public health interest".[52]

36. Voluntary groups also told us about the impact of the cuts 'on the ground'. Butterfly Conservation said the budget cuts would have "serious impacts on both the delivery of Government biodiversity targets and on the volunteer community who are trying to help Government meet its own targets to halt biodiversity loss".[53] For example, cuts would cause the "virtual cessation of care and maintenance" to Stewardship sites by Natural England staff because "cut-backs have resulted in them having to focus on claims".[54] The Bat Conservation Trust (BCT) told us that Natural England's budget cuts had resulted in "great uncertainty and high risk to BCT" and affected "thousands of volunteers dedicated to bat conservation".[55]

37. In both evidence sessions with the Department, we expressed concern about the impact of the budget reductions on Defra's environmental work. In the July session, the Permanent Secretary agreed with our assertion that the Defra agencies and NDPBs affected were facing "a pretty big headache".[56] By the time of the December session, the Department was much more positive about the impacts of the cuts. The Permanent Secretary described the impacts as "relatively invisible", with the exception of the impacts on the voluntary sector, and she praised the "hard work" done by Defra's delivery bodies to ensure that this was the case.[57] When questioned about the examples provided by Defra agencies and NDPBs in their evidence, she responded that many of these impacts were "as much about people's fears of impacts [rather] than impacts on the ground".[58] The Department also stressed that impact on PSA targets had been "slight" because, in many cases, the targets stretch over long periods.[59]

38. We questioned the Department specifically about the impact of the in-year budget cuts on British Waterways' work, and the high-profile protests that had occurred in wake of the cuts. The Permanent Secretary believed that the postponement of British Waterways' services was more a consequence of British Waterways' wider restructuring programme rather than a result of the in-year cuts to its 2006-07 budget.[60] She also stressed that Defra's grant represented only a "small proportion" of the turnover of British Waterways, in terms of its asset base and its commercial activities.[61] She acknowledged that British Waterways had been "very vocal" in its comments but believed the organisation was "sensibly looking forward".[62] We will be looking in more detail at British Waterways in our next Sub-Committee inquiry.

Lack of certainty and the decision to set 2006-07 budgets in January 2006

39. In evidence, several Defra agencies and NDPBs expressed disappointment about the sudden nature of the budget cuts and the lack of certainty given by the Department before the cuts were formally announced. British Waterways had been subject to two reductions to its expected 2006-07 budget in quick succession. British Waterways was advised about the first reduction around February 2006, a couple of months before the start of the 2006-07 financial year. British Waterways described this as "late but acceptable notice" because it was able to incorporate the reduction within its business plans.[63] British Waterways was warned about the second cut in May 2006 and formally notified in July. The in-year nature of this second cut meant options were restricted, with little choice but immediately to reduce its programme of major works and repairs "as this was the only area of expenditure of significant value that could be cut at this stage".[64] This meant that "some time and resource was wasted as many schemes were quite well advanced".[65]

40. Similarly, the Environment Agency said that the "lack of notice" from Defra had required the Agency to make budget assumptions which were to an extent "tactical and opportunistic". The Veterinary Laboratories Agency told us there was "considerable uncertainty" about the extent of the budget reductions before formal notification. It said "a number of different percentage reductions were being quoted in early correspondence that only added to the uncertainty".[66]

41. When questioned about the timing of the decision, the Permanent Secretary acknowledged that the Department had "failed in our aim to give our delivery agencies enough warning", and she said that much of the criticism in this respect was "perfectly reasonable".[67] She emphasised, however, that the agencies could not have expected to receive more money had allocations been made earlier in the year; only that the Department could have given them "greater certainty".[68]

42. We wanted to know why the Department did not amend its 2006-07 budget allocations when budgets were set in January 2006, in order to give the agencies and NDPBs more certainty and more time to adjust their 2006-07 work programmes accordingly. After all, the Department was aware by the end of the calendar year 2005 that it would not be able to draw down its full End-Year-Flexibility (resolved in October 2005), that it was unable to transfer a total of £85 million of non-cash into near-cash as it had hoped, and that it was deferring a significant number of programmes and projects into 2006-07. According to the Parliamentary Answer given on 6 November 2006, these factors equate to about £155 million of the £200 million deficit experienced in 2006-07.[69] The Permanent Secretary told us that the Department was fully aware in January that the 2006-07 budgets it had set would be "tight".[70] However, she said:

43. However, the Permanent Secretary acknowledged that she might not have taken this risk had she been better informed about the workings of Defra's budget.[72] In January 2006, she had only been employed at the Department for two months. She explained that Defra, as an organisation, was unusual because much of its budget was granted, to its agencies and NDPBs, at the very start of the financial year, on April 1. When the budget cuts were made in-year, therefore, the Department and its agencies were restricted in the areas in which it could impose a moratorium, because much of the money had already been committed. Ms Ghosh summed up:

Conclusions

44. Our evidence shows that the chaos and disruption caused by imposing budget reductions in-year could have been prevented by the Department. Defra was fully aware by the end of the calendar year 2005 that it was deferring at least £150 million worth of costs into 2006-07. Yet, when 2006-07 budgets were set in January 2006, the Department decided not to revise substantially budgets to take account of these deferred costs. The Permanent Secretary told us several times that it was a "matter of judgement" as to whether the Department could absorb these additional costs within its 2006-07 budget. It is clear to us that this judgement—made by senior Defra officials and ministers—was seriously flawed. The Department was over-optimistic to assume it could cope with the additional deferred costs from 2005-06 and not incur any further significant unexpected costs in 2006-07. The error of this decision was exposed within just two months, when the relatively minor additional costs from the Rural Payments Agency and the Spring 2006 avian influenza outbreak were enough to 'tip the balance'. Given that neither additional RPA running costs or an avian flu outbreak in 2006-07 could have been totally unexpected, the decision not to revise budgets substantially in January 2006 appears even more inexplicable, and unwisely risky.

45. We were taken aback by the Permanent Secretary's acknowledgement that she might have acted more cautiously in January 2006—when setting budgets for 2006-07—if she had been aware that much of Defra's money was spent at the start of the financial year. This decision had severe repercussions for those bodies affected, particularly British Waterways which had little choice in-year but to postpone major works and repairs. The Permanent Secretary was relatively new to Defra, so the blame for her lack of awareness must be shouldered by the Finance Director and his team.

DEFRA'S PUBLIC EXPLANATIONS ABOUT BUDGET CUTS

46. Defra's public statements about the causes and impacts of its budgetary changes have often been difficult to understand, and even contradictory. For example, inconsistencies have appeared in various public statements about the causes of the deficit, particularly the cost that each factor contributed to the £200 million deficit.[74] In response, Defra said it was not possible to provide "a definitive, single list" of pressures that amounted to the current deficit because the situation was "evaluated on a rolling basis, with estimates of expected costs and pressures changing over time".[75]

47. There was similar confusion about the impacts of the cuts, when full details of these were made public in October 2006. In a House of Lords debate on 30 October 2006, Lord Rooker confirmed that the State Veterinary Service had been subject to a £3 million reduction in its expected 2006-07 resource budget. However, he said that this did not amount to an overall reduction in the State Veterinary Service's total budget because the resource money had been "swapped from capital".[76] A Written Parliamentary Answer published by the Department the same day, however, said that, with the exception of the RPA, "no changes have been made to the original capital budgets for 2006-07" of those bodies listed—including the State Veterinary Service.[77] On 2 November, the Parliamentary Under-Secretary of State further complicated the issue when he told the Commons that the State Veterinary Service had moved £3 million "from revenue to capital".[78]

48. We questioned the Department about the process of cross-checking and review it had used in preparation for its public statements about the 2006-07 budget changes. The Department said it used "normal Departmental procedures and processes" for making public statements for this issue, and these involved senior management. However, it added:

49. The Department's communication about the causes of its deficit has been poor. Ministers should have provided a much more complete and comprehensive explanation about the budgetary changes instead of often placing emphasis on avian influenza and Rural Payments Agency spending and vague references to changes in Treasury accounting rules.

50. We acknowledge that many of the issues related to Defra's budget are complicated and opaque, particularly those related to various Treasury procedures. However, this complexity does not excuse Ministers—who took important decisions and approved much of what occurred in 2005-06 and 2006-07—from blame for giving confusing explanations. This raises some important questions about the understanding levels both within Defra, and outside, about how the Department's budgetary processes operate. Government accounting is complex, but the Department has a responsibility to provide good, clear explanations to help lay-people—including us—to understand these matters. Ministers should also ensure that they master the complex matters within their brief—especially those relating to financial issues. The Department should say what steps it is taking to raise Ministers' understanding in this area. HM Treasury should also try harder to be more transparent in the language and rules it uses.

Budgeting in future years

51. In the light of this year's events, we wanted to know whether funding would continue to be tight for the foreseeable future. The Permanent Secretary confirmed that the Department would no longer have an increasing line of spending beyond 2007-08.[80] She said that spending across the whole of Government was likely to be tight during the Comprehensive Spending Review 2007 period because all money received by departments would be "flat cash"—that is, absorbing the costs of inflation year on year.[81] She described the Department's financial problems in 2006-07 as "a swift adjustment but on a path which is effectively … a declining one".[82]

52. Several witnesses told us they feared the consequences of budgeting restrictions in future years. British Waterways told us that, in the short term, further cuts would result in an "under-spend on … major works programmes of repair, replacement and renewal".[83] Reduced funding over the long-term could mean the Government failed to meet its aspirations for waterways policy, as set out in the 2000 document Waterways for Tomorrow.[84] Similarly, the Veterinary Laboratories Agency said that reduced budgets would mean it could undertake less surveillance work and its "ability to absorb work whilst still meeting our financial target will be difficult".[85] Butterfly Conservation told us long-term reductions would have an "especially significant" impact on Non-Governmental Organisations, such as itself, who have had long term Memoranda of Understanding with Natural England, and "rely on long term grant aid".[86]

53. We are extremely concerned by the Permanent Secretary's statement that funding will continue to be extremely tight for the Department, and its agencies, over the next few years. Although we recognise that this reflects the financial reality across the whole of Whitehall in the next few years, it raises the question that if expenditure on environmental work remains a departmental priority, what then will happen to other areas of Defra responsibility. Defra must publish as soon as possible what its spending priorities will be and how much will have to be met from further efficiency savings. In the tighter financial environment that is likely, however, Defra has not helped its case for a good settlement from HM Treasury for the Comprehensive Spending Review 2007 period with its poor financial management in the past two years.

EU DISALLOWANCE

54. Defra is currently facing the prospect of disallowance—that is, financial penalties imposed on the UK by the European Commission—for not implementing the requirements of the Single Payment Scheme fully or making payments after the deadline

55. The method of payment for disallowance changed in 2006-07. Defra will now be expected to pay any disallowance payment incurred from its own Departmental Expenditure Limit (DEL) budget—the part of the budget primarily used for spend on programmes and projects, and in which Defra had its £200 million deficit. Previously, disallowance payments were made from the Annually Managed Expenditure (AME), budget, which did not significantly affect Defra's DEL budget, and with provision granted by the Treasury.[87]

56. We asked the Department whether EU disallowance costs incurred from 2006-07 onwards would have a detrimental impact on the rest of Defra's budget. Defra's Director Finance, Planning and Resources confirmed that it "impacts on the whole of the Defra budget".[88] However, the Treasury had provided "some additional disallowance cover" for 2006-07 and 2007-08, as part of the transition to take disallowance from AME into Defra's DEL.[89] This cover had been agreed with the Treasury as being about 2% of the Single Payment Scheme.[90] Defra's Director Finance, Planning and Resources said Defra's "key task" now was to "quantify what we believe the disallowance payable will be in any financial year and to make necessary provision in the budget to cover it".[91]

57. We are extremely concerned about the changes in accounting rules whereby the Department will now bear the costs of EU disallowance directly from 2006-07 onwards. This could have a serious impact on Defra Departmental Expenditure Limit (DEL) budgets in the future, in a period when the Department will already be under increased financial pressure. We recommend that the Department keep us informed at an early stage, by means of a ministerial letter, about any future EU disallowance which could potentially affect Defra's DEL budget.

Efficiency savings

58. The Gershon Review of Efficiency was a major component of the 2004 Spending Review.[92]The Review identified a range of potential efficiency savings across Government. In its response to the Review, Defra undertook to find £610m in financial efficiencies and 2,400 staff reductions by 2007-08.[93] We have followed Defra's progress towards meeting its two efficiency targets in our previous reports.[94] Last year, the Department told us it was "on track" to meet its targets.[95]

ACHIEVEMENT OF THE DEPARTMENT'S EFFICIENCY TARGETS

59. The pie charts below show how Defra plans to meet its financial and headcount efficiency targets. Each is largely dependent on one specific programme. Figure 2 shows that almost half of the financial efficiencies target (£299 million) is to be achieved though efficiency gains in the waste sector. Figure 3 shows that 1,400 of the 2,400 headcount reductions target are to be achieved through the Rural Payments Agency (RPA) Change Programme.

60. Progress towards the Department's targets is verified quarterly reporting to the Office of Government Commerce (OGC) and by 6-monthly 'moderation' discussions between the Permanent Secretary and the Chief Executive of the OGC. The most recent discussion, in November 2006, provisionally agreed a 'Red' assessment to Defra's Efficiency Programme.[96]

61. Recently, the Department acknowledged for the first time—in its Autumn Performance Report (APR) 2006—that it will not achieve its workforce reduction target of 2,400 staff reductions by the end of 2007-08, largely because of problems at the RPA.[97] By the end of September 2006, the Department had made just 416 staff reductions.[98] This amount is actually a substantial decrease from the 1,016 staff reductions reported by Defra in its Departmental Report 2006, just a few months earlier.[99] The number had decreased because temporary agency staff employed at the RPA—to replace the 876 full-time staff reductions—would now not be released by the target deadline, as initially hoped. The APR 2006 explains:

100

62. Defra officials were more confident, however, that the Department would meet its financial efficiencies target of £610 million by 2007-08. By the end of September 2006, Defra had delivered financial efficiencies worth £342 million, which amounted to 56 per cent of its target.[101] Defra's Director of Finance, Planning and Resources told us the Department could even finish "slightly over the target".[102] If this occurred, the Treasury would credit the Department.[103]

63. We are extremely disappointed that the Department will not meet its efficiency headcount reduction target by the end of 2007-08, and will most likely miss this target by some margin. This is yet another example of how the Rural Payments Agency debacle has had wider negative repercussions across the whole Department. The Department is more optimistic about meeting its financial efficiencies target by 2007-08. However, gaining the remaining financial efficiencies necessary to meet the target may be more difficult than anticipated because the Department will be operating in a much tighter spending environment over the next couple of years. At the same time, the tighter spending environment only increases the importance of making these efficiency savings, so that money can be freed up for other purposes within the Department. We consider it imperative that the Department does not lose focus in attempting to meet its financial efficiencies target of £610 million by 2007-08. Failure to achieve both the financial and headcount efficiency targets would amount to another major embarrassment for the Department. Defra should now provide a clear statement as to how these efficiencies will be made and the timescale to achieve them.

13 HC Deb, 6 November 2006, col 730W Back

14 The resource budget is for current expenditure such as salaries, rent, maintenance, consultants, training etc. The capital budget is for spending on acquiring or building fixed assets such as buildings, vehicles, equipment, etc. Back

15 Ev 47, Q11 (a) Back

16 HC Deb, 6 November 2006, cols 730-31W Back

17 In oral evidence, however, the Permanent Secretary told us a total of about £150 million worth of programmes were deferred from 2005-06 into 2006-07 (Q 151). The Department's written evidence to the Committee, suggests, the amount was £128 million (Ev 47, Q 11(a)). We believe these higher numbers have been calculated by combining both factors 1 and 2 of the Department's Parliamentary Answer of 6 November (both of these factors occurred in 2005-06 and resulted in costs being deferred) although we cannot be certain. We comment on Defra's public explanations about its budgetary changes in paras 46-50. Back

18 Ev 48, Q 11 (a) Back

19 Ev 48, Q 11 (a) Back

20 Ev 48, Q 11 (a) Back

21 Ev 104 [Treasury], Ev 48, Q 12. Again different numbers were given in oral evidence. Defra's Director Finance, and Resources Planning said the Department was hoping to draw down £90 million EYF in 2005-06 (Q 106). Back

22 Q 127; Ev 48, Q 12. Treasury has stipulated to the Department that "up to £50m" of the remaining stock could be drawn in 2006-07 and the balance in 2007-08. Defra says its intention is to draw down £50m near-cash EYF in the Spring Supplementary Estimate 2006-07 (Ev 49, Q 14). In a letter to the Chairman, Mr Stephen Timms, the Chief Secretary to the Treasury, confirmed that his predecessor had agreed that Defra could spend £65m of its near-cash EYF in 2005-06, £50m in 2006-07 and £5m in 2007-08 (Ev 103). Back

23 Ev 48, Q 12 Back

24 The National Audit Office (NAO) reported that a significant underspend in 2001-02 was caused by weaknesses in Defra's systems of budgetary control. We commented on the NAO's findings in the Twelfth Report of Session 2002-03, The Departmental Annual Report 2003, HC 832, para 7. Back