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Reforming fiscal and accounting rules to support investment and public ownership of assets

Ross Campbell argues that this issue is about how the Chancellor sets targets for overall public expenditure and investment, as well as how Treasury controls the way departments spend their allocation of capital and resource budgets.

Accounting standards

Accounting standards are not rules as such and do not dictate spending choices, they merely set out the ways in which the consequences of those choices should be recorded.

In the UK both government and businesses use the same accounting standards to prepare their annual report and accounts: International Financial Reporting Standards (IFRS). These are high quality standards and have contributed to the UK having a reputation as one of the highest quality jurisdictions for reliable accounting and transparency. They are not however used by government for day to day management.

As a separate exercise, the Office for National Statistics is required by the EU to prepare the national accounts, based on an international set of statistical rules. The national accounts are a set of statistically based summaries of economic activity in the whole UK – of which government forms a part. Most of the figures discussed in the media around the government’s finances, such as public sector net debt (PSND) or public sector net borrowing (PSNB) are extracts from the national accounts and they form the basis of what government uses for day to day management purposes.

The advantage of these figures is they are quick to produce and in theory comparable between countries. However in practice countries publish their figures on a range of slightly different bases making direct comparison harder. The UK alone uses 12 different measures for the national debt, so the reality is more complex. These figures are also partly based on  statistical estimates and subject to frequent revision so are less reliable than the accounts used in business.

Fiscal rules

The ‘fiscal rules’ are set out in the Charter for Budget Responsibility. They are comprised of the government’s objectives for fiscal policy and for the management of the national debt, its fiscal mandate, and the minimum requirements of the financial statement and budget report. What this means, is the government sets out the rules which the Treasury has to operate within in drawing up its fiscal plans and has to tell parliament about any changes.

Consequently, if a future government wished to instruct officials to borrow more, or invest more, or spend differently, it could do so. Under the current arrangements it would however need primary legislation to change the framework  within the Treasury is obliged to act.

Recent chancellors have set out their policy proposals in the terms of the national accounts. This is a policy choice, not an externally imposed rule or regulation they have to follow. This is in particular reference to PSNB and PSND. It should be noted that while public sector net borrowing is similar to cash expenditure and includes investments, it is not the same as what would be understood by most people to be an accounting surplus or deficit. Similarly public sector net debt does not include all the financial liabilities of government, for example a significant omission are pension liabilities.

If future chancellors wished to set out their mandates in terms, which for example did not include amounts spent on investment in the calculation of the ‘deficit’, they would be free to do so.  However anyone in possession of the national accounts, could easily recalculate the deficit on a basis that included such amounts. Indeed, this is the sort of thing that credit rating agencies and lenders to government, invest quite a lot of effort in doing, to better assess liabilities and compare countries.

The point is that there are multiple varieties of these measures already that vary depending on what is left out or included, but there is also a whole industry of economists skilled in deciphering them who inform media commentary.

Budgeting guidance (rules by which officials construct budgets)

The budgeting guidance maintained by HM Treasury derived from these numbers makes distinctions between capital and resource spending and sets out departmental expenditure limits (DEL) for both. However it is the limits that are set by the government of the day which impact investment, not the existence of the categories.

There are of course exceptions to this. For example, the treatment in the Statistical Accounts of PFI projects as resource expenditure, has favoured them in budgetary terms.  Not so much due to a limit on capital expenditure, but due to the fact that no matching debt obligation is scored for PFI projects, flattering both the deficit and debt measures. In the main however, this framework is responsive to government policy and does not unduly constrain it.

Government policy and state ownership

In the years since 1979, the policy choices of successive governments have been to privatise state owned industries, dispose of government assets where possible, limit the creation of new ones and encourage investment to take place in the private rather than public sector. These are the policy choices however, and not the outcome of a rule based process. The accounting profession would generally concur with these policy choices – because the private sector is largely perceived as more efficient in its use of capital due to the profit incentive. There is some evidence to suggest that some services do not perform as well under government control.

That is not to say that government should not own some assets – for example those required for the duties of the state. Including:

  • the maintenance of civil order or defence;
  • those needed for delivery of essential public services; or
  • where experience has shown the scale and risk are too great for private capital, such as the nuclear industry.

Debate around public services should, we believe, be about the quality and efficiency of the service, not the ownership structure.

Reforming the rules

The question is more about what is politically possible, or desirable, than what needs to change in the ‘rules’.

In terms of what is politically possible, that is a judgement for a party about what to put in a manifesto that sufficient numbers of the electorate will endorse. If the electorate are to be asked to pay more taxes to pay for investment or to renationalise industries, they will need to be convinced.

On the one hand they will need to know that such investment is worthwhile and on the other that there is a problem with the current arrangement that renationalisation will fix. It is hard to point to evidence that politicians or public servants are any better at running utilities or businesses than the private sector.

In terms of what is desirable, it is also necessary to consider the impact of public investment and ownership policies on the UK as a desirable destination for international investment and talent. That is not to say that public investment, and the taxes needed to pay for it, could not be higher, they clearly could. The question is more one of whether those required to pay those taxes are confident that they will receive value in return – for example in the form of high quality infrastructure.

A future government must ensure policies are realistic and their implementation is efficient and well managed.

Can a Labour government balance the books?

This essay forms part of an six-part discussion between ICAEW and the Fabian Society exploring the tough spending choices that would face a Labour government, if its policies remained consistent with its 2017 manifesto pledges. Read more about the project and find links to all the discussion papers.