2013 SPENDING REVIEW Kitty Ussher Chief Economic Adviser
1. TOP LINE
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his spending review precipitated a realignment in the political debate. Gone are divisions on the speed of deficit reduction and the consequences of cuts; dividing lines have now shifted to levels of capital investment and more fundamental structural reforms. The coalition government has succeeded in
negotiating a fifth consecutive year of large cuts in public expenditure across Whitehall with spending decisions for 201516 broadly following the outline that was established at the last spending review in October 2010.
economic recovery for the political debate around the next election to be the same as it would nevertheless have been in that rosier scenario: is the improving economy because of this government or despite them?
Back then, it was presumed that the deficit would have been eliminated by now, and the economy growing strongly. This has not happened. But there is enough hope of an
2. WHY NOW?
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pending reviews were introduced in 1998 to give greater financial certainty to public sector managers; they introduced three-year budgeting cycles for current programme expenditure where previously budgets had been fixed on an annual basis. In return for greater financial certainty, government departments committed themselves to achieving negotiated performance indicators. The general election in May 2010 came at the beginning of the third year of a threeyear spending review cycle. On taking office, therefore,
George Osborne needed to decide the budgets for all Whitehall departments for the period beginning in April 2011. He used this opportunity to fix the path of the entire fiscal consolidation he hoped he would need, extending the time horizon to four years. So the spending review that took place in October 2010 fixed the top-line budgets of government departments from April 2011 until April 2015. With the next election due in May 2015, a month after the current spending review period ends, the government was always going to have to revisit
the issue of allocations between departments at some point in this parliament. What was not initially anticipated is that this spending round would require a continuation of cuts. But slower-thanexpected economic growth in the intervening years has contributed to an ongoing gap in the finances that means austerity is not going away any time soon. In the words of the FT “this was the spending review George Osborne did not want to make�. Neither was there much political pressure to reopen the spending round. Negotiations between cabinet ministers over resources aren’t a bed of
roses in any environment. Add to this the complexities of a coalition, plus the continuing requirement for harsh cuts, and the prospect of agreement becomes even more daunting. The Liberal Democrats in particular did not want to tie themselves
to the Conservative shirt-tails into the next parliament, preferring the freedom to distinguish themselves from their current coalition partners in an election campaign. As a result in March this year the Chancellor
announced he would simply be holding a one-year spending review for the year 2015-16 and that the results would be announced in parliament on 26th June 2013.
3. MAIN POLICY DECISIONS: CURRENT SPENDING
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n the main, the decision of how to prioritise resources between government departments did not change in this spending round. The chart on the following page shows the how the real term changes in departmental programme budgets compare to the annual average real term changes as announced in the last spending round. As can be seen, the broad political decision to protect real terms funding to health (in absolute terms) and education (relative to others) has been continued into this spending round, with deep cuts across the other main spending departments. Notable exceptions are the Department for Work and Pension programme budget which was spared the axe last time round to give it the capacity to introduce the universal credit, but suffers a large real term loss this time. Similarly the Cabinet Office, which has done well from the centralisation of procurement and IT functions, albeit from a low base, has offered up savings this time.
Funding for international development is fixed as a proportion of national income, through policy choice. What looks like a less generous settlement for development at this review is actually a product of lower-than-expected GDP growth compared to last time (in fact they have not received as much resource in cash terms as was expected in 2010 for the same reason). The only departmental programme allocation to have done well this time round is the intelligence agencies, albeit from a relatively low base compared to other departments. Overall, the cash savings in 2015-16 generated from these cuts total ÂŁ11.5bn, roughly equivalent to a continuation of the austerity programme that was announced in 2010. In presentational terms, the Chancellor adopted the tactic of listing the percentage cash cut followed by picking out a (relatively minor) area of growth in either current or capital spending that came under the responsibility of the department in question; a large bite was taken out of each departmental cake, but a sprinkling of sugar
was added on top. For example a 10 per cent cut in the local government budget was sweetened with a commitment to fund council tax freezes for the next two years; a 7 per cent cash cut in the DCMS budget was sweetened with greater financial freedoms for art galleries; cuts to defence were balanced with increases in the equipment budget and protection of army pay; a 6 per cent cash cuts to the business department budget was coupled with a commitment to more apprentices and cuts to the environment department were sweetened with water subsidies in the South-West of England. In welfare, where cuts do not require the same level of sweetening, additional savings are being made from introducing a 7-day gap between losing your job and signing on; this is being used to fund more job centre capacity to provide personalised support for claimants. In addition claimants whose English is poor and do not improve it will lose entitlement.
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Efficiency Savings Just under half - £5bn - of the total savings came from “efficiency savings” such as from the sharing of back-office functions and procurement across departments and more effective e-delivery of public services, similar to the amount of savings achieved in 201112. Some gains to the exchequer have also been accruing due to departmental underspends; that is, departments simply not spending what they had budgeted for, either through finding unanticipated ways to make cuts or because of slow project management; simply shifting implementation of programmes to the right can be a less painful way of making savings.
Public sector pay Other across-the-board cash savings have come from the pre-announced policy to cap public sector pay awards at an average of under 1 per cent, representing a real terms fall and portrayed as bringing the public sector in line with recent private sector experience. In addition, the chancellor confirmed his intention to end public sector pay progression, that is the system where public servants, including for example in schools, could expect their pay levels to rise with years of service. Instead ministers are signalling that managers should move to payments by results systems.
Health ringfence In the run-up to the spending review announcement, some ministers attempted to unpick the real-terms ringfence on NHS spending that had originally been pledged by the Conservatives in the run-up to the last election. There were attempts to argue that medical research spending, for example in the science and defence budgets, should be classified as health-related in order that their ministers could achieve cuts by offloading them to the Department of Health. The health secretary Jeremy Hunt was forced to defend the status quo, arguing that because price inflation in the health sector is higher than consumer inflation, and demand for services is rising fast, even a real terms flat settlement puts pressure on the service. In the event his argument was successful: health spending was protected in real terms and medical research remained within the research council structure overseen by BIS. In the longer terms savings are anticipated by rolling together the health and social care budgets, a neat purloining of Labour’s developing policy in this area.
Schools ringfence Although front-line spending in the classroom is protected, this has not meant that other areas of the education budget have not required cuts. Conservative ministers put the Liberal Democrats under pressure over their flagship policies of a schools premium that follows children from low-income families and opposition to reducing pre-school ratios, as
well as the commitment to roll out free nursery places for two year olds. In the end the Liberal Democrats defended their position; the quid pro quo was an announcement to consult on looking at fairness in funding across schools in different locations where a variety of historical factors mean that some schools receive more funds per pupil than others even before the operation of the pupil premium. This may become a highly politicised exercise if, for example, it emerges that there is a connection between current school funding and a community’s socio-economic characteristics such as income, voting patterns or ethnicity, particularly when coupled with a commitment to 180 new free schools without consideration of where the need is greatest. In addition, the Budget 2013 included a commitment to look at the potential for efficiency savings within schools, sending a signal that this remains a live issue for the future.
Localism Devolving (and cutting) of budgets to local authorities has become a consistent strand of policy direction. Politically expedient in some ways - local authorities are forced to make the unpopular decisions, making it harder for national campaigns of opposition to develop - it also supports a wider localism agenda that talks of handing power to microcommunities to resolve their own issues. In the March 2013 Budget the scene was set for a big shift towards so-called “whole place community budgeting” where local agencies, their contractors and public sector workers pool budgets to work with residents and other organisations as appropriate to decide their own priorities based on local needs at a lower cost to the public. In the event, the Chancellor did not mention this explicitly although the continuing cuts to local authority budgets may mean it nevertheless becomes the norm; the five Whole Place Community Pilots saved £800m over five years. Instead the Chancellor chose to highlight a commitment to put £2bn of capital funding into a pot that Local Economic Partnerships could bid into for strategic sub-regional projects. But given that Lord Heseltine’s review had recommended a figure of £70bn, this was widely seen as paltry.
4. CAPITAL SPENDING
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he spending review traditionally only applies to departmental programme expenditure. However the government took the opportunity to signal a step-change in its attitude towards capital spending. Recent budgets have included decisions to “bring forward” previous capital spending commitments in itself a departure from the rhetoric in 2010 that spoke of how business would invest more if government cut back - but this spending review went a step further, committing an additional £3bn for this year and the next five years followed by the publication of all-economy capital expenditure plans to 202021. In terms of taxpayer commitments, the main
winner was the Department of Transport which obtains an additional £9.5bn in capital in 2015-16, a real growth increase of 5.5 per cent, although this was somewhat undermined by an admission in the hours after the spending review that the anticipated costs of the HS2 highspeed rail network were £8bn more than expected, albeit over a longer time frame. Nevertheless, the government will still be able to point to a number of road and rail projects across the country that will now be able to go ahead due to this increased capital commitment. In recognition of this, external lobbying has increased, most notably in favour of the London Crossrail 2 scheme. Other winners in the capital allocations were the Department for Business, Justice, the intelligence agencies and the Energy
department albeit from much lower starting points. This change in stance is an implicit (some might say belated) recognition that public investment is needed in order to spur the private sector to commit. Indeed figures from the first quarter of 2013 show that private sector investment is still woefully low. In recognition of this the government is intensifying its efforts to be associated with private sector investment where the regulatory regime is a key component of decisionmaking, such as in energy generation and broadband. Moreover by focussing on so-called “economically valuable” schemes the government is hoping to associate its actions in the eyes of the public with the economic recovery, when it comes.
5. AME SPENDING
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he other very large area of government expenditure traditionally not covered by spending review is Annually Managed Expenditure, or AME. Thought of within Whitehall culture as spending on demand-led services that were therefore exogeneous to the type of rigorous spending controls that applied to departmental programme budgets, the AME budget has morphed over time into a hodgepodge of bits and pieces from different departments, including public sector pensions, social security benefits of various types and spending on areas that are not raised through general taxation; full details are given in the annex to this paper. Following its commitment in March to “introduce a
new limit on a significant proportion of annually managed expenditure” to “bring real control to areas of public spending that had been out of control” the spending review announced a cap on all parts of the welfare budget except for state pensions and the automatic stabilisers. Of all social security spending, state pensions account for just under half, with the main unemployment benefit, jobseekers allowance, accounting for a mere 3 per cent. What the government’s cap means therefore is that half of social security spending will be subject to a cap with tax credits and public sector pensions likely to also be included. If spending looks as if it will breach the cap, policy changes will need to be made in order to bring total spending on these
items back into line. The cap will be set annually for the next four years and adherence will be monitored by the Office of Budget Responsibility. The largest items affected are housing benefit and tax credits, each comprising roughly a fifth of spending included in the cap. Other vulnerable benefits include those affecting pensioners such as pension credit and the winter fuel allowance; those affecting people with health issues such as disability living allowance, carers allowance, attendance allowance and incapacity benefit; statutory maternity pay and, depending on the definition of “automatic stabiliser”, possibly employment and support allowance and income support. Again. the annex to this note provides more detail.
6. DISTRIBUTIONAL IMPACT The government does not publish a distributional impact of the spending review in isolation, but it has published an analysis of all the changes that are expected to affect households in 2015-16, both in terms of tax and benefit changes and to the extent that different income groups consume public services to different extents. A copy of this snipped from the Treasury documents - is reproduced below. The grey boxes give the effect of the spending review alone, as this represents the impact of changes to the programme budgets of government departments. As the lowest income group consumes more public services, they are disproportionately badly affected. The lowest income groups are also hit by pre-announced changes to tax credit and benefit rates but as the overall shape of the graph shows, this is mitigated by the more progressive changes to taxation.
7. BATTLEGROUND ISSUES The main political effect of the spending review was to force a change in Labour’s attitude towards the levels of government spending in general and welfare cuts in particular. In anticipation of what was to come in the Spending Review, Labour in early June signalled not only that they would stick to the overall envelope of spending cuts in 2015-16 if they won the election but also that they, too, would implement a cap to welfare spending. This marks a shift from their previous stance of generalised principled opposition to most of the cuts. On spending, the debate has instead shifted to capital expenditure, which is not included in the main spending review settlement, with Labour accusing the government of moving too slowly and failing to unlock the private sector investment necessary to stimulate the recovery. The Conservatives counter by pointing out that their capital expenditure plans,
if implemented, are more ambitious than Labour had achieved in office. There is also an opportunity for the Conservatives to attempt to portray Labour as profligate if they want to move faster on public sector investment but if they do so it will not fit well with their own efforts to demonstrate that they in fact are moving swiftly, which they need to do in order to associate themselves with the nascent economic recovery. More profitable for the Conservatives will be to continue to taunt Labour on welfare spending. The two parties are currently matched; both supporting a cap. When the detail on the level of the cap and the extent to which policy change will be required in order to maintain it is better understood, the Conservatives will use this mechanism to try and propose populist changes that take a path Labour feels unable to follow. Labour, in turn, will embark on a swift and heavy-lifting policy journey to try and counter this by coming
up with credible policies that will achieve better outcomes at a cheaper price for the least-well off through structural changes rather than by slicing budgets. An example is a recent proposal to reduce the housing benefit bill by more housebuilding and greater reliance on social landlords. The Liberal Democrats meanwhile have secured a number of lower-level victories in this spending round. They have protected their key policies, for example the pupil premium and expanded pre-school nursery places. In addition they have associated themselves with a new initative to pool local budgets creating a new pot of money to support so-called “troubled families� and obtained some reflected kudos from their chief secretary have been personally associated with being able to secure agreement of the spending round in the first place.
8. NEXT STEPS Now that all parties accept the principle that cuts will need to continue into the next parliament, the debate will shift into previous no-go areas of public sector reform. An acceptance of the need to means test some universal benefits such as child benefit and winter fuel allowance is an early example of this. Next on the list will be discussions around the removal of the health ringfence in the next parliament and/ or a discussion of the circumstances in which the NHS can propose charges for, or even restrict access to, some of its services.
Intergenerational issues will rise to the fore: whereas fifteen years ago the desirability of giving more to pensioners was undisputed, questions are now being asked as to whether this is the best use of available resources. As a first step there will be no obstacles to the continued raising of the retirement age. The mechanism of an externally-monitored cap on most of welfare spending will prompt deep debates about the effectiveness of benefit transfers. The likely outcome will be a medium
term shift away from cash payments and towards greater accessibility of services, possibly through a devolution of responsibility to local authorities particularly in healthrelated benefit expenditure. Looking back, this may be seen as the moment where salami slicing of departmental budgets reached the end of what was possible and the debate finally shifted to more fundamental structural reforms in the delivery of public services.
ANNEX: COMPONENTS OF AME SPENDING Annually Managed Expenditure currently consists of around half of total public expenditure, or around ÂŁ350bn. By far the largest single item is social security spending, accounting for just over half of total AME spending, followed by debt interest and expenditure on tax credits. However there are also a large number of other items, in particular spending for which the income is separately determined from the usual central forms of taxation, as the chart on the right shows. Chart 2 below shows the breakdown of the social security payments that form part of the AME budget. This shows that the vast proportion of social security payments go to pensioners either through pensions themselves or through other age-related benefits. Of the remainder, the next largest category is to working age people who are far from the labour market due to ill-health. Jobseekers allowance accounts for a mere 3 per cent of the total social security budget, or around 1.5 per cent of the total AME budget. Excluding payments to pensioners and those with health problems, the largest remaining category is housing benefit payments, at 15 per cent of the total social security budget.
Source: DWP. Data for 2012-13
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