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«Longer-term trends - Public Sector Finance Author Name(s): Andrew Jowett & Michael Hardie Abstract These articles examine the longer-term trends for ...»

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21 November 2014

Longer-term trends - Public Sector

Finance

Author Name(s): Andrew Jowett & Michael Hardie

Abstract

These articles examine the longer-term trends for a number of key economic statistics, providing

context in which to view more recent movements in these series.

Introduction

The public sector finances offer a number of insights into how the UK economy has developed over

time. Like any household, the Government is able to borrow and invest to support current and future activity, which can add to the country’s debt level. However, the Government is also able to generate income from taxes which can then be used to provide public goods and services, such as schools, public roads and social support.

The public sector finance statistics show that government income and expenditure can vary considerably from month to month. Yet the longer-run picture demonstrates that since the 1970s central government income from taxation (current receipts) has remained broadly stable relative to the size of the economy. Changes in public spending have therefore had a greater influence on variations in the amount of borrowing. Public investment has also been on a downward trend since the 1960s, from a time when the economy was rebuilding after the effects of war to one where a number of public bodies have been nationalised.

This article will look in detail at the long-term trends within public sector income and expenditure, investment, borrowing and debt. This will provide the context against which the most recent movements in the public sector aggregates can be assessed.

Key Points

• The public sector current budget deficit and borrowing have fluctuated considerably over time as a share of GDP, in large part the result of the economic cycle.

• The current budget has been in deficit for most of the period since the mid-1970s, only returning to surplus for short periods around 1990 and 2000. The deficit peaked at more than 5% of GDP Office for National Statistics | 1 21 November 2014 in the late 1980s and in 2009/10. The profile of borrowing is broadly similar, rising to a peak of just over 10% of GDP in 2009/10.

• Central government current receipts have varied mainly in the range of 32% to 35% of GDP since the mid-1970s, and remain within that range in the latest year.

• Current spending has varied a little more widely than receipts, and has risen outside its long-run range of variation relative to GDP since 2008/09.

• Public sector net investment has been on a long-run downward trend since the 1960s, but started to rise again from the late 1990s. Most recently, it has peaked as a share of GDP in 2009/10 but has fallen back again.

• Public sector net debt increased rapidly as a result of financial intervention since 2007. Net debt has now fallen below 100% of GDP in Q2 2014.

What is the public sector?

The public sector is the part of the economy controlled by the state and it comprises a number of sub-sectors. Each has different income and spending capabilities, and a range of statistics can be found for each of them. Figure 1 shows how these different sub-sectors fit together to make the public sector. Central government covers areas of government activity that are administered at a national level, whereas local government provides goods and services at a smaller local or regional level. Public non-financial corporations are government-owned trading businesses, and now include the Meteorological Office, the Driving Standards Agency and many housing associations for example. However in earlier periods, they also included many of the major energy, transport and communications companies that have since been privatised.

Public finance statistics in the UK focus on the public sector as a whole, whereas the sector for monitoring compliance with the EU’s Excessive Deficit Procedure (EDP) is general government, i.e.

central government and local authorities only.

Figure 1: The components of the public sector Source: Office for National Statistics The majority of tax revenue is collected by central government, with some local taxes being collected by local authorities. There are also a number of public non-financial corporations that sell goods and services and therefore generate their own income. All sectors add to public spending,

–  –  –

and this is overseen by the Treasury and Parliament, often constrained within spending limits of the time.

Deficit and debt There are two key concepts that attract the headline discussions of the public finances – the budget deficit and debt. In the UK these are measured by Public Sector Net Borrowing (PSNB) and Public Sector Net Debt (PSND) respectively, and are consistent with international reporting standards and legislation. PSNB is the difference between all public sector income and its expenditure, which results in either a deficit or surplus in each period. PSND is the stock of debt, which is the cumulative sum of these deficits or surpluses over time.

Public Sector Net Borrowing (PSNB)

Public Sector Net Borrowing (PSNB) is the difference between the income that government receives and its current plus net capital expenditure in a given period of time. PSNB is reported on an accrued basis – this means that transactions are recorded according to the period in which they are incurred, and not necessarily when the cash transaction takes place. This headline measure incorporates net borrowing across all of the public sector, including central and local government, as well as public corporations. PSNB has been the widely accepted measure of overall deficit/surplus since the late 1990s.





PSNB can be broken down into the excess of current expenditure over income, otherwise referred to as the Public Sector Current Budget Deficit (PSCBD), and Public Sector Net Investment (PSNI).

The latter refers to the acquisition less disposal of capital assets and liabilities by government. For the former, when current government expenditure exceeds current government income, the current budget deficit is positive, which adds to net borrowing. Therefore PSNB is governed by the following

equations:

–  –  –

where:

PSCBD=current expenditure-current receipts (2) In addition to PSNB, the Public Sector Net Cash Requirement (PSNCR) is another flow statistic that can provide useful information about the public finances. This was formerly referred to as the Public Sector Borrowing Requirement prior to the adoption of net borrowing measures for policy purposes in the late 1990s. The PSNCR is a measure of how much cash is required by the public sector to meet the difference between income and expenditure. This means PSNCR differs from PSNB as it is measured in cash terms rather than accruals, with transactions being recorded at the time that the cash changes hands.

Public Sector Net Debt (PSND) Public Sector Net Debt (PSND) is the total outstanding amount that the government has borrowed, cumulated over the entire period of government borrowing. It is expressed as total public sector

–  –  –

liabilities net of liquid financial assets. A liquid asset is one that can be converted to cash at short notice and with little loss in its value – government-held foreign currency and cash balances are examples.

The PSNCR is the flow equivalent of Public Sector Net Debt (PSND) – so changes in PSND between two points in time will approximately equal the net cash requirement for the intervening period, as shown in equation (3).

PSNDt ≈PSND(t-1) +PSNCRt (3) Note that this relationship does not hold exactly. Differences can occur, for example, if government bonds (mainly gilts) are issued at discounts or premia. The level of PSND is deemed to have changed by the nominal value of the gilts issued, whereas the PSNCR is affected by the actual cash amounts received, i.e. the nominal value minus its discount or plus its premium. PSND can also be impacted by fluctuations in exchange rates affecting the value of official reserves and reclassifications in and out of the public sector, while PSNCR is not.

“Ex” measures of Public Sector Finances The Government has made several direct interventions into the financial sector since 2007 in response to the global financial shock. The resulting reclassification of several recapitalised banking groups (including Royal Bank of Scotland and Lloyds Banking Group) as public financial corporations instead of private companies led to distortions to some of the aggregate public finance statistics. In order to be able to assess the underlying performance of the public finances free from such distortions, parallel measures of public sector deficit and debt were introduced which exclude these temporary effects.

The public sector net debt and net borrowing figures excluding these interventions are referred to as “PSND ex” and “PSNB ex”. These were initially measures that excluded the temporary effects of a number of financial interventions, such as the debt and borrowing of public sector banking groups as well as that related to schemes such as the Asset Purchase Facility, but included public sector banks’ transactions with government and interventions where the money spent was not expected to be recovered.

Following a public consultation and review of public sector finance statistics in 2014, the “ex” measures were simplified to exclude only the debt and borrowing of public banking groups.

Therefore, all other interventions are now included in the “ex” measures. This article uses the new “ex” measures throughout.

Factors affecting the public finances

Trends in the public sector finances tend to be driven by three main groups of factors. The first is the economic environment: the state of the business cycle is an important determinant of government income and expenditure. When the economy is growing strongly, tax revenues are likely to be buoyant reflecting strong growth in incomes and spending, while low levels of unemployment should reduce expenditure on social benefits. This should reduce the need for the government to borrow to bridge the gap between income and expenditure. In contrast, during a period when the economy is

–  –  –

contracting, such as the 2008-09 economic downturn, tax revenues are likely to be more subdued, while rising unemployment will increase expenditure on social benefits, resulting in an increase in borrowing and therefore debt.

The second set of influences on the public finances arises as a result of Government policy actions.

Government provides a range of goods and services that may not be readily supplied by the market in order to satisfy the individual and collective needs of the nation. The government also transfers resources between different parts of the population by levying taxes and re-distributing through social benefits. In the UK, government spending includes the provision of healthcare via the National Health Service and administering the welfare system, such as payment of the state pension. The main taxes are levied on consumption, wealth, profits and incomes. Changes in fiscal policy, such as tax rates and allowances, or changes in the level and composition of government spending will therefore have an effect on PSNB and PSND. However the public finances are also affected by other policies, such as the privatisation of nationalised industries or a programme of social housing sales. Annex A contains a timeline of some of the key policy changes that have had an impact on the UK’s public finances.

Finally, long-term trends and societal changes can have an impact on the public finances through changes in demand for certain public goods and services. For example, improving health outcomes should lower the need for certain treatments while the ageing population may increase the demand for others. The birth rate will also have an impact on the demand for education in the future. More subtly, changing consumption patterns can influence tax receipts though changes in demand for taxed relative to less-taxed goods.

Trends in Public Sector Finances

Public Sector Finance (PSF) statistics are measured in current prices and therefore reflect the effects of both price and volume changes. To allow for inflation and growth in the economy over time, long-term trends in public finances are expressed as a proportion of nominal GDP. However it should be noted that changes in income, expenditure, deficits and debt on this basis may arise due to variations in nominal GDP, even if the cash figures themselves are unchanged.

Public Sector Net Borrowing (PSNB)

As discussed, ONS measures Public Sector Net Borrowing (PSNB) as the difference between government income and expenditure. This can be split into current expenditure on the day-to-day activities of the government and capital spending, where the government spends money in one period in order to generate benefits in future periods. Figure 2 shows trends in PSNB (black line), and its components – PSNI (orange bars) and the public sector current budget deficit (PSCBD, blue bars), as a percentage of GDP.

–  –  –

Figure 2: Public sector current budget deficit and public sector net borrowing, % of nominal GDP, four-quarter moving average, Q1 1956 to Q2 2014 Source: Office for National Statistics

Notes:

1. PSCBD ex refers to Public Sector Current Budget Deficit excluding banks.

2. PSNI ex refers to Public Sector Net Investment excluding banks.

3. PSNB ex refers to Public Sector Net Borrowing excluding banks.

4. A negative current budget deficit implies a budget surplus, likewise negative net borrowing implies public sector net lending.

Having run a persistent current budget surplus between 1956 and the mid-1970s, the 1973-74 economic downturn saw a move into deficit which persisted through to the late 1980s. As net investment spending was reduced during the 1970s, the trend in net borrowing towards bigger deficits was less marked, and the average level of borrowing by the mid-1980s was similar as a share of GDP to its share in the 1960s.



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