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Select Committee on Treasury First Report

2 OVERALL SPENDING ISSUES

The final spending totals

3. We explored the background to the 2007 Comprehensive Spending Review in our earlier Report on the subject published in June 2007.[8] As we noted then, in accordance with the practice in 2002 and 2004, the overall spending totals for the period to be covered by the Comprehensive Spending Review—from 2008-09 to 2010-11—were announced in the preceding Budget. Thus, in the 2007 Budget, the then Chancellor of the Exchequer, the Rt Hon Gordon Brown MP, announced that total public spending would rise by an average of 2.0% a year in real terms in the period from 2008-09 to 2010-11.[9] In announcing the outcome of the Comprehensive Spending Review in October 2007, the new Chancellor of the Exchequer confirmed that total spending in 2008-09 and 2009-10 would rise in line with those earlier plans, but also indicated that there would be additional spending on health and education of £2 billion in 2010-11, so that total public spending is now expected to rise at 2.1% a year in real terms over the period from 2008-09 to 2010-11.[10] Projected net borrowing in 2010-11 has risen from £26 billion to £28 billion in consequence of this decision.[11] The Chancellor of the Exchequer told us that his decision to increase planned expenditure in 2010-11 arose from a judgement that "the investment is needed" and that it would be "prudent" to increase spending in this way.[12]

4. As we noted in June 2007, the planned rate of growth in public expenditure in coming years is significantly below the rate of growth delivered by the preceding Spending Reviews in 2000, 2002 and 2004. Total Managed Expenditure rose or is planned to rise at an annual average rate of 4.0% between April 1999 and March 2008, broadly twice the rate of growth envisaged for the period from 2008-09 onwards.[13] The Chief Secretary stated that this slowing in the pace of growth followed "ten years of significant if not unprecedented investment in public services", had been "well signalled" and was "the right response to the situation that faces us today".[14]

Annually Managed Expenditure

5. When we considered prospects for this Comprehensive Spending Review, we noted the importance of the decision to be announced as part of the final outcome of the Review on the division of Total Managed Expenditure between Departmental Expenditure Limits to be set for a three-year period and Annually Managed Expenditure. The latter comprises those elements of public spending that the Government does not consider it appropriate to subject to firm multi-year limits at a departmental level. Annually Managed Expenditure includes expenditure on social security benefits and tax credits, locally-financed government expenditure, central government gross debt interest and net expenditure transfers to EU institutions. During the period since 1998, Annually Managed Expenditure has generally grown more slowly than Total Managed Expenditure as a whole, principally due to the savings in social security expenditure from falling unemployment and the reductions in debt interest payments arising from improvements in the overall state of the public finances. This has meant that the Government has been able to plan to increase spending within Departmental Expenditure Limits more rapidly than public spending as a whole and to re-allocate shortfalls in spending within Annually Managed Expenditure to programme expenditure in addition to initial allocations in Spending Reviews.[15]

6. During the period covered by the 2007 Comprehensive Spending Review, in contrast to most of the preceding decade, both expenditure within Departmental Expenditure Limits and Annually Managed Expenditure are forecast to rise at the same average annual rate of 2.1% in real terms.[16] Because the growth rate of expenditure within Departmental Expenditure Limits had previously exceeded that of Total Managed Expenditure as a whole, this means that the slowdown in the rate of growth of expenditure within Departmental Expenditure Limits will be sharper than the slowdown in public expenditure as a whole.[17]

7. By its nature, Annually Managed Expenditure is not easy to forecast, and is not subject to firm multi-year controls of the kind that apply to expenditure within Departmental Expenditure Limits. By far the largest component of Annually Managed Expenditure is that on social security benefits. This is forecast to rise slowly, based in part on the "cautious assumption" that United Kingdom claimant unemployment will rise slowly from recent average levels of 0.86 million to 0.92 million at the end of 2009, and stay constant thereafter.[18] Expenditure on tax credits is forecast to grow slightly faster than that on social security benefits, although we have noted previously that this forecast is made on the basis of existing take-up rates, while the Government is seeking ways to increase take-up rates, particularly the low take-up rate of 25% of entitlement in 2004-05 for Working Tax Credit among those entitled to claim it and who do not have children.[19] Net expenditure transfers to EC institutions are forecast to rise at above the overall rate of increase of Annually Managed Expenditure as a whole. Treasury officials confirmed that this was partly due to changes to the United Kingdom's abatement arrangements, while also pointing to other factors affecting net expenditure transfers.[20] Overall, the Treasury was confident that its forecasts for Annually Managed Expenditure were "prudent, sensible and consistent with recent trends in social security, for example".[21] Mr Robert Chote of the Institute of Fiscal Studies broadly supported this characterisation of the Treasury's forecasts, subject to the point that no additional provision had been made for spending to reduce child poverty,[22] a matter to which we return later in this Report.[23]

Understanding growth in "real terms"

8. As we have noted previously, both increases in overall spending and individual spending settlements are generally referred to by the Government as percentages in "real terms". This approach is generally clearer than describing percentage increases in "nominal terms"—in other words, without taking account of the effect of inflation. The use of nominal terms would have the effect of overstating increases. For the purposes of determining "real terms", the Treasury uses the GDP deflator, which is a measure of general inflation in the domestic economy. For the years covered by the Comprehensive Spending Review, the Treasury is currently using a GDP deflator of 2¾% in each year.[24] The use of the GDP deflator in describing public sector budgets is a long-standing practice of the Treasury, but this measure can be of limited value in understanding the actual effect of expenditure allocations of a particular size in particular areas, partly due to the Relative Price Effect—in other words, the movement over time of a specific price index relative to a general price index such as the GDP deflator.[25] Dr Martin Weale of the National Institute of Economic and Social Research pointed out to us that the cost of Government consumption during the period from 1997 to 2006 relative to 1996 prices had risen 1.7 percentage points per year faster than the GDP deflator, so that, if that pattern persisted, claimed real terms growth of 2.1% a year over the period of the Comprehensive Spending Review would only generate a real increase in Government consumption of 0.4% a year.[26]

9. Treasury officials argued that the GDP deflator was still the most appropriate measure to use for calculating public expenditure in "real terms", arguing that overall cost pressures across the public sector were not substantially higher than cost pressures across the economy as a whole.[27] Both they and the Chief Secretary stressed that individual spending settlements took account of the particular cost pressures in particular sectors so that, for example, the transport settlement took account of construction costs.[28]

The impact of population growth

10. The overall value of spending settlements is also likely to be affected by the size of the population using particular public services. When we examined the prospects for the Comprehensive Spending Review, we noted the potential impact on public spending of population growth in coming years, as a result of both natural growth and net inward migration. We concluded that the Government could have provided more information on the likely impact of net migration on demand for public services over the period covered by the Comprehensive Spending Review and we recommended that, in advance of the final outcome of the Comprehensive Spending Review, the Treasury commission an analysis of the impact of net migration on demand for individual public services, to be published as part of the final announcement on the outcome.[29] In its response to our earlier recommendation and in oral evidence, the Treasury pointed to the analysis that had previously been undertaken on demographic pressures.[30] The Chief Secretary assured us that "population change was very much part of [the] planning process that underpinned the whole exercise", with the settlements for individual departments reflecting that analysis.[31]

11. Shortly after we took evidence from the Chief Secretary, the Office for National Statistics (ONS) published updated forecasts of the population of the United Kingdom in coming years.[32] The central projection of the ONS is that the population of the United Kingdom will rise from 61.0 million in mid-2007 to 62.3 million in mid-2010. The House of Commons Library estimated that, on the basis of these figures and the public spending totals given in the 2007 Comprehensive Spending Review, public spending per head will grow in real terms by 1.3% in 2008-09, 1.2% in 2009-10 and 1.4% in 2010-11.[33] The Chancellor of the Exchequer noted that population growth had been a feature for a number of years and stated that the spending settlements had taken full account of the ONS's projections. He pointed to individual spending settlements, such as those for the National Health Service, housing and transport infrastructure, which took particular account of population pressures.[34]

Public sector pay

12. At the time of the 2007 Budget, the Government indicated that it saw restraint on public sector pay spending as an essential way of securing value for money for overall spending throughout the period to 2010-11, making it clear that "pay settlements must be consistent with the achievement of the CPI [Consumer Prices Index] inflation target of 2%".[35] In oral evidence to us in January, the Rt Hon Stephen Timms MP, the then Chief Secretary to the Treasury, implied that upward pressure on public sector wage settlements might lead to job reductions.[36]

13. We received some evidence that questioned the sustainability of restraint in public sector wage settlements. Ms Bridget Rosewell, Chairman of Volterra Consulting, thought that industrial relations problems "will intensify under these circumstances".[37] Dr Weale thought that the Government's ambitions to deliver an increase in the volume of services might be threatened if public sector workers obtained higher settlements than the Government was planning for, a view echoed by Mr Chote.[38] The Public and Commercial Services Union argued that "a continuation of the current 2% cap on public sector pay awards is both unjustified and unsustainable … The policy will fail to recruit, retain and motivate staff with the necessary skills for the wide variety of tasks and jobs across the public sector."[39]

14. Treasury witnesses emphasised that the pay policy applied to overall wage bills rather than individual pay. Overall settlements at 2% were likely to result in individual public sector wages rising by about 3½% a year, which was consistent with real income growth.[40] They contended that overall pay restraint was compatible with measures to address localised problems, most notably those associated with lower paid workers, including those within the National Health Service.[41] Overall, however, the Chief Secretary emphasised the need for continuing "discipline" with regard to pay to "help departments reach their value for money targets and also live within their overall spending allocation".[42]

8 HC (2006-07) 279, paras 4-13 Back

9 Ibid., paras 17-18 Back

10 HC Deb, 9 October 2007, col 175; Pre-Budget Report and Comprehensive Spending Review 2007, paras 3.23-3.24, p 40 Back

11 Pre-Budget Report and Comprehensive Spending Review 2007, Table 2.2, p 24 Back

12 HC (2007-08) 54, Qq 273-276 Back

13 HC (2006-07) 279, paras 19-21 Back

14 Q 2 Back

15 HC (2006-07) 279, paras 22-28 Back

16 Pre-Budget Report and Comprehensive Spending Review 2007, Table 3.2, p 41 Back

17 HC (2007-08) 54, Q 41. See also HC (2006-07) 279, paras 23-24 Back

18 Pre-Budget Report and Comprehensive Spending Review 2007, Table B.11 and Box B1, pp 173, 163 Back

19 HC (2006-07) 279, para 26 Back