A Survey of Public Spending in the UK

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2 A Survey of Public Spending in the UK Rowena Crawford, Carl Emmerson and Gemma Tetlow Institute for Fiscal Studies September 2009 Address for correspondence: Institute for Fiscal Studies, 7 Ridgmount Street, London WC1E 7AE; Rowena_C@ifs.org.uk or Carl_Emmerson@ifs.org.uk or Gemma_Tetlow@ifs.org.uk Acknowledgements: This Briefing Note is a revision of earlier versions by Carl Emmerson, Christine Frayne and Sarah Love, which can be downloaded from The paper was funded by the ESRC Centre for the Microeconomic Analysis of Public Policy at the Institute for Fiscal Studies (grant number M ). The authors would like to thank Robert Chote for help and advice during revision of this Briefing Note, and Lionel Browne for copy-editing. All remaining errors are the responsibility of the authors.

3 Contents A Survey of Public Spending in the UK Introduction Public spending in the UK Total public spending Total public spending in an international context The planning of UK public spending The elements of TME Why does the government divide total public spending into DELs and AME? Resource accounting and budgeting How the various parts of TME relate to the fiscal aggregates Spending on each of the main functions over time Social security The National Health Service Education Defence Public order and safety Debt interest payments Transport Official development assistance Recent issues in public spending Regional spending and the Barnett formula Public sector investment How firm and fixed are the Spending Reviews? Departments use of end-year flexibility Future pressures on public spending The government debt burden and medium-term spending plans Government policy commitments Longer-term spending pressures Conclusions Appendix A. Glossary

4 1. Introduction This Briefing Note provides an overview of public spending in the UK. It begins in Section 2 with a description of total public spending in the UK, how this has changed over time, and a brief international comparison. Section 3 explains how the current government plans spending, and gives a brief history of how and why this system for planning public spending has evolved. Section 4 describes the current allocation of public spending between different areas, and then focuses on how the amounts received by eight particular areas have changed over time. The areas considered are social security, health, education, defence, public order and safety, net debt interest payments, transport, and official development assistance: together these account for about 80 per cent of overall public spending. Section 5 comprises a discussion of some recent issues in public spending, including: the allocation of spending to the devolved regions through the Barnett formula, and how this might operate in an environment of spending cuts; the path of public sector investment over the past 60 years, and how things might look going forwards; and how the supposedly firm spending settlements have been affected by weak economic growth and departments use of end-year flexibility. Section 6 considers some future pressures on public spending, including the effect of the government debt burden on future spending plans, and the implications of some specific policy commitments and aspirations. Section 7 concludes. Data for most of the spending series contained in this Briefing Note are also available from the Fiscal Facts section of the IFS website

5 2. Public spending in the UK 2.1 Total public spending In the fiscal year the UK government spent billion, or 43.2 per cent of the UK s national income. This translates into just over 10,100 for every person in the UK, or about 13,000 per adult. The total amount of public spending is set out each year in the Budget. This expenditure is an aggregate derived from the National Accounts called total managed expenditure (TME). TME comprises expenditure by the entire public sector namely, the central government, local authorities and public corporations. Figure 2.1(a) shows TME in real terms and as a share of national income since , and the latest government projections to Figure 2.1(b) breaks down TME as a share of national income into various components of spending. Figure 2.1(a) shows that TME has grown relatively steadily in real terms, while both Figure 2.1(a) and Figure 2.1(b) show that public spending as a share of national income tends to fluctuate with the economic cycle. During the recessions of the early 1980s, the early 1990s and the late 2000s TME rose as a share of national income. This was both because national income grew slowly and because certain components of public spending (for example, spending on social benefits and debt interest payments) tend to rise during recessions. The former makes the denominator of the fraction relatively small (which is particularly important during the late 2000s recession, as inflation is exceptionally low) and the latter makes the numerator larger. Conversely, during the booms of the late 1980s and late 1990s the ratio of TME to national income fell. The gradual increase in TME as a share of national income between April 2000 and April 2006 took place during relatively strong economic conditions. So this increase reflects a structural increase in public spending, i.e. an increase in the amount of public spending over and above the natural variability that occurs over economic cycles. Similar to the early 1980s and early 1990s, the recession of the late 2000s is projected to cause an increase in social benefits spending and TME as a share of national income from April TME is forecast to peak at 48.0 per cent in , a level not seen since Figure 2.1(a). TME in real terms, to Between and the average annual real increase in TME has been 3.4 per cent. The average real rate of increase during the Conservative years of 1979 to 1997 was 1.5 per cent, and under the Labour government from April 1997 to March 2009 it has been 3.2 per cent. The plans from April 2009 to March 2011, if realised, imply growth averaging 4.7 per cent a year. 4

6 Figure 2.1(b). Composition of TME as a percentage of national income, to Note: Other current spending includes depreciation. Source: TME is from HM Treasury, Public Finances Databank, July 2009; components of public spending are ONS series ANLO, ANLT, ANLY, ANNW and ANNZ from Table 2.3C of Financial Statistics Freestanding; GDP is ONS series BKTL from Table A2 of the UK Economic Accounts. Projections are from Table 2.8 of HM Treasury, Budget 2009: The Economy and Public Finances: Supplementary Material, April Figure 2.2. General government expenditure over the 20th century Source: T. Clark and A. Dilnot, Long-Term Trends in British Taxation and Spending, IFS Briefing Note no. 25, June 2002 ( Figure 2.2 uses an alternative measure of government spending general government expenditure to look at spending over a longer period. General government expenditure is a narrower measure of government spending than TME, because the former excludes spending by public non-financial corporations, such as the formerly nationalised utilities. Government spending as a percentage of national income was relatively 5

7 low (below 30 per cent) in the 1920s and 1930s, grew rapidly during the Second World War, and fell back to about 10 percentage points above its pre-war level in the 1950s. From the 1960s onwards the fluctuations in the path of general government expenditure are very similar to those shown in Figure 2.1(a) and 2.1(b) for TME. 2.2 Total public spending in an international context In 2008 UK total government outlays as measured by the OECD were 48.1 per cent of national income. 2 As shown in Figure 2.3, this gave the UK the tenth highest level of public sector spending as a proportion of national income out of the 28 countries for which the OECD has consistent data, and the third highest out of the G7 countries. Figure 2.3. Total public spending, OECD countries, 2008 Note: Figures refer to general government total outlays. Source: Annex 25 of OECD, Economic Outlook No. 85, June 2009 ( Figure 2.4 shows how the changes in total government spending as a proportion of national income in the UK between 1970 and 2010 compare with the experience of a selection of other countries. Most of the countries had a similar increase in total public spending as the UK during the recessions of the early 1980s, but while the boom of the late 1980s resulted in a significant fall in UK government spending as a share of national income helped in part by a real fall in spending on social security benefits (see Figure 4.2(a)) France, Italy and the USA saw only small falls. All the countries again saw increases in government spending during the recession of the early 1990s, but this increase was halted or reversed in Europe and the US by the late 1990s. Since 1999 the UK has experienced a sustained increase in public spending, greater than that experienced by the other countries described, who typically either maintained 2 For more details see OECD Economic Outlook, Sources and Methods ( 6

8 or saw falls in their levels of public spending as a share of national income. All countries are projected to see public spending increase rapidly as a share of national income in 2009 as a result of the recession, with the increase between 2007 and 2010 in the UK totalling some 10 per cent of national income being projected to be the largest among these countries. Figure 2.4. Total public spending in selected countries, 1991 to Source: Data from 1991 onwards are as Figure 2.3. Historical data are from OECD.Stat ( 7

9 3. The planning of UK public spending 3.1 The elements of TME For planning purposes, TME is divided into two components: 1. Departmental expenditure limits (DELs) cover spending that the government argues can be controlled rather than being driven by demand. For example, most spending on the NHS, transport and education falls into this category. DELs are supposedly firm limits for departments spending over a three-year period. Since 1998 they have been determined in Spending Reviews once every two or three years. The most recent such review, 2007 Comprehensive Spending Review, fixed the limits for departments until The remainder of spending, which the government argues cannot sensibly be planned for in advance, is allocated annually. It is known as annually managed expenditure (AME). The major components of AME are social security payments, debt interest, and spending by local authorities. (The government actually has greater control over social security spending than its classification as AME suggests; the number of people qualifying to receive particular benefits under given rules may be out of the government s control, but it can determine the qualification criteria and the generosity of the payment concerned.) The Treasury publishes forecasts of AME in each Pre- Budget Report and Budget, which normally take place in autumn and spring of each year, respectively. In DELs accounted for 58 per cent of TME, and AME accounted for 42 per cent. Between April 1999 and March 2009 DELs grew at an average real rate of 4.7 per cent per year while AME grew at an average 2.9 per cent per year. Over the period April 2009 to March 2011, however, AME is forecast to grow faster than DELs, with planned average annual real growth rates of 8.1 per cent and 2.8 per cent respectively. This is, in large part, due to high growth in spending on social security benefits and debt interest payments arising as a result of the recession. 3.2 Why does the government divide total public spending into DELs and AME? Gordon Brown introduced the division of public spending into DELs and AME in It represents the most recent stage in a gradual evolution in the planning of public spending that has been under way since the early 1990s. This evolution has seen a lengthening of the time horizons of public spending planning and an increased focus on controlling departmental spending. The government asserted that its fiscal and public spending framework has been designed specifically to avoid the mistakes of the past. 3 But when one compares the current system with its predecessors, it is clear that the new framework does not represent a radical change. Rather, it is a development of previous techniques to try to minimise the extent to which the public spending framework produces inefficient incentives for departments. Public Expenditure Surveys and the control total Prior to 1992, public spending was determined in annual Public Expenditure Surveys. These usually took the form of a series of bilateral negotiations between the Treasury and each spending department. This made it difficult for the government to take a strategic decision on the overall level of public spending, or on the priorities within the total. Also, the lack of distinction between cyclical and non-cyclical components was seen as allowing the spending total to creep up. For example, a rise in discretionary 3 Source: Page 18 of HM Treasury, Planning Sustainable Public Spending: Lessons from Previous Policy Experience, London, November 2000 ( 8

10 spending after a recession could be masked by the fall in cyclical spending. Conversely, the rise in cyclical spending during recessions could potentially crowd out other programmes, particularly public investment. In 1992 the system was reformed to give the government greater power to manage aggregate public spending in a top-down way. Each summer the government set out each department s total planned spending for the next three fiscal years. This amount was known initially as the New control total, later became the control total, and was published in the autumn Budget. For example, the November 1996 Budget planned the control total for the years , and However, the plans for years 2 and 3 were not intended to be set in stone, and were often increased for certain functions, such as the NHS. Any department that failed to spend its control total in a given year forwent the unspent money. Each year s government spending forecasts included, in addition to the control total, other items such as the cyclical component of social security, central government debt interest payments, and various accounting adjustments. Unlike DELs, the control total included non-cyclical social security spending, such as that on child benefit and the basic state pension, since the numbers of recipients are relatively easy to predict. The control total excluded only social security payments that were highly cyclical by nature (such as unemployment benefits). All of these social security spending items are now in AME, even though, as we noted above, the government determines the qualification criteria for and generosity of payments. AME also includes various other elements of spending. The control total therefore accounted for a larger proportion of total public spending (about 85 per cent) 4 than DELs do. To allow some flexibility for reaction to unanticipated events, each year s planned control total included a reserve, which was not allocated to individual departments. This reserve was allocated as extra spending or removed from the spending plans altogether in the Budget prior to the spending year in question. After the control total was introduced, the Conservative government managed to meet its cash spending plans for the rest of its term in office. Therefore the reforms of 1992 should be recognised as an improvement in the planning of public spending. In many respects the control total can be regarded as a forerunner of the Labour government s DEL approach. The Labour government s criticisms of the 1992 spending framework The Labour government that came to power in 1997 argued that the control total method of budgeting hindered departments from spending and investing money in a calculated and efficient fashion. First, the Labour government argued, the indicative nature of the control totals for two and three years ahead meant that they could be revised substantially up to a year in advance, which created an uncertain environment for departments to plan expenditure. Second, the fact that the totals were not divided into current and capital spending meant that, if budgets were tight, departments might be tempted to cut back on investment to meet more pressing needs, such as public sector workers wages. This is because the effects of underinvestment on the quality and quantity of public services provided may take several years to become apparent, whereas the effects of cutting back on current spending are noticeable much sooner. Third, if departments failed to spend the money they had been allocated for a particular year, they were not able to carry forward the spare cash from one year to the next. This encouraged a use it or lose it mentality, and led to concerns that rushed spending towards the end of the financial year might be used wastefully. The Labour government argued that, taken together, the factors outlined above encouraged underinvestment (or inefficient investment) in public services. 4 Source: Chapter 6 of A. Dilnot and C. Giles (eds), Options for 1997: The Green Budget, IFS, London, October

11 The Spending Reviews The Labour government replaced a system in which control totals were determined through annual surveys with one in which departmental spending (within DELs) is formally fixed for three years in Spending Reviews. There have now been five such reviews: Comprehensive Spending Review in 1998 (planning for April 1999 to March 2002), Spending Review 2000 (planning for April 2001 to March 2004), 2002 Spending Review (planning for April 2003 to March 2006), 2004 Spending Review (planning for April 2005 to March 2008), and 2007 Comprehensive Spending Review (planning for April 2008 to March 2011). Before each Spending Review, the Economic and Fiscal Strategy Report (now published each spring at the same time as the Budget) sets out an envelope for the next three years spending. The Spending Review then fills in the details, allocating spending by department. For example, the 1998 Comprehensive Spending Review was preceded by an Economic and Fiscal Strategy Report in June 1998, and the latter set the plans for TME. The Spending Review then allocated the TME to DELs and AME, and split the DELs by department. 5 Similarly the March 2007 Budget set the TME and planned allocations for the Department for Education and Skills until March The October 2007 Pre-Budget Report and Comprehensive Spending Review then determined the split between DELs and AME, and the remaining departmental allocations. 6 Departments DELs are divided into one DEL for capital spending (i.e. for spending that adds to the public sector s fixed assets) and another for spending on other items, known as resource spending. A department cannot transfer funds from its capital DEL to its resource DEL. Separating DELs into nonfungible capital and resource components was designed to encourage departments to undertake the public investment they were budgeted to do. AME is also divided into capital and resource components. Figure 3.1 shows the current division of total DELs by department for , the most recent year for which actual (as opposed to planned) allocations are available. The DELs are split into capital and resource components. The graph shows that in the Department of Health had the largest DEL, and accounted for over one-fifth of total DELs by itself. Defence had the highest capital DEL, at 8.6 billion. Communities and Local Government ( CLG Communities ) and the Department of Energy and Climate Change had the highest ratios of capital DEL to total DEL, making them the most capital-intensive departments. Their capital DELs each accounted for nearly two thirds of their total DEL. The Department for Transport was the third most capital-intensive department, with just over half its DEL being accounted for by capital DEL. Overall, 11.3 per cent of departments total DELs was allocated to capital spending. The amount and form of capital spending done by the public sector are discussed in section 5. The distinction in DELs between capital and non-capital spending has given the government the ability to target each type of spending specifically. When the Labour government introduced the distinction, longstanding underinvestment in the public sector was seen as a problem, and the ring fencing of capital DELs helped to correct this. This approach does have potential drawbacks, however. If departments have a certain proportion of their budgets set aside for capital spending, irrespective of the benefits of that capital spending relative to the current spending that could be done in its place, then a situation could arise in which capital spending projects of low value to the public get commissioned while current spending ones of higher value do not. 5 Similarly, the March 2000 Budget set the TME and planned NHS spending to March 2004; the April 2002 Budget set the TME and planned NHS spending until March 2008 (whereas all other departments plans, which were announced in July 2002, extended only to March 2006); and the March 2004 Budget set the TME and planned the allocations for the Department for Education and Skills and for total education spending in the UK until March Some smaller departments had already had their allocations announced prior to this, in the March 2006 Budget and the December 2006 Pre-Budget Report. The departments whose allocations were announced in the March 2006 Budget were the Home Office, the administrational part of the Department for Work and Pensions, HM Revenue and Customs, HM Treasury, and the Cabinet Office. The departments whose allocations were announced in the December 2006 Pre-Budget Report were the Department for Constitutional Affairs, the Privy Council Office, National Savings and Investments, the Central Office of Information, the Food Standards Agency, and the Government Actuary s Department. 10

12 Figure 3.1. Departmental expenditure limits for each department, Notes: DIUS is the Department for Innovation, Universities and Skills; DEFRA is the Department for Environment, Food and Rural Affairs; BERR is Business, Enterprise and Regulatory Reform; FCO is the Foreign and Commonwealth Office. The Northern Ireland category refers to the Northern Ireland Executive, and does not include the Northern Ireland Office. The Chancellor s departments include HM Revenue and Customs, HM Treasury, and the Office for National Statistics. DIUS and BERR were merged in June 2009 to form the new Department for Business, Innovation and Skills (BIS). The distinction between resource DEL and capital DEL is explained in Section 3. Source: HM Treasury, Public Expenditure Outturn Update, July 2009 ( More recently the capital budget has been targeted for spending cuts. The October 2007 Comprehensive Spending Review planned for investment spending to continue to rise to 2.3 per cent of national income in , while the Treasury s subsequent Long Term Public Finance Report, published alongside the March 2008 Budget, assumed that in the long run this would then stabilise at 2.0 per cent of national income. 7 The government has since cut back its investment plans, and is now planning on investment spending of 1.3 per cent of national income in If delivered, this would be comparable to the level seen in the first half of the 1990s. While in the short term the impact of this low level of investment on public services might be mitigated by the recent high levels of investment spending, it seems clear that this decision has been motivated by the impact of the financial crisis and recession on the government s finances, rather than by a belief that lower levels of investment spending are consistent with its aspirations (or at least its previous aspirations) for public services. Another change that was introduced in 1998 was in the way in which any unspent budget allocation is dealt with at the end of the financial year. Instead of forgoing any money that is not spent in the year to 7 Paragraph 3.44, page 31, HM Treasury, Long-Term Public Finance Report: An Analysis of Fiscal Sustainability, March 2008 ( 11

13 which it is allocated, departments can now carry funds over from one fiscal year to the next by accruing an end year flexibility (EYF) entitlement. Under the EYF scheme departments retain an entitlement to all of their unspent DELs from previous years (less any adjustments for any DEL reserve claims agreed during the course of the year). 8 The government hoped that this would remove the incentive for end-of-year splurges. But comparing the monthly totals for central government cash outlays before and after the introduction of EYF entitlements, there appears to have been hardly any change in the proportion of annual spending that takes place in the final months of the financial year. Figure 3.2 shows the proportion of central government total cash outlays that were spent in the final month, and final two months, of each financial year for the past two decades. There seems to be little difference between these proportions before and after the introduction of EYF (represented by the dashed line). The average proportions spent in the final month and two months of the financial year between and the introduction of EYF in were 9.8 per cent and 18.0 per cent respectively. In the period since the introduction of EYF these have fallen slightly to 9.5 per cent and 17.4 per cent respectively. These figures are still both higher than if spending was evenly distributed over the financial year, in which case 8.3 per cent (1/12th) would be spent in the last month, and 16.7 per cent (2/12ths) in the last two months. Figure 3.2. Proportion of central government net departmental outlays spent in the final months of the financial year, to Source: ONS series RUUP from Financial Statistics Freestanding, Table 2.1A. 3.3 Resource accounting and budgeting Prior to the changes announced in 1998, spending was listed in a department s budget in the year in which it took place. Public spending was either current or capital, the former being spending on items such as wages and the latter being spending on fixed items such as buildings, vehicles and machinery. In 199, the government decided to change from cash-based budgeting to resource accounting and budgeting (RAB). The aim of RAB is to provide an accurate account of a department s underlying financial position in any given year, rather than a snapshot of how much money went into/out of that department as cash. For instance, depreciation does not show up in cash-based spending plans, because the department is not literally paying cash for it each year. But it is a genuine annual cost that worsens the 8 EYF was introduced in HM Treasury, Economic and Fiscal Strategy Report 1998: Long Term Stability and Investment, Cm. 3978, London, June

14 department s asset position. If, for example, a department buys an item of machinery worth 10 million that has a resale value of 0 at the end of 10 years, then (under straight-line depreciation) the department loses 1 million-worth of machine each year, although the loss does not take the form of a cash payment. RAB takes this loss into account. The move to RAB took place in two stages. In Spending Review 2000 the DELs were given on an accruals basis. Under accruals accounting, costs and revenues are matched to the years in which they occurred, as opposed to the years in which the cash entered or left the department. The second stage was the incorporation of non-cash costs, such as depreciation and cost of capital charges (which reflect the opportunity costs of holding capital), into resource DELs. This happened in the 2002 Spending Review. All current spending is in the resource budget (resource DEL + resource AME). Unlike the old current budget, the resource budget includes the costs of depreciation, cost of capital charges, provisions for future costs, and grants paid to the private sector. The capital budget (capital DEL + capital AME) includes only departmental spending on items that create new assets on the balance sheet of the government. Grants to non-governmental organisations to fund those organisations investments are not included, because the grants do not change the government s net asset position. 3.4 How the various parts of TME relate to the fiscal aggregates The resource budget of all government departments measures the government s spending on various current items. It is closely related to public sector current expenditure. The connection between the two fiscal measures is shown in Figure 3.3. Similarly, capital DELs and capital AME relate to public sector net investment, as shown in Figure 3.4. Figure 3.3. The components of public sector current expenditure Resource budget of departmental DELs + Resource budget of non-departmental DELs + Resource budget of departmental AME + Resource budget of other AME + Accounting adjustments + Adjustments for classification differences = Resource DEL = Resource AME = Adjustments = Public sector current expenditure 13

15 Figure 3.4. The components of public sector net investment Capital budget of departmental DELs + Capital budget of non-departmental DELs + Capital budget of departmental AME + Capital budget of other AME + Accounting adjustments + Adjustments for classification differences - Depreciation = Public sector net investment = Capital DEL = Capital AME = Adjustments Total managed expenditure is the sum of public sector current expenditure, public sector net investment and depreciation. Public sector current expenditure plus depreciation, when subtracted from public sector current receipts, gives the current budget surplus. So an increase in resource spending that increases public sector current expenditure (or depreciation) will reduce the current budget surplus. Public sector net borrowing in a given year reflects the difference between public sector net investment and the current budget surplus (or, equivalently, the difference between current receipts and TME). So a larger amount of capital spending in a given year means an increase in public sector net investment. This adds to public sector net borrowing, and increases the public sector net debt ratio. 14

16 4. Spending on each of the main functions over time The amounts allocated to spending functions differ from the allocations to government departments (which were shown in Figure 3.1). For example, spending on education comprises spending from the DEL of the Department for Children, Schools and Families and DIUS, spending by local authorities, and spending in Scotland, Wales and Northern Ireland. The DEL of the Department for Work and Pensions is only a small proportion of spending on social security, because most of this spending takes the form of AME. Figure 4.1 shows where government spending in went, by function. Seven of the areas we shall examine individually social security, the National Health Service (NHS), education, defence, public order and safety, net debt interest payments, and transport together accounted for nearly 80 per cent of total spending in The biggest of these, social security, accounted for 27 per cent by itself. The UK government s spending per family amounted, in , to about 5,400 on social security, 3,600 on health, 2,600 on education, 1,200 on defence, 1,100 on public order and safety, 800 on debt interest payments, and 700 on transport. We can therefore account for, and explain changes in, most of government spending by understanding what changes have taken place in these seven areas. We also look briefly at spending on overseas aid at the end of this section. Figure 4.1. UK government spending measured as TME, by function, Source: Social security spending is taken from Budget 2009 estimates. Net debt interest payments are from ONS series ANLO and ANBQ. All other figures are taken from HM Treasury, Public Expenditure Statistical Analyses Table 4.1 shows the real average annual rate at which public spending in the seven areas mentioned above has changed over time. Spending on social security, education and the NHS has grown faster over the past five decades than have total public spending, current spending and national income. These three areas have therefore increased their respective shares of public spending and national income. The NHS in particular has experienced substantial growth, with average annualised real increases of 3.2 per cent under the Conservative governments from 1979 to 1997, and 6.3 per cent under Labour from 1997 to 15

17 2008. Spending on public order and safety has also experienced very high real growth over the period since 1979, with an average annual growth rate of 4.0 per cent between April 1979 and March 1997, and 3.7 per cent between April 1997 and March In contrast, spending on net debt interest payments has historically grown more slowly than TME: under the Conservatives between 1979 and 1997 real average annual growth was just 0.6 per cent, and under the Labour government to date spending on net debt interest has been falling by an average 2.5 per cent in real terms each year. However, from April 2008 this area of spending is forecast to increase at an average annual real rate of 16.1 per cent, which is far more rapid than the growth seen in any other area of public spending. Expansions in health, education and social security spending have been at the expense of other spending areas. Defence in particular saw a lengthy period of falling spending under the Conservatives, and has seen relatively slow growth under the Labour government to date. Net investment spending also saw a long-term decline, with an average annual real decline of 5 per cent during the Conservative government 1979 to However, under the Labour government investment spending increased dramatically, with average real growth of 13.9 per cent a year between 1997 and The path of investment spending over the last five decades is discussed in more detail in section 5. The changes in current and capital spending have had drastic effects on the composition of public spending. The ratio of current to investment spending has increased from 10:1 in to 19:1 in , hitting peaks of 118:1 in and 70:1 in Table 4.1. Real increases in spending in the main areas. Annualised average real increase, % Long-term trend April 1979 to March 1997 April 1997 to March 2008* April 2008 to March 2011 Social security NHS Education Defence * n/a Public order and safety n/a n/a Net debt interest payments Transport n/a n/a TME, of which: Net investment Current spending National income Notes: *Defence trend is April 1998 to March Current spending includes depreciation. Long-term trends are to for TME, current spending, net investment, net debt interest payments and social security; to for the NHS; to for education; and to for defence. Sources: HM Treasury, Public Expenditure Statistical Analysis 2009 and previous PESAs; HM Treasury, Public Finances Databank, July 2009; HM Treasury, Public Expenditure Outturns key series update July 2009; HM Treasury, Budget 2009; HM Treasury website ( Office for National Statistics, Blue Book; Office for National Statistics, Financial Statistics Freestanding; Office for National Statistics, UK Economic Accounts; Office of Health Economics. Table 4.2 shows spending in the same areas as a percentage of national income at various points over the last 50 years. Once again, social security, the NHS and education are the main areas of growth. TME itself occupied a larger share of national income in than in , and, within TME, current spending s share has grown while net investment s share is still less than what it was in There has however been a significant increase in investment spending s share of national income since the late 1990s. 16

18 Table 4.2 Spending as a share of national income in the main areas Percentage of national income, % Social security NHS Education Defence Public order and safety n/a Net debt interest payments Transport n/a TME, of which: Net investment Current spending Notes: Net investment spending and current spending may not sum to TME exactly because of rounding. Current spending includes depreciation. Sources: As Table Social security Social security is the largest single component of public spending. Its share of general government expenditure had risen from about 15 per cent just after the Second World War to 30 per cent by the late 1990s. 9 As a share of TME, social security spending increased from 14.5 per cent in to a peak of 33.0 per cent in , before falling to 27.5 per cent by Spending on public sector social benefits in real terms, from fiscal year onwards, can be seen in Figure 4.2(a). The same spending, presented as a share of national income, is shown in Figure 4.2(b). Much of the variation in social security spending over time is due to fluctuations in the economic cycle, as is shown in Figure 4.2(a) and accentuated in Figure 4.2(b). For example, social security dipped markedly during the late 1980s, mainly because rising incomes and falling unemployment reduced people s reliance on benefits such as income support and support for the unemployed. A similar dip in spending occurred in the late 1990s: this happened partly because Labour s tight spending limits allowed benefits only to be increased in line with prices for the government s first two years, and partly because of strong economic performance, which delivered rising incomes and falling unemployment. By contrast, in the recessions of the early 1980s, the early 1990s and the late 2000s social security spending as a share of national income increased markedly, owing to rising spending on unemployment and means-tested benefits, and poor economic growth. Because social security is so responsive to the economic cycle, unlike other spending areas it is planned largely on an annual basis. The total DEL for the Department for Work and Pensions (DWP), which administers social security, was set in the 2007 Comprehensive Spending Review to be just under 8 billion in compared with AME for social security of 170 billion. However, spending on the basic state pension alone totalled 47.7 billion in , which was 30.6 per cent of total benefit and tax credit expenditure in the UK. 10 The number of individuals entitled to this benefit is actually largely unresponsive to the economic cycle. This suggests that a large component of AME can be forecast with reasonable accuracy more than a year in advance. Indeed, the Conservative government was able to include a large proportion of social security in its control total. 9 Source: T. Clark and A. Dilnot, Long-Term Trends in British Taxation and Spending. IFS Briefing Note no. 25, IFS, London, Source: Department for Work and Pensions, Benefit and Expenditure Tables (available at 17

19 Figure 4.2(a). Social security spending in real terms, to Figure 4.2(b). Social security spending as a share of national income, to Source: to from ONS series ANLY; to from HM Treasury, Budget Projections for social security spending to indicate rising spending in real terms, owing to the impact of the recession in the late 2000s. However, the projections in Figure 4.2(a) and 4.2(b) incorporate only spending announcements up to the present, so any further government announcements that increase social security spending will change the prognosis. There are a number of government aspirations that represent sources of upward pressure to spending on social security. These are discussed in section 6. The accuracy of the projections also depends on that of the macroeconomic forecasts. If the economy is slower to recover from the recession than anticipated, or if unemployment remains high for longer, then social security spending over the next few years could be higher than currently being forecast. 4.2 The National Health Service Spending on the NHS has grown significantly both as a share of public expenditure and as a share of national income. Between and it went from 9.3 per cent of TME to 18.3 per cent. The fact that overall health spending (i.e. public and private) has increased as a share of national income is not surprising, for at least three reasons: the demographic changes that have increased the proportion of 18

20 elderly people in the population; the general propensity of societies to spend a higher share of their income on health as that income rises; and the increase in the range of treatable ailments. These are likely to outweigh the countervailing pressure from technological improvements and the expiry of patents, which should reduce the cost of treatments over time. Figure 4.3(a) shows that spending on the NHS has grown steadily in real terms. From April 1979 to March 1997 UK NHS spending rose at an average annual real rate of 3.2 per cent. Between April 1999 and March 2008 spending on the NHS grew by an average 6.3 per cent a year in real terms. According to the plans set out in Budget 2009 the average annual growth rate is expected to slow to 4.3 per cent between April 2009 and March Figure 4.3(a). Historical and forecast NHS spending in real terms to Figure 4.3(b). Historical and forecast NHS spending as a share of national income, to Source: to from Office of Health Economics; to uses plans for NHS England from HM Treasury, Budget 2009, and assumes that regions shares of UK health spending are the same as their shares of UK NHS spending, and that these shares remain constant over time (at England 83%, Scotland 9%, Wales 5% and Northern Ireland 3%). Shares of UK health spending are from HM Treasury, Public Expenditure Statistical Analyses The spending increases seen since the late 1990s are not only much larger than in past decades, but have also been more sustained than any spending increases in the past. Historically the NHS has often received large real increases in spending for one or two years in a row, interspersed with years of lower spending 19

21 growth. For example, the annual real increases in NHS spending were 7.4 per cent and 4.8 per cent in and respectively, but spending growth in fell to 2.0 per cent. The recent substantial increases in NHS spending were determined in light of the recommendations of the Wanless Review, an independent review of the health service in the UK that was undertaken by Derek Wanless and completed in April The review set out three scenarios for funding the NHS up to , each of which made assumptions about the future demand for and supply of healthcare, including factors such as levels of obesity, smoking rates, lifestyle changes, demographic change and increases in NHS productivity. The government agreed to meet the spending figures implied by the scenario with the most optimistic view of the future (the fully engaged scenario which required the lowest growth in NHS spending) up to March In 2007 a review of NHS funding and performance since was conducted. 12 Wanless concluded that spending on the NHS up to had increased broadly in line with the 2002 recommendations for the fully engaged scenario, but that the spending increases had not been combined with the productivity increases that were assumed in the review. Increases in NHS productivity have been more like those assumed under the slow uptake scenario (the Wanless scenario with the least optimistic view of the future, and requiring the greatest increases in NHS funding). This means that funding increases even greater than those recommended in the 2002 Wanless Review for to would be needed if the high-quality services envisaged for are to be delivered. A recent analysis by Appleby, Crawford and Emmerson shows that the plans for total public spending over the period to will, in the absence of deep cuts to spending on public services elsewhere, lead to spending on the NHS falling further behind that deemed necessary by the initial Wanless Review, and that increased NHS productivity is unlikely to be sufficient to fill the gap. 13 The vast majority of health expenditure in the UK is financed publicly nearly 87 per cent in Figure 4.4 shows how public and private health expenditure, each as a proportion of national income, have changed over time. Private health expenditure, as a share of national income, has been gradually increasing since the mid 1970s, from 0.5 per cent in 1975 to a peak of 1.4 per cent in However, since then, private health expenditure has been declining, falling to 1.1 per cent by The rapid increases in NHS spending since could be in part responsible for this. The increase in NHS spending, and the consequent improvement in services and reduction in waiting times, has reduced the quality differential between the NHS and the private sector. This could have reduced individuals willingness to pay extra for private health care, and so the increases in NHS spending may have crowded out some health spending that would otherwise have occurred privately. It is clear from Figure 4.4, however, that despite the fall in private health spending since 1999, total health care spending in the UK as a share of national income has been increasing rapidly over this period, and so most of the increase in NHS spending does represent additional UK health spending. 11 D. Wanless, Securing Our Future Health: Taking a Long-Term View, HM Treasury, London, April D. Wanless, J. Appleby, A Harrison and S. Patel, Our Future Health Secured? A review of NHS funding and performance, King s Fund, 2007 ( ) 13 See J. Appleby, R. Crawford and C. Emmerson, C. How cold will it be? Prospects for NHS funding: , King s Fund, London, 2009 ( 20

22 Figure 4.4. Private and public health expenditure in the UK, 1960 to 2007 Source: OECD, OECD Health Data Figure 4.5 shows how the share of national income that the UK spends on health compares with that for five other major economies in All of the other countries except Japan spend a higher share of national income on health than the UK does. The USA, which is the biggest spender on health in the OECD, devotes a share of income that is over 80 per cent higher. As well as spending a relatively low share of national income on health, the UK also finds a relatively high proportion of that publicly. Out of total spending on health, 82.0 per cent is public expenditure in the UK, compared with 81.3 per cent in Japan, 79.1 per cent in France, 76.8 per cent in Italy and Germany, and just 45.2 per cent in the USA. Figure 4.5. Spending on health as a share of national income in selected major economies, 2006 Source: OECD, OECD Health Data

23 4.3 Education The percentage of general government expenditure devoted to education spending rose steadily from 7.3 per cent in 1953 to 13.3 per cent in By 1979 it had fallen to 12.2 per cent. Measured as a share of TME, education spending has remained relatively steady between 10 and 13 per cent for the past 45 years. In real terms, the average annual increase in education spending between and was 4.3 per cent. Figure 4.6(a) shows that education spending remained almost unchanged in real terms between and , after which it rose gradually until , then fell very slightly, and has recently begun to increase at a faster rate from April Viewed as a share of national income, education spending increased rapidly until the 1970s, and has since fluctuated at around 5 per cent (Figure 4.6(b)). Figure 4.6(a). Historical and forecast education spending in real terms, to Figure 4.6(b). Historical and forecast education spending as a share of national income, to Source: HM Treasury, Public Expenditure Outturns key series update July 2009; HM Treasury, Public Expenditure Statistical Analyses 2009 and previous PESAs; ONS Blue Book. Forecasts from HM Treasury, Budget Spending on education is driven by a combination of demographics and demand. Spending on primary and secondary education, for example, is a function of the number of school-aged children. By contrast, spending on higher education depends not only on the student-age population but also on how large a 22