Public spending

This issue brief relates to a developing news event. For full details of the 2008 Budget visit our in-depth Budget section.

What is Public Spending?

Public spending is expenditure incurred by the "public sector" in the course of its activities. The public sector, in organisational and economic terms, is the sum of those parts of the economy formally under the control of or responsible to the state, including both central and local government.

The term "public spending" is most commonly used to refer to the aggregate sum of all public sector expenditures. As with most economic terms, there are many different ways of measuring public spending so conceived.

The Government's preferred measure is Total Managed Expenditure (TME), which describes all forms of expenditure made by central government, local authorities and public enterprises. This includes in particular spending on social services and benefits, health provision, transport, education, defence, debt interest, housing, judicial and protective services and employment.

In terms of budget planning and control, TME is the sum of Departmental Expenditure Limits (DEL) and Annually Managed Expenditure (AME) set by the Treasury.

Departmental Expenditure Limits are the budgets set for Departments of State and the Non Departmental Public Bodies and local authorities they are responsible for in the course of three-yearly Spending Reviews. They include provision for all firm spending plans for the Department, running and procurement costs, subsidies and grants paid to the private sector, capital depreciation and receipts, and reserves.

The Annual Managed Expenditure comprises Departmental spending programmes that cannot be reasonably restricted to three-year cycles (notably social security and public sector pension spending, tax credits, Common Agricultural Policy payments etc), "Locally Financed Expenditure" (council spending funded by council tax and other local sources), net payments to the European Union, and central government debt interest.

Background

Responsibility for spending monies raised from taxation and other sources has always been at the heart of the modern concept of government.

Prior to the 19th Century, this was principally a matter of funding the armed forces, with social improvement and economic development left largely in the hands of the private sector. The notion that the Government was responsible for improving the lot of the public for paternalistic reasons became established during the Victorian era, and accelerated in the first half of the 20th Century, with the growing influence of socialism and related doctrines.

The First and Second World Wars, unsurprisingly, pushed public spending as a proportion of Gross Domestic Product up dramatically (from under 15 per cent to over 45 per cent, and from around 25 per cent to over 60 per cent, respectively). After each, however, the "size" of government did not revert to its prewar state, with public spending undergoing two step-changes upwards - a phenomenon known as the "ratchet effect". The experience of the Second World War, in particular, was responsible for the birth of the modern "welfare state" and the National Health Service, each representing a massive expansion of state responsibilities and spending commitments.

Coinciding with a period of social democratic “consensus politics”, the ascendancy of Keynesian economics in the postwar years up to around 1980, saw public spending treated as an instrument of macroeconomic management. This produced a volatile, but clearly upward trend until the mid-1970s.

The economic crises of the 1970s led in political terms to the eclipse of Keynesianism, and the revival of neoclassical liberal economics and monetarism under the Thatcher governments. From the mid-1980s to around 1999, the trend was downwards. Since then, it has risen again. Nonetheless, since the late 1970s, public spending as a proportion of GDP has remained between 48 per cent and 37 per cent.

Shortly after coming to power in 1997, Labour shifted the basis of financial management from one-year cycles to three-year cycles, in order to facilitate stability. Prior to the adoption of the current Spending Review process, public bodies had suffered from uncertainty about future allocations, making the planning of multi-year programmes difficult. Treasury rules about recovery of unspent funds at the end of the year also encouraged inefficient spending. Under the present system, funds can be carried over between years within the Spending Review period.

The fiscal strategy of the Labour government is based on five key principles as laid out in the government's "Code for Fiscal Stability 1998" - transparency, stability, responsibility, fairness and efficiency. These principles are in turn implemented through observance of two fundamental rules. The "Golden Rule"- stipulating that the Government will borrow only to invest and not to fund current spending, and the 'Sustainable Investment Rule' - which holds that that public sector net debt, all things being equal, will be maintained below 40 per cent of GDP over the economic cycle. Public Sector Spending frameworks have subsequently been tailored in order to adhere to these targets.

Controversies

Public spending is a controversial issue, not only in the basic matter of how much there should be, but also in terms of the details of its distribution and funding, and of how it is defined. The public sector forms a large part of the economy, and as such public spending has a major impact on the macro-economy, as well as on the day-to-day quality of people's lives.

Some economic theories have suggested that increasing public spending exercises a negative "crowding out" effect on private sector economic activity, and have opposed it accordingly.

Historically, in the language of Labour, more aggregate spending has been a good thing, while in the language of the post-Thatcher Conservatives, it has been a bad thing. This crude simplification does not do justice to the detailed positions of the parties and the related contemporary discussion. Each party has different priorities for spending - traditionally over the last 50 years, the Conservatives have supported higher defence spending, while Labour has not - which have little to do with a concern with "public spending" as such.

All parties, moreover, are committed to improving the efficiency of public spending. In recent years, for example, Labour has emphasised its achievement in reducing the amount spent on servicing the National Debt, which has made it possible for a greater proportion of public spending to be committed to frontline projects. Waste and excessive bureaucracy is a persistent political theme, with the Conservatives in 2004 claiming to be able to reduce public spending (and thereby, the tax burden) by £18 billion without affecting spending on services themselves.

Since Labour came to power, the greater use of the Private Finance Initiative as a means of funding public sector investment has been controversial. PFI spending falls outside the parameters of current accounting rules, enabling the Government, say critics, to conceal costs and liabilities "off the balance sheet". Controversial for similar reasons was the structure adopted for Network Rail, which resulted in the debt-laden company being treated by the Office for National Statistics as a private sector body, despite being underwritten by the Government.

2008 Budget update

- Government debt: £36 billion, £1.4 billion lower than forecast at time of pre-Budget report.
- Borrowing: Will rise to £43 billion next, some 2.9 per cent of national income. It will then fall to 1.3 per cent by 2012/13, or £23 billion.
- Budget deficit: £18 billion surplus by 2012, forecast to meet the golden rule over economic cycle.
- Sustainable investment rule: To be met, peaking at 39.8 per cent before 2012/13.

Statistics

Total Managed Expenditure is projected at £587 billion in 2007-2008

Since 1971, TME reached its highest point as a proportion of Gross Domestic Product in 1975, at 49.9 per cent. It reached its lowest point in 1999, at 37.7 per cent.

Statistics 1 (Source: HM Treasury "Budget 2007); Statistic 2: (Source: Office for National Statistics, "Social Trends 34: Total managed expenditure as a percentage of gross domestic", 2004)

Quotes
"The UK's public spending framework is based on four key principles: consistency with a long-term, prudent and transparent regime for managing the public finances as a whole; the judgement of success by policy outcomes rather than resource inputs; strong incentives for departments and their partners in service delivery to plan over several years and plan together where necessary; and the proper costing and management of capital assets to provide the right incentives for public investment."

HM Treasury, "Public Expenditure Planning and Control in the UK - A Brief Introduction", 2004
“We are saving nearly £9 billion this year from debt and unemployment, so 84p of every extra pound of public spending goes on national priorities, compared to 58p under the Conservatives.”

Labour Party Manifesto, "Ambitions for Britain", 2001