Spending Review 2002
I welcome Richard Dennis from the Scottish Executive finance and central services department, who will brief the committee on the 2002 spending review. He will deliver a PowerPoint presentation on the mechanics of the spending review and its likely impact on this year's budget process. In particular, it will be important to gauge opinion on the likely effect of the spending review on the figures in this year's annual expenditure report. I hope that the briefing will inform members of some of the issues that are involved in the setting and distribution of end-year flexibility reserve moneys, on which Peter Peacock will brief the committee informally tomorrow.
Richard Dennis (Scottish Executive Finance and Central Services Department):
I will start by apologising for the strange symbols on the top of my slides. We seem to have a slight technical incompatibility between the Executive and the Parliament. Somehow, those symbols are there instead of "Scottish Executive" and our little logo. I hope that it will be fixed during the presentation. I am sorry that I have not had time to change it since I arrived.
It is worth reminding ourselves that spending reviews are a relatively new way of setting public spending totals for future years. The first such review was launched in Whitehall in 1997, after Tony Blair came to power. The present spending review is only the third that we have had and only the second in which the Executive has played a full part.
Inevitably, any finance process generates jargon. Part of the spending review jargon has been a little confusing for the press and the public because only the 1998 spending review was called a comprehensive spending review. In other words, that review deliberately examined every penny of expenditure. The rationale for that was that Labour, having come to power in Whitehall after many years of Conservative rule, wanted to check that all spending was linked to its priorities. Labour has, having done that once, been fairly confident in the following two spending reviews that it has been starting from a baseline that is vaguely in line with its priorities.
The second review, which is known as SR2000, set the plans to which we are currently working. We are now in the process of the 2002 spending review. Another slightly confusing point is that spending reviews are dated by the year in which they finish rather than by the year in which they start. I will say more about that later. If the process continues, we expect that the next spending review will be SR2004. However, there can be no guarantees that Whitehall will continue to set its public spending totals in this fashion. Immediately prior to the introduction of spending reviews, we had an annual cycle in which spending plans were formally negotiated on a three-year basis, but were actually reconsidered every year.
Another confusing thing—even for people who work in finance—is that although the Treasury will allege that it is setting three-year spending totals in each spending review, in fact we have such a review every other year. The Treasury therefore never really talks about spending plans that cover more than about two years. The third year—which is always the first year of the subsequent review—is always considered again. In the pre-budget report, the Treasury finesses that: the Chancellor of the Exchequer talks about 2003-04 being the base year for the current spending review, which will set new plans for 2004-05 and 2005-06.
Different reviews have had different implications for the base year. Committee members might remember that in SR2000 the chancellor made quite a large addition to public spending in the first year. Later, I will say a little about our expectations for this year, but the basic message is that the third year is not quite as fixed as the first two.
The other change in the current review will take us a step closer to full implementation of resource accounting and budgeting. The big change that will affect all the numbers is that capital charges and depreciation are to come within departmental expenditure limits. In the previous spending review, they were left in annually managed expenditure. Under the previous review, if an asset was revalued and the capital charges went up, the department involved would automatically receive an offsetting increase from the Treasury. However, under the new system, if capital charges go up there will be a direct squeeze on other departmental spending. There is now a direct trade-off between capital charges and depreciation on the one hand and, on the other, normal current grants and the like.
We have not yet gone all the way to full resource accounting. A number of items are still left in AME; from a Scottish perspective the biggest is the roads capital charge, which the Treasury has not yet worked out how to bring properly into its budgeting system.
I said that reviews are misleadingly named after the year in which they conclude rather than after the year in which they start. Because we must in some ways follow the Whitehall process, it is worth reminding ourselves of the kind of timetable that the Whitehall process runs to. Its spending reviews last roughly a year. The slide that is on the screen behind me shows my approximation of what has happened in the previous three reviews. I have tried to apply a standard format, although the rules for each review were slightly different. The timetable that is shown is close to, but is not exactly, what has been happening in the current review.
Last July, the Chief Secretary to the Treasury wrote to departments announcing the review and setting out his priorities and what he wanted to focus on. In early autumn, ministers down south would have gone through their own priority-setting process—I will talk about our process later—with departments having to submit their bidding documents by the middle of February. It is not a secret—I picked it up in the press, where I picked up most of the things I will mention about Whitehall—that most departments' bids were late. Many departments have done quite a lot of their bidding in public.
The February deadline is set so that the chancellor can, when he makes his budget judgments, consider tax and spending together. The system that immediately preceded 1997 was a first attempt to bring together tax and spending decisions. For a brief period, those decisions were announced at the same time, but they are announced separately again. Tax decisions are announced in April and spending decisions are announced in July. When the chancellor makes his budget statement tomorrow, he will have a clear idea of the totals for public spending. We expect him to announce the aggregates for total managed expenditure for the spending review period—I will mention some of the implications of that later—but there can be no guarantee that he will do so.
After the budget, there is in Whitehall a process of negotiation between ministers, the results of which we expect to be announced in July. However, there is no fixed timetable, which can be a problem for us. Last time, in SR2000, the chancellor announced the results on July 14. For us, that would be in the recess, but down south it would be pushing up against the recess. This time, the budget is a month later, so it is hard to say whether the chancellor will manage to announce results by July 14. He will certainly need to take decisions more quickly this time than he did last time.
All that is important for us for two main reasons. For our spending review, the chancellor's July announcement will include totals for the Scottish assigned budget for the spending review period. That will be the first time we see that information. Unlike the chancellor, who will already know the public spending totals that he is thinking about for the UK, we will not know until July the total public spending that is available for Scotland for the spending review period. Not until then will we be able to start to have meaningful discussions on how the money should be allocated between portfolios, which is obviously awkward. The announcement will come during the recess, which is an awkward time for ministers to come back and take serious decisions about major allocations for the coming three years. It would be much nicer if the chancellor's timetable did not mean that ministers lost most of their holidays—but there we are.
The direct effect on the budget cycle for 2003-04 is also awkward. As members will know, a couple of weeks ago we published the annual expenditure report for 2003-04, which sets out the Executive's plans. It is possible that the chancellor's announcements in June and July will include additional resources for that year. I will talk later about our expectations but, last time round, there was a significant increase in the third year, which meant that the plans in the annual expenditure report had to be added to and rejigged.
Ministers have promised that they will get the draft budget document to members by September 20. If the chancellor does not make his announcement until the very end of July, ministers will have about six weeks—allowing for the printer's deadlines—to decide on their allocations. The process is therefore compressed, intensive and comes right in the middle of the time ministers would like to take their holidays. The later the chancellor makes his announcement, the less detail we are likely to be able to give when we come to the committee with the draft budget document on September 20. At the moment, the chancellor and his officials are still saying that he might manage to make his announcement in June, which would give us significantly more time. We will have to wait and see.
The next slide—entitled "Expectations"—is in many ways the key slide. What do we expect to get out of the chancellor's process? It is again worth reminding ourselves that the previous two reviews have been relatively generous on public spending. I use the word "generous" deliberately. I am actually a Treasury official on loan to the Scottish Executive, so I know that we do not like to give out huge sums of money. However, in the previous two spending reviews, that is precisely what Gordon Brown has done.
I have given figures for total managed expenditure, which show an annual increase of 6 per cent. That is about double the figure for a typical year in the 1990s. We are therefore coming to this spending review on the back of two very generous spending reviews. All the signs are—this is no more than reading the runes, at which committee members and their advisers will be every bit as good as we are—that this review will be much less generous. In his pre-budget report, the chancellor spoke about bringing spending back into line with the average growth rate of the economy. That will mean an increase of about 2.25 per cent, compared with the 6 per cent increase that we had last time. All the signs are also that, in 2003-04, there will not be very much money. I spoke earlier about how the Treasury has slightly finessed its language in that it talks about 2003-4 as the base year rather than as the first year of the review.
It is very hard to tell exactly what is going on. This is a great opportunity for me to make a fool of myself, because the chancellor may stand up tomorrow and say something that is completely out of line with what I am saying today. However, we do not expect huge additional resources for 2003-04. The one area on which a betting man might want to have a small wager is health spending. The chancellor announced additional health spending for 2002-03, but not for 2003-04, and we expect that he will have at least to match that extra £1 billion. Your guess is as good as mine.
The next slide relates to how the Executive might determine how to spend any extra resources that it is allocated and to reallocate the money that is in the baseline. I am sure that the committee has seen the list of the Executive's priorities; Professor Midwinter analysed it in his paper for the next agenda item. In the past couple of months, the First Minister and the Minister for Finance and Public Services have set out pretty consistently their list of priorities for additional spending. That does not mean that all additional resources will be spent on those priorities, but that those priorities come first. Items in portfolios will be differentiated as much as portfolios are differentiated. I will talk more about the process later.
Alongside those fairly silo-based priorities are the usual cross-cutting issues that the committee will be used to. In several recent speeches, such as his speech on sustainable development, the First Minister made it plain that all the spending in the review will be assessed against sustainable development principles. Closure of the opportunity gap and spending on children and young people remain at the heart of the Executive's programme. The other cross-cutting issues are central to the Executive's priority list and will be taken into account in different ways as the spending review process continues.
The committee will be used to seeing the list of principles that the Executive has set out to guide spending decisions. I think that the list was first used when the draft Budget (Scotland) (No 3) Bill was introduced in January. I will not go into the principles in detail, but they give a clear idea of the process that ministers envisage for allocating resources. Three key messages arise from the principles. The first is that ministers are interested in baseline spending and not just in additions. That is natural in a review when resources are tight. If ministers want to undertake new initiatives, but a huge amount of new money is not available, they must look to create efficiency savings to fund those new initiatives.
It is clear that ministers share the committee's wish—expressed in discussions on the budget documentation—to improve the standard of targets, milestones and measures for what we receive in return for public funding. We can expect a push on that. I hope that the committee has noted that much work has been done in the annual expenditure report to tighten some of the targets and measures. We can expect that to be developed.
The final element, which ministers have discussed with the committee, is how far they can move towards priority and outcome-based budgeting. The process is slow. We are keen to go as far as we can toward that, but we will see how far we can take the process as it works out. Spending ministers have been asked to be clear in their bids about their priorities in their portfolios and about what the existing level of resources and the additional level that they seek would deliver in real-world outcomes. It is hoped that the process will lead to further tightening of the budgetary cycle, which should be reflected in the draft budget document in September.
I will mention some complicating factors in the spending review process. The 2003 election is a complicating factor only from an official's standpoint. The new plans that will be set in September will cover a period that extends to the other side of the election. Given that we have, at present, a coalition Government, some interesting issues are raised for us about how tight those spending plans will be and whether we will be able to announce spending plans that both coalition parties will say they will stick to when we reach the spending review period. If the committee wants to pursue that issue, it should do so with ministers rather than with officials.
The committee will be aware that when the chancellor makes his announcement in July, all his colleagues down south will immediately reel off a list of new initiatives, many of which we will not have heard about. It is not assumed that we should automatically follow Whitehall's lead, but we will want to have a chance to consider whether some initiatives are good value for money and whether they will apply in Scottish circumstances. That is tricky because of the limited window of time before we must make allocations. Officials, special advisers and commentators are trying to read the runes to establish what is going on in Whitehall. To the extent to which we can do that and to which Whitehall lets us know what is going on, we will try to build such matters into the process early.
Another issue that is worth touching on is how the Executive can take account of wider views from a range of its partners throughout Scotland and build those views into the spending review process. That has been done largely at departmental level. For example, the health department is taking into account the views of health boards and others as it works up its bid. Ministers will also hold a series of discussions with bodies such as the Finance Committee and the Scottish Trades Union Congress to identify priorities to feed into the review.
The outcome of the spending review will be included in the draft budget document that will be produced in September, which is a consultation document. It is hoped that that will provide another opportunity to bring all the ends together and to let everyone feed into the process.
Your slide on the SR2002 priorities lists five topics. The following slide contains another eight topics and ends with the word "etc". How does your department read the weighting of those priorities? I appreciate that the First Minister probably does not consult you before he makes a speech, but it would help the committee to be given an idea about weighting of priorities, so that we can take a view on what the Executive is doing, which we are measuring.
As far as we are aware, the five portfolio priorities have not been weighted against one another. The list of cross-cutting issues is based on information in public documents that the committee will also have seen, but our initial view is that the priorities are the closure of the opportunity gap and sustainable development, which the First Minister said recently will underpin every penny of expenditure. However, these are early days in the process. Ministers have still to take decisions on how they want the priorities to be played out.
If there is no weighting, one would expect the same percentage increase or decrease for each priority.
I am not sure whether that is right. Most of the priorities—particularly the portfolio priorities—face significant pressures that must be dealt with before we can talk about the free money. I have not seen the bidding documents but—in my view—the health, crime and education portfolios face much larger pay pressures than do jobs and transport. Once a number of unavoidable pressures and other pressures have been met, the free money might be allocated in roughly equivalent amounts. However, because health starts with 40 per cent of the budget and the percentage of the budget for jobs is much less than that, I would expect health to receive a slightly larger share of the free resources. Those are decisions for ministers to take much further into the process.
That is helpful.
What role does the Scotland Office have in the review?
At this stage in the process, it is a very useful channel for information. The Scotland Office is better than we are at getting Whitehall to reveal how the process is going.
What is the Scotland Office's role, apart from to pass notes up from Whitehall to Edinburgh? You set out a timetable, with dates for the launch of the review, for priority setting and for the submission of bids. Does the Scotland Office have a role in that process?
Yes, in so far as the Secretary of State for Scotland has a seat in the Cabinet, and priorities will have been endorsed by the Cabinet and by Whitehall.
Are you talking about priorities that relate to England and Wales, except in so far as they relate to departments that have a reserved remit as far as Scotland is concerned?
Yes.
How advanced is work by officials on the cross-cutting reviews to which you referred? We have been told that the drugs review is fairly well advanced; we will hear a bit about that later from Peter Collings. Are the reviews a reasonable distance down the track, or at least some way down the track?
It is hard to give a fair answer that would apply across the board. From reading between the lines of my presentation, members will have realised that in some ways the real hard bargaining does not start until after the chancellor has made his announcement, in June or July. At official level, we will have got out of the way as much of the preparatory work as we can before then, so that ministers can immediately start to make their decisions.
Some cross-cutting reviews—the review of sustainable development is a good example—will need to influence how each portfolio puts together its bid. The drugs review is rather different, as people are working from a clearly identified baseline—they know the limited number of programmes in which they are interested, so they can get ahead of the game.
You have set out a timetable for ministerial input into the process. What implications does that have for input from the Finance Committee into the process? Do we have to wait until 20 September, when announcements are made, before responding? Is there a sensible time between July and 20 September for us to make an input into the process?
By July the process may be fairly closed and internal. If the committee wants to comment on the Executive's priorities or to make clear its own view of what the priorities for a future funding allocation should be, there is no reason for it not to do that before July. I expect other bodies, such as the Scottish Trades Union Congress and the Confederation of British Industry Scotland to write in with their shopping lists, which will consist of much more blatant bids for their personal interests. I do not see why the committee should not also take that route, if it wants to. The committee has the advantage of having a formal process after 20 September, through which its views can be taken into account at a later stage.
How open is the process after 20 September? Would it be better for us to submit views before then? How does that relate to the annual budget round exercise in which we are engaged?
It is tricky for me to say, as I have not yet been involved throughout the process in the Executive. However, I guess that the earlier that interventions are made—in particular, interventions addressing priorities—the better. I imagine that once initial announcements have been made it would become much trickier for the Executive to change allocations, if only because increasing resources in one area would then involve taking them away from another. At this stage, the additional money is sitting in a central pot. If the committee has views on where additional money should be allocated—if the chancellor gives us any—those views can be fed in at the first stage of the process.
Our difficulty is that, as I understand it, we will not know until July what the consequentials are. The Parliament is in recess between then and September. Announcements will be made on 20 September. You seem to be suggesting that the optimum way for us to make an input is to do so in the context of our annual budget round, with half an eye towards the spending review.
That is certainly one way forward. However, although neither the committee nor we will know the consequentials until July, I am sure that the committee's advisers will attempt to guess what they will be, just as we will. If the committee has in mind one or two highest priorities for additional resources, I am sure that ministers would welcome that input at an early stage.
We will know what the Barnett consequentials are after July. Before that, is it open to the Executive to make bids for moneys that will not be affected by the Barnett consequentials system?
The vast bulk of resources will come from the Barnett consequentials system. However, we will expect departments to have finished putting together bids setting out what they would like and what they could deliver in return for a set level of resources well before the chancellor makes his announcement. If ministers are to be able to have serious discussion, all the preparatory work must be done well before the chancellor makes his announcement.
That work is internal to the Executive. Could the Executive make direct bids to the chancellor in advance of his statement? Is a mechanism for that currently available?
No. Fortunately, because the Executive is a devolved institution, the chancellor would not take any notice of our bids. The Scottish assigned budget just falls out of the allocations that he makes to Whitehall departments.
You talked about this being the first review involving resource accounting and effective capital charges and depreciation. Will that affect some departments more than others? You said that the roads capital charge was not included in the system.
We deliberately left out roads because of the scale of the impact that introducing the new system would have in that area. Off the top of my head, I cannot think of any single portfolios that are massively affected relative to the others. The annual expenditure report indicates that the department with the largest charge for depreciation in 2003-04 is the health department, which has a depreciation charge of £231 million. Relative to its budget, that charge is much smaller than the charge for the environment portfolio, which is £180 million.
Obviously, account was taken of the fact that this is the first budget to include effective capital charges and depreciation, so that there would be no shocks. Year on year, will the fact that those charges are included make things more difficult for certain departments than for others, or should it have no impact at all?
In theory, it should have no impact. In principle, if a larger share of a department's baseline expenditure is consumed by capital charges and depreciation, and those numbers change, the department should generate a significantly larger windfall or take a significantly larger hit. In practice, that should not happen.
A growing number of capital projects are funded through the public-private partnership/private finance initiative mechanism. How will the onset of PPP/PFI affect the depreciation charge element to which you referred? Obviously, some of it is switching capital costs into revenue costs.
Again, it is hard to generalise. It depends on the accounting treatment of individual PPP/PFIs.
It also depends on the accounting rules that operate in the different sectors. For example, health and education are quite different.
Yes. In theory, in most PPP/PFIs, the capital asset will sit on the balance sheet of the partner rather than the Executive, so there will not be a capital charge or depreciation element within the relevant department's spending limits.
What happens when the contract reaches its conclusion, which will obviously be some time away? If the asset passes to the local authority or the health board, is there a sudden impact on the budget for that year?
Not if the asset were to pass to the local authority or health board, because it would score on their books rather than ours. If the asset were to come back to the Executive, the Executive would benefit from having a large additional asset on the books and it would have to start paying a capital charge on it. Fortunately, because we are talking about assets that would be 20 or 30 years into their life, the charges should not be very significant.
Would it be possible for us to be provided with more information about PPP/PFI, its impact on depreciation and the effect of that on resource budgeting? We would find that useful in the context of our inquiry.
Sure.
I did not find the answer to the question about the capital asset coming into the equation at the conclusion of a contract very satisfactory. My understanding is that the arrangements mean that the capital asset should have a real value at that point, which should be the same real value as it had at the beginning. If the capital charges are accruing against the asset, that ought to have a significant impact. The essence of PFI/PPP is that the onus is on those who provide the services to maintain the asset, so that it is a real asset at the end of the process. In most cases, the asset will transfer to the public sector at the end of the process and it ought to have a fairly significant impact. I know that that will happen some way down the line and there may be time to take it into account in the accounting procedures, but my point is that it is not a wasted asset; it is a real asset.
That is certainly right. Some assets, such as design, build, finance and operate roads, should come with the same whole life as they have at the start of the contract. Even 30 years down the track, the same capital charge and depreciation issues would apply as if the assets had been bought off the shelf by direct capital investment. The value of a building, for example, 30 years into its life will be significantly less than when it was constructed.
Not if it has been properly maintained.
The point that Brian Adam is missing is that what is a useful hospital today might not be a useful hospital 30 years down the line, as a result of medical developments. Whether the asset is useful will be open to question at that time.
You showed a slide about the principles governing SR2002, one of which was to be clear about what the resources will buy and when. Do the principles translate into an analytical template against which you can assess bids that are made by various departments? Have the Minister for Finance and Public Services and the Deputy Minister for Finance and Public Services given any indication to their colleagues of how allocations will be determined in the context of the application of those principles?
The process is in its early days. The Minister for Finance and Public Services has gone as far as to say that he expects to see clear statements from his colleagues about what they will deliver in return for the additional resources that they sought. He expects to see much better targets; those targets will be reflected in the draft budget document. Ministers who do not produce bids that state either exactly what will be produced or how it will be measured cannot expect to be looked on as favourably as those ministers who do. The process has not gone much beyond that so far.
How rigorous will the scrutiny process be? Will it simply be a matter of looking at a proposal against a set of principles, or will a more detailed investigative process be put in place to examine the assumptions and how they hold up against structured financial scrutiny? There are examples within the Executive of such a systematic process being adopted. How systematic and rigorous will the tests be against the application of the principles?
Our expectation is that the tests will be very systematic and rigorous. We have set up a new team of six people, in which I work, which will work full time on the spending review from now until September. If it were simply a matter of looking at the bids and considering them against the principles, we would not be very busy. The eventual allocation process will inevitably be highly political, alongside the analytical work that is done.
We cannot get into the business of trying to make decisions on behalf of ministers, but more information about the process and the mechanisms by which you will test the proposals against the principles would be useful to the committee.
Do members have further questions?
No.
I thank Richard Dennis for his presentation. It would be helpful if he could let the committee have a look at the two additional bits of work that we asked about.