How did we get to this method of planning public spending?

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In 1998, Gordon Brown introduced today's division of public spending, into departmental expenditure limits (DELs) and annually managed expenditure (AME). AME was originally defined as spending that could not 'reasonably be subject to firm, multi-year limits', and the intention was that it would be controlled on a discretionary basis. DEL (departments' budgets) was meant to be allocated between departments in advance, to spend on relatively stable or predictable items.

This move represented a step in a gradual evolution in the planning of public spending, which 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, and is a development of previous techniques to try to minimise the extent to which the public spending framework produces inefficient incentives for departments.

Prior to 1992, public spending was set annually, usually following bilateral negotiations between the Treasury and each spending department. This approach had two main disadvantages:

  • It was difficult to take a strategic decision on the overall level of public spending or on the priorities within the total.
  • The lack of distinction between cyclical and non-cyclical components meant that spending might be allowed to 'creep up' following recessions as falls in cyclical spending masked increases in discretionary spending or that increases in cyclical spending during recessions could potentially crowd out other worthwhile 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 and to create a greater distinction between cyclical and non-cyclical spending. Over each summer, the government set out the 'control total', or the sum of all the departments' total planned spending for the next three fiscal years. This was a step towards the current distinction between DELs and AME, as it was intended to create a distinction between cyclical and non-cyclical spending. The control total roughly corresponds to what is in DEL today, plus several components of spending that are currently included in AME such as predictable parts of social security spending, including child benefit and the basic state pension. The control total therefore represented a much higher fraction of total spending (around 85%) than do DELs today (around half).[1]

To allow some flexibility for public spending to react 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, though any department that failed to spend its control total in a given year lost the unspent money. In many respects, the control total can be regarded as a forerunner of the Labour government's DEL approach.

The Labour government came into power in 1997 and claimed that this way of planning public spending led to underinvestment (or inefficient investment) in public services. Its three major criticisms can be summarised as follows: 

  • The second and third years of the spending limits set annually were only indicative, and were frequently revised upwards, creating an uncertain environment for departments to plan expenditure.
  • The lack of distinction between current and capital spending invited departments to cut back on investment when times were tight instead of cutting current spending – in other words, avoiding short-term pain at the longer-term cost of underinvestment in public services.
  • The inability of departments to carry cash forward to the next financial year encouraged a 'use it or lose it' mentality, which resulted in some wasteful spending. 

In response, Labour imposed a new fiscal framework. Its response to each issue listed above was as follows:

  • It imposed the separation of capital and resource budgets.
  • It set 'firm and fixed' totals at each Spending Review.
  • It introduced 'end-of-year flexibility' in 1998, so that rather than losing any unspent funds, departments could now transfer as much money as they wanted to subsequent financial years.

This third action had surprisingly little effect on the proportion of departmental spending occurring at the end of a financial year, and it allowed departments to accumulate large entitlements to their unspent resources.

The coalition government that came to power in 2010 largely retained the methods of planning public spending that it inherited from the previous Labour government, with two major exceptions. In 2011, the coalition government introduced a new 'budget exchange' regime, which imposed a cap on the amounts that could be moved between years. And in the 2014 Budget, the government introduced a 'welfare cap', which set a cash limit on a large slice of spending on social security spending and tax credits (a large component of AME spending). If spending on these items is forecast to increase by more than the level of the cap, then the government will have to either enact policies to cut forecast spending or seek approval from parliament to increase the level of the cap.

 

Useful resources

[1] Source: Chapter 6 of A. Dilnot and C. Giles (eds), Options for 1997: The Green Budget, Institute for Fiscal Studies, London, October 1996; HM Treasury, Public Expenditure Statistical Analyses (PESA) 2014; Office for National Statistics (ONS) series for TME: JW2Q, JW2S and JW2Z.