In July, the UK’s Office for Budget Responsibility (OBR) published for the first time a combined report on the fiscal risks facing the UK and the long-term sustainability of its public finances. Fiscal risks and sustainability marks an important shift for independent fiscal policy institutions worldwide, as it highlights the long-term trends that are inevitably impacting public finances and, in theory at least, challenges government to think beyond the short term when setting fiscal policy.
‘History is governed by long-tail events,’ says Alex Metcalfe, global head of public sector at ACCA. ‘A sudden change like the pandemic, or an energy price shock, has huge implications for public finance, but so too do longer term trends like demographic change.
'Combining fiscal risk reporting with sustainability reporting in a single document is a really good development'
'This report looks at what that means in terms of divergence from the predicted trends. I think combining fiscal risk reporting with sustainability reporting in a single document is a really good development, and an example of best practice for the rest of the world. These things do need to be looked at together.’
Potential pressures
The OBR’s report focuses on three potential pressures to the public finances:
- heightened geopolitical tensions – the economic and fiscal implications of conflicts such as Russia’s invasion of Ukraine
- higher energy prices, the implications of long-term changes to energy supply and demand, and the trade-offs involved in shifting the UK’s energy mix to one that is compatible to reaching net-zero emissions by 2050
- longer term fiscal pressures such as demographic change.
The report makes for sobering reading, laying out in detail the impact of successive crises, from the global financial crisis to the steep rise in energy costs, on the UK’s finances. The OBR’s projections show debt rising to more than 100% of GDP by 2052/53 and reaching 267% of GDP in 50 years if the upward pressures on health, pensions and social care spending continue.
It points out that this comes at a time of escalating challenges for governments worldwide: ‘In the decades ahead, governments face perhaps the still greater economic and fiscal challenges of addressing climate change, dealing with the fiscal costs of ageing, and managing all these pressures and risks against a backdrop of potentially weaker productivity growth, higher levels of public debt, and rising interest rates. It is hard to escape the conclusion that the world is becoming a riskier place.’
‘Public finance professionals can improve decision-making to support long-term sustainability'
New clarity
Combining fiscal risk with sustainability reporting brings new clarity to the slow-burning pressures that governments face in managing the public finances, as well as allowing for future short-term shocks. The report says clearly, for example, that the pressures of an ageing population on spending with the loss of motoring taxes in a decarbonising economy ‘leaves public debt on an unsustainable path in the long term.’
An ageing population in the UK and many other developed economies is a particular cause for concern. The OBR estimates that the UK’s old-age dependency ratio – defined by the UN as people aged 65 and over as a proportion of the population aged between 15 and 64 – will rise by 18 percentage points between 2020 and 2070, while other advanced economies will on average see a 26 percentage-point rise in their dependency ratio (see graph).
The million-dollar question, of course, is what can be done to address these problems? The OBR’s role is advisory, but Metcalfe argues that professional accountants working in the public sector will play a vital role. ‘A core aspect is the ways in which public finance professionals can improve decision-making to support long-term sustainability,’ he says.
‘It’s much better to think about this now than our children discover the horrible reality of it in 30 or 40 years’ time’
Balance-sheet approach
ACCA’s 2020 report, Sustainable public finances through Covid-19, called for government to use accounting data and take a balance-sheet approach to managing public finances through the pandemic. This seems prophetic in light of the OBR’s report: one of its key recommendations was that independent fiscal policy institutions worldwide should ‘begin fiscal sustainability reporting or increase its frequency.’ Central finance departments should also be required to respond publicly to these reports, it added, in a timely manner.
The ACCA report also set out a number of recommendations for accountants working in the public sector, including taking a commercial approach to the management of public assets. ‘Making full use of public assets, and thinking carefully about liabilities, is an important technique in mitigating these challenges,’ says Metcalfe. ‘There are important interventions that professional accountants can make, for example in addressing the fiscal illusions of short-term decisions – such as the distress-sale of assets that results in a quick influx of cash but that could make us worse off in the longer term.’
‘The UK is clearly leading in this area,’ Metcalfe concludes. ‘The OBR report is unique in that it provides a much longer view of public finances than most other jurisdictions. It shows the need to think about intergenerational equity, and how we manage public finances with a long-term view in mind.
'It makes for difficult reading, but it’s much better that we think about this now rather than our children discover the grim reality of it in 30 or 40 years' time.’
