Just how bad is it anyway?

I VOWED to myself to stay clear of commenting on States business this month, but the publication of the accounts on Monday was a topic just too interesting not to cover this week. I can’t pretend I didn’t read about the £135m. loss in 2022 now, can I?

But here’s the deal, and I’ll play it with a super straight bat. Despite any temptation, no facetious remarks. Regular readers – cue regular joke, both of you – will appreciate just how disciplined I’m going to need to be.

First off, a note of congratulations. The accounts are becoming more comprehensive, more informative and, dare I say it, more transparent and easy to follow, though I admit I could always follow them. I’m pleased to see the attempt at a consolidated approach to presenting income and expenditure (that is revenue and social security together). This was how I presented revenues and expenditure in the ISI paper on the Tax Review in January. It makes a whole lot more sense economically.

So, bottom line. On the income front, the States made just over £800m. through taxes, fees and social insurance contributions in 2022. Today’s not the day to get into how large this figure is – all we need to do is look at expenditures to arrive at a sense of the underlying fiscal position. On Tuesday the Guernsey Press reported the position as 'its bleakest yet'. Is this true?

But, and there’s always a but, it’s not quite as easy as that. The underlying position needs to strip out the variance arising from the position in the economic ‘cycle’ and we need to recognise capital expenditures somehow and take a view on structural trends.

So after the positive, a negative, but I have to say it. I don’t like or agree with the presentation of unrealised losses on valuation of assets in the reserves as a loss in the income statement. It’s what’s driving the headline £135m. loss and it makes the figures prone to volatility. A £77m. gain in 2021 becomes a £94m. loss for 2022. That’s a swing of £170m., but not because of any fundamental changes in income or expenditure. Looking at it economically, this presentation doesn’t make sense to me.

Apologies, I’m discussing the figures without explaining. This £94m. figure I’m referring to is the loss incurred by the States Investment Funds in 2022 recognised in the statement of financial performance. The actual loss was some £300m., but £200m. was attributed to the superannuation scheme, so isn’t included in the statement of financial performance.

If these assets were being held to generate an income, then recognising the associated dividend income in the financial statement would make some sense to me. Say a notional yield of 3.5% on £3.2bn of financial assets (the 2022 year-end value of financial reserves) gives us a notional income around £112m. Hold that thought, it might be important later. But these assets aren’t held in that manner – most of the reserves are held for a specific purpose.

As an economist, I just want to look through all these accounting adjustments and ascertain the sustainability of the fiscal position in the long run. The big picture. I want to remove all this noise from my considerations. So I’m going to ignore all this to get to an assessment of the underlying structural position.

I’ll be frank, there’s a lot I don’t read to do that. I’m a macro-economist by trade or rather by PhD. I just scan through looking for the few significant variables of interest to get a big picture view. I’m not scrutinising every penny of expenditure in this exercise. No critiquing of that today. No opining on investment performance. I’m not even going to give a view on the assets and liabilities of the superannuation scheme which is a favourite for some. But on that point, I will say that I did write last year that I didn’t think the investment review of 2020 was a sound basis on which to make decisions on contribution rates.

That big picture is pretty much as I expected. An operating loss of £3m. on gross revenues of £800m. with £3.2bn in financial assets stashed away in one reserve or another suggests the fiscal position is in comparative good health – admittedly the comparator is most public sectors, which are fiscal basket cases.

So those comments suggest I’m not in the ‘We’re doomed’ camp, but similarly, I’m not about to suggest getting out the bunting either. Stay with me.

A £3m. operating deficit might be nothing but there’s no reported capital spending in these figures as far as I can see. In the Statement of Financial Performance there’s a £30m. depreciation item (against the £1.7bn value of the new Fixed Asset Allocation Reserve, an innovation this year, which is a first pass of valuing all States fixed assets). This £30m. contributes to this (in my view notional) accounting deficit of £135m. But I don’t think it leaves us any closer to understanding the nature of the underlying deficit.

To do that we still need a figure for capital expenditure. At this point, I want to recuse myself from even an implied participation in the capital prioritisation debate, but the point is, capital expenditure is a necessity. You can get away with stopping it for a period, but it builds up and before you know it there’s a backlog. On the other hand, it’s easy to overspend, white elephants etc. Tricky eh? All sounds very familiar. And in terms of paying for it, borrowing isn’t a free lunch. Accountants look away now, but in my view, borrowing is always more expensive than paying for things up front.

So, how to arrive at a capex figure? Well how about a heurism? How much on average might we expect, or should we be looking to spend, in an economy such as ours? What’s a rule of thumb to give a sense of the underlying fiscal position? The OECD average is 3%, equating to around £100m. for us. As chance would have it, that’s not too dissimilar to the reported 2022 net cash withdrawal of £115m. from the States Investment Portfolio to pay for ‘operating expenditures and capital expenditure’. So there we have it, an underlying fiscal position of a £100m. in the red?

In fact, this is pretty similar to my estimate of the 2021 deficit in the ISI paper on the tax review published in January. In that I estimated a £50m. deficit in 2021 based on the reported capital expenditure of £40m. that year.

So between £50m. and £100m. in the red, depending on the underlying level of capital expenditure, which I think we can assume lays between £50m. and £100m. Ouch. But before we start to panic too much, that’s covered by that notional dividend income I referred to earlier, so the scribblers at Standard and Poor’s can rest easy.

But an underlying deficit is an underlying deficit. How did we get here? It only seems like yesterday that we had filled the black hole arising from zero-10 with a policy of freezing revenue expenditure.

But that was 10 years ago. To repeat the points I made in January, two key factors have created our present situation – growing expenditure on health particularly, but pensions too, and lower income from a lack of economic growth. It’s the rising relative costs of health and pensions due to worsening demographics that tends to be the focus of attention. But as I pointed out in January, the lack of growth issue has been of similar magnitude in impact.

Exerting some degree of control of the spending growth in these two areas must be part of the mix in putting public finances on a sustainable footing. The point of my producing the long-term projections of public spending in 2012 was to illustrate that those spending commitments then were unsustainable, not to just serve as a guide to how much extra taxation was needed to fund them.

‘Every year, the size of our state will be growing by half a percent more than the rate of our economy. That is not a sustainable position and one which demands higher borrowing, higher taxes or a combination of the two unless pro-growth policies aren’t pursued’. Sound familiar? That was the UK Chancellor, Jeremy Hunt, at the beginning of June, talking about the potential path for the UK economy. As I demonstrated in the January ISI paper on the Tax Review, this has sadly been the Guernsey economy’s actual recent path.Truth be told we’ve already caught a major dose of the British disease.

Both issues require major structural fixes, revisions to the terms of benefits and a well thought out strategy to catalyse growth, which aren’t likely to quickly materialise, which makes the need to control other expenditures paramount.

Finally, but what of the cyclical position of the finances?

What first jumped out at me on my first read of the accounts was the table at the top of page four of the treasurer’s report which reported revenue income as being £70m. less than forecast. As these were the forecasts in the 2023 budget, this gave me cause to think something was seriously amiss in the economy. I suspect, though, there’s an error in this table, because this doesn’t reconcile with the figures in the Statement of Financial Performance.

But it helped me crystallise a sobering thought. Increases in income tax revenues for 2022 don’t look much more than an inflationary uplift. These revenue numbers don’t really reflect a supposed buoyant economy of anecdotal evidence. One that was so red-hot post-Covid it has thrown up housing shortages across the economy. We recently had annual net migration of 500, but the numbers in work grew by little more than 30 in 2022. This gives me pause. I suspect that despite some appearances, we might have been flirting with recession at least towards the end of last year or signals some problems in the labour market, or perhaps both.

With the full impact of the higher interest rates arising from the Bank of England’s disastrous conduct of monetary policy being felt this year, it’s likely the 2023 position will worsen. That is structurally it’s likely slightly worse than suggested by the 2022 figures. So that £135m. figure might not be too far away from the underlying structural deficit after all.

Putting that final flippancy to one side (my discipline cracked right at the end), the task of getting finances on a sustainable path becomes that much harder in such an environment and the imperative of producing a growth strategy increase. The purpose of the ISI report in January was to try and help shine a light on the many issues that we need to address to place the public finances on a sustainable path. I trust that today’s column provides a constructive contribution too.