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Statement by President of Policy & Resources, Deputy Gavin St Pier - The Review Of The Fiscal Policy Framework And Fiscal Pressures

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Wednesday 15 January 2020

Sir,

In this Policy Letter, the Policy & Resources Committee is presenting proposals for a revised Fiscal Policy Framework. This Framework, which was first introduced a decade ago, represents the highest level of fiscal policy in Guernsey and is a set of strategic principles which form an envelope within which the States' finances should operate. These principles are designed to endure across multiple political terms to promote stability and consistency in fiscal policy.

Members are asked to remember that this forms the firsttier of several layers of fiscal policy, with each layer operating at a sequentially shorter time scale. For example, the Fiscal Policy Framework proposes an upperlimit on States' revenues. It does not set any restraints on how this money is collected from our community, which is a matter that should be addressed by each successive States in the 4 yearly Medium Term Financial Plan. Neither does it dictate how these resources should be allocated, since this is the function of the annual budget cycle.

These various layers of policy should work together to set progressively more detailed fiscal policy objectives, and we are here today to discuss our strategic level objectives and not the Medium Term Financial Plan or the minutiae of annual budgeting.

This review was prompted by the revision of GDP in late 2017 which, together with implementation of the first phase of the progression towards adoption of International Public Sector Accounting Standards, necessitated the Framework's first full review.

The proposed principles are, I hope, fairly self-explanatory. They retain the theme of general fiscal prudence, setting a guiding principle of long term permanent balance - and we will debate what that means if the amendments are debated.

In summary, the fundamental principles of our fiscal policy mean that:

There are two principles which are worthy of particular mention.

The first principle I would like to deal with is the one which posed the Policy & Resources Committee's biggest challenge in developing its proposals. It was also by far the largest point of discussion at the workshops held for States Members on the framework. That is capital spending and the investment in infrastructure.

Members will know that we have consistently failed to meet the 3% of GDP target set in the original Framework. Even in years when we have managed to set aside enough money for capital spending, we have not managed to progress a sufficient number or scale of projects to spend it. In only one year, 2012, did we actually manage to spend the requisite amount and this was only achieved because there was an overlap between two substantial capital projects (the work on the Airport runway and the rebuild of Les Beaucamps school).

I don't think anyone will argue that we need more capital investment in infrastructure than has been achieved in recent years - direct capital spend has averaged only 1% of GDP over the last 4 years. However, it is also apparent that it is impossible to maintain the level of capital spend implied by the former criteria of 3% of GDP. Financial considerations aside, we do not have the management and resource capacity to sustain the projects implied by that level of investment.

Neither is it evidenced that we need to spend at this level; we do not we wish to promote spending for spending's sake. Expenditure of any sort must be justified and cost effective and financed in an appropriate way. The way in which we support capital spending has changed significantly, with more capital investment being made via commercialised or trading entities at arms' length from government and outside the scope of our direct capital spending.

So recognising the feedback from those who attended the workshops on this matter, we are proposing a more achievable minimum level of expenditure of 1.5% of GDP - with the emphasis being that this is the minimum. In addition to this we are proposing embedding the requirement for a continuous medium-term review of capital expenditure needs into the Framework. This will bring the adherence to our plans for infrastructure spending within the scope of the proposed four-yearly external review, making this subject to external validation and scrutiny.

The second of these principles is the limit placed on aggregate States' revenues, which is intended to provide guidance and surety to the community regarding the MAXIMUM amount the States COULD raise to pay for public services. Whilst this principle does not specify how revenues should be raised or what services should be provided, when the limit on aggregate revenues was first added to the Framework in 2015, it was deliberately set to allow headroom to manage the known pressures on our expenditures which related mainly to the aging of the population and the resulting burden placed on pensions, health and social care services as a result.

Nothing has really changed in this regard since 2015 - other than now we have greater clarity on the quantum of those long-term fiscal pressures, including: climate change policy, Long-Term Care funding, the final resolution of which is becoming increasingly urgent; funding the Old Age Pension (since 2011 - the first year in which the number of people turning 65 exceeded those turning 16 - the amount we spend each year on the Old Age Pension has increased by 42% and will continue to grow); changes to the policy for funding of NICE drugs and treatments (which we will be debating later at this meeting); introduction of a secondary pension scheme, which will reduce tax revenues in the short to medium term; and access to primary health care.

This Assembly will be considering policy letters on each these issues in due course, which will all undoubtedly have merit in their own right, but will also have very significant implications for the necessary size of our government in the long term. Their financial implications will result in a substantial change to the scale and distribution of costs borne by individuals and the productive economy.

It is worth emphasising, that these specific issues are in addition to the baseline expenditure pressures, which will rise due to the unavoidable demographic changes as a result of the ageing population and the attendant increase in the dependency ratio - namely reduced tax revenues accompanied by increased health and care spending. In addition, we are intending to shortly submit a Policy Letter for consideration which reports on the findings of a review which we commissioned of the myriad of public service employment terms and conditions, together with any recommendations to ensure that remuneration to employees is based on the principles of equity and fairness.

Finally, we also need to ensure that we can fund an appropriate level of investment in our capital infrastructure and replenish our reserves.

As set out in the Policy Letter, these pressures are estimated to total between £79million and £132million per annum, over a period of 5-10 years. Bearing in mind that our 2019 revenues were in the region of £720million, these pressures represent 11-18% of our current revenues.

Let's be very clear. We do not currently collect enough revenue to cover the additional funding requirements that will arise if all these policy changes approved. We may be able to find temporary funding for these - as is proposed for the NICE drugs and treatments - but in the long term the decisions we take on these policies will require us to raise more revenues from the economy through government taxes and charges. If we remain committed to balancing our long-term budget, any increase in spending will need to be accompanied by an increase in the amount that the government takes out of the economy - whether by fees, charges, contributions or taxation.

Measured against current estimates of GDP there is approximately £84million of available headroom within the proposed limit on revenue - this is some 2.5% of GDP. However, if we do not remain cognisant of the cumulative effect of our decisions in the coming months, our successors in this chamber would need to run up to or beyond this limit in order to fund the expenditure commitments we make. Nothing is free. We must remember that for every expense we commit to now, we commit the next assembly to finding a long term, sustainable source of funding for it and doing so within the limits we set today. The key question that needs to be addressed is "what level of public services should be provided and how much tax are we prepared to take out of the economy and from the community in order to provide them."

At this point, I am going to repeat an extract from the speech I made when delivering the 2020 Budget to the Assembly in November last year:

"I should point out now that Guernsey's tax take - the contribution required by islanders to pay for the public services we all utilise every day - remains relatively small as a proportion of the economy - 21% of GDP in Guernsey - compared to 26% in Jersey, 38% in the United Kingdom and 53% in France. If we are to meet the increased demand on public services, we are going to need to raise additional revenues. Like any organisation, particularly large organisations, the States will contain examples of waste - some of which will no doubt be egregious. I do not condone that and we must continue to identify those examples and work to eradicate them.

And we must absolutely continue to drive with determination and rigour benefits derived from the transformation of the delivery of services. However, we do our community no service at all pandering to a popular narrative that all their current needs - and more in the future - can be met costlessly for them, either by simply slaying a mythically inefficient spending dragon, or by finding someone else to pay more in taxes. But on the other hand too, we cannot use the real, systemic upward pressures on public services as an excuse or cover to fund all manner of new expenditure - and in the process soak islanders with an increased tax burden. In other words, there is a balance to be struck. Where we choose to strike it, is a matter of subjective judgement that will be criticised by those who think it should have been struck either higher or lower. These are difficult and unpopular messages to deliver - but I am not afraid to deliver to them."

Due to our comparatively small and exceptionally narrow existing tax base, there is very little opportunity to raise additional revenues from the current structure. The scale of revenues required to fund emerging policy cannot, and should not, be met from 'tweaking round the edges' of the existing system - a series of small, uncoordinated and opportunistic tax increases would not raise sufficient revenues or create the most efficient and equitable outcome. To put into context, a 1% increase in the headline income tax rate - i.e. from 20% to 21% would raise only £13.5million of additional revenues. Raising the headline rate of income tax will never be the solution. Especially if we keep in mind that the pond from which we are fishing is and will continue to shrink as the proportion of dependents to economically active will continue to grow. Before anyone criticises me for having a go at pensioners, I emphatically am not. They are not the problem. The problem lies with is the growing number queuing up behind to join them, including in my generation, with fewer in the generations behind mine to support us.

There is an ongoing commitment to Public Service Reform, including a programme of service design initiatives to improve organisational efficiency, freeing resources which can be used elsewhere. We must - absolutely must - deliver on our commitment to the community to deliver on ensure that those transformations do deliver benefits - financial and non-financial. Initiatives such as the Reform of Health Care Funding and the modernisation of the Princess Elizabeth Hospital provides opportunities to make more effective use of existing resources and mitigate some of the upward pressure on healthcare costs. In addition, the transforming education programme identified net annual savings of in the region of £2million per annum.

In addition, economic growth resulting in real-terms' increases in employment, earnings and company profits will provide SOME of the additional revenues - so the news published last week that our economy grew more strongly in 2016 and 2017 at 3% and a stellar 4.6% respectively is very much to be welcomed. Whilst that is feeding through to higher tax revenues than budgeted, we must be realistic that it can only form part of the solution - it is not the magic bullet.

Notwithstanding the mitigating effect of efficiency savings, transformation of service delivery and economic growth, there will be a shortfall in the revenues required in order to fund the emerging policy initiatives, if they are all to be progressed. Therefore, it is proposed to initiate a review of potential long-term options to ensure that the tax base has the capacity to raise the amount of revenues to meet long-term needs in an economically but also, importantly, in a socially sustainable and fair manner - this will incorporate consideration of options for generating additional revenues from: taxation of company profits; the existing income tax and social security contribution system; a health tax, and the addition of general or limited consumption taxes to the tax base. The review must also investigate options for the implementation of any recommended measures in such a way as to minimise the economic impact of changes to the tax structure - and provide analysis of the financial, economic and social implications of any options presented.

We need to protect and enhance our economy which generates the income, employment, profits and consumption from which our tax revenues are raised. This includes ensuring that Guernsey remains competitive and an attractive location for business; continuing to protect Guernsey's status as a low tax jurisdiction, maintaining tax neutrality whilst remaining internationally acceptable in an era when international standards are shifting and shifting fast. Therefore, the terms of reference for the review will preclude the consideration of any form of capital taxes which are considered incompatible with Guernsey's status as a finance centre.

As Benjamin Franklin said, "in this world nothing can be said to be certain, except death and taxes" and both are equally unpopular with the public. We cannot expect the recommendations of this review to be welcomed with open arms but we do need to take the public on this journey with us so that they fully understand why it is taking place, become engaged with the process and are consulted and communicated with as it progresses, culminating in the Policy & Resources Committee presenting its report for consideration by the States no later than June 2021.

Sir, In conclusion I would like to highlight the importance of having a clear and simple set of high level principles to guide fiscal policy over the long term. They are intended to promote prudent fiscal behaviours across multiple States' terms, sending a strong signal of government's commitment to the community, business and future investors in our economy, whilst ensuring that each Assembly will have the freedom to set more detailed fiscal policy to suit the prevailing conditions and political will.

When considering expenditure proposals, we must be cognisant that government spending is funded by local people and local businesses - no-one else - it is not just that we need to consider whether we wish to introduce or expand a service but we need to also consider whether and how we can responsibly fund it - in other words, there is a need to evaluate and prioritise what the community would like against what we are willing to ask the community to pay for.

We need to take a strategic view, look beyond the electoral cycle and agree clear principles to underpin long-term fiscal prudence and put in place a cohesive approach to raising revenues in a sustainable and equitable manner in order to fund prioritised services.

I want to finish upbeat - because I am.

I am actually confident that we can have it all - we can meet the needs of our community whilst ensuring we remain a competitive, low tax economy with a fair distribution of the tax burden. To do so though is going to require the same planning and discipline as the States has exercised in the last 8 years. It may be dull. It may be painful. But it is effective. It is what has helped deliver the stronger economic and fiscal performance that we have experienced in recent years.

I ask Members to vote for these proposals.

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