Draft 2015 Budget - Report - 15 September 2014

CONTENTS

1. EXECUTIVE SUMMARY ....................................................................................................... 1
2. KEY FINDINGS AND RECOMMENDATIONS ....................................................................... 3
3. CHAIRMAN'S FOREWORD .................................................................................................. 7
4. INTRODUCTION ................................................................................................................... 9
5. INCOME FORECASTS ....................................................................................................... 11
6. BALANCING THE CONSOLIDATED FUND ........................................................................ 20
7. TAXATION PROPOSALS .................................................................................................... 26
8. CAPITAL EXPENDITURE ................................................................................................... 31
9. THE LONGER-TERM PICTURE ......................................................................................... 41
10. CONCLUSION .................................................................................................................... 50

11. APPENDIX 1: PANEL MEMBERSHIP, TERMS OF REFERENCE AND EVIDENCE CONSIDERED .................................................................................................................... 51

12. APPENDIX 2: REPORT FROM CIPFA ................................................................................ 55
13. APPENDIX 3: REPORT FROM MJO CONSULTANCY ....................................................... 97

1. EXECUTIVE SUMMARY

1. The Draft 2015 Budget contains the proposals of the Minister for Treasury and Resources in respect of taxation and the Capital Programme. In most years, it is those taxation proposals which prompt most reaction and discussion. This year much of the focus has instead been on income forecasts and the fact that the Draft Budget is based upon forecasts downgraded from those used in the 2014 Budget.
2. It is apparent that the income-forecasting process in 2013 was not ideal and measures were ultimately adopted in the 2014 Budget which should not have been proposed. Such circumstances should not be allowed to repeat themselves and we have recommended that the Minister introduce more formality into the forecasting process. Decisions of the States Assembly need to be based upon the most recent information and we have recommended that the Minister ensures that the most up-to-date forecasts are used as the foundation for the Budget-setting process. In that regard, we had anticipated that the Long-Term Revenue Plan would have been made available to Members earlier; it is of direct relevance to the debate on the Draft Budget and must be presented as soon as possible to the Assembly.
3. The downgraded forecasts have required the Minister to present a number of contingent measures to ensure the Consolidated Fund is not shown in deficit at the end of the year. Some of these measures are included in the Budget proposition itself, namely transfers from a number of funds to the Consolidated Fund. Other measures are described in the report accompanying the Draft Budget and include proposed dividends from the utilities and Departmental savings. The timing and character of these contingent measures undermine confidence in the States' financial strategy and it is vital that their deliverability is critically appraised. In respect of proposed base budget reductions we have recommended that the Minister confirm with Departments that there is sufficient management and financial information available to monitor and report upon the proposed reductions. The proposed reductions should also be subject to independent validation.
4. A Capital Programme for 2015 of approximately £75 million has been proposed. The Minister has advised that the Draft Budget is intended to help continue supporting the economy with the injection of capital expenditure. In order to ensure the efficacy of fiscal stimulus, measures proposed to support the economy in this way must meet the 3 Ts' test of being timely, temporary and targeted. Unfortunately, actual performance in capital expenditure in recent years does not instil confidence that forecasted profiles for future capital expenditure will be achieved. We have therefore recommended that the Minister review the legislative framework surrounding the capital allocation process to ensure it allows for realistic delivery of the Capital Programme and for appropriate performance

management arrangements to be put in place.

5. The Capital Programme includes the latest updates in respect of the Hospital and Liquid Waste Projects. In terms of the Hospital Project, we have found that whole-life costing needs to be embedded within project-modelling and revenue budgets and that further work is required to ensure confidence in the expected spending envelope. We have recommended that the Minister take action to address these points. Furthermore, there are reservations about the anticipated investment returns on the Strategic Reserve (which are due to be used to fund the Hospital Project) and we have recommended that further testing of these anticipated returns should be undertaken. In terms of the Liquid Waste Project, the Draft Budget seeks the Assembly's approval of the spending envelope. The Project is in part due to be funded by expected savings from the Department of Transport and Technical Services. It remains unclear how those proposed savings will be achieved and we have therefore recommended that clarification of their delivery be provided.
6. Ultimately, this year's Draft Budget has raised significant questions in respect of the States' future financial management. It calls into question the current MTFP model and we have found that an urgent recalibration of the MTFP is required; its redesign needs to be on the basis of a robust economic model and not simply an accounting model.
7. The downgraded forecasts and the concerns identified over the contingent measures highlight the risk that deficit-financing may become the norm for the States. We have recommended that the Minister investigate the potential for the States to run a budget surplus of 0.5% or 1% of GVA over the economic cycle.
8. Given the risk that our income position might be deteriorating, the time has come for a full debate on States' expenditure and income. Further work is required in order to determine both the size of any structural deficit facing the Island and the strategy to be used to address it. In that regard, we recommend that the Minister ensure that Departments are requested to identify not only budget-reducing proposals but also measures to optimise income generation capability.

2. KEY FINDINGS AND RECOMMENDATIONS

Key Findings

1. Problems arose in the income-forecasting process in 2013 which meant that measures were proposed (and ultimately adopted) in the 2014 Budget which should not have been. These circumstances should not be allowed to repeat themselves.
2. Decisions of the Assembly need to take into account the most recent and up-to-date information.
3. The timing and character of the proposed remedial measures undermine confidence in the States' financial strategy. It is vital that the measures are critically appraised in relation to their propensity for delivery.
4. It remains unclear how proposed savings will be met to ensure the Liquid Waste Project can be funded in the way envisaged.
5. There are reservations about how much confidence can be attached to the Draft Budget's anticipated level of sustained investment return performance on the Strategic Reserve.
6. Further work is required to ensure confidence in the expected spending envelope for the Hospital Project.
7. Whole-life costing should be fully embedded within project modelling and revenue budgets for the Hospital Project.
8. In order to ensure the efficacy of the fiscal stimulus programme, measures to stimulate or support the economy must meet the 3 Ts' test of fiscal stimulus.
9. Actual performance in capital expenditure in recent years does not provide sufficient confidence that forecasted profiles for future capital expenditure will be achieved.
10. There is a risk that deficit-financing may become the norm for the States.
11. The Long-Term Revenue Plan will provide directions to both the Budget setting process and the foundation for the MTFP and is of direct relevance to the debate on the Draft Budget.
12. An urgent recalibration of the MTFP is required and its redesign needs to be on the basis of a robust economic model and not simply as an accounting model.
13. The time has come for a full debate on States' expenditure and taxation.
14. Further work is required in order to determine both the size of any structural deficit facing the Island and the strategy to be used to address it.

Recommendations

Our advisors from CIPFA and MJO Consultancy have both made a number of recommendations which we fully endorse and recommend should be implemented. In particular from our advisor's recommendations, we have identified the actions listed below, some of which need to be addressed immediately and others which should be addressed before the next MTFP is lodged.

We recommend that the Minister for Treasury and Resources should immediately take action:

1. To ensure that the most up-to-date forecasts are used as the foundation for informing the Budget Setting Process.
2. To ensure that proposed base budget reductions are subject to independent validation in order to ensure both their deliverability and their ability to be monitored.
3. To confirm with Departments that they have sufficient management and financial information to be able to monitor and report upon the proposed savings that the Draft Budget will require them to deliver.
4. To ensure that the capital cost of the Hospital Project is re-evaluated to ensure that there is appropriate precision within the expected spending envelope and that approved functionality synchronises with that expectation.
5. To review the legislative framework surrounding the capital allocation process to ensure it allows for the realistic delivery of the Capital Programme and for appropriate performance management arrangements to be put in place, with the outcome of this review to be reported to the States Assembly ahead of the lodging of the next MTFP.
6. To investigate the potential for the States to run a budget surplus of 0.5% or 1% of GVA over the economic cycle, with the outcome of this work to be reported to the States Assembly ahead of the lodging of the next MTFP.
7. To ensure that the Long-Term Revenue Plan is presented to the Assembly as promised prior to the Draft Budget debate.
8. To request that work begin immediately on the recalibration of the MTFP with a report on progress to be provided to the new Assembly by Christmas 2014.

We recommend that, prior to the lodging of the next MTFP, the Minister should take action:

9. To ensure that membership of the ITFG is formalised within a structured reporting framework and with formal minutes being made available to the Council of Ministers.
10. To ensure that an assessment is undertaken of the ability of the Department of Transport and Technical Services to identify savings in order to fund the Liquid Waste Project.

11. To ensure that the feasibility of proposed investment returns on the Strategic Reserve is subject to further testing.
12. To ensure that the full-life running costs of the Hospital Project are appropriately evaluated against the MTFP financing capability in respect of the Health and Social Services budget.
13. To ensure that Departments are requested to identify measures to optimise income generation capability, with service delivery benchmarking to be used as a means of identifying wider options.
14. To ensure that the economic drivers that influence tax yields are re-evaluated and that all sources of data (including Social Security and other contributions) are used to inform financial strategy and to determine the extent of any structural deficit.

3. CHAIRMAN'S FOREWORD

1. The original MTFP tied income to expenditure. Since 2013 the fall in income and the increase in expenditure have removed that link. Until the link is re-established there is a significant risk that the deficit will increase.
2. We have been particularly concerned about the income forecasts. The previous two Budgets, those for 2013 and 2014, used the forecasts from the MTFP. The Draft 2015 Budget used a lower set of forecasts produced by the Income Tax Forecasting Group. These are significantly lower for 2015 than those in the MTFP - £455 million as against £500 million. We understand that forecast for 2014 continues to drift downwards, a drift which is underlined by Social Security statistics. The total contributions and number of contributors is down by 1% in 2013 compared to 2012. The value of 2013 contributions in cash terms is now less than 2009, despite inflation over this period. The number of contributors is also down. This will have implications for income tax receipts for 2014.
3. The FPP has been warning of possible structural deficits since 2008. In 2008 it was merely a warning. By July 2011, the FPP commented that the Stabilisation Fund had been used to "finance deficits arising for both cyclical and structural reasons" and that "if savings cannot ultimately be delivered then any shortfall may have to be made up through tax increases if there remains a structural deficit over the medium-term." The FPP has also recently commented that it welcomes the property tax review as "it could also help the States to find revenue raising measures in the event there is a structural deficit."
4. Finally, in its most recent report, the FPP recognised that the next MTFP will have to contain measures to address the structural shortfall between States' income and expenditure and that "the medium-term outlook, while uncertain, suggests that there are significant challenges in even maintaining a balanced budget." In an interview for BBC Radio Jersey on 18th July 2014 the Chairman of the FPP remarked he was now far more certain a structural deficit existed.
5. The Panel has other significant concerns.
6. Although the fall in the forecasts was known in September 2013, the Budget for 2014 was not adjusted and contained the original MTFP forecasts. If the States of Jersey was a private company then a profits-warning would have been issued. The quantum of the change can be considered in the context of the balance on the Consolidated Fund in the 2014 Budget changing from a positive balance of £5.7 million to a projected deficit of some £40 million in the latest figures from the Treasury.

7. The measures to balance the Consolidated Fund are in effect reserves which are being used to fund core net spend. Using such reserves in this manner is a real wake-up call and is typically the product of a rapidly deteriorating fiscal position. It is disappointing that although the deterioration of the income figures was known in September 2013, the measures being taken to balance the Consolidated Fund for 2014, and to adjust the forecast Budget for 2015, were not commenced until July 2014.
8. In our review of the 2014 Budget we said that productivity is a fundamental part of economic growth and,  given the comments by Standard & Poor's on our economic growth  ("the recovery is likely to be uneven and shallow"), consideration of taxation measures in respect of productivity in the economy in the public and private sectors is an area demanding urgent work.
9. We also concluded that there is a risk that the injection of large amounts of capital funding over the next ten years could overheat the local economy. Forecasting the impact of such expenditure on the economy is difficult given the current challenges in measuring capacity within the construction industry.
10. We have been advised that work has progressed on these matters but we have seen no reports on them. In the meantime the income tax receipts have continued to fall short of the forecasts whilst expenditure has exceeded the levels forecast in the MTFP.
11. We are left with questions regarding the quality of the advice being given to the Minister for Treasury and Resources. Was there sufficient appreciation of the deteriorating financial situation and was the Council of Ministers fully aware of the overall situation at an early stage? It is not possible to reach conclusions as to whether the capital spend has fed through to the fiscal stimulus and whether that spend meets the 3Ts' or is recurring. We are also concerned that it is only now that the question of the existence of a structural deficit is being investigated and that apparently there is as yet no plan to deal with the deficit.
12. Our advisors have made a number of recommendations which are a more detailed reflection of those made by the FPP. We recommend that these are followed.
13. I would like to thank the Panel, our advisors and our Scrutiny Officers for their hard work and participation in this review, which has been achieved under considerable time pressures.

Senator Sarah Ferguson Chairman

Corporate Services Scrutiny Panel

4. INTRODUCTION

1. The Draft 2015 Budget Statement (the Draft Budget') was lodged on 18th July 2014 as P.129/2014 and will be debated on 22nd September 2014. It contains the proposals of the Minister for Treasury and Resources (the Minister') in respect of taxation; capital expenditure; and, more generally, the Fiscal Framework. The Draft Budget has been prepared and lodged under Article 10 of the  Public Finances (Jersey) Law 2005 which dictates what the Minister must (or can) propose:

1. The amount of income to be raised by taxation. The Minister has proposed, under Part
   1. of the proposition, estimated income for 2015 of £615,502,000. This estimate takes into account specific proposals in relation to Income Tax, the Goods and Services Tax (GST), Stamp Duty and Impôts.
2. A maximum amount, if any, that the States may borrow. No borrowing is proposed in the Draft Budget.
3. Amounts, if any, of growth expenditure to be allocated. All the 2015 growth allocations were agreed as part of the 2014 Budget. No provision for them is therefore included in the Draft Budget.
4. For each capital project to be started or continued for which no other approval exists, a capital head of expenditure. The Minister has proposed under Part (b) of the proposition a capital programme for 2015 totalling £76,382,000 (£75,144,000 if the Minister's amendment to the Draft Budget is adopted). In Part (c) the States Assembly is asked to approve the spending envelope for the Liquid Waste Project.
5. Details of each capital project to be undertaken by a States Trading Operation. Approval is sought for projects totalling £6,064,000 under Part (d) of the proposition.
6. Amounts, if any, to be transferred between the Strategic Reserve, Stabilisation Fund, Consolidated Fund or any other Specially Constituted Fund. A number of transfers to the Consolidated Fund are proposed under Parts (e), (g) and (h) of the proposition: £22.7 million from the Strategic Reserve; up to £6.12 million from the Housing Development Fund; up to £1.058 million from the Stabilisation Fund; and £2 million from the Dwelling-Houses Loan Fund (rising up to £6.5 million if the Minister's amendment to the Draft Budget is adopted).

2. There are other aspects to the Draft Budget beyond the above. In Part (f), the Assembly is asked to approve revised rules for the operation of the Housing Development Fund. In Part (i), the Minister seeks the Assembly's agreement in determining the capital limit of the Strategic Reserve whilst in Part (j) the Assembly is asked to approve rules for the future operation of the Stabilisation Fund. Finally, in Part (k), the Minister seeks the Assembly's backing for the proposed redemption of preference shares held by the States of Jersey in Jersey Water.

3. As in previous years, the Minister has also presented a number of reports alongside the Draft Budget. None of these reports seeks a decision from the Assembly at this time but they give an indication of future work that is to be undertaken or of decisions that might be required in due course.
4. We set out to explore all these various facets of the Draft Budget with a view to understanding not only the short-term implications of its proposed measures but also its long-term impact. To that latter end, we endeavoured to understand where the Draft Budget sits within the longer-term financial planning framework, building upon the work we had previously undertaken on the Medium Term Financial Plan (MTFP) and the Budgets of 2013 and 2014.
5. Our review had to be undertaken within a very short time frame and over the summer recess: Budget proposals remain strictly confidential until they are published and our review could not therefore begin in earnest until the Draft Budget had been lodged. We are grateful for the efforts of the Minister and his Department to brief us on draft proposals and to provide us with the information we required. We are also extremely grateful for the work of our expert advisors from the Chartered Institute of Public Finance and Accountancy (CIPFA) and MJO Consultancy whose reports may be read in Appendices 2 and 3.

5. INCOME FORECASTS

1. The most significant issue we explored during our review related to income forecasts and their use in the development and construction of the Draft Budget.
2. Under  Article 10(3)(a) of the Public Finances Law, the Minister  is obliged to seek the Assembly's approval of the amount of income intended to be raised by taxation during the year to which a draft budget relates. The Assembly's approval of intended amounts of income is also required in the MTFP (for each of the years to which the MTFP relates). This should be noted because each Budget fits within a context of longer-term financial planning established by the relevant MTFP. The Draft Budget is the last Budget relating to the current MTFP.   These  amounts  of  intended  income  provide  the  basis  on  which  subsequent decisions can be taken in relation to taxation and expenditure. Whilst the amounts might be intentions' or estimates, they are therefore vital to the Assembly's decision-making.
3. The Minister stated in his testimony to us that, as a forecast, any statement of intended income would undoubtedly be proven to be incorrect by actual returns.[1] Whilst the generality of that argument may hold true, it is also the case that, for the sake of the Assembly's decision-making, there does need to be confidence that those stated intentions of income are realistic and that taxation and expenditure proposals brought to the Assembly are well- founded.
4. In the Draft Budget, the Minister seeks approval for estimated income from taxation in 2015 of £615,502,000. Questions were raised about income forecasts because the Draft Budget has been developed on the basis of lower income forecasts than either its two predecessors or the MTFP. This situation primarily stems from lower forecasts for Income Tax, which represents the greatest proportion of States income; major changes in forecasted Income Tax receipts therefore impact significantly upon forecasts for overall income.
5. The downgrading of Income Tax forecasts has been highlighted by both of our expert advisors in their reports and can be seen from the following table:

6. We examined how Income Tax forecasts are developed and how decisions were taken on their use in the development of the Draft Budget.

7. In terms of how income forecasts are constructed, we received the following advice from the Department of Treasury and Resources:

"There is one future forecast, produced by means of a model, by the Income Tax Forecasting Group produced each year to inform the next year's Budget proposals. The forecast produced for the Budget 2015 predicts income tax for the years 2014 to 2017 and the current year's position is informed by the Taxes Office's in-house forecast. A similar forecast is performed by areas responsible for other income, for the same period to also inform the Budget e.g. Customs and Excise will produce their Impôt forecast."

We were advised that a full review of all States income is only carried out once a year to support the production of the Draft Budget. Work on sources of income is therefore undertaken by the sections with responsibility in those areas. There is also in-year monitoring of forecasts on a monthly basis (more comprehensively on a quarterly basis).

8. In relation to Income Tax forecasts, there are effectively two separate processes of which we were made aware: forecasts produced by the Income Tax Forecasting Group (ITFG) and in- year and in-house monitoring of Income Tax receipts by the Taxes Office.
9. In relation to the ITFG, it does what one would expect from its name: on an annual basis, it produces a forecast for Income Tax (recently in March 2012 and then May 2013 and May 2014). The ITFG's work is supported by the Economics Unit who make use of a model (based on a number of various economic assumptions) to forecast Income Tax receipts. Work is done annually on recalibrating the model by using actual Income Tax receipts to determine where the model may currently be mis-hitting. It is apparent that the ITFG is not obliged to follow the results of the model, however; rather the ITFG considers the outcome from the forecasting model used and "reach[es] a consensus forecast using their judgement."
10. Our advisor from CIPFA has stated that the "the structure of the group is rarely stable and lacks formality." We understand that at present the ITFG includes the following individuals: the Treasurer of the States; the Economic Advisor and one further officer from the Economics Unit; the International Advisor; the Director of Treasury Operations; the Head of Financial Planning; the Comptroller of Taxes; the Director of Tax Policy; and the Finance Director of the Taxes Office. We have also noted that there does not appear to be a formal report produced by the ITFG itself; the reports which we have received in the past (and which have been made available to the Assembly) appear to be the report prepared by the Economics Unit for the ITFG. We were advised that the Unit's final report reflects the consensus view of the ITFG after having considered a draft of the Unit's report over a series

of meetings. In his testimony to us, the Minister underlined the independence of the ITFG (i.e. from political interference).[2]

11. Separately from the work of the ITFG, the Taxes Office monitors in-year Income Tax receipts and provides forecasts for the monthly and quarterly reports which go to the Corporate Management Board (CMB) and (in relation to the quarterly reports) to the Council of Ministers. We were informed by the Department that this work entails the following:

"The approach that has been adopted by the Taxes Office is to identify the sub set of assessments in 2014 that can be compared to a 2013 equivalent assessment and therefore identify, on a comparable basis, the increase / decrease in revenue vs prior year for assessments that have been completed year to date. This result is then extrapolated over the full year and compared to budget.

Adjustments are then made to take into account the following:

• Payment on account taxpayers
• Refunds associated with dividends received from the States holdings in Jersey Utility Companies.
• Assessments that have been performed but not yet issued (Bulk Issue) - these are not yet loaded on the ledger (as assessments are only loaded to the ledger when issued). However it has been included in the year end forecast figure as by year end these values will have been loaded to the ledger and will therefore effect 2014 outturn.
• The value of the comparable assessments for last year has been calculated as a percentage of the total revenue for last year, and this percentage is then used to extrapolate forward the year to date position.
• The non-comparable value year to date is uplifted to give an expected outturn for full year.
• Adjustments made to prior year assessments.
• Non-collectible values expected to arise between now and the year end.
• Shareholder dividends that have been declared on returns but that we are awaiting vouchers for to confirm tax has already been deducted at source.
• The revenue raised from Penalty files.

Comparable assessment values are then compared on a percentage basis to prior year to sense check any increase / decrease.

The forecast revenue is then compared to the MTFP forecast revenue."3

12. Our advisor from CIPFA was given the opportunity to walk through' the Taxes Office's model on tax yield performance and forecasting. He has advised us that "there is a considered approach to tracking and forecasting tax yields and [it] employs a bottom up' approach which aims to capture movements within all components of tax using Excel and Chrystal Report  Writing  Tools  on  top  of  the  iTax  Base  system." CIPFA's  view  is  that  "the methodology  appears  to  be  robust  and  that  the  extent  of  variances  experienced  on forecasting reflects the volatility and complexity of tax impacts as well as prevailing economic conditions."
13. It is these two separate processes which are seemingly used for the identification of Income Tax forecasts for inclusion in the MTFP and the Annual Budget and it is clear that the decision is not always simply to follow the forecasts produced by the ITFG. When we asked who was ultimately responsible for providing the forecast, we were informed that it is the Treasurer's responsibility to advise the Minister.[3]
14. If the ITFG's forecasts from recent years are considered alongside the table presented above, the following picture emerges in respect of Income Tax forecasts:

15. As our advisor from MJO Consultancy has stated, "every forecast since the publication of the MTFP has shown a deterioration."
16. In light of this picture, we questioned the Minister on how, and why, decisions had been taken  about  the  income  forecasts  included  not  only  in  the  Draft  Budget  but  also  its predecessor, the 2014 Budget. From the advice and information we received, the following timetable can be constructed:

• In  February  and  March  2012  a  full  review  of  all  States  income  forecasts  was undertaken. This included the work of the ITFG.
• In July 2012 the MTFP was lodged and used the mid-point of the ranges identified by the full review as the forecast. The MTFP was debated and approved in November 2012.

3 Written advice, Department of Treasury and Resources, 18th August 2014

• In October 2012 the 2013 Budget was lodged and used the same income forecasts as the MTFP. They were subsequently adjusted to take into account the measures approved in the 2013 Budget (which was approved in December 2012).
• In May 2013 the next full review of all income was undertaken (including the work of the ITFG). The Income Tax forecasts were lower as was the overall income forecast as a result.
• The 2014 Budget was lodged in October 2013. Notwithstanding the lower forecasts produced by the annual review, a decision was taken to base the 2014 Budget on the MTFP forecasts. A supplementary note was made available to Members at the time of the debate which explained the reasoning for this decision.[4] The Budget was approved in December 2013.
• In February 2014, the Minister answered a written question tabled by Deputy J.A.N. Le Fondré about income forecasts. The answer to this question confirmed that MTFP forecasts had been used for the 2014 Budget but that the May 2013 forecasts were being used as the basis for the Long-Term Revenue Plan.
• In May 2014 the latest full review of all income was produced including the ITFG forecasts, which revealed lower forecasts than both the MTFP and the May 2013 review.
• The Draft 2015 Budget was lodged in July 2014 and was based upon the forecasts produced in May 2014. Work on the Long-Term Revenue Plan was also updated to incorporate the May 2014 forecasts.

17. The Minister and his Department were aware of downgraded forecasts at the time of the 2014 Budget. However, a decision was taken to continue to use MTFP forecasts for the basis of the 2014 Budget. From our own consideration of this matter and from the reports of our advisors a number of questions arise: Why were the MTFP forecasts used for the 2014 Budget when the ITFG's latest report suggested those forecasts were optimistic? What were the implications of that decision? Is the forecasting process (including the decisions about which forecasts to use) sufficiently robust?
18. The Minister stated to us that that there was no reason for surprise at what had come to pass, advising us that "we have known that the income line was going to be less than expected all the way through almost from the beginning of 2013 and it has become clearer and clearer what the numbers are."[5] Indeed, the pressure' that had been felt on Income Tax

had led to steps to improve income through other sources, for example the investment of the Currency and Consolidated Funds.[6]

19. We were advised that MTFP forecasts were used for the 2014 Budget due to the results of the in-year and in-house monitoring by the Taxes Office during 2013. At the time the 2014 Budget came to be lodged, the actual Income Tax receipts from the first two quarters of 2013 were known. The Taxes Office's forecasts on the basis of its work suggested that receipts would not be as low as the ITFG's forecasts suggested. A decision was therefore taken to continue using the MTFP forecasts for the 2014 Budget but to use the ITFG May 2013 forecasts for development of the Long-Term Revenue Plan. The Plan, which we have been advised will be presented in due course, will look at financial planning out to 2020 and will form the platform for development of the next MTFP. As a further mitigating factor, we were informed that the actual receipts for 2013 had ultimately been close to the MTFP forecasts in that Income Tax receipts had amounted to £450 million (compared to the MTFP position of £452 million). However, within that context, personal Income Tax receipts had underperformed by £20 million whilst business Income Tax receipts had over-performed by £18 million.[7]
20. In terms of the implications of that decision, it would seem that some of the proposals included in the 2014 Budget might not have been put forward if lower forecasts had been used. In particular the proposal to reduce the Marginal Rate of Income Tax from 27% to 26% might not have been put forward. In that regard, we were informed by the Treasurer that the measure would not have been recommended if what is known now had been known then, on account of the lost revenue the measure would entail (although it was also stated that the measure might still have been included on economic grounds).[8]
21. Our advisor from MJO Consultancy has also suggested that a number of errors were made in the decision-making process over 2012 to 2014. First, there was in his view an apparent misunderstanding of the economic situation in 2012 when the initial forecasts were made. Economic factors affect the economic assumptions placed into the model used for the ITFG forecasts and our advisor has suggested some of the assumptions were optimistic. He has suggested that optimism also drove the decisions made on the basis of the forecasts and meant that the 2012 ITFG Income Tax forecasts (i.e. the MTFP forecasts) continued to be used for the 2014 Budget (even though the ITFG had itself revised the Income Tax forecasts downwards in May 2013). Our advisor has ultimately stated, "it is very difficult to comprehend why the Treasury did not use the May 2013 forecasts for the 2014 Budget and to persist with forecasts which were out-dated even at the time of the publication of the MTFP in July 2012." He has recommended that "the process of economic forecasting should be re-examined."

22. Our advisor from CIPFA has expressed similar reservations, advising us that "we fear that this lack of transparency, coupled with the sub-optimal behavioural element of optimism bias, may be contributing factors behind what can now be seen as less than robust' income forecasting and a consequential failure to recalibrate expenditure." He expresses concerns for the longer-term picture in relation to tax revenues, a matter we shall return to later in this report. He has also suggested that it might be a distraction to refer constantly back to the MTFP position and that, instead, reference should be made to the position on real income and expenditure.
23. The downgraded forecasts from May 2014 (or, more particularly, the decision to use those forecasts as a basis for the Draft Budget) have had immediate implications for the measures proposed in the Draft Budget. We shall explore those implications in subsequent chapters of this report. We have also considered, however, what this recent experience suggests in the longer term for forecasting income (in particular Income Tax) and the decision-making on the basis of that process. This is particularly pressing given one of the findings of our advisor from CIPFA. He was given the opportunity to consider the latest available corporate report (which at the time of this report was June 2014). Consideration of that report has led him to advise us that there may be a "downward trend in income" which raises the question of whether even the May 2014 ITFG forecasts will be realised. Indeed, our advisor has expressed some concern at the prospect that the Draft Budget, even with lower forecasts, is deliverable. He has stated that the Draft Budget should be considered on the basis of the most recent intelligence; as the Draft Budget stands (it was lodged in July 2014) it takes into account the May 2014 forecast produced by the ITFG and does not therefore take into account the in-year and in-house monitoring and forecasting undertaken by the Taxes Office. He has therefore recommended that "latest forecasts MUST be used as the foundation for informing the Budget Setting Process, as far as reasonably practical to the point where Members are provided with the details within the States approval process."
24. During our hearings, the Treasurer advised us of her own view that income would in fact prove to be more positive than the revised forecasts suggested. However, it had been prudent to plan for the longer-term on the basis of lower forecasts and hence the decision was made to move away from using MTFP forecasts;[9] it was therefore highlighted to us that the revised forecasts had been used for the Long-Term Revenue Plan, which will form the basis of the next MTFP. We were also advised that, in the longer run, income levels were

expected to return to previously anticipated levels; it was in 2014 and 2015 that there was particularly a problem.[10]

25. The Executive itself is considering changes to the forecasting process. One measure is proposed in Updating Jersey's Fiscal Framework (R.102/2014), in which it is suggested that income forecasts could be made the responsibility of the Fiscal Policy Panel (FPP). Our advisor from MJO Consultancy has considered that option and has suggested that this would need "a thorough debate as it calls into question the purpose of the Income Tax Forecasting Group and the Economics Unit." He asks whether this transfer of responsibility would weaken the FPP's independence and whether it would in fact allow for "more credible and transparent fiscal and economic forecasts."
26. Our advisor from CIFPA has recommended that "Membership and attendance of [the ITFG] should be formalised within a structured reporting framework [and] with formal minutes being made available to the Council of Ministers."
27. It is evident that questions can be asked about the preparation of the 2014 Budget. The Treasury itself advised us that the reduction in the Marginal Rate would not have been proposed if what is known now had been known then. However, it was known then: as the Minister has highlighted, the work of the ITFG in May 2013 had already downgraded the forecasts from the MTFP position and there was therefore awareness during preparation of the 2014 Budget that the position might have changed. The 2014 Budget was ultimately passed but it is paramount that a similar set of circumstances are not allowed to develop. This is particularly pressing given the findings of our advisor from CIPFA that the position on Income Tax receipts might in fact be worse than the current forecast from the ITFG (which is used within the Draft Budget).
28. Our advisor has considered the models used within the income-forecasting process and has concluded that the models themselves are robust. We acknowledge the work that has been undertaken on their development and on the efforts taken to improve them. The issue would not seem to be one of how forecasting numbers are produced but on how decisions are made on which numbers to use. In 2013, the problems appear to have occurred in the period between the production of the ITFG forecasts and the presentation of the 2014 Budget (which continued to use MTFP forecasts). In that regard, it is of some concern to hear that the work of the ITFG lacks the formality and we endorse the recommendation from CIPFA that greater formality should be introduced.
29. The current Draft Budget uses ITFG forecasts. However, from the work of our advisor there remain concerns that the ITFG forecast in itself may be too optimistic. The Assembly needs

to be fully aware of the current situation when it comes to debate the proposition, as CIPFA has recommended.

6. BALANCING THE CONSOLIDATED FUND

1. The Minister's proposals in the Draft Budget (and indeed the MTFP) in respect of intended income may be based on forecasts (and therefore might well prove to be incorrect in the long run) but they are vital to subsequent decisions about taxation and expenditure. They also have a knock-on effect on the development and construction of the MTFP and the Annual Budget.
2. In that regard, under Article 10(8) of the Public Finances Law, the Minister "must not lodge a draft budget that includes a report that shows a deficit in the Consolidated Fund at the end of the financial year to which the budget relates." The revised income forecasts from May 2014 (which have been used as a basis for the Draft Budget) have impacted on the balance that was expected in the Consolidated Fund at the end of 2014 and 2015.
3. In the Draft Budget report as initially lodged, Summary Table F showed what the position of the Consolidated Fund would have been at the end of 2015 if all the measures proposed in the Draft Budget were approved. It indicated that if all the measures proposed in the Draft Budget were pursued (and if the income forecasts used as a basis for the Draft Budget were realised), the balance on the Consolidated Fund at the end of 2015 would have been £0. An amendment to the Draft Budget lodged by the Minister on 8th September 2014 changed the expected position slightly to show a final balance at the end of 2015 of £3,851,000.
4. That took into account measures which prepared specifically to ensure the Consolidated Fund does not go into deficit; measures which would not be required if higher income forecasts were used. This is not the first time the forecast balance of the Consolidated Fund has been downgraded: the 2014 Budget report showed that the Consolidated Fund would stand at £5.709 million at the end of 2014 – somewhat lower than the MTFP had foreseen; the MTFP had forecast a balance of £11.563 million in the Consolidated Fund at the end of 2014. Meanwhile,the 2014 Budget had forecast a balance on the Fund for the end of 2015 of £6.090 million.
5. Measures have therefore been developed and incorporated precisely because of the revised income forecasts and the need to ensure that the Consolidated Fund is not shown to be in deficit. Some of these measures appear explicitly in the proposition itself; they relate to three transfers to the Consolidated Fund:

1. Under Part (g)(i), a transfer of up to £6.12 million from the Housing Development Fund;
2. Under Part (g)(ii), a transfer of up to £1.058 million from the Stabilisation Fund; and

3. Under Part (h), a transfer of up to £6.5 million from the Dwelling Houses Loan Fund.[11]

6. Furthermore, the Minister is also seeking approval for a course of action whereby the Jersey New Waterworks Company Limited (i.e. Jersey Water) would reduce its share capital by removing the Fifth Preference Share class of share capital and would repay to the States a fair market value for the shares.
7. Further measures are described within the report accompanying the Draft Budget. They are described in Chapter 11 of the report and are shown in Figure 11.1 alongside those we have just described:

1. A proposed extraordinary dividend from Jersey Post;
2. A possible payment from JT (i.e. Jersey Telecom) in respect of the deferred Gigabit Dividend;
3. Transfers from Court and Case Costs Contingency and the Insurance Fund;
4. Utilisation of funds from the Drug Trafficking Confiscation Fund and the Criminal Offences Confiscation Fund;
5. Proposed savings from all Departments of 2% on pay budgets and 2% on gross non- pay budgets;
6. A reduction in the use of Departmental Carry Forwards from both 2014 and 2015;
7. Reduction in the Contingency allocation to Freedom of Information funding;
8. Proposed deferral or reduced contribution to the Long-Term Care Fund; and
9. Further rephasing of capital approvals, increased shareholder contributions and savings.

8. The Minister advised us that the measures proposed had been identified as a means of ensuring that proposed capital expenditure could still be funded. This was, he reported, in line with a recommendation from the FPP that such funding should be maintained and not be constrained by the balance of the Consolidated Fund.[12]
9. In its report on the Draft Budget, the FPP has indicated its support for the Draft Budget's "proposed approach to mainly using savings and reserves to fund the potential shortfall in income because it limits the negative impact on the economy in the short term."[13]
10. Our advisors have commented upon the measures. Our advisor from CIPFA has highlighted that "the utilisation of reserves to fund core spend is a real wake-up call' and is typically the product of a rapidly deteriorating fiscal position." This relates to the various transfers from other funds which appear amongst the measures and, indeed, our advisor from CIPFA has stated that the Department of Treasury and Resources was in fact intending to build up the Court and Case Smoothing Reserve at the beginning of the year. However, now it is being proposed that it be used to ensure the Consolidated Fund remain in balance. In its written submission, the Jersey Consumer Council raised concerns that the transfers of monies to the Consolidated Fund should not "expose Islanders to a shortfall in funds in years to come."

11. In relation to the proposed deferral or reduced contribution to the Long-Term Care Fund, our advisor from CIPFA suggests it is "another indicator of the seriousness of the situation now faced" given that the Fund was established to "provide a necessary stream of finance to underwrite the expected demographic care demands of an ageing population and extent of progressively complex care costs."
12. CIPFA has ultimately concluded that "it is clear that the proposed remedial measures lack maturity and in some examples clearly contradict what was thought to be settled strategy." Indeed, our advisor also concluded that "it would be our considered view that the timing and the character of the remedial measures as now presented seriously undermines the confidence attached to the robustness of the States' Financial Strategy."
13. Our primary question in relation to these measures concerned their deliverability. We understand that they will only be required in their entirety if actual income matches the May 2014 ITFG forecast. If actual income is higher, fewer measures will be required to ensure the Consolidated Fund remains in balance. By the same token, however, if income in 2015 turns out to be lower than forecast, further measures might be required to ensure the Consolidated Fund remains in balance.
14. The Chamber of Commerce stated to us:

"Clearly they [the contingent measures] all need to be definites in order to achieve a zero position in 2015 if the tax forecasts are true and always if they come through."

15. In respect of the savings, both of our advisors have indicated it may be difficult for Departments to realise savings of the magnitude identified if the experience of the Comprehensive Spending Review (CSR) were used as an example. Both acknowledge, however, that the level of Carry Forwards which are permitted each year suggests there might be sufficient slack for Departments to be able to accommodate the proposed savings. CIPFA has in fact stated that "it is not understood why such a measure was not incorporated within the 2015 Budget proposals in the normal course." Our advisor ultimately stated in respect of the proposed savings measures that:

"It is critical that Departments are signed-up to delivering on Base Budget reductions. We would recommend that the ability of remedial measures designed to ameliorate expected Budget deficits are critically appraised in relation to their propensity for delivery. We believe that this savings' validation work is urgently required as delivery of such measures will be an important component of how Jersey deals with realigning deficits. In terms of independence it may be expedient if this work was conducted by the Comptroller and Auditor General."

16. CIPFA has suggested that some of the measures, if not all of them, were identified fairly late in the development of the Draft Budget. This appeared to be the case from investigations we undertook ourselves. The Draft Budget provides for an extraordinary dividend from Jersey Post of £5 million in 2014 that would be used in 2015 to offset the balance in the Consolidated Fund. At our first public hearing with the Minister, however, we were advised that Jersey Post had indicated that a dividend of £2 million would potentially be feasible, but not the £5 million requested.[14] Given this advice, we approached Jersey Post about the situation. We also approached JT and Jersey Water about the measures included in the Draft Budget relating to them. The Jersey Electricity Company, we were advised, had not been approached by the Department of Treasury and Resources as the company was "making heavy investment at the moment."[15]
17. In its submission, Jersey Post confirmed that the board had decided to pay a dividend of £2 million in 2015 (i.e. not £5 million as described in the list of contingent measures in the Draft Budget). Jersey Post also advised us that it had been approached on 4th July 2014 about the prospect of paying a special dividend. We were ultimately advised that a decision about the dividend would not be made until May 2015 when the board would receive and approve the 2014 annual report and audited financial statements.[16]
18. In relation to the deferred Gigabit dividend (of £3 million in 2014 and £3 million in 2015) JT informed us that "assuming the 2015 Budget is approved in its current state, JT would have to perform strongly during the course of 2014 and 2015 and the Board would have to assess at the appropriate time whether it is in the position to make the budgeted payments (as it is legally obliged to do for all dividend payments)." JT subsequently advised us that it was possible the dividend could be paid through the re-phasing or slowing down of fibre deployment. The payment in question is referred to as the deferred Gigabit dividend'. This refers to the fact that, in December 2011, the Minister agreed that the dividend from JT could be reduced by £3 million (in each of the years 2013 to 2015) in order to ensure that JT had sufficient funds to undertake the Gigabit project.[17]
19. In relation to Jersey Water, we were informed that the company had first been approached about the redemption of the preference shares on 4th July 2014 and that it was discussed at a meeting on 8th July 2014. At the time of Jersey Water's submission to us, it was investigating the options for redemption. However, we were informed that, if the Draft Budget were approved as it stood, the following would need to occur:

1. Jersey Water's board would need to consider whether the redemption was in the long- term interests of the company (with the decision to be based on professional advice);
2. A mutually agreeable price would need to be negotiated with the States;
3. Alternative funding for the redemption price would need to be identified; and
4. An Extraordinary General Meeting would need to be held for shareholders to vote on the resolutions.[18]

20. Figure 11.1 in the Draft Budget report shows a £5 million dividend from Jersey Post in 2014 to be used in 2015. It also initially showed a balance of £0 in the Consolidated Fund at the end of 2015 (if all proposed measures were adopted). If the dividend from Jersey Post were only £2 million (as we have been advised) this would have suggested a resulting negative balance for the Consolidated Fund at the end of 2015.[19] We have considered what this would mean in respect of the Minister's obligations under the Public Finances Law. We understand that, in a sense, he has met the requirements of Article 10(8) in that the Draft Budget has been lodged with a report that shows the Consolidated Fund will not be in deficit. The question is, however, whether any further action should be required of the Minister if the robustness of that report (and the calculated balance of the Consolidated Fund) can be challenged.
21. We had significant concerns about the deliverability of the proposed measures at the time the Draft Budget was lodged and from the Minister's amendment. This can be seen from the circumstances surrounding the proposed dividend from Jersey Post and, in terms of the proposed  savings  measures,  from  the  fact  that  further  discussion  ont  the  proposals (including the savings) was required by the Council of Ministers at its meeting on 3rd September 2014. In terms of the remedial measures, we endorse the recommendation of our advisor from CIPFA that further appraisal of their deliverability is required and we would highlight the need for progress and outcomes on these measures to be monitored in order that their delivery might be measured in due course.

KEY FINDING

22. The timing and character of the proposed remedial measures undermine confidence in the States' financial strategy. It is vital that the measures are critically appraised in relation to their propensity for delivery.

RECOMMENDATION

23. The Minister for Treasury and Resources should ensure that proposed base budget reductions  are  subject  to  independent  validation  in  order  to  ensure  both  their deliverability and their ability to be monitored.
24. The Minister for Treasury and Resources should confirm with Departments that they have sufficient management and financial information to be able to monitor and report upon the proposed savings that the Draft Budget will require them to deliver.

7. TAXATION PROPOSALS

1. The estimated income which the Minister is proposing under Part (a) of the proposition is the income raised through Income Tax, GST, Impôts and Stamp Duty. The figure takes into account any proposed changes in respect of those sources which the Minister might make. Quite often it is these measures which prove to be the headline issues connected to the Budget. However, that has not been the case this year. Indeed, our advisor from CIPFA has highlighted that the specific taxation measures will collectively affect States income levels by £0.962 million. Nevertheless, we shall touch upon the Minister's specific proposals in this chapter. The impact of taxation measures are often described with reference to the MTFP benchmark; however, as we have previously stated our advisor from CIPFA has highlighted that references to the MTFP are potentially irrelevant given the shift there has been within the model in respect of income.

Income Tax

2. There are a number of measures proposed in respect of Income Tax, which have been examined by our advisor from CIPFA. These measures include:

1. Increasing Income Tax exemption thresholds by 1.7% in line with RPI (as of March 2014);
2. Stating that returnees to the Island who previously paid Income Tax on a prior-year basis will move to paying on a current-year basis;
3. Ensuring Marginal Rate taxpayers benefit from double tax credit; and
4. Capping mortgage interest tax relief at £15,000 from the 2015 year of assessment.

3. Our advisor has highlighted that these measures have "a recurring structural change in the base line position for the Income Tax component of the States income model." In addition to the measures listed above, there are proposals within the Draft Budget in respect of pensions and pension schemes.
4. The Minister advised us that the cap on mortgage interest tax relief would not affect a large number of taxpayers but that it would send a message of the direction of travel in respect of that area of taxation. The Minister referred us to research which suggested that the existence of such measures as mortgage interest tax relief could inflate the housing market and assist in keeping prices high. The Draft Budget report itself states that "the more credit is extended to homebuyers, the higher prices become." It was therefore likely that in the long term the relief would be phased out, as had happened in other jurisdictions. The

Chamber of Commerce confirmed its own understanding that such relief had been phased out elsewhere. Chamber advised us, however, that "capping mortgage interest will be difficult for plenty of people who are relying on some of that income. Whether it will have the effect on the housing market that is desired I am not quite so sure."[20] The FPP has described the proposed cap as "potentially a significant and welcome development." There are questions as to whether the introduction of a second aspect of relief will make the tax system inherently more complex (when our understanding of the principles underlying the tax system is that it should be kept simple) given that there will be two aspects of relief to administer rather than one.

5. Perhaps the most significant Income Tax measure is one which has not been proposed. Last year, much of our focus was on the proposal (subsequently adopted by the Assembly) that the Marginal Rate be reduced from 27% to 26%. We understand that consideration was given to including a further reduction in the Draft Budget but the idea was ultimately not pursued. Nevertheless, we were advised that it remains the Minister's intention to lower the Marginal Rate to 25% in due course.[21] Indeed, further reductions were mooted in the report on the move to independent taxation, which was presented alongside the 2014 Budget, in which it was recommended that following the reduction in the 2014 Budget consideration be given to "further reduction in future Budgets." Such a reduction would have the same impact as last year's reduction in that it would lower Income Tax receipts by reducing the tax burden of all those taxpayers who pay at the Marginal Rate and by transferring a certain number of taxpayer from the Standard Rate to the Marginal Rate. Both of our advisors have remarked upon the fact that consideration was given to a further reduction of the Marginal Rate, given the income forecasts. We understand a further reduction was not proposed because it would essentially have been unaffordable: a reduction to 25% would have required further contingent measures to ensure the Consolidated Fund did not go into deficit as the reduction would have lowered States income still further.

Stamp Duty

6. The Minister has proposed that Stamp Duty on a property of not more than £400,000 will be charged at a rate of 0.25% between a mortgage threshold of £300,000 and £400,000. In addition, he has proposed increases in the Stamp Duty on properties worth more than £1 million. Our advisor from CIPFA has considered these proposals and has concluded that "there is a lack of detail on expected volumes of transactions." He has therefore recommended that there be "more transparency on expected transaction volumes." Furthermore, he has found that the additional revenue anticipated to be raised on higher

worth properties would benefit "from some empirical foundation within the Budget Statement notes."   We  are  concerned  about  the  impact  this  measure  may  have  on  individual households. The Draft Budget also proposes that the temporary threshold for determining entitlement to reduced rates of Stamp Duty (and Land Transaction Tax) which are available to First-Time Buyers is not extended. This would see the threshold move from £450,000 to £400,000.

7. The proposal of having no Stamp Duty on properties up to £300,000 in value was welcomed by the Jersey Consumer Council who stated that "it could encourage more movement at the bottom of the market and in turn may allow home owners who wish to move up the market to do so more easily, as their properties will become more marketable."

Impôts

8. The Impôts on alcohol, tobacco and fuel often stimulate debate and have been subject to amendment in recent Budgets. In the Draft Budget, the Minister is proposing the following increases in Impôts:

• Tobacco  4.7%
• Strong beer  1.7%
• Strong cider  8.7%
• Spirits  1.7%
• Wine  1.7%
• Weak cider  6.9%
• Weak beer  0%
• Fuel  2.2%
• VED  1.7%

9. The Chamber of Commerce advised us of its view, in relation to Impôts on alcohol, that "we would want to see a pause while a longer-term policy is agreed and it could be worked out exactly what we are trying to achieve with alcohol Impôts."[22] Whilst acknowledging that this year's proposed increases were more "measured", Chamber advised that it would like to see "a tax escalator over a period of time."[23]
10. Again, our advisor from CIPFA has considered the proposals. He has advised us that "forecasting and modelling on relevant assumptions / options appear to be sound for this component of income." However, he also advised that "the original MTFP position for 2015 of £53.111 million requires to be adjusted for changes in the assumptions related to specific elements."

11. We approached industry representatives about the proposed changes. We received fewer representations than last year although the written submission from Randalls Limited suggested that the situation had not changed from the previous year and that the issues in respect of Impôts and potential increases remained the same. It must be noted in that regard that whilst the Impôts and taxation measures might not have been the headline issues of the Draft Budget, that does not diminish the impact and relevance that such measures have for certain individuals or sectors.
12. In our review of the 2014 Budget, there were two issues in particular which we highlighted and where we recommended that action be taken. In respect of tobacco Impôts, we explored the amount of duty-free consumption occurring in the Island. We found that an unhelpful situation existed, whereby claims from the industry (regarding the level of duty-free tobacco consumption in particular) could not be countered or verified. We recommended action be taken to address this situation. We were advised by the Minister of the measures which had been taken.
13. From our review of the 2014 Budget, we also recommended that the Minister should endeavour to reconcile differences with the industry in respect of price margins and comparisons for alcohol and tobacco. We asked him to update the Assembly on this work in July 2014. We were advised by the Chamber of Commerce, however, that there had been less consultation on this point than had been hoped for. The only meeting had taken place one week before the Draft Budget was presented to the Council of Ministers for consideration and the Chamber had hoped for greater communication.[24] It would therefore appear that our recommendation, though accepted, has not been pursued. This is unfortunate as it appears unlikely that the differences between Government and business which we identified last year will be resolved unless there is meaningful engagement.

Other Measures

14. When we reviewed the 2014 Budget, we received comments from witnesses that more could have been done to support the economy. We were advised of suggestions which had reportedly been put to the Department of Treasury and Resources in that regard, for example the development of a Seed Enterprise Investment Scheme.

15. Similar comments were made to us this year by the Chamber of Commerce, who intimated that the Draft Budget would do relatively little to support the economy[25] (beyond the injection of capital expenditure which we shall explore in the next chapter). Chamber advised us that whilst there had been some positive developments in the finance sector, there remained concerns within non-finance sector in relation to profitability and operating costs.[26] The Jersey Consumer Council also advised us of its desire to see efforts made to grow the economy. The Council suggested that measures could be taken to "make it easier and more attractive for small businesses to start up by reducing red tape and offering incentives such as tax breaks to those businesses." It added that the level of Social Security contributions for the self-employed could be revisited. The Council stated in its submission that "regrettably, there appears to be little in the Draft Budget to help achieve [economic growth]."[27] The Chamber of Commerce also suggested a review of Class 2 contributions "to help people who have left employment and want to set up their own business."[28]
16. The Minister refuted the Chamber's criticisms and described all the measures which had been taken to assist the economy. He also stated that it would be difficult to identify measures which could feasibly be taken given that Jersey's tax system:

"We are struggling with finding evidence that an incentive programme or an incentive package on tax matters would be effective. We have zero tax, we have one of the lowest personal tax rates in the world, and we have provided fiscal stimulus in terms of the Innovation Fund and we stand ready to respond to economic developments, further proposals on finding opportunities to invest."[29]

He had undertaken to consult stakeholders about what could potentially be done and we were informed that the work was ongoing; the Chamber of Commerce confirmed that one meeting had been held specifically in respect of an enterprise investment scheme.[30] The Minister also advised us of his awareness of the productivity challenge' and the need to address it.[31]

8. CAPITAL EXPENDITURE

1. Under Article 10(3)(d) of the Public Finances Law, the Minister must seek the Assembly's approval of a capital head of expenditure "for each capital project to be started or continued in the year by a States funded body (other than a States Trading Operation) and for which no other expenditure approval sufficient to complete the project exists." Under Part (b) of the proposition the Minister has proposed a capital programme for 2015 of £75,144,000.[32]
2. Under Article 10(3)(e) of the Law, the Minister must also seek the Assembly's approval of details for each capital project to be undertaken by a States Trading Operation which is scheduled to start. The Trading Operations are Jersey Airport, Jersey Harbours, Jersey Fleet Management and Jersey Car Parking. In Part (d) of the proposition, the Minister seeks approval for £22.7 million of capital funding to be withdrawn from the trading funds for the Trading Operations' capital projects.
3. Provisions are included in the Draft Budget in respect of the three Major Capital Projects: Housing, Hospital and Liquid Waste. These three Projects were initially proposed or described in the 2014 Budget and we considered all three in our report on the 2014 Budget.
4. The Draft Budget sets out a (Departmental) Capital Programme for 2015 totalling £75,144,000. Under the Public Finances Law, the total amount for the Capital Programme must not exceed the envelope agreed for the year in the MTFP. In the MTFP, the Assembly approved capital spending of £77,341,000 for 2015 and that provision of the Law has thereby been respected. In terms of the projects contained within the Programme, there are differences from the provisional programme for the year which was initially included within the MTFP. These differences reflect developments in policy and priorities which have occurred since the MTFP was debated in 2012.  
5. Summary Table C in the Draft Budget report describes how the 2015 Capital Programme will be funded. We will touch upon some of the funding sources below. However, those sources include the measures in respect of Jersey Post, JT and Jersey Water which we have covered in a previous chapter of this report. The income to be generated through those measures is therefore not only to be used to ensure the Consolidated Fund does not go into deficit but also to ensure that the 2015 Capital Programme can be funded. The Minister confirmed as much in his testimony to us, explaining that this had been done in order to meet recommendations from the FPP that capital expenditure should not be hampered or limited by the level of the Consolidated Fund.  

Housing Project

6. One reason for the difference in the 2015 Capital Programme from what was provisionally indicated in the MTFP for the year is implementation of the Housing Project. In the 2014 Budget, the Assembly agreed to borrow £250 million through the issuance of a public rated bond in order that the sum could subsequently be loaned to Housing Trusts and Associations. The majority of the amount borrowed (£207 million) would be loaned to the publicly-owned company that would be established following the incorporation of the Department of Housing in line with the Housing Transformation Programme. That incorporation took place on 1st July 2014 when Andium Homes officially came into existence.  
7. The MTFP, when debated in 2012, did not assume the incorporation of the Department of Housing and therefore included proposed capital expenditure on social housing within the spending envelopes for 2013, 2014 and 2015.[33] For 2015, that represented an allocation of £45,873,000 (out of the overall spending envelope mentioned above of some £77.3 million). With the incorporation of the Department, those capital programmes will now be undertaken by Andium Homes and will be funded through the borrowing referred to above. That part of the overall funding envelope for 2015 which had been attributed to the Department of Housing can therefore be used for other matters.
8. The Housing Project has essentially already been approved by the Assembly with the adoption of the 2014 Budget. The Draft Budget makes some provision for the Project, however, with Part (f) of the proposition, in which approval is sought for revised rules underpinning the operation of the Housing Development Fund (into which the borrowed £250 million has been deposited and from which loans will be made). The rules are contained in Appendix C to the Draft Budget. This aspect of the Draft Budget has been proposed in line with a recommendation of  Updating Jersey's Fiscal Framework (R.102/2014) which suggested that the rules underlying the Housing Development Fund should make a distinction between its current uses and the uses to which it would be put for the Housing Project.

Liquid Waste Project

9. Part of the space within the capital spending envelope for 2015 created by the establishment of Andium Homes has been taken up by funding for the Liquid Waste Project. This effectively relates to the construction of a new sewage treatment works. Information on this Project was presented alongside the 2014 Budget (including the anticipated cost, the proposed funding mechanisms and the nature of the works to be built) but the Project itself was not approved at that time (aside from the allocation of £10.1 million in the 2014 Capital Programme).

10. The Assembly approved the construction of a new sewage treatment works with the adoption of Waste Water Strategy (P.39/2014). In terms of the Draft Budget, approval is sought under Part (c) of the proposition for the overall spending envelope. Part (c) thereby asks the Assembly to approve a total capital allocation of £75 million for the new sewage treatment works, funding which is to be delivered through allocations "in future Medium Term Financial Plans and Budget Statements respectively." That envelope is consistent with the indications given in the 2014 Budget.
11. The Draft Budget itself includes an allocation towards the new works within the 2015 Capital Programme. In the 2014 Budget, it was proposed that the Liquid Waste Project would be funded through the following methods:

1. The annual Capital Programme would be used in part, with allocations in 2014, 2016, 2017, 2018 and 2019.
2. Some of the annual infrastructure capital vote to the Department of Transport and Technical Services would be used (in 2014, 2016 and 2017).
3. An investment from the Currency Fund would be made with the investment to be repaid by the Department of Transport and Technical Services.

12. The 2014 Budget reported that the first two methods would provide £45.5 million of funding with the investment of the Currency Fund due to make up the remaining £29 million. This is reflected in the Draft Budget where Part (b) of the proposition makes explicit reference to the fact that (if the Draft Budget is approved) the 2015 Capital Programme will in part be funded by an investment of £25,494,000 from the Currency Fund towards the Liquid Waste Project. This is one of the funding sources to which we referred in Paragraph 8.5 above.
13. Part (b) of the proposition also stipulates that the investment would be repayable over a period of 40 years according to a "formula of investment return determined by the Minister for Treasury and Resources after taking advice from the States investment managers."
14. At the time of the 2014 Budget, it was envisaged that repayments could be made with a 4% return and that those repayments would work out at £1.7 million per annum. That sum, it was reported at the time, would be funded through savings within the Department of Transport and Technical Services. £1 million of those savings would be achieved through the greater efficiency delivered by the new sewage treatment plant. Our advisor from CIPFA has highlighted that this would break down into £0.5 million through energy savings; £0.25 million on chemical pasteurisation savings; and £0.25 million of savings due to reduced maintenance costs (there no longer being outdated and customised equipment).

15. The remaining £700,000 per annum would be found in other ways by the Department of Transport and Technical Services. The level of savings required by the Department would be lowered if the new sewage treatment works could be delivered for less than £75 million.
16. In our report on the 2014 Budget, we highlighted the uncertainty regarding the deliverability of savings to repay the investment from the Currency Fund and we recommended that the Minister clarify how £1.7 million in savings each year would be delivered. Our advisor from CIPFA remains of the view this year that "this will pose a formidable challenge for the Department especially against the backcloth of further revenue savings it may be obliged to make as a result of overall expenditure retrenchment." We were advised by the Department of Treasury and Resources that there had been a commitment that the savings would be made. Nevertheless, our advisor from CIPFA has recommended that "in the context of an additional 2% departmental savings requirement it is recommended that an assessment is undertaken of the ability of the Transport and Technical Services Department to fund the Liquid Waste Project as previously set out within the Budget setting process."

KEY FINDING

17. It remains unclear how proposed savings will be met to ensure the Liquid Waste Project can be funded in the way envisaged.

RECOMMENDATION

18. The Minister for Treasury and Resources should ensure that, prior to the lodging of the next MTFP, an assessment is undertaken of the ability of the Department of Transport and Technical Services to identify savings in order to fund the Liquid Waste Project.

Hospital Project

19. In the 2014 Budget, the Assembly agreed to the funding mechanism proposed for the Hospital Project (namely the planning and creation of new hospital services in Jersey). The Assembly thereby approved an amendment to the policy underlying use of the Strategic Reserve to allow the Reserve to be used towards the Project and also agreed to the first transfer from the Reserve (of £10.2 million) towards the Project. At the time the Assembly was advised that the spending envelope for the Hospital Project was £297 million although that figure was not explicitly agreed as part of the 2014 Budget.

20. In the Draft Budget, the Minister seeks the Assembly's approval of the second tranche of funding; under Part (e) of the proposition, approval is sought for the transfer of £22.7 million from the Strategic Reserve.
21. Under Part (i) of the proposition, the Minister is also seeking the Assembly's agreement to the definition of the capital value of the Strategic Reserve. If agreed, this would reportedly clarify  that  only  investment  returns  beyond  the  established  capital  limit  could  be  used towards the Hospital Project. The Draft Budget explains the assumptions which underline this policy: over the ten years which the Hospital Project is expected to take to be delivered, investment returns are assumed to be 5.2% in 2014; 5.7% in 2015 and 2016; 5.5% in 2017; and then a constant 6.5% from 2018 to 2024. The Draft Budget shows that the actual investment return in 2013 was 14.1%. On this basis, the capital value of the Strategic Reserve would still grow and there would be sufficient investment returns to pay for the Hospital Project. Interestingly, we were advised during our review of the 2014 Budget that planning in respect of the Hospital Project had assumed average returns of 5% during the period of the Reserve's use towards that Project. Returns of 10% had been experienced during the three previous years and the 2014 Budget presented scenarios to demonstrate what would happen to the Reserve if used for the Hospital Project and if there were returns of 2% and 10%.
22. Our advisor from CIPFA has indicated "reservations on the confidence attached to the level of sustained investment return performance" and stated that he would be more cautious about the general outlook. He refers in his report to the prospect in respect of interest rates and  their  link  to  potential  investment  returns  and  suggests  that  "an  inherently  prudent approach be taken upon the incorporation within the Budget modelling." He has ultimately recommended that "in light of current investment returns that the feasibility of delivering investment returns on the Strategic Fund of 5.7% in 2014, 5.7% in both 2015/2016 and 6.5% each year from 2018 to 2024 is further tested."

KEY FINDING

23. There are reservations about how much confidence can be attached to the Draft Budget's  anticipated  level  of  sustained  investment  return  performance  on  the Strategic Reserve.

RECOMMENDATION

24. The Minister for Treasury and Resources should ensure that, prior to the lodging of the  next  MTFP,  the  feasibility  of  proposed  investment  returns  on  the  Strategic Reserve is subject to further testing.

25. The proposals in respect of the Strategic Reserve have wider implications in relation to the Fiscal Framework and we shall return to this subject in the next chapter.
26. The Hospital Project has been considered by the Health, Social Security and Housing (HSSH) Scrutiny Panel in its review of the redesign of Health and Social Services. A large part of that Panel's work has been to consider plans for future hospital services, including the choices  made  for  the  delivery  of  acute  hospital  services.   That  Panel  has  therefore considered the choices made in respect of siting services and has also looked at how the spending envelope for the project was established. For our part, we have focused on the funding mechanism chosen for the Hospital Project and the implications thereof and have not therefore considered questions regarding the two-site option which has been mooted.
27. Last year, we highlighted that there appeared to be at least some doubt regarding the spending envelope for the Hospital Project as although a sum of £297 million had been identified, it had not been agreed'. That would appear to remain the case, unlike the Housing Project (for which the spending envelope was agreed as part of the 2014 Budget) and the Liquid Waste Project (for which approval is sought in the Draft Budget). Indeed, our advisor from CIPFA has recommended that the "capital costs are re-evaluated to ensure that there is appropriate precision within the expected £297m cost exposure and that approved functionality synchronises with these expected costs."

KEY FINDING

28. Further work is required to ensure confidence in the expected spending envelope for the Hospital Project.

RECOMMENDATION

29. The Minister for Treasury and Resources should ensure that the capital cost of the Hospital Project is re-evaluated to ensure that there is appropriate precision within the expected spending envelope and that approved functionality synchronises with that expectation.
30. Furthermore, our advisor has repeated comments made to us in respect of the 2014 Budget "regarding the lack of detailed recurring costs associated with running any new facility" He has  therefore  recommended  that  "the full  life  recurring  running  costs  are  appropriately evaluated against the MTFP financing capability in respect of the appropriate Health and Social Services Budgets. Whole Life Costing should be fully embedded within the Project Modelling and Revenue Budgets."

RECOMMENDATION

32. The Minister for Treasury and Resources should ensure that, prior to the lodging of the next MTFP, the full-life running costs of the Hospital Project are appropriately evaluated against the MTFP financing capability in respect of the Health and Social Services budget.

Economic Impact and Deliverability of the Capital Programme

33. The following table indicates the anticipated level of capital expenditure over the next few years,  as  presented  in  the  Draft  Budget.   This  includes  capital  expenditure  from  both Departments and the States Trading Operations.

35

34. The FPP has highlighted that "the amounts of capital expenditure planned by the States between 2015 and 2019 are up to three times higher than previously experienced in Jersey."
35. In recent years the capital programme has been used to help support the economy and that remains the intention. The Minister advised us of his desire to follow recommendations from the FPP that support continue to be delivered in 2015.
36. In its report on the Draft Budget, the FPP has downgraded its economic forecasts for 2013 and 2014 from those it produced last year but the FPP expects to see some GVA growth in 2015. The FPP has found that the outlook suggests "that fiscal policy should continue to support the economy" in 2014 and 2015. It has therefore recommended that "the focus in 2014 and 2015 should be on supporting the economy (by running deficits) while there is still spare capacity." The FPP stated that this support should not be deflected in light of lower tax receipts.
37. In its report, the FPP also provides information on the Draft Budget's economic impact by looking at actual anticipated expenditure within the financial year. The Draft Budget itself includes information which shows the economic impact its measures (including the Capital

35 Draft Budget Statement 2015 (P.129/2014), Figure 12.9, Page 65

Programme) has as well as the accounting impact it has on the balance sheet (e.g. in relation to the level of the Consolidated Fund.

38. The FPP has therefore advised that it would be acceptable to run deficit Budgets over 2014 and 2015 to ensure capital expenditure is delivered. If capital expenditure is to be used to stimulate or support the economy, our advisor from MJO Consultancy has indicated that it is necessary to be sure that the fiscal stimulus meets (and is seen to meet) the 3 Ts' test of the stimulus being timely, targeted and temporary'. He has found that this does not consistently appear to have been the case. He has recommended that "the fiscal stimulus needs to be re-appraised using all available evidence and international experience."

KEY FINDING

39. In  order  to  ensure  the  efficacy  of  the  fiscal  stimulus  programme,  measures  to stimulate or support the economy must meet the 3 Ts' test of fiscal stimulus.
40. Planned expenditure is not the same as delivered expenditure, however, and in order for the Capital Programme to have the desired economic impact, the projects need to become reality. This was an issue which became apparent in 2013 when it was made known that, in 2012, capital expenditure had merely amounted to £36 million. We were informed last year that, from the FPP's perspective, capital expenditure was taken to have an economic impact when the tender for a project was awarded. In 2013, capital expenditure amounted to £43.2 million  from  an  approved  capital  allocation  of  £62.9  million  (£98.9  million  in  unspent approvals from previous years).
41. In terms of deliverability, we have considered whether there would be sufficient capacity within the local construction sector to accommodate capital plans. At the time of the 2014 Budget, we were informed that discussions had taken place with the construction industry about the matter. The FPP's own report on the 2014 Budget suggested that "output [was then] 12% below the 2010 level, suggesting a significant level of spare capacity." We ultimately highlighted in our report last year that there was a risk that the injection of large amounts of capital funding over the next ten years could overheat the local economy and we therefore recommended that the Minister should seek to improve the information available on capacity within the construction industry. We were also advised last year that a new reporting mechanism had been developed for the Council of Ministers on capital expenditure to show whether local contractors had been used for existing capital projects.
42. In  its  2014  report,  the  FPP  has  highlighted  the  risk  that  significant  levels  of  capital expenditure could put pressure on the capacity of the local construction industry although it acknowledged the work underway to assess construction sector workflow and capacity. We were also advised during our review by the Assistant Minister of the Draft Budget that work had been undertaken on this matter, with figures to be produced in September 2014. The Minister also informed us of the work which had been undertaken with the Department of Social Security (through the Back to Work scheme) on developing local skills in order that the local construction sector could deliver as much as possible.

43. It has been acknowledged, however, that some external labour will be required, for example where specialist skills are required that do not exist within the local sector. The Chamber of Commerce acknowledged that this would sometimes be the case although it asked for consistent communication with the construction industry as a means of mitigating any potential ill-will that might arise. The Chamber President advised us:

"I always find them [the construction industry] pretty reasonable and if they have gone for the piece and they have not got it because of the specialist requirement I usually find they are fairly accepting of that. What they do not like is that they did not know about it and then find out that it has gone outside the Island and they have perceived they could have done it. That is when you will get the contact just as much as we do and that is when they complain vociferously because of that."[34]

44. Our advisor from MJO Consultancy has suggested that some 500 additional people within the construction industry will be required to deliver the planned capital programme. Consideration of the external resources required is important in light of the Island's migration policy. In 2014, the Assembly adopted an Interim Population Policy which established a planning assumption for use by Departments that 150 households (equating to 325 people) would be the level of net inward migration allowed to the Island for 2014 and 2015. Until further information is provided by the Minister, it is unclear how the proposed Capital Programme (and the resources it will require) will fit in with the Interim Population Policy. The Chamber of Commerce asked how the required capital programme would be resourced within the context of the Interim Population Policy.[35]
45. As well as the capacity of resources to undertake the planned capital expenditure, the question of whether the planned expenditure will be realised is affected by other factors (e.g. the receipt of planning approval). We asked the Minister what had been done to address any bottlenecks that might impact upon the delivery of capital expenditure. The Minister advised us of the improved quarterly monitoring process which had been introduced and of work undertaken to meet recommendations from the FPP in this regard.
46. Our advisor from CIPFA has highlighted concerns, stating that "irrespective of further assurances obtained in 2013 and 2015 on better monitoring and a more hands on' performance management approach being applied to Capital Projects, the actual outturn performance does not provide sufficient confidence that forecasted profiles will be achieved

on the substantive projects." He has therefore concluded that "given recent track record and the propensity for complex non-standard projects to be impacted by optimism bias, it would be our view that spend profiles should be treated with an appropriate degree of caution."

47. Our advisor has therefore recommended that "the legislative framework around the capital allocation process and incorporation within the Budget process be reviewed to allow for the realistic delivery of the Capital Programme and that appropriate performance management arrangements are put in place to ensure delivery."

KEY FINDING

48. Actual performance in capital expenditure in recent years does not provide sufficient confidence that forecasted profiles for future capital expenditure will be achieved.

RECOMMENDATION

49. The Minister for Treasury and Resources should review the legislative framework surrounding the capital allocation process to ensure it allows for the realistic delivery of  the  Capital  Programme  and  for  appropriate  performance  management arrangements to be put in place, with the outcome of this review to be reported to the States Assembly ahead of the lodging of the next MTFP.

9. THE LONGER-TERM PICTURE

1. We have considered the Draft Budget in the wider context of longer-term financial planning. The Draft Budget will be the last to be debated under the current MTFP. In 2015, the next Council of Ministers will propose a new MTFP and the next Assembly will debate and approve it. We therefore explored the implications of the Draft Budget for the decisions that the next Council and the next Assembly will be required to consider. This appeared to be something which the Minister had also considered; he advised us that a number of reports would be presented alongside the Draft Budget in order to ensure that future decisions about taxation and expenditure would be taken on an informed basis. Some had been presented in time for us to consider them in our review but others had not.

Strategic Reserve

2. There are elements within the Draft Budget proposition itself which impact on the longer-term picture and the overall Fiscal Framework. In Part (i) of the proposition, for instance, the Minister seeks the Assembly's agreement:

"To note the future operation of the Strategic Reserve Fund (The Fund'), as set out in Appendix D of the Budget Statement and to agree that the Strategic Reserve balance of £651,216,000 as at 31st December 2012 should be defined as the capital value of the Strategic Reserve and that, for future years, the capital value be maintained in real terms by increasing the capital value in line with increases in Jersey RPI(Y)."

This is not a matter which the Minister is obliged to cover in the Draft Budget under the Public Finances Law but is something he has chosen to include.

3. As we have discussed, this measure has been proposed in part because of the use to be made of the Strategic Reserve for the Hospital Project. However, the measure has also been proposed in order to meet a recommendation from the FPP. In its report on the 2014 Budget, the proposed funding mechanism for the Hospital Project led the FPP to express some concerns and to recommend that, before any decision was taken on whether or not to use the Strategic Reserve, "the States should clearly define the purpose of the Strategic Reserve and set out conditions for its use, including how borrowing from the Reserve would be dealt with." The FPP also indicated that the use of the Reserve in this way might set a "worrying precedent."  
4. We picked up on the FPP's concerns in our own report on the 2014 Budget and recommended that the Minister should ensure that the purpose and optimal size of the Strategic Reserve and the conditions for its use are clearly defined. Given that the policy

that the Reserve may be used "solely for the purpose of protecting the standard of living of future generations in the Island when the economy faces severe structural decline or a natural disaster", there needs to be clarity about the capital level.  

5. At the time of the 2014 Budget, we were advised that the capital level of the Strategic Reserve stood at £117,175,224. That effectively represented the balance of funds which had been transferred in and out of the Reserve by the Assembly over the lifetime of the Reserve.  
6. We have considered the use of the words to note' and to agree' in Part (i) of the proposition. There was initially some doubt in our minds as to what the Assembly would agree to if that part of the proposition were adopted. We have concluded that the Assembly is simply being asked to approve the capital value of the Strategic Reserve and the mechanism by which that value will be uprated in future years. The Assembly is not being asked to approve Appendix D which describes the future operation' of the Strategic Reserve. We sought confirmation from the Minister that it remained the intention that transfers from the Reserve would only occur with the approval of the Assembly (as the Public Finances Law states). The Minister confirmed that was the case and we were advised that Part (i) of the proposition was intended to make it more, rather than less, difficult for the Strategic Reserve to be used.
7. In that vein, it will therefore remain the case that the Strategic Reserve can only be used in the following circumstances:

1. In accordance with P.133/2006, the capital value of the Strategic Reserve can only be used in exceptional circumstances to insulate the Island's economy from severe structural decline such as the sudden collapse of a major industry or from major natural disaster.
2. In accordance with P.84/2009, an exception can be made to enable the Reserve to also be used, if necessary, for the purposes of providing funding for the Bank Depositors Compensation Scheme up to a maximum combined total not exceeding £100 million.
3. In line with the 2014 Budget, a further exception can be made to fund the creation of a new hospital services.

8. In its report on the Draft Budget, the FPP has highlighted how the Strategic Reserve can be considered in a different light: as a proportion of GVA rather than simply a monetary value. The FPP has recommended that the aim should be for the Strategic Reserve to sit at a certain proportion of GVA and has shown what will happen in that regard as the Reserve is used for the Hospital Project. The FPP's work indicates that, whilst the monetary value of the Reserve might continue to increase during the undertaking of the Hospital Project (presuming investment returns are in line with assumptions), its value as a proportion of GVA

will in fact be negatively affected. It has thereby found that the value is expected to reduce from 20% of GVA in 2014 to 15% of GVA in 2015. In its 2014  report, the FPP has recommended that the value of the Reserve in relation to Jersey's economy and States expenditure should be monitored and that an indication of the desired size should be given.  

9. It does appear to be the case that the Strategic Reserve is often considered in terms of its monetary value. However, it is apparent from looking at the proposition through which the policy underlying the Reserve was agreed that this might not have been the original intention. The report accompanying Establishment of a Stabilisation Fund and Policy for Strategic Reserve (P.133/2006) stated that "a suitable long-term aspiration is to grow the Strategic Reserve by another £100-£120 million, to a minimum level of around £600 million, so that it equates to about 20% of GDP."

Stabilisation Fund

10. In Part (j) of the proposition, the Minister seeks the Assembly's approval of rules for the future operation of the Stabilisation Fund. Those rules are set out in Appendix E to the Draft Budget. The wording of Part (j) means that, if adopted, the wording of Appendix E would have received explicit approval from the Assembly. The provisions in respect of the Stabilisation Fund are therefore different from what the Assembly is asked to do in relation to the Strategic Reserve under Part (i) of the proposition.  
11. As the Draft Budget states, the Stabilisation Fund was established on 5th December 2006 with the purpose of making fiscal policy more countercyclical and creating in the Island a more stable economic environment with low inflation.
12. We recall that, in its 2013 report, the Fiscal Policy Panel recommended that consideration be given to the maximum buffer' that is required in the Consolidated Fund "for remaining contingencies in a year", above which level funds should be transferred to the Stabilisation Fund. Given the anticipated levels of the Consolidated Fund described in the Draft Budget, it would not appear that there is a prospect of this mechanism being used to replenish the Stabilisation Fund in the short term.
13. Other indications have been given in the past that the Stabilisation Fund would be built up again. For example, when an advance was made to the Department of Housing of £27 million for social housing projects, the Minister indicated at the time that, upon repayment, £10 million from the returned funds would be placed in the Stabilisation Fund.[36] Similarly, last year, during our review of the 2014 Budget, he indicated he would give consideration to placing returns from the States of Jersey Development Company (SoJDC) in relation to the

proposed Esplanade Square development in the Strategic Reserve or Stabilisation Fund.[37] Neither occurred. We were indeed advised during our review that the best course of action would be to put money back in the Stabilisation Fund which would resolve the conflict between an economic drive to run deficits and an accounting imperative for prudent financial management.[38]

14. Indeed, the Draft Budget proposes a transfer from the Stabilisation Fund to the Consolidated Fund (as part of the contingent measures). That would leave the balance of the Stabilisation Fund at £0 and it is unclear when the Fund will be used again. It is also apparent that use of the Stabilisation Fund alone may not be sufficient for the States to deliver a counter-cyclical economic policy.

The Fiscal Framework

15. The Minister has presented alongside the Draft Budget a number of reports which indicate (or foreshadow) the direction of travel in relation to taxation and expenditure. They have implications for the Fiscal Framework which provides the basis on which policy decisions about taxation and spending are made. Those reports are:

1. Updating Jersey's Fiscal Framework (R.102/2014);
2. Property Tax Review Green Paper (R.101/2014); and
3. Property Rates and the States (R.103/2014)

16. R.102/2014 is of particular pertinence. Indeed, the measures proposed in the Draft Budget in relation to the Strategic Reserve, Stabilisation Fund and Housing Development Fund in part stem from the recommendations made in the report. The report was produced in response to recommendations made by the FPP in 2013. MJO Consultancy has welcomed the report. He has highlighted the suggestion contained therein of "a new rule to maintain balanced budgets over the economic cycle'." He has suggested that there would need to be a discussion as to what that would mean and whether, for instance, it would mean there no longer being a requirement to ensure the Consolidated Fund did not go into deficit within the financial year but, instead, that deficit financing may become the norm. That would require changes to the Public Finances Law. MJO Consultancy has concluded that an argument is being made for Jersey to follow the route of the United Kingdom and to enter the world of deficit-financing. Our advisor has instead recommended that Jersey should "run a budget surplus of 0.5% or 1% of GVA over the economic cycle."

KEY FINDING

17. There is a risk that deficit-financing may become the norm for the States. RECOMMENDATION
18. The Minister for Treasury and Resources  should investigate the potential for the States to run a budget surplus of 0.5% or 1% of GVA over the economic cycle, with the outcome of this work to be reported to the States Assembly ahead of the lodging of the next MTFP.
19. In addition, documents in respect of the Long-Term Tax Policy and Long-Term Revenue Plan were also due to be presented ahead of the debate on the Draft Budget but they were not presented before this report was completed. Their presentation indicates that the Draft Budget should indeed not only be viewed as the last Budget of the current MTFP but also as the precursor of subsequent financial decisions to be taken. The Minister confirmed that the Draft Budget was consistent with what would be mapped out in those documents. Our understanding during the review (taken from previous statements in respect of the Long- Term Revenue Plan) was that it would have been available earlier in the process and that it would provide a more comprehensive picture than we now expect to see (we understand that it will essentially provide a context in which the Plan can be developed). This is disappointing and we challenged the Minister on why the Long-Term Revenue Plan was not available earlier and highlighted its relevance to the debate on the Draft Budget. The Minister  suggested  that  the  Long-Term  Revenue  Plan  was  not  directly  relevant  to  the immediate provisions of the Draft Budget. However, we do not agree and we have noted the recommendation of our advisor from CIPFA that the Plan "should be presented to Members as soon as possible for approval."

KEY FINDING

20. The  Long-Term  Revenue  Plan  will  provide  directions  to  both  the  Budget  setting process and the foundation for the MTFP and is of direct relevance to the debate on the Draft Budget.

RECOMMENDATION

21. The Minister for Treasury and Resources should ensure that the Long-Term Revenue Plan is presented as soon as possible to the Assembly for Members' approval.
22. We have noted further comments made to us about the Draft Budget from stakeholders but also from our advisors. The views expressed have taken into account the issues and questions we have considered in this report, including income forecasts and the need for contingent measures. The advice we have received suggests that there are indeed some significant discussions to be had in the future about fiscal policy.

23. The Draft Budget was described to us by the Chamber of Commerce as a wake-up Budget'. Similar  comments  were  made  to  us  by  both  of  our  advisors. Our  advisor  from  MJO Consultancy, for instance, has stated that the Draft Budget is the "calm before the storm" and "signals the storms ahead" whilst our advisor from CIPFA has described the Draft Budget as a "wake-up call."
24. The reasoning behind these statements from our advisors is explained in their respective reports. Both have expressed concerns about the deliverability of a second CSR and the salami slicing' that such an approach would entail. They have both commented on the fact that the revised income forecasts suggest the current MTFP model requires recalibration. Our advisor from CIPFA, for instance, has recommended that "the LTRP and, indeed, the 2015 Budget requires to be updated with the very  latest forecasting rather than using components forged in May / June [2014] [] if more precise information is available as at August." Indeed, in terms of income, CIPFA has raised the prospect that there has been a shift in the nature of income received by the States. In his report, our advisor shows how Income  Tax  receipts  as  a  proportion  of  both  total  States  income  and  of  net  revenue expenditure has fallen. He has highlighted the possibility that "it may well be the case that Jersey's  tax  system  is  no  longer  easily  generating  tax  revenues"  which  would  have implications for overall fiscal policy. MJO Consultancy has advised us that "the next MTFP needs to be thoroughly redesigned on economic grounds, using proper economic forecasts and not constructed as if it is an accounting exercise." Our advisor from CIPFA has therefore recommended that "the MTFP requires urgent recalibration and Treasury should commence upon this work without delay. It is further recommended that the Council of Ministers should be given the opportunity to approve the changes needed to re-align the MTFP in a way that can provide stability for medium and longer term financial planning." MJO Consultancy has recommended to us that "the next MTFP needs to be thoroughly redesigned on economic grounds, using a more robust economic model and not constructed as if it is an accounting exercise." He has also recommended that "an investigation [be undertaken]  into  how  the  macroeconomic  policymaking  process  can  be  improved  and calibrated to the Economic Growth Plan."

KEY FINDING

25. An urgent recalibration of the MTFP is required and its redesign needs to be on the basis of a robust economic model and not simply as an accounting model.

RECOMMENDATION

26. The Minister for Treasury and Resources should request that work begin immediately on the recalibration of the MTFP with a report on progress to be provided to the new Assembly by Christmas 2014.

27. CIPFA has also concluded that "the income and capital assumptions underpinning the MTFP model are now so removed from the latest tracking that the 2013 – 15 MTFP model is no longer considered to be fit for purpose' and requires significant recalibration." CIPFA has therefore "strongly suggest[ed] that a framework is created which formally connects expenditure with income capability and is embodied within the Budget setting process in a way that expenditure is fully driven by income generating capability and not on the utilisation of reserves." MJO Consultancy has has also advised us that expenditure appears to be the driver of the MTFP and has recommended that Sweden's fiscal policy be examined, particularly with regard to annual expenditure limits, as an example of how fiscal policy could be constructed.  
28. This reflected the testimony of the Chamber of Commerce to us in which we were advised of their view that the time had come for decisions to be made about taxation and expenditure. In that regard, the Chamber President told us:

"I would hope it would really focus States Members' minds on reform in terms of how expenditure is handled within the States, because I think that we are going to see a few years yet of difficult tax receipts because there is not a whole load of levers you can pull on the income side."

29. Chamber also welcomed the moves towards longer-term planning, however, away from annual budgeting and advised that the next step' would be "a long-term tax policy and [a] move towards some longer-term planning for expenditure and income. So, looking forward 15, 20 years, so a 2030-type plan: where are we going to be by 2030?"[39]
30. The Jersey Consumer Council commented to us that it wished to see reduced government spending as opposed to increased revenues through more taxation. It also wished to see measures introduced to grow the economy which, in turn, would reduce unemployment and generate increased income through taxation. The Council advised us that its recent Money Matters' survey had highlighted that "many consumers are now drawing significant amounts regularly from their savings to stay afloat and to supplement household income."[40]
31. The FPP's report on the Draft Budget also touched upon the longer-term outlook. The FPP highlighted the possibility of a structural deficit within the Island's public finances. However, if there were such a deficit, the FPP recommended that it should be addressed once the economy has recovered (which it was expected would begin in 2016) and intimated that it would be an important consideration for the next MTFP. In particular, the FPP recommended that, in formulating the next MTFP, consideration should be given to balancing the budget over the economic cycle; adopting prudent assumptions for income and realistic assumptions for expenditure; and including flexibility within a clear framework for expenditure. The FPP's report highlights the challenge facing the States in continuing a counter-cyclical fiscal policy at a time when economic conditions would improve. This would require consideration of reducing expenditure and / or raising revenue.  

32. In his testimony to us, the Minister refuted the Chamber's description of it being a wake-up Budget' and claimed that the issues raised by the Draft Budget had not come as a surprise and had been known about well in advance. He advised us that the work surrounding the 2015 Budget was intended to assist with subsequent decision-making:

"Whoever the Minister for Treasury and Resources is, is going to be before this Panel about a year today discussing the lodging of the next M.T.F.P. and that is the time that we will be debating what we are going to be doing. Do we hold back on expenditure? Do we continue to  support  a  struggling  economy?  Do  we  hold  back  on  further  revenue  investment  in healthcare? These are very good legitimate debates and we hope that the issues paper that we publish in September is going to help inform those debates and I hope that they are informed in a way that has not been done in the past."[41]

33. The time has therefore come for a significant debate on the States' finances to take place. The need for this debate is reflected in the advice we have received from our advisors. Our advisor  from  CIPFA,  for  instance,  has  recommended  that  "the  economic  drivers  that influence Tax yields are appropriately evaluated [including] the determination of the extent of any Structural Deficit and the likely impacts on Financial Strategy. All available sources of data including any correlation between Social Security contributions and Income Tax yields should be used to inform Financial Strategy. This should be a joint initiative between the Economics Unit and Treasury and Resources." Finally, he has recommended that "as well as concentration on expenditure reduction Departments should be encouraged to identify aspects of service provision or other opportunities that can optimise Income generation capability. Service delivery benchmarking should be used to identify wider options deployed by competitors and the UK where appropriate. Such efforts should be co-ordinated centrally by Treasury and that appropriate incentivisation measures should be deployed to encourage and  concentrate  efforts."   Our  advisor  from  MJO  Consultancy,  for  his  part,  has recommended that "the process of economic forecasting should be re-examined" and that "an immediate strategy should be agreed for  dealing with the structural deficit." MJO Consultancy has recommended to us that there be "a full public debate on government expenditure and taxation."

10. CONCLUSION

1. The Draft Budget will be one of the last propositions debated by the current Assembly. However, the context in which the Draft Budget has been produced, and in which it will be debated, means that the Budget will have significant implications for debates and decisions of  the  next  Assembly. Normally  discussions  about  Draft  Budgets  centre  on  individual taxation proposals. That has not been the case this year and attention has been drawn to more fundamental issues regarding income forecasts; whether the Island's income profile is changing; and what implications that might have for expenditure plans. As we have noted, the time has come for a significant debate on States income and expenditure to take place.
2. It would be tempting to look back and focus on what could or should have happened in 2013 in relation to income forecasts. We have instead endeavoured to look ahead to the 2016 Budget and the next MTFP in order to identify constructive recommendations which, if implemented, will assist the next Assembly in debating those propositions and in addressing the issues which we have highlighted. It is apparent that a number of actions are required.
3. In the immediate term, there should be an independent review of income figures and the Department of Treasury and Resources should conduct an investigation into the size of the structural deficit. It may well be beneficial if the FPP were asked to review both of these actions and to advise on the economic options.
4. Looking further ahead to the lodging of the next MTFP, by that time there needs to have been a root-and-branch review of expenditure in all Departments. There needs to be a Fundamental Spending Review (FSR) to identify real and permanent savings (i.e. base budget reductions) with the Comptroller and Auditor General subsequently invited to review that FSR. Of particular significance, the Long-Term Revenue Plan needs to be produced.
5. If there is a shortfall in income (and if the balance of the Consolidated Fund is adversely affected in relation to the Public Finances Law's requirements), we anticipate that there might need to be a further Budget. This is feasible under the Law: the next Minister could lodge a further Budget in 2015 for the year if it became necessary. What also might need to be considered is the use of the Strategic Reserve (although we would hope to see any funds used replaced over the lifetime of the next MTFP). There also needs to be a review of economic forecasting and efforts made to top up the Stabilisation Fund.
6. Such measures are necessary to ensure that the next MTFP and the 2016 Budget can be developed in a context in which the financial picture is truly understood and in which the significant challenges which lie ahead can best be addressed.

11. APPENDIX 1: PANEL MEMBERSHIP, TERMS OF REFERENCE AND EVIDENCE CONSIDERED

Panel Membership and Terms of Reference

1. The Corporate Services Scrutiny Panel comprises the following Members: Senator S.C. Ferguson, Chairman

Deputy J.G. Reed, Vice-Chairman

Connétable D.W. Mezbourian

Deputy R.J. Rondel

Deputy T.A. Vallois [Co-opted to the Panel for the purposes of the review under Standing Order 138(5A)]

The Panel appointed MJO Consultancy, represented by Professor M. Oliver, and the Chartered Institute of Public Finance and Accountancy (CIPFA), represented by Mr. S. Fair, to act as expert advisors during the review.

2. The following Terms of Reference were agreed for the review:

1. To consider the proposals of the Minister for Treasury and Resources in the Draft 2015 Budget Statement in respect of:

1. Income Tax;
2. Goods and Services Tax (GST);
3. Impôts;
4. Stamp Duty; and
5. Other tax proposals;

2. To consider the Capital Programme for 2015 as presented in the Draft 2015 Budget Statement;
3. To consider any transfers which the Minister may propose in the Draft 2015 Budget Statement between the Consolidated Fund and other Funds;
4. To consider how the Draft 2015 Budget Statement fits within long-term tax policy;
5. To consider the economic implications of the Minister's proposals in the Draft 2015 Budget Statement;
6. To consider the current status of the financing of the Housing, Hospital and Liquid Waste Projects;

7. To consider how the Key Findings and Recommendations of Medium Term Financial Plan (SR18/2012) have been addressed by the Minister; and
8. To assess the implications of the Long-Term Revenue Plan for the 2016 – 2018 Medium Term Financial Plan.

Evidence Gathered

3. The following documents were considered by the Panel and its expert advisors during the review:

1. Review of States of Jersey Financial Forecasting (SR13/2008), Corporate Services Scrutiny Panel, 2nd December 2008
2. Strategic Reserve Fund Investment Strategy
3. Fiscal Policy Panel Report: Response of the Minister for Treasury and Resources (R.149/2013), Minister for Treasury and Resources, 3rd December 2013
4. Written Question to the Minister for Treasury and Resources tabled by Deputy J.A.N. Le Fondré, 18th February 2014
5. Ratings on States of Jersey Affirmed at AA+ / A-1+'; Outlook Stable, Standard and Poor's Ratings Services, 23rd May 2014
6. Income Tax Forecast Note for Income Tax Forecasting Group, May 2014
7. 2013 Carry Forward Report, Department of Treasury and Resources
8. Monthly Budget Monitoring Report – May, Department of Treasury and Resources
9. Long-Term Tax Policy Programme [Draft], Department of Treasury and Resources, 4th June 2014
10. Act B2, Council of Ministers, 11th June 2014
11. Budget 2015 Pre-Budget Briefing, Department of Treasury and Resources, 13th June 2014
12. Tax Revenues Report for the period ending 30 June 2014 [Extract], Taxes Office
13. Quarterly Corporate Revenue Report – June 2014, Department of Treasury and Resources
14. Jersey's Fiscal Policy Panel Annual Report – June 2014
15. Budget 2015 Pre-Budget Briefing, Department of Treasury and Resources, 10th July 2014

16. Budget 2015 – Council of Ministers 11th July 2014, Department of Treasury and Resources, 11th July 2014
17. Budget 2015 Pre-Budget Briefing, Department of Treasury and Resources, 17th July 2014
18. Draft Budget Statement 2015 (P.129/2014), Minister for Treasury and Resources, 18th July 2014
19. Draft Income Tax (Amendment No.44) (Jersey) Law 201- (P.130/2014), Minister for Treasury and Resources, 18th July 2014
20. Property Tax Review Green Paper – July 2014, Minister for Treasury and Resources, 18th July 2014
21. Updating  Jersey's  Fiscal  Framework  (R.102/2014),  Minister  for  Treasury  and Resources, 18th July 2014
22. Property Rates and the States (R.103/2014), Minister for Treasury and Resources, 18th July 2014
23. MTFP Financial Forecasts – Timeline, Department of Treasury and Resources
24. Social Security Contributions Data 2007 – 2014, Department of Social Security
25. Budget 2015 – Plan of Proposed Measures to Manage the Consolidated Fund, Council of Ministers, 3rd September 2014
26. Draft Budget Statement 2015 (P.129/2014): Fourth Amendment (P.129/2014(Amd4)), Minister for Treasury and Resources, 8th September 2014

4. The Panel wrote directly to a number of key stakeholders, from which the following written submissions were received:

1. Randalls Limited  16th July 2014
2. Chartered Institute of Taxation  25th July 2014
3. Jersey Consumer Council  29th July 2014
4. JT  1st August 2014
5. Jersey Water  4th August 2014
6. Jersey Post  5th August 2014

5. The Panel received two briefings from the Minister for Treasury and Resources and his Department during the development of the Draft Budget: on 13th June and 10th July 2014. In addition, the following Public Hearings were held:

18th July 2014 23rd July 2014 31st July 2014

Senator P.F.C. Ozouf , Minister for Treasury and Resources, accompanied by Ms. L. Rowley, Treasurer of the States