Tax by tax, spend by spend

General government depreciation

This Forecast in-depth page has been updated with information available at the time of the March 2023 Economic and fiscal outlook. We are aware of a technical issue with our tableau charts across the site. Access the data from our March 2023 forecast and our November 2023 forecast supplementary tables directly.

The Treasury manages public spending within two ‘control totals’ of about equal size:

  • departmental expenditure limits (DELs) – mostly covering spending on public services, grants and administration (collectively termed ‘resource’ spending) and investment (‘capital’ spending). These are items that can be planned over extended periods.
  • annually managed expenditure (AME) – categories of spending less amenable to multi-year planning, such as social security spending and debt interest.

Depreciation is a measure of the reduction in the value of an asset over time, due in particular to wear and tear. For example, in the absence of maintenance spending, the value of the roads network would decline over time as the weather and traffic cause potholes to emerge. In the National Accounts, depreciation is measured by assuming different assets have different lifespans and that their value depreciates smoothly over that lifespan.

We forecast depreciation by sub-sector: central government, local authority and public corporations. It has a complicated impact on the public finances, as illustrated by the table below:

WordPress Data Table

Only general government depreciation (central government and local authority) affects total managed expenditure (TME). It increases AME spending, but is directly offset in current receipts, where it increases public sector gross operating surplus (GOS) by an equal amount. These effects all net off in terms of public sector net borrowing, but depreciation does increase the current budget deficit. In the past, governments have used the current budget balance as the main fiscal target (for example, the Labour Government’s ‘golden rule’ from 1997 to 2008 and the Coalition Government’s ‘fiscal mandate’ from 2010 to 2015).

In our March 2023 forecast, we expect general government depreciation in 2023-24 to amount to £52.6 billion (with £35.1 billion of central government depreciation and £17.0 billion of local government depreciation). That would represent 4.4 per cent of total public spending and is equivalent to £1,847 per household and 2.0 per cent of national income. Public corporations’ depreciation amounted to £7.3 billion in our March 2023 forecast (£258 per household and 0.3 per cent of national income).

  Forecast methodology

Forecast process

We commission the depreciation forecast from the Treasury, which we then scrutinise. We hold meetings with the forecast contributors where necessary.

Forecasting model

Up until March 2017, we forecast depreciation using a series of equations based on past depreciation stock, the past rates of depreciation and our forecast for investment and asset value growth. In our November 2017 EFO, we changed the modelling approach in order to address the systematic over-prediction of outturn by the previous model. Given that depreciation has been growing at a relatively steady rate in recent years, we used linear extrapolation to derive future depreciation levels. We are working with the Treasury to refine this approach and build a model that is more robust to future changes in outturn data, while addressing the forecasting bias.

In the October 2018 EFO, we applied a new methodology that reflected falling R&D depreciation in the ONS outturn data and an update for historical trends. Since then we have incorporated subsequent updates to depreciation data, including a large revision to ONS estimates of the capital stock in the 2019 Blue Book revision, which changed asset lives and methods for calculating depreciation. These changes are explained in our March 2019 restated forecast.

Main forecast determinants

The main determinants driving our depreciation forecast are:

  • the GDP deflator, which is used as the measure of inflation in revaluing each sector’s capital assets at each quarter. This is used to uprate the capital stock from the previous period; and
  • our latest forecast for net investment for each of the five sub-sectors (central and local government, public corporations, funded public sector pensions and the Bank of England), which drives the forecast for the future capital stock which is to be depreciated, as well as the composition of net investment (as different assets have different rates and methods of depreciation).

Main forecast judgements

A degree of judgement is required in arriving at manual correction factors for linear extrapolation. We also have to make some judgements about the split of public sector net investment between direct capital formation (which creates assets which will be held by the public sector) and grant spending (which creates assets owned by the private sector and therefore not depreciated as part of the public sector).

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  Previous forecasts

Given that the outturn data has tended to follow a relatively stable upwards trajectory, all our forecasts have remained similarly stable over time. The most common source of forecast-to-forecast revision is changes in outturn data, affecting either the jumping-off point for the forecast or the forecast depreciation rate. The most significant revision was at the December 2014 forecast, when the latest European System of Accounts (ESA10) classification changes were implemented in the National Accounts and our forecast, and when Network Rail was reclassified into the public sector by the ONS. These changes meant more assets were subject to depreciation:

  • research and development (R&D) was reclassified as capital spending and R&D assets therefore became subject to depreciation, adding between £4.2 billion and £5.5 billion to our forecast for general government depreciation;
  • single-use military expenditure (SUME) was also reclassified as capital spending. The depreciation of SUME assets added between £4.1 billion and £5.3 billion to the forecast; and
  • the reclassification of Network Rail into the public sector as a central government body (having previously been classified in the private sector) meant that its capital stock was also subject to general government depreciation, with amounts between £1.7 billion and £2.5 billion added to the forecast.

These changes increased the total public sector capital stock and therefore the estimated baseline flow of depreciation. In total, the changes increased general government depreciation by around £10 billion a year, explaining the discontinuity in the chart below. This increase was matched by an equivalent increase in public sector gross operating surplus, meaning public sector current receipts were revised up by an equivalent amount. The changes were therefore neutral for borrowing overall.

A number of ONS classification decisions related to housing associations further affected depreciation. From 2015, they started to be treated as public corporations in the National Accounts, and we consequently included them in our forecast. This added between £2.0 billion and £2.3 billion of depreciation spending a year (at the whole-UK level). In November 2017, the ONS revised its treatment of English housing associations and reclassified them back into the private sector, which had the effect of reducing our forecast for public corporations’ depreciation by a similar amount. As discussed above, public corporations’ depreciation does not affect total managed expenditure or borrowing, but only affects the current budget balance. The effect is therefore not shown in the chart below.

In the 2019 Blue Book, the ONS overhauled its estimates of the size of capital stock owned by the public sector and the assumptions that it applies when calculating the rate at which it is assumed to depreciate. Among the changes are shorter average lives for some asset types and different assumptions about the profile of depreciation over the life of an asset. The overall effect was to revise estimates of depreciation materially higher, by between £9 billion and £10 billion a year. We included these revisions in our March 2019 restated forecast. Since then, there have been some upward revisions to historical depreciation charge estimates, which have meant higher jump-off points for our forecasts.

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