The effect of universal credit overpayments on borrowing

The public finance measures of public sector net borrowing (PSNB) and public sector net financial liabilities (PSNFL), as recorded by the ONS and forecast by the OBR, are based on accruals accounting, which aims to record transactions when the associated economic activity occurs and so to reflect the underlying economic reality of a transaction.

The ONS is obliged to follow international accounting guidance when recording the public finances. In some cases, the guidance used for accruals accounting does not record the underlying economic reality in a timely fashion and so can give distorted signals. We call these occasions ‘fiscal illusions’. One such illusion relates to the effects of universal credit (UC) overpayments on borrowing.

In economic terms, UC overpayments can be thought of as having two components:

• a recoverable amount that results in what should be viewed as a temporary transfer of cash to the recipient and so should not be recorded as spending and should not affect PSNB; and
• an unrecoverable amount that represents a permanent transfer out of the public sector, and so should be counted as spending and so increase PSNB.

Therefore to reflect this, when UC payments are made two transactions impacting borrowing should be recorded: an amount which reflects the correct payment to the recipient and a transfer representing any unrecoverable overpayment. The recoverable amount of any overpayment should not be recorded as it represents a temporary transfer to the recipient. In practice, however, under current accruals accounting guidance a more complex series of effects of various transactions on borrowing takes place over a long time period:

• Payments: when an initial payment is made it is in effect assumed to be the correct payment to which the recipient is eligible. This stage therefore over-estimates spending within PSNB as any portion of the total payment which is in fact a recoverable overpayment should not be recorded as spending.
• dentifications: when an overpayment is subsequently identified and referred for recovery it is recorded as an equal reduction in UC spending and borrowing, regardless of whether it will eventually be recovered or not. This is therefore an over-estimate of the recovery and reduces spending and PSNB by too much.
• Recoveries: when recoveries are actually made they do not reduce UC spending or PSNB, as they have already been recorded at the point they are identified and referred for recovery.
• Write-offs: at the point that DWP decides it will not recover the overpayment and a write-off occurs, spending and PSNB increase by an amount equal to the value of the write-off.

After all these steps have taken place the correct amount of spending and borrowing will have been recorded. But the time lags involved – especially before reaching write-off – can be decades long. This means that a fiscal illusion – where full recovery of an overpayment is assumed and so reduces spending and PSNB by more than will finally be the case because some portion will eventually be written off – can persist far into the future and well beyond our five-year forecast period.

This persistent underestimate of spending due to the long lag before writing off unrecoverable debt has a material impact on borrowing. Approximately 25 per cent of UC overpayments which are referred for recovery are likely to be written-off eventually. This means that PSNB is eventually increased by around £0.5 billion a year by this effect. Put differently, were the accounting treatment to better reflect the economic reality, PSNB would be around £0.5 billion higher each year over our forecast.

We have raised this issue with the ONS which has recently stated that it intends to now consider its approach to cases such as these where there are long time lags involved in accruals accounting, with explicit reference to UC overpayments.^a