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:

 

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 latest forecast, we expect general government depreciation in 2017-18 to amount to £32.0 billion (with £19.8 billion of central government depreciation and £12.1 billion of local government depreciation). That would represent 4.0 per cent of total public spending, and is equivalent to £1,100 per household and 1.6 per cent of national income. Public corporations’ depreciation amounted to £10.9 billion in our latest forecast (£400 per household and 0.5 per cent of national income).

  • Latest forecast

    Our latest fiscal forecast was published in March 2017. General government depreciation stood at £29.4 billion in 2015-16 and is forecast to rise steadily to £38.6 billion in 2021-22. The year-on-year upward trend is relatively smooth, with any variation likely to reflect changes in the capital stock over a period of many years, since capital assets are depreciated over their average lifespan. These lifespans can vary significantly: for example, roads are depreciated over roughly a 55-year period while research and development assets are depreciated over roughly five years.

    More detail on our latest forecast and how it was revised relative to our previous forecast in November 2016 was provided in paragraph 4.151 of our March 2017 EFO.

    Expand to read the extract from our March 2017 EFO

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  • Latest monthly data

    Depreciation: ONS (IDs: NSRN, NSRO, NSRM, NMXO and JW2S for central government, local authority, public corporations’, general government and public sector depreciation, respectively)

    Monthly data are available for central government depreciation only. For local authority and public corporations’ depreciation, data are available on a quarterly basis. A fairly smooth pattern of central government depreciation is seen throughout the year, reflecting the way it is estimated by the Office for National Statistics (ONS), as discussed in further detail below in the forecast methodology section. The focus of our forecast is on the end-year position, with in-year data used to inform the starting point for the forecast.


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  • 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. The forecast is consistent with our economy and fiscal forecast determinants, as detailed below.

    Forecasting model

    The forecast uses a series of equations, detailing the development of the relevant capital stocks, the past rates of depreciation and recent outturns to forecast each sector’s depreciation. The forecast equation for the capital stock for each sector separately is:

    Total capital stockt = (1 – d) ((Dt * Total capital stockt-1) + Ct)

    In the equation above:

    d is the rate of depreciation, which is calibrated in outturn;

    Dt is GDP deflator growth at time t; and

    Ct is capital spending at time t.

    For depreciation, we use a relatively simple methodology in the forecast from time T onwards, rather than trying to replicate the bottom-up approach used by the ONS to generate outturn data.

    In outturn, where t < T, depreciation is estimated using the ONS’s perpetual inventory method (PIM)

    Depreciationt = PIMt + roadt

    In our forecast, where tT, depreciation evolves according to the following equation:

    Depreciationt = (d * Total capital stockt) + α0 + (α1 * (tT))

    In the equation above:

    d is the rate of depreciation; and

    α0 and α1 are manual correction factors to ensure continuity of depreciation between the latest outturn data and our forecast.

    The rate of depreciation, d, is imputed from outturn data and held constant in the forecast. The rate utilises data on the capital stock and outturn levels of depreciation across recent outturn years to arrive at the rate of depreciation that is applied over the forecast period.

    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 three sectors, which drives the forecast for the future capital stock which is to be depreciated.

    Main forecast judgements

    A degree of judgement is required in arriving at the manual correction factors, α0 and α1, discussed in the forecasting model section above. This was a source of error at the November 2016 forecast – as discussed in paragraph 4.151 of the March 2017 EFO – and is under review. We typically do not apply further judgements beyond the near term, using the output of the model as our central forecast.

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  • Previous forecasts

    Given the modelling approach described above, all our forecasts have a similar relatively stable upward trajectory. The most common source of forecast-to-forecast revision is changes in outturn data, affecting the jump-off point for the forecast. 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 (GOS), meaning public sector current receipts were revised up by an equivalent amount. The changes were therefore neutral for borrowing overall.

    A further classification change affecting depreciation was the reclassification of housing associations into the public sector. As housing associations are now treated as public corporations in the National Accounts, this only affected public corporations’ depreciation, adding between £2.0 billion and £2.3 billion a year to the forecast (at the whole UK level). 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.

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