Gordon Brown’s favoured mechanism for renewing the UK’s aging infrastructure has become as unpopular as the former Prime Minister himself. Two recent House of Commons’ Select Committee reports have been coruscating in their criticisms of the Private Finance Initiative – to the extent that it now seems inevitable that PFI will be fundamentally reformed, or perhaps even scrapped.
Leading the outspoken complaints has been Margaret Hodge, chair of the Public Accounts Committee, a former Labour minister and one-time close political ally of Tony Blair. “At present, PFI looks like a better deal for the private sector than for the taxpayer,” she said. While conceding that the PFI has enabled 700 infrastructure contracts to be in put in place, delivering new schools and hospitals, she added that “it is far from clear that it has provided value for money”.
Within days, the equally influential Treasury Select Committee threw its weight behind the anti-PFI arguments. The committee was particularly exercised about the off-balance sheet treatment of PFI projects and how this had meant that officials often regarded PFI as the ‘only game in town’. While PFI schemes are now mostly shown on departmental accounts – which comply with IFRS – they often do not appear on departmental budgets – prepared according to the more lax Eurostat standards.
Treasury committee chairman Andrew Tyrie said: “PFI means getting something now and paying later. Any Whitehall department could be excused for becoming addicted to that. [But] we can’t carry on as we are, expecting the next generation of taxpayers to pick up the tab. PFI should only be used where we can show clear benefits for the taxpayer. We must first acknowledge we’ve got a problem. This will be tough in the short term, but it should benefit the economy and public finances in the longer term.”
Given that these are, arguably, the two most important select committees in Parliament, there is little scope for the Government to ignore their findings – even if they wanted to. In fact, ministers also seem keen to change the way infrastructure is paid for.
Health secretary Andrew Lansley demonstrated the level of anxiety within the Cabinet when he briefed journalists about the impact of existing PFI contracts on the NHS. Loading PFI payments onto large hospitals’ budgets, while putting them under cost competitive pressures through the introduction of Payment by Results, is putting at risk the viability of 22 hospitals, Lansley warned.
One of the Government’s most likely changes is to decouple long term service contracts from asset procurement, say industry insiders. This might involve public bodies obtaining short-term funding to cover the construction phase and then refinancing on cheaper terms for the operational phase. This should cut costs, while still offering the prospect of transferring construction risk onto the private sector.
Other possible changes are the insertion of clauses to prevent ‘excessive profits’; making contracts easier to change; ensuring that project risks are genuinely transferred to the contractor; and bringing all PFI-type contracts fully on-balance sheet.
There is already a model that incorporates much of this approach. Increasingly, the procurement practices of the Scottish Futures Trust (SFT) are being examined as a possible way forward for the UK as a whole. SFT uses three principles to determine the way it operates: substantial stakeholder engagement in project management; no profit-distributing equity; and a cap on the return any private sector partner can obtain. Contractors can earn reasonable profits, but the use of special purpose vehicles to finance and manage projects – which under PFI has sometimes led to vast equity returns for shareholders – is prohibited under these arrangements.
SFT calculates that this approach has achieved substantial savings for the Scottish Executive. Claimed benefits and savings – audited by Grant Thornton and the London School of Economics – were £129m for last year alone, with an ongoing portfolio of investment projects of £9bn.
One of the models SFT is experimenting with to pay for infrastructure programmes is Tax Increment Financing (TIF) – borrowing today, with the loan costs covered by increased future revenues. The TIF approach is widely used in the United States and is being actively championed by both the Liberal Democrats’ leader Nick Clegg and by the party’s chief secretary to the Treasury, Danny Alexander.
The Department for Communities and Local Government is keen that TIF is used by local authorities, as part of a strategy that will enable councils to directly benefit from the proceeds of business rates. (At present, business rates across England are pooled and re-distributed to councils on a needs-based allocation system.)
Neil Rutherford, associate director of SFT, is excited by the opportunities presented by TIF. He explains: “TIF is a different way of doing things and brings in additional revenue streams. It is paying for growth by using the proceeds of growth. We see this as key in the current [fiscal] environment.”
But, says Rutherford, it is not simply a matter of taking what happens in America and applying it in Scotland. Where in the US the private sector is in the driving seat, SFT is clear that local authorities in Scotland must be the lead parties. This, though, means that councils must adopt strategies that protect them in case things go wrong – in particular, if revenue proceeds are less than anticipated.
“In Scotland we have a slightly different model because local authorities are involved,” says Rutherford. “So we are seeing the projects [come through] that local authorities see as important. So there is more control with this, but there is an element of risk with this. To make it work the private sector needs to deliver what it says it will. So a lot of what we have learnt is about how the public sector can define this, how it protects [scheme] benefits and revenues and manages risks.”
There is now a clear commitment from the communities department to implement TIF to allow local authorities to develop local infrastructure projects. What is as yet unclear is the extent to which a similar approach might be taken with major national infrastructure schemes. But it is clear that giving the private sector an incentive to generate the revenues that make a scheme self-financing has many attractions for a government with tight fiscal constraints.
Edinburgh City Council received approval in September last year from the Scottish Government to go ahead with the Edinburgh Waterfront regeneration project, funded through TIF – Tax Incremental Financing. This is the first such scheme in the UK and is one of three pilot schemes in Scotland being developed by the Scottish Futures Trust.
The scheme involves the development of a new cruise liner terminal, lock gates, esplanade and link road, which intends to use £83m of public money to trigger an estimated £660m of private finance into the area’s regeneration. It is hoped this will create nearly 5,000 jobs and provide economic growth of about £140m per annum. All being well, up-front costs from the public sector will be recovered through the higher business rates revenues generated by that economic growth.
Scottish finance secretary John Swinney said that cuts in financial support from Westminster made it necessary to use the TIF approach to kick-start schemes such as Edinburgh Waterfront.