PFI contracts need to be thoroughly investigated, so we can return some of the money to schools and hospitals
Tackling the public debt and austerity is a key issue in British politics. The debate needs to focus on the issue of profiteering from public contracts by the private sector, a key cause of the squeeze on public finances.
A good example of this is the Private Finance Initiative (PFI) pioneered by the Conservative government in the early 1990s and enthusiastically embraced by the Labour administration of 1997-2010. The current government is still wedded to it.
The key idea behind the PFI is that the private sector borrows money to build schools, hospitals, roads, prisons and government offices. These are then effectively leased to central/local government and public bodies who in turn make payments for the next 20-30 years. In due course, the asset ownership may be transferred to the public authority.
PFI has been a financial disaster. Currently there are 728 projects, of which 671 are operational, with a capital value of £57 billion. In return, the government is committed to paying £232 billion by 2049/50, effectively guaranteeing a profit of about £175 billon to corporations.
For the next 18 years, the repayments are about £10 billion a year. Hospitals, schools and local authorities have to pay their share of the PFI costs out of their shrinking budgets, a major cause of the degradation of public services.
PFI operators are also allowed to boost their profits by charging hundreds of pounds just to change light fittings and perform other mundane tasks.
The social infrastructure should have been funded by government borrowing. The cost of this is always much lower than that faced by corporations, but successive governments chose the PFI route because they believed that somehow this was off balance sheet, or would not count as part of the official borrowing.
This crazy financial engineering was preferred because the 1992 Maastricht Treaty restricted EU member state deficits to 3 per cent of annual GDP and public debt levels to 60 per cent of GDP.
So the government pretended that the cost of PFI was not really borrowing even though it has to be repaid by taxpayers. Armies of accountants, lawyers and advisers have collected vast fees for selling the fiction that ministers wanted to hear.
Cost of capital or cost of borrowing is a key variable in PFI contracts, but has been loaded in favour of corporations. In 2011, a House of Commons Treasury Committee report noted that:
“The cost of capital for a typical PFI project is currently over 8 per cent —double the long term government gilt rate of approximately 4 per cent.
The difference in finance costs means that PFI projects are significantly more expensive to fund over the life of a project. This represents a significant cost to taxpayers.”
Since 2009, the Bank of England base rate (interest rate) has been fixed at 0.5 per cent. The PFI cost of borrowing is not adjusted to reflect this. Consequently, the profit of contractors is much greater.
Banks such as Barclays, HSBC, Royal Bank of Scotland, Bank of Scotland, Lloyds and Royal Bank of Canada have been key players in PFI. Many have also been bailed out by taxpayer-funded loans, guarantees and direct injection of finance. The fallout from the banking crash has shown that banks rigged interest rates and several have paid fines for fraudulent manipulations.
These penalties have not been followed-up by an investigation of the impact of rigged interest rates on PFI profits. The banks and other companies have made excessive profits from interest rate rigging. They have also made excessive profits because since 2009 the actual cost of borrowing has been considerably lower than the one incorporated into PFI contracts.
The 2011 Treasury committee report noted that some 90 major PFI projects have been moved offshore. Hospitals and numerous NHS PFI projects are now based offshore. This enables PFI companies to avoid capital gains tax and corporation tax on their profits. Some have arranged their shareholdings in such a way that their executives are also able to avoid income taxes.
The result of profiteering, rigging of interest rates and tax avoidance means that the public pays more for the services. The public deficit is greater and schools and hospitals are unable to provide the required level of public services.
There are calls for the government to buy-up PFI contracts and relieve hospitals of the need to make payments. However, this should be preceded by an independent investigation of every past and present PFI contract.
This would probably recover billions of pounds from PFI contractors. No one should be allowed to make profits by rigging interest rates, making excessive changes or by dodging taxes. The amounts recovered, together with financial penalties, should be returned to schools, hospitals and local authorities.
Prem Sikka is Professor of accounting at the University of Essex, and a contributing editor to Left Foot Forward
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