Select Committee on Treasury Minutes of Evidence

Examination of witnesses (Questions 1 - 19)




  1. Welcome. Firstly, may I say that we publish today two reports: Banking and the Consumer, and on the International Monetary Fund. This is our first hearing on the Budget and we are fortunate enough to have four experts here whom I wonder if I could invite to give a very short overview of the Budget and perhaps also tell us where you think it fits into the general economic background over the last four years, and looking ahead as well.
  (Mr Dicks) If any of you have managed to read anything I have sent to you over the last week or so, you will know that I am typically schizophrenic; a bona fide economist—I am going to say "on the one hand and then on the other". I was accused at this gathering last year of being inconsistent; I am pleased to say I am consistent in my inconsistency! I do applaud the Chancellor's strategy, by which I mean the medium term objective of removing the Budget surpluses. I see no reason why the government should be running these large continuing Budget surpluses. I think the aim of macro-economic policy should be to remove them. I am completely with George W Bush on this; I think we have been over-charged; we need a refund and we are obviously going to get that refund. Incidentally, the applause that greeted the fact that we have repaid so much debt in the last year was entirely misplaced: if the best we can do with the mobile telephony windfall is to pay down debt, we might just as well not have taken the money in the first place. That is the medium term and the strategy and now I come on to the tactics. I do worry, as many of us do, that the Chancellor is over-egging it for this year. The Budget itself, of course, was parsimonious, but it is not just the Budget you have to take into account. This Chancellor has a carefully cultivated reputation for prudence and what he does prudently is announce small measures bit by bit, but it is not when you announce the measures that is important, it is when they all come in, and if he had announced this month all the measures that are coming in in April—pensions, road fuel duties, excise duties, income tax, public spending, the introduction of the children's tax credit—there would have been a bonanza. I draw your attention to the forecast for real household disposable income in table B3 on page 170 of the Red Book, where the Treasury is forecasting 4.25-4.5 per cent growth in real household income this year. If that transpires, it will be the biggest increase in household spending since the boom of 1988. There have been two other good years in the 1990s—1992 and 1997—and you do not need me to tell you what happened in those years. As David Smith of the Sunday Times said to me, "If I were the Prime Minister, I would call an election on the back of those numbers". We are, therefore, forecasting very big increases and, if I were you, if I could make one recommendation I would ask the Treasury officials, "What is the breakdown of that 4.25-4.5 per cent? How much is that particularly due to the Budget, pensions and other tax measures?". We are forecasting a modest increase in consumer spending and that requires the savings ratio to rise. It may well do but the trend in the savings ratio is down so, if that were to continue, we would be looking at 5 per cent consumption growth, not 3 per cent. If you look at the Treasury's forecasts on the next table for the current account and the trade side, you will see that the Treasury is forecasting trade deficits rising from about £2.4 billion a month to £3 billion and then £4 billion a month. One set of bad trade figures was said to have lost Harold Wilson the 1970 election and the Chancellor is happy to forecast bad trade figures every month for the next three years. My conclusion therefore would be that the fiscal measures taken as a whole are expansionary. They will add 1 per cent to demand in the coming year—this is not prudent: it is risky. The Chancellor may get away with these risks and history may say that this was a well-timed fiscal expansion because the global background is that much more difficult and these fiscal measures may be timed to offset a weakness in the global economy, but it seems a rather perverse state of affairs that, if anything, the Treasury and the Chancellor must be hoping for a relatively hard landing in the United States which would justify their more aggressive fiscal stance. I think you can say the word "prudent" as often as you like, therefore, but just saying it does not make you prudent. It is the Chancellor's mantra but I suspect that, if you look at the whole package of measures and their impact on the economy this year it is far from prudent; it is risky and expansionary.
  (Ms Barker) As ever, I think you will find quite a reasonable measure of agreement between the witnesses on the question of the overall public finances. Very often at this Committee we have a discussion about whether or not the Chancellor has, in fact, loosened policy and like Geoffrey I would argue that he has certainly done so in at least two ways—one is compared with standing up last week and saying absolutely nothing and the other, more significantly, is that the government policy will certainly be adding a lot more to demand in the economy—as Geoffrey says just over 1 per cent to GDP—than last year. In both those senses, policy is certainly looser. However, I would differ slightly with his interpretation of the short term. I agree with his view in the long term—that it is undesirable to be forecasting very large surpluses over a very extended period. There is no particularly good economic reason for it and, therefore, in some sense the discussion, as it has been for the last couple of years, is all about what is right just for this year. I think I am a bit more sympathetic to what Gordon Brown has done this time and I am conscious of the fact that, when I have given evidence before, I have tended to suggest I was concerned that, at the margin, the measures added to inflation a bit more than was desirable. Certainly this time round again, compared with doing nothing, the measures announced last week must add a little bit to inflation prospects although, in leaving excise duties unchanged and cutting fuel duties, in some senses he has also taken some of that heat out. I am more concerned about the global slowdown and, in that sense, I would argue that the measures that were taken are a sensible response to the global slowdown which I am concerned is going to turn out to be a little bit more serious than some people are now assuming. I would argue that one of the benefits of the very prudent fiscal and monetary policy we have seen under this government is we are now in a particularly good position to respond to the global slowdown. We have seen some of that action taken through fiscal policy and I personally would continue to expect some further small interest rate cuts through this year. I would also say in passing that again we are, as ever, forced to take the numbers at face value. Given the experience we have had over the last few years of taxes turning out to be stronger than expected and government spending underrunning, there is a reasonable chance that, although this big boost to GDP is factored in, we have another year when we did not quite get it and particularly, if you look at the very large rise pencilled in for government investment, I think it is reasonable to say that this may not quite be achieved. Where in general terms I would express some concern is about the balance of the measures. It always sounds rather churlish to be critical of measures that are aimed at the bottom part of the population and also to be warning about the dangers of strong consumption but, if you look at the problems of low investment in the UK over a very long period and look at the balance of these measures, they were too much directed towards the consumer. Although we had some interesting measures for business in the longer term, there was very little to encourage investment in the short term in the Budget at a time when companies may find the desire to invest against the background of falling, equity prices—certainly as far as manufacturing is concerned, very weak profitability, really rather unfavourable. Perhaps it is the balance of the measures that is the place where we would have most concerns.
  (Professor Congdon) The last four years have seen a move from a deficit in the public finances to a surplus. Indeed, on some measures it is a large surplus. So it is rather churlish, again, to complain about measures that are going to reduce that surplus and perhaps move back to a deficit. It is understandable that there are complaints about these surpluses and so, in that respect, what Gordon Brown has done to reduce the surplus is understandable. But I do think that the combined total of all of the measures undertaken in the last eighteen months or so is expansionary. We need to remember not just the give-away—so-called—in this Budget, but also the pensioner package in the pre Budget report; the July spending measures last year; and also there was a carry-over from the Budget of 2000 which will have an effect in the coming year. If you add up all these changes, therefore, the effect on GDP is, indeed, about 1 per cent—I agree with Geoffrey's estimate on that. It is in the Budget documents that the figure for cyclically adjusted public sector net borrowing changes by about 1 per cent of GDP. That is a move towards relaxation after having these years of restraint. It happens when the economy is already quite over-heated, not very over-heated, but—according to the Treasury—output is about half a per cent above trend. So we have the prospect of output staying above trend, tight labour markets, rising pay settlements and also, of course, this widening payments deficit. So, although it is understandable that Gordon Brown has had this sequence of tax cuts and expenditure increases—a very impressive surplus had previously been built up—the result is that there is going to be a fiscal boost at the wrong time. This, of course, is a very common pattern in Britain's history but there we are. It is a big fiscal boost at the wrong time. Now, how much damage will follow is not clear yet. One point about the Budget is that, in the next few months, it is quite likely that the annual increase in RPIX will go under 1.5 per cent; that reflects the cut in fuel duties and a standstill on other excise duties. There is pressure on the Bank of England to reduce interest rates: I hope it does not but there we are—it may do. Then the question is what will the impact be on inflation further out, and I am not particularly happy about that prospect. I think we are going to see a deterioration in inflation in 2002 and 2003. Much depends on the exchange rate and in that context we have this large balance of payments deficit. The risk has to be that, at some point, the pound falls and then we get into a pattern that we have had in the British economy in the past. The pattern may not be familiar from the last ten or fifteen years, but will certainly be familiar to those who remember the 1970s and the 1960s. May I make one comment, which you might perhaps expect from me? There has been rather high growth of money on the broad measures in the last few quarters and this Budget will tend to increase that. I do not believe in the medium term that we can have monetary growth of around about 8, 9, 10 per cent a year and 2.5 per cent inflation. Finally, two general comments. First, I think the Chancellor should be criticised for increasing indirect taxes quite substantially in his first two or three years and then cutting them in what is likely to be an election year. That, frankly, is not good economics and needs to be criticised. Secondly, I think some of the Budget measures need to be criticised. I am not going to talk about micro-economics, but I have heard from many people that the tax credit system is very complex. Some of the benefits that are supposed to accrue to the less well-off will not because it is so difficult to administer. I would like to complain about the length of this Budget and its complexity.
  (Mr Weale) Of the three people who have just spoken, I think I find myself in closest agreement with Tim Congdon. As economists always say, looking at the state of the economy at the moment there are forces pulling in two directions. There is the reflationary, or you could say inflationary, budgetary situation that Gordon Brown is delivering: he is adding just over 1 per cent of GDP to demand. Remember that President Bush is campaigning hard for mainly tax cuts of a similar sort of magnitude but Gordon Brown is delivering them, Parliament will be giving effect to them I expect within the next few weeks so we already have the sort of fiscal stimulus that President Bush is angling for and may well not deliver. This has come at a time when private sector saving is low: the increase in government or the reduction in government saving, the increase in borrowing that is the counterpart of this stimulus, has to be paid for by other people raising their savings rates and, in the Budget, that is approximately evenly split between an increase in household saving and an increase in the balance of payments deficit. The forecast relies on income growth of households increasing, growing faster than it did last year, while consumption this year is expected to grow slightly more slowly and, as a corollary of that, the savings rate increases but, of course, if the savings rate does not go up then the balance of payments situation is likely to get worse in the short term. In the longer term that is likely to translate into weakness of sterling and greater inflationary pressures or higher interest rates. The Budget is set out entirely in terms of achieving the Chancellor's target: it is nice to have clear rules and principles but I should say that I think economists are generally agreed that the optimal fiscal policy is one where you try and keep expected future tax rates constant: that people should be able to plan on the basis of tax rates staying constant. Of course, as shocks impinge on the economy that means you need to adjust your tax rates; it does not mean they should be fixed for ever but it means that they should be expected to be constant. That implies that you do not try and run down debt: you typically absorb the level of debt where it is. So I am not sure that the Budget is designed along what economists would regard to be the best principles: in fact, instead, the Chancellor is focusing on balancing the current account, although he is not expecting to get there quite by the end of the period. I think the Budget has been a missed opportunity to promote and accelerate the process of convergence with the Euro area. The Euro area has a tighter fiscal target. As a consequence—or at least in part as a consequence—it has lower interest rates. Had the Chancellor taken the opportunity to reduce the inflation target and to tighten the fiscal target slightly, then I think in the medium term we would have lower interest rates, and the process of convergence with the Euro area would have been facilitated. Whether we are to draw any conclusions from the fact that that did not happen, I do not know. I have talked about the inflationary risks that the economy faces; it is fair to acknowledge, as Ms Barker did, that there are also concerns about a fall in output. From the United States we see a rather odd situation; people apparently are surprised that a situation which looked like walking on water has turned out to be walking on water. The savings ratio in the United States fell to zero last year. It is difficult to see that that could last. Valuations of financial markets were at levels which, let's say, were outside historical experience and, in the United States, coming to grips with reality has been I think confused with a rather gloomy outlook and the fear of a recession. On the other hand, coming to grips with reality may result in a substantial loss of confidence and, as Kate says, the world situation could turn out weaker than the Chancellor has assumed here. If that does happen, if the economy grows slower than his 2.25 per cent, then the fiscal arithmetic will start to look unpleasant. So the Chancellor has trodden a tightrope between feeling the need to support the economy and worrying about the inflationary pressure. My concerns are that he has gone a bit too far towards reflating and that, therefore, interest rates are likely to be a bit higher than probably would be desirable.

  2. On convergence, I was a bit surprised at what you said. Am I not right in saying that our debt ratio and public sector borrowing is lower than most of the continental economies: secondly, our inflation rate judged by the measure used by the continental economies is lower, the lowest of the lot; and, thirdly, probably the bit which is out of alignment has been the pound so the slight stimulus which led to the weakening of the pound might lead to a greater convergence of our exchange rate.
  (Mr Weale) On those points, that accurately describes the situation at the moment but, if you look at the long-term targets that we have relative to those in the Euro area, there the target is for Budget balance whereas our target is to balance the current account and, therefore, to run a Budget deficit, so the long-term fiscal position is slacker. On the inflation target there are certainly questions about the numbers from the euro area but the ECB has a target range of 0-2 per cent: we have a target of 2.5 per cent, and we worry about being below that as well as being above it. It is certainly true that, in the past, the RPI has tended to rise faster than the harmonised index but I think if the Chancellor wanted to lock inflationary expectations into a situation compatible with a euro area inflation target of 0-2 per cent, then it would have been prudent to reduce the inflation target to 2 per cent at the moment. Remember that would still allow it to rise above 3 per cent before needing an excuse letter.

Mr Fallon

  3. Mr Dicks, on the eve of the Budget, the Centre for Policy Studies estimated the net rise in the tax burden over the last four years to be £36 billion. Do you agree with that?
  (Mr Dicks) I do not know if I agree or disagree. My point is that it is the change in the Budget from one year to the next that is important in terms of its impact on the economy. The Treasury in paragraph 1.14 talks about the cyclically adjusted public sector net borrowing and seems to imply that it is the level of that that is important. I think it is the change in that measure that is important for the stance of policy, so what has happened to the tax burden over a period of time—and it is not my speciality—in terms of changes in the overall stance of policy from one year to another is quite clear.

  4. It is quite important for those who have to pay the taxes, is it not? Mr Weale, would you agree with the claim that the net rise in the tax burden over the last four years has been £36 billion?
  (Mr Weale) Looking at table C23 in the FSBR, in 1996-97 taxes and social security contributions were 35.2 per cent of GDP; in 1999-2000 they were 36.9 per cent of GDP. That is an increase of 1.7 per cent of GDP which is rather lower than the £36 billion you mentioned—it is just under £17 billion—so I cannot say how I would reconcile that with the figure you mentioned but, asked what the increase in the tax burden has been, I would take that as my first estimate of the figure. You might want to look at the cyclically adjusted figures instead: I do not think they would be terribly different.

  5. How easy is it to distinguish between the cyclical factors and the discretionary factors? What do you think the net rise in the tax burden due to discretionary tax measures has been over the last four years?
  (Ms Barker) This is quite difficult and I have a great deal of sympathy with Martin's approach. You can look at this in a great number of ways. We have argued from the CBI's point of view that the rise in the tax burdens that applies to business over the last four years has been very significant and, if you add it up over a period, it comes to probably in excess of £22 billion, but if you were to ask me what I wanted to describe as the discretionary rise in the whole tax picture over the period, I would take Martin's view and look at what has happened to taxes relative to GDP and the share of the tax take has risen. On the other hand, if you go back to the period when the government came into office and there was a very large deficit, clearly either taxes needed to rise or public spending needed to be cut very significantly. I find it quite difficult to criticise the balance between tax and public spending that the Chancellor has taken, although I might criticise the nature and balance of the tax increases themselves.
  (Professor Congdon) This is a difficult subject and I cannot say I have a great deal to add. Obviously the burden of the state is ultimately measured by the level of public spending and, up until now, the ratio of public spending to GDP has not risen very much. In fact, it has fallen a bit under this government, so we have this combination of higher taxes and a lower ratio of spending to GDP so there is this large surplus. Over the next few years, though, public spending is going to be rising faster than GDP when output is already above trend, and that may lead to some over-heating. But there has been a rise in the tax burden—there is no doubt about that.

Mr Ruffley

  6. Could I ask this of each of the witnesses? If the public spending growth path in the CSR as amended in the Budget is continued beyond the CSR period, would it be prudent to raise taxes and, if so, by how much?
  (Mr Dicks) You are talking some way into the future really.

  7. Yes, I am.
  (Mr Dicks) We are trying to get our Budget deficit back to about 1 per cent of GDP and stabilise it there so the simple arithmetic behind your question is that, if public spending continues in the out years to rise at the rate that has been necessary to transform a big surplus into a modest deficit, then the arithmetic is inevitable—the tax burden would have to rise pari passu with the public spending.

  8. I appreciate it may be a bit unfair to ask you to do the arithmetic in your head without notice of this question but I think it is 3.7 per cent it is running at per annum which I think is the amended figure after the budget. If that growth path is continued for the next three years of the CSR, what magnitude over a three-year period of tax increases would we be looking at for the Chancellor to maintain a prudent stance?
  (Mr Dicks) If you are talking real increases of 3.7 per cent, assume that inflation is 2.3 to make the arithmetic simple, that would give you a 6 per cent nominal increase in public spending. To stabilise a deficit of 1 per cent in GDP taxes would have to rise at 6 per cent a year. If the underlying growth of rate of the economy is 2.5 and if inflation is 2.5 so that nominal GDP is rising by 5 per cent a year and taxes by 6 per cent a year, the real tax burden has to continue to increase; taxes have to rise 1 per cent a year in nominal terms faster than incomes but that is because the volume of public spending is going to, in this hypothetical scenario, continue to rise 1 per cent a year faster than the underlying rate of growth of the economy.

Mr Beard

  9. Except the gap could be bridged by borrowing?
  (Mr Dicks) Well, if you assume that the three outer year period, I think it is, in which the deficit is 1 per cent of the GDP is meant to continue through the future, if we are going to keep borrowing constant and do a given growth in spending, we obviously have to do the same growth in taxes.

Mr Ruffley

  10. That is a very helpful answer. Could I go to the other three witnesses and ask if they have anything to add to that?
  (Ms Barker) It would be very difficult to disagree with the arithmetic. Assuming that all the other assumptions between now and then are correct, clearly if you were going to continue to have public spending growing faster than GDP and stabilised borrowing, you have to have a rising tax ratio. I am prepared to go further and say that I would not support that as a scenario because, of course, it would imply rising public spending relative to GDP, as it were, in perpetuity and, like Tim, I would agree with the point that that is the true burden of government, and the CBI has gone on record many times as saying that above that 40 per cent you really do not want to see public spending rise further.
  (Professor Congdon) This is a very difficult question because of the detail implicit in it. But the forecast for the coming year is that the public sector net borrowing is going to be in surplus by a small percentage—about 0.3 per cent of GDP—and then there is to be deficit of about 1 per cent of GDP thereafter. So you have a certain amount of scope to have spending rising faster than taxes, as long as you go along with this framework. But obviously if, after that leeway has been taken up, public spending keeps on growing by 3.5 per cent against a trend growth rate of GDP of 2.25 or 2.5, then you need to be raising taxes by quarter or half a per cent of GDP year after year simply to be keeping that deficit stable at 1 per cent of GDP.
  (Mr Weale) I was trying to do the calculations and have not quite got the answer. An alternative way of looking at it would be to say, supposing you wanted to have public spending growing at 1 per cent faster than GDP indefinitely, you could have taxes rising faster than GDP or you could have a sudden increase in taxes and, in essence, save up the money in the early years of this extended growth in order to live off the interest in the later years. That is the example of keeping the expected tax rate constant. Now, the one-off tax increase that would be needed to make the policy sustainable would be very large indeed: it would take the total tax burden to something towards the whole of GDP and, having done that, provided when you levy those sorts of taxes you can still collect revenue, it is a sustainable if not desirable policy whereas, of course, increasing tax revenue 1 per cent a year faster than GDP for ever cannot be done because in the end the tax rates would rise above one hundred per cent.

  11. The first part of that answer was very helpful; the second bit less so! Can I ask a second question of you all: Credit Suisse First Boston have estimated that household disposable income after taxes, after inflation, on average has grown under this Chancellorship by 1.6 per cent; 2.5 per cent under the Major administration and under their calculations 2.9 per cent under the Thatcher administration. They conclude that that poorer performance under this Chancellorship, and this is their assessment not mine, is largely attributable to tax increases which we have already talked about and know about. Could I just ask you what your analysis is of household disposable income under this Chancellor and, reading the documents in front of us, how you see household disposable income performing in the next three years? Whilst doing so, could you comment on how far explicit tax increases since May 1997 have contributed to the lower than average performance?
  (Mr Weale) I do not have the numbers with me but I do not doubt the figures that Credit Suisse First Boston have worked out. I think you would expect household disposable income to have grown more slowly in this period certainly than in the period of the Major government because higher tax revenue was needed to close the Budget deficit: someone had to pay those taxes and, at the end of the day, the only people who can pay taxes are people. Companies belong to people; if company taxes are increased, dividends are in the end depressed so the burden, in the end, falls on the household sector. The figures you say are no surprise and they are the counterpart of what a moment ago we were describing as a successful fiscal policy of having closed the large Budget deficit which the government inherited when it came into office and, incidentally, which the previous government also had plans to close. As to the situation in the next two or three years, I do not disagree significantly with the figures shown in the Red Book at table B3 that disposable income is likely to grow fairly rapidly this year. That comes from two elements: one is the Chancellor's tax cuts and another, perhaps more important, is the slow growth we are expecting in the retail price index. Wages have gone on bobbing around at 4.5-5 per cent a year but the rate of inflation is dropping towards 1.5 per cent and that obviously facilitates the growth of real disposable income. The Chancellor is also increasing transfer payments and those are helping, so when I said I did not disagree very strongly for any of the next three years with the figures in the Red Book, I am a bit more of an optimist on overall growth than the Treasury is so I would expect to see slightly faster growth in disposable income in 2002 and 2003 compared with the figures shown here.
  (Professor Congdon) I have not seen the CSFB working so I do not know the detail of the calculation but, in terms of comments on it, I assume social security is one element in this calculation. One point is that, under this government, in fact social security spending has been rising less than GDP, unlike the Conservative government—perhaps rather ironically. So there has been that important effect which needs to be noticed which reflects the declines in unemployment and the tougher benefit regime. I would make really two other comments in detail. The first is that one must not forget it is the broader picture of national resources that matters in the end and, in fact, consumption growth in the last few years has been relatively strong so there has obviously been a decline in the savings ratio. Secondly, the fiscal policies that have led to this outcome are now being reversed because there is a big increase in household incomes in the coming year. This business of raising indirect taxes in the first two or three years of a government and then cutting them in the final year is, in my view, very reprehensible, and that would have been one factor in this contrast between the slow growth of household incomes and then the large increase in household incomes.

  12. Why do you feel it is reprehensible?
  (Professor Congdon) First of all, there is the effect of the monetary policy because plainly it may lead to making life more difficult for the Bank of England in achieving a stable path for RPIX and, secondly, it may have some effect on the cyclicality of the economy. We get a weakness in the economy and strength at other points for reasons which have nothing to do with the underlying economic situation. Further, it is in a sense deceptive. Plainly, it has a misleading impact on the way we think about the Budget balance, the retail price index and all sorts of things.
  (Ms Barker) In terms of the figures that you quoted, like my colleagues I am sure they are correct, and I remarked earlier as other people have remarked the tax burden clearly had to rise. I also share the view that there is nothing particularly out of line about the Chancellor's forecast as produced in the Red Book as far as real disposable income is concerned. The real question it seems to me over the next few years is exactly what is going to happen to the behaviour of household savings. We have seen quite a run down in household savings—partly I think as people have felt more secure about future tax rates: they have seen the Budget deficit corrected: they are looking forward to a period where public finances are clearly in better health; people have seen rising house prices and rising equity markets. We are now moving into a period where the wealth effects that we have seen become rather more uncertain and it may be that, although the household disposable income numbers are correct, what happens to the savings ratio is different. It is possible that people may find that times become a little more uncertain; they may feel less wealthy if equity markets fall; particularly we may see the savings ratio rise a bit more and not quite such a big burst in household consumption. I would slightly take issue with Tim on the point he has made about indirect taxation and I was about to say something in the defence of the Bank of England. Of all that is around that will mislead the Bank of England, I am not sure that the cuts in indirect taxes which, after all, are pretty transparent and you can assess the effects very easily and pretty much be sure when they may fall out of the index, are particularly likely to mislead monetary policy. I would have thought other uncertainties were rather greater. There are criticisms that can be made of indirect tax policy and the effect it has had on particular industries. To see indirect taxes raised very strongly—for example, fuel taxes raised very strongly—with then a realisation that it has perhaps gone too far and having to be rolled back, is undesirable.
  (Mr Dicks) I would add that it is partly accidental that the Budget has overshot and therefore the tax burden has gone up by more than was intended. If you are going to move from a deficit to a surplus position, then you either have to squeeze spending or raise taxes and, if that has had an adverse impact on household incomes, then so be it. Also, if you take the five-year average rather than the four, it will look very different because we have done the work now and we are giving taxes back and we are going to get a 4 per cent plus increase in incomes this year. I think you said the four-year average was 1.6; the five-year average will be over 2; the six-year average will be 2.25 and the seven will be 2.5, so it will look different as time goes by.
  (Professor Congdon) May I just add this, which I think is important? The Bank of England of course can see through these fluctuations in indirect taxes. Nevertheless, the papers are saying they should cut interest rates because RPIX is going to go beneath 1.5 per cent. In that sense the reduction in indirect taxes does make the conduct of monetary policy more awkward. I quite agree, of course the Bank can see through it, but in my view it is misleading and not appropriate.

Mr Plaskitt

  13. I want to flick back to the introductory comments you made. Most of you were critical of the Budget in the sense you said there is too much fiscal stimulus here, yet most of you who voiced that criticism also said you do not like the fact there is a large surplus because it is people's taxes that should be given back. Are those two positions not contradictory?
  (Mr Dicks) I said it explicitly but I drew a distinction between a medium term strategy and the effect on the first year. It is strategy and tactics. The strategy is correct; tactically he may be doing too much in the first year. He may not be, because we are in a global deflationary environment and history, as I said, may judge him kindly. Napoleon wanted lucky Generals; maybe this Chancellor is a lucky Chancellor. Not one has been before now; he might be.

  14. It has turned out up until now that his forecasts on it have not been right and there has always been more buoyancy in the fiscal position than his estimate. If recent history repeats itself, it is going to be more phased anyway.
  (Mr Dicks) I am judging his intention rather than exactly how events might transpire because not one of us can say. The intention is clear.

  15. Does any other witness want to comment on this apparent contradiction?
  (Ms Barker) I would agree with Geoffrey broadly but he made a point right at the beginning where he said the Chancellor might be hoping, as it were, that the global situation might turn out to be worse than the fiscal policy but, on top of that, there must be precisely the concern you have just raised that the fiscal forecasts themselves are over-cautious. So, in fact, I suspect we will end up with about the right fiscal policy for this year because I do think the Chancellor's luck is going to hold.
  (Professor Congdon) I like surpluses, but I have given evidence to this Committee before on the shortage of gilts because the ratio of public debt to GDP is falling. So, in a way, there is a constraint on how large and continuous these surpluses can be.
  (Mr Weale) I agree with the view that you would not try and run surpluses indefinitely but putting just over 1 per cent of GDP into the economy all in one go does seem like a very large stimulus. As Ms Barker said, it may well be that the world situation turns out badly and the Chancellor's judgment proves vindicated. It may also be that underlying productivity in the economy grows a bit faster than the Chancellor has assumed and in that sense the economy can afford the expansion without inflationary pressures becoming too acute.

  16. Surely you would agree that the risk in putting that kind of injection in against a background of government surpluses is far lower than if you were doing it against the background of a balanced budget or deficit?
  (Mr Weale) That is not necessarily true. It comes back to the question "Are we worried about the overall level of debt of the government?". If it put 1 per cent of GDP in from a balanced budget that would be a 1 per cent deficit and in any particular year that would not matter. It comes back to the point that Geoffrey Dicks raised that actually what matters is the influence of the government on the state of demand in the economy and it is adding 1 per cent of demand to the economy; that is a lot in an economy which normally grows at about 2.5 per cent a year.

Mr Fallon

  17. If the two fiscal rules are so easily met and if they are not clearly constraining policy measures, then they are pretty meaningless, are they not?
  (Mr Weale) I do not think the two fiscal rules are meaningless. They are meant to be inequalities and not exact constraints, ie, debt will not be above 40 per cent of GDP and tax revenues will be at least enough to pay for current consumption; but the difficulty is that, when the economy is in surplus, as it is at the moment, the Chancellor seems just to be repeating those two rules and seems to have no other guide. The logical guide would be what is the appropriate fiscal change in the light of the overall state of the economy and, if that were the only thing you focused on, it could even say that, when you run a surplus, because demand is booming elsewhere, you need to increase the surplus. The Chancellor seems to be ignoring what are called the demand management aspects of fiscal policy and focusing solely on the long run. Now that has the disadvantage, of course, that the whole of the job of demand management is left to the Bank of England.
  (Professor Congdon) One point that the Committee might want to think about is that the sustainable investment rule was originally framed in terms of 40 per cent of GDP: it now appears it is 30 per cent of GDP. I think it is a good thing to have a low public debt and, on the whole, to have surpluses of this kind—maybe they are rather large—but that does appear to have been a change in this Budget which has not been noticed.

Mr Cousins

  18. Mr Dicks, in your rather splendid memo you say, "I am here asking for a refund", and you associated yourself with the fiscal policies of President Bush to the Committee but in fact in answer to Mr Fallon it was clear that the refund that you wanted you did not want this year. Is this not rather misleading, because President Bush wants it this year?
  (Mr Dicks) You did accuse me of inconsistency last year and I am pleased to see that you are consistent in your accusations! I think it is the difference between strategy and tactics that, over the medium term, we want to move from a surplus to a deficit position but how quickly can we go along that particular route? I think we have been overcharged: I do not think we should be starting from here but, given that this is where we are starting from, then we have to reduce the surplus and move into deficit but we have to do it relatively slowly. I think we are going too fast along the desirable route.

  19. Just to be clear about this: when you are telling the people who read this "I am here asking for a refund", what it really should say is, "I am here asking for a refund sometime but not yet"?
  (Mr Dicks) No. I say at the bottom of that piece that we are in a world of making Budget judgments. We have just established that the fiscal rules provide little guidance to the Budget judgment so that the Budget judgment, in an old-fashioned 1960s sense, is paramount and the Budget judgment that we can take an additional 1 per cent on demand would not have been my Budget judgment—not in one year. Maybe over two or three years but not at one fell swoop.

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