Select Committee on Treasury Minutes of Evidence

Examination of witnesses (Questions 200 - 219)



Mr Fallon

  200. Mr Maxwell, you are reducing petrol duty and you are freezing other fuel duties. You have frozen vehicle excise duties. Overall, that is going to increase car use, is it not, not decrease it?
  (Mr Maxwell) I think it needs to be seen in the round. There is a series of different policies taking place here. We have the introduction of the new company car tax. In this year's Budget, the Chancellor announced not only reductions in duty on the cleanest available current petrol and diesel but also set out a route map for cleaner fuels for the future, starting first of all with the road fuel gases, and LPG, CNG and then biofuels. In the round, it is the package of these measures plus the changes to vehicle excise duty for new cars coming into place this March and the incentives for smaller existing cars that needs to be considered.

  201. Seeing it all in the round, which is your phrase, will car use increase or decrease this year as a result of these measures?
  (Mr Maxwell) The DETR has estimated in its ten year plan for transport that car use will increase by something like 17 per cent by 2010.

  202. I am asking about this year's measures. Will they increase or decrease car use?
  (Mr Maxwell) As a result of the reductions in duty, we would expect an extremely small impact on the use of cars.

  203. Which way?
  (Mr Maxwell) There are two things going on. There is the differential which is encouraging people to use cleaner fuels. That has air quality benefits and, in the medium term, it has potential CO2 benefits. There is also an impact on car use at the lower duty rate and that is likely to increase very slightly. We are talking of the order of less than half a per cent in the context of a 17 per cent increase by 2010.

  204. This year's duty measures will increase car use slightly?
  (Mr Maxwell) A reduction in duty has a number of effects, one of which is in air quality. The other is, if the duty on fuel falls, the demand could rise slightly and therefore car use would increase very slightly, but we are talking about extremely small amounts.

  205. That is not going to make the roads safer for your new generation of cyclists, is it? You are encouraging car use on the one hand and trying to get people to use cycles on the other.
  (Mr Maxwell) You have to see things in the round.

  206. If you are a cyclist, there are going to be more cars to contend with.
  (Mr Maxwell) Congestion has grown over many years in the United Kingdom. The DETR has forecast that car journeys will increase over the period to 2010.

  207. In the Pre-Budget Report, you said you were going to do a proper assessment of the environmental implications of removing the duty premium on lead replacement petrol. Now you have done that so you are reducing it but you have not published the assessment. Is that a secret?
  (Mr Maxwell) I do not think it is a secret. The DETR carried out an assessment of the environmental impacts.

  208. Do you expect that to be published? Is there any reason why it should not be published?
  (Mr Maxwell) I cannot see a reason why it should not be published, no.

Mr Beard

  209. Could we turn to productivity? Do you believe that the various measures that have been announced to boost productivity are actually working?
  (Mr O'Donnell) We take an overall look at what is happening to productivity. There are tables in here which look at what has been happening in the current recovery. At the moment, it is quite interesting that the recovery has been very employment rich. We have had a big expansion in employment and this has brought new people into the workforce who were previously marginal. We would expect those new entrants to the workforce to have below average productivity because they were relatively low skilled. What has been happening so far is that you have had big increases in employment but not much in productivity. We had expected this to turn round somewhat. It had not until 2000. If you look at GDP growth for 2000, essentially it is about half and half. About half the growth is due to increased productivity and about half to increased employment. As we go forward from there, we would expect the proportion due to employment growth to be relatively small and the proportion due to productivity growth to be somewhat higher. That reflects the view that there is quite good econometric evidence that when people come into the workforce they certainly start with relatively lower skills but between two and three years on their productivity goes up towards the average. There will be that effect coming through. Also, we have had a very big rise in business investment. The individual workers are working with more capital, so we would expect that to have a productivity effect coming through. We expect overall business productivity to be affected positively by the macro-economic stability that has been delivered—low inflation, low interest rates and the like—and then there is the whole raft of individual measures that we are implementing. The one I would point to in this Budget, which I think is a key measure is the consultation that we have announced on research and development tax credits. There is quite a lot of good economic evidence that the social returns from research and development are quite a lot higher than the private returns. Mr Troup in his evidence to you pointed that out. Therefore, there is a good case for trying to stimulate research and development. There is already a credit for small and medium sized enterprises. We released a consultation document with this Budget to explore an incremental R&D credit—i.e., additional on what was done last year—to explore a tax credit for R&D for medium and larger firms. There are issues about how you define incremental and how you define R&D. Those are issues that have been put out for consultation. There is quite a lengthy discussion of those in the consultation document. There are a number of other individual measures that we hope will have small but positive effects on productivity like venture capital funds, enterprise management initiatives, community investments, those sorts of areas. Overall, these measures will take time to come through. This is the sort of thing that is a very long term programme. We are not expecting suddenly to be able to observe increases in productivity month by month. This will be a pattern that emerges over years.

  210. Why has the growth of productivity in the last three or four years been so poor?
  (Mr O'Donnell) It essentially reflects the employment rich character of our recovery. Basically, we are bringing a lot of new people into the workforce, expanding employment quite substantially. These are people who have been at the margins and whose actual productivity is below the average, so they are bringing down average productivity. It is not unexpected.

  211. What are your forecasts of productivity growth for the future, given the measures that have been taken and the factors you have already outlined?
  (Mr O'Donnell) It is difficult to know precisely how much these measures will stimulate productivity. Essentially, what we are doing is adopting a very cautious approach. As we go forward, we are assuming that labour productivity grows at around two per cent per annum. Our neutral view of trend growth is made up of two per cent labour productivity growth and half a per cent increase in the number of workers. The half per cent is given to us by the demographics. One can be fairly certain about that although there are labour supply effects. We talked about some of the ones at the margin that might have an impact on that. We are rather hoping that that half a per cent will turn out to be cautious as well, so we might induce rather more people into the workforce and we might improve upon the long run average productivity figure of two per cent. There are good reasons to believe that two per cent should rise because of the very high levels of business investment we have seen. Increasing levels of public sector investment through time should improve the infrastructure which will help the private sector increase its productivity through better transport and the like. The combination of those, we would hope, will start to push up productivity. When those things happen, we may be in a position to say that the trend growth rate has gone up. At the moment, we have a neutral assumption of trend growth rate of 2.5 per cent, but we will need to look at the evidence and see the numbers as they come in. This is not something that we are in a position to have the evidence for yet, but there are some signs that things are moving in the right direction.

  212. The Chancellor recently announced the joint working parties involving the CBI and the TUC on productivity. How are they progressing?
  (Mr O'Donnell) They are progressing well. The Chancellor has had a number of workshops and breakfasts on productivity where we have been working with businessmen and unions to get them to think about what kind of measures would help increase overall productivity. We produced a paper with this budget on productivity which had some case studies in there. It is interesting to see that the debate is being engaged by the employers as well. I pick out for mention the Engineering Employers' Federation who produced a booklet recently called Lessons from Uncle Sam, where they compared US and UK productivity and looked at reasons for the productivity gap and considered ways of trying to learn from best practice in other markets. This is going to be one of those areas where the answer is probably that there are lots and lots of smaller answers rather than any one big answer.

  213. Mr Paul Myners's report was accepted by the Chancellor recently. Are you doing any assessment of what the impact of implementing those recommendations on productivity might be?
  (Mr O'Donnell) Yes, we will be. The Chancellor has accepted the Myners recommendations but for some of them—for example, one of the key ones like abolition of the minimum funding requirement—they will require legislation. That has not happened yet. What you have observed is the markets moving ahead and taking the assumption that these things will change. One of the problems we faced in the pension industry was that, because of prudence on public finances and the fact that people only see that we are running surpluses now but expect us to carry on with tight fiscal positions long term into the future, we have very low, long interest rates in the United Kingdom. They are below the US and Germany and that has consequences for the pension industry. The announcement of the Myners proposals did in fact cause some effect at the long end of the gilts curve. It meant that people saw that pension funds would be able to diversify somewhat more out of just buying gilts. That meant the demand for gilts would go down a bit and push the prices down and yields up somewhat. Myners is not just about buying gilts; it is about diversifying pension funds holdings overall and making pension funds perform better. That will mean that they may hold a slightly wider set of assets and move towards a slightly riskier but slightly higher return overall portfolio. That will include things like venture capital funds possibly.

  214. When would you expect legislation to implement the Myners report to come in?
  (Mr O'Donnell) That will be a matter for the usual channels to consider when there is parliamentary time. I know this is a priority matter.

  215. The minimum funding requirement took some time to devise. Is it likely that any replacement for it would be equally difficult to devise?
  (Mr O'Donnell) I do not think so in the sense that the minimum funding requirement required a certain amount of legislation, but then there were questions about the implementation and how should one implement it. Those issues went to actuaries who were giving advice on it. As I understand the implication of the Myners proposals, it is that quite a lot of the way forward will be to establish standards, voluntary codes and use transparency to allow pension fund managers who are faced with pension funds that are in very different circumstances to be able to explain their circumstances and their particular investment strategy in the light of their liability, so that they can match their asset and liability management. A lot of this will come about through more transparency and a greater role for trustees, for example. How much of it has to be done via the legislative route and how much can be done through that route I am not sure but it may well be that the legislation does not have to be too complex.

Mr Fallon

  216. Coming back to the research and development tax credit, when you planned to move it from the small firms to the larger firms, what lessons did you learn from its operation in small firms?
  (Mr O'Donnell) Remember that large firms R&D tax credit is simply out there for consultation at the moment. We are in the process of learning. For the small companies R&D tax credit, again, we will be able to get more information. It takes a while from the tax credit being introduced to being able to have good, solid information as to what the behavioural impact of that has been. As yet, we have not been able to learn much from it but I hope through time we will be able to by observing precisely what has happened to R&D spending by small companies. Obviously, we have to compare that against a relevant counter factual. That will require us being able to establish what R&D spending by SMEs would have been in the absence of the tax credit. That is where evaluation work is always quite difficult.

  217. Presumably, you have to make some estimate of the dead weight cost if R&D would have gone ahead anyway?
  (Mr O'Donnell) Exactly.

  218. You have not done that work yet on the smaller companies?
  (Mr O'Donnell) That work will be carried out but it is a question of having simply enough data post the tax credit. It is not very sensible to have done it until you have a reasonable amount of data to analyse the impact. The credit has not been in force for very long.

  219. There has not been an evaluation?
  (Mr O'Donnell) We have not completed an evaluation yet, no.

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