APPENDIX: MEMORANDUM FROM HM TREASURY
The Government notes the conclusions of the Treasury
Committee's report on the 2003 Pre-Budget Report.
The Pre-Budget Report
1. We regret this omission [of a debate
on the Pre-Budget Report], given that transparency and openness
demand that government financial statements like the Pre-Budget
Report should be subject to parliamentary scrutiny in the Chamber
of the House of Commons. We reiterate our recommendation that
every year the House should hold a half or full day's debate on
the Pre-Budget Report. (Paragraph 3)
As the Government set out in its response to the
Treasury Select Committee's report on the 2002 Pre-Budget Report,
the programming of business and allocation of parliamentary time
is a matter for the business managers, acting in close consultation
with other parties in the House through the usual channels. Parliamentary
time is a scarce commodity and there are usually several competing
demands for slots on the Floor of the House, especially either
side of the Christmas recess. The Government will consider the
need for a debate on future Pre-Budget Reports in the light of
the circumstances prevailing at the time.
2. We can only repeat our view that
as much notice as possible for the Budget date is desirable and
we therefore urge the Government to regard the 2002 practice —
of at least 2 months' advance notice — to be at least a
working target. Advance notice for the Pre-Budget Report is also
helpful. The announcement of the date for this year's Pre-Budget
report and statement was made during oral Question Time on Thursday
13 November, less than one month before the statement. We believe
that the same arguments hold for advance notice for the Pre-Budget
Report as for the Budget. (Paragraph 4)
On 29 January the Chancellor announced on the floor
of the House of Commons that Budget 2004 would be on 17 March,
thereby providing seven weeks advance notice. As the Government
set out in its response to the Treasury Select Committee's report
on the 2003 Budget, it will announce the date of the Budget (and
Pre-Budget Report) at the earliest convenient opportunity. However,
it may not prove possible to give two months notice.
The economy: the recent past
3. We note the European Commission's
comment that "the UK economy weathered the recent global
slowdown well". This is particularly notable in the face
of the continued weakness in activity in its major trading partners
in the euro area. (Paragraph 5)
In recent years, the domestic stability delivered
by the Government's macroeconomic framework has enabled the UK
economy to cope well in a challenging global economic environment.
Strong economic fundamentals and proactive monetary policy have
supported private consumption, and fiscal policy has also supported
demand, with sound public finances allowing counter-cyclical action
through the operation of the automatic stabilisers.
4. The Committee is concerned that
the recent fall in the dollar may jeopardise global recovery prospects,
although some of the evidence we received on this point was generally
reassuring (Paragraph 6)
Box A2 of the Pre-Budget Report highlights the danger
posed by large global imbalances. It pointed out that a sharp
fall in the value of the US dollar could have significant implications
for growth in those economies that are dependent on US trade,
and might also hit US domestic demand by pushing up long-term
interest rates and reducing household purchasing power. Similarly,
paragraph A16 notes that "sudden sharp movements" in
major exchange rates pose a threat to the Pre-Budget Report forecasts
for the world economy. Excess volatility and disorderly movements
can dent confidence and hurt financial markets.
While the dollar has continued to decline steadily
since the Pre-Budget Report was published, notably against the
euro, so far this development has coincided with a general improvement
in financial conditions - rising equity markets, narrowing corporate
spreads and falling or steady long-term interest rates—and
rising confidence across the world's major economies. As a result,
global growth has continued to gather strength.
Nevertheless, global current account imbalances remain
a threat to the medium term sustainability of this recovery. It
is important that policy makers in all major economies continue
to focus their attention on the underlying cause of these positions
- imbalances in growth. This is why the Chancellor continues to
press for policies that will foster more balanced medium term
growth among the world's major economies, in particular structural
reforms in Europe, which can raise potential growth rates and
increase resilience to shocks. The 7 February 2004 Statement of
G7 Finance Ministers and Central Bank Governors reiterated the
importance of supply side structural policies that increase flexibility
and raise productivity growth and employment. It noted that this
Agenda for Growth initiative and sound medium term fiscal policies
are key to addressing global imbalances.
5. In spite of a rather disappointing
trend in fixed investment and exports, current estimates of UK
economic growth in 2003 are consistent with the reduced forecast
of 2-2½% growth published by the Treasury at the time of
the last Budget. (Paragraph 7)
It is inevitable that as a highly open economy the
UK is substantively affected by global developments; and international
uncertainties in the first half of 2003 adversely affected investment
and underlying external demand. In the circumstances, UK GDP held
up well, though it grew at below trend rates. The second estimate
of GDP in 2003, published by the Office for National Statistics
on 25 February 2004, showed growth of 2.3 per cent for 2003 as
a whole, consistent with the 2003 Budget forecast and slightly
above the 2003 Pre-Budget Report estimate.
6. Throughout a volatile period in
the world economy the Committee observes that the MPC has continued
successfully to maintain UK inflation close to the target laid
down by the Chancellor. Moreover, while maintaining inflation
inside the target range, monetary policy has also been able to
provide substantial support to growth by delivering historically
low short-term interest rates to the economy. (Paragraph 8)
The Government welcomes the Committee's positive
remarks on the monetary policy framework and the performance of
the Monetary Policy Committee of the Bank of England. The Government
notes that the average rate of RPIX inflation has fallen since
the introduction of the monetary policy framework in May 1997.
Between May 1979 and May 1997, average RPIX inflation was 5.9
per cent while between May 1997 and the present, average RPIX
inflation was 2.4 per cent. Inflation expectations have remained
anchored close to the inflation target throughout.
The Government would, however, like to make clear
that that the inflation target is a symmetric, point target; the
trigger points for an open letter do not constitute a target range.
7. The successful complementarity of
monetary and fiscal policy has played a key role in delivering
a UK economic performance over the past few years which the IMF
describes as "enviable". Key tests for both monetary
and fiscal policy nevertheless lie ahead as recovery emerges.
(Paragraph 9)
See response to conclusion 8 below.
8. As the global economy recovers it
is vital that UK economic policy adapts as anticipated to the
upswing, to avoid potential problems flowing from the current
imbalances in the economy. (Paragraph 9)
The frameworks for monetary and fiscal policy provide
a coherent strategy for maintaining high and stable levels of
growth and employment. They are designed to help achieve macroeconomic
stability throughout the economic cycle.
The monetary policy framework, through its symmetric
inflation target, ensures that equal weight is given to under-
and over-achieving the target. The Monetary Policy Committee has
raised interest rates in November and in February in response
to a strengthening global economy and pick up in UK economic growth.
Similarly, setting the fiscal rules over the economic
cycle allows the automatic stabilisers to work in full at times
when the economy is above trend as well as times when the economy
is below trend, thereby helping to smooth the path of the economy.
As can be seen from Chart 2.6 of the Pre-Budget Report, as the
economy returns to trend so fiscal policy is forecast to return
to a more neutral position.
There are already signs that a rebalancing of UK
economic growth is underway. Private consumption growth for 2003
as a whole moderated compared with rates seen in recent years.
Manufacturing output has risen since the end of 2002 and business
surveys point to further strengthening going forward. There is
also some evidence that exports have begun to pick up. The 2003
Pre-Budget Report forecast shows a continuing rebalancing of growth
as the global recovery gathers pace.
The outlook for the economy
9. The Treasury's economic forecasts
for 2004 and beyond continue to look more optimistic than most,
although the gap between the Treasury's assessment and that of
most other forecasters has narrowed, with most independent forecasters
now a little more optimistic about growth in 2004 than they were
in the spring. (Paragraph 10)
The Treasury's forecasting record is good. Since
1997, Treasury Pre-Budget Report forecasts for economic growth
in the year ahead have, on average, outperformed the independent
consensus prevailing at the time.
For example, in April 2003, the Treasury's comparison
of independent forecasts showed the independent average forecast
for GDP growth in 2003 was 1.9 per cent, compared with the Budget
2003 range of 2 to 2½ per cent. Moreover, the average of
new independent forecasts at that time - those made in
the most recent month - was 1.8 per cent. By August 2003, the
independent average for GDP growth was 1.7 per cent in 2003, with
only 11 per cent of forecasters surveyed expecting GDP growth
to be within or above the Budget forecast range.
By January 2004, the independent average had risen
to 2.1 per cent - consistent with both the Budget 2000 and the
2003 Pre-Budget Report forecasts, and the preliminary outturn
for 2003 published by the ONS on 23 January 2004—with 50
per cent of forecasters surveyed in line with or above the Pre-Budget
Report projection.
Outside forecasters projections for GDP growth in
2004 have also risen in recent months. At the time of the Budget
the average of new independent forecasts for GDP growth
in 2004 was 2.3 per cent, compared with the Budget range of 3
to 3½ per cent. In August the average still stood at 2.3
per cent, with only 8 per cent of forecasters surveyed expecting
GDP growth within the Budget range. By March 2004, the independent
average had increased to 3.0 per cent with the average of new
forecasts at 3.1 per cent - both consistent with the Pre-Budget
Report range. Moreover, a number of prominent forecasters are
now within the Budget and Pre-Budget 2003 range of 3 to 3½
per cent, including the IMF, Deutsche Bank, Goldman Sachs, the
ITEM Club, J P Morgan, OEF.
Indeed, over ninety per cent of all forecasters included
in the Independent comparison have revised up their 2004 GDP forecasts
since September 2003.
The Bank of England has also recently revised up
its projections. Indeed, chart 6.1 in the February Inflation Report
suggests the MPC's latest GDP growth forecasts are fully consistent
with Pre-Budget Report 2003 forecasts in every year of the projection
period 2004 to 2006. As the Bank state in the Inflation Report
'the four-quarter growth rate is projected to increase sharply
at the beginning of 2004. Recent survey data are consistent with
a pickup in quarterly growth. Revisions to 2003Q3 and a higher
expected outturn for 2003Q4 also mean that the near-term profile
for GDP growth…..is somewhat stronger' (Inflation Report:
February 2004, p.44).
10. While the probability of either
a fall in house prices or a rise in interest rates on a scale
that would create widespread problems for households should be
viewed as very limited, we think it is nevertheless important
for both the Treasury and the Bank of England to consider how
policies could impact on individual households whose debt servicing
ratios have become unsustainable. (Paragraph 13)
The Government is alert to the risks that households
with high levels of debt are more vulnerable to any significant
future adverse shocks. However, for most households debt remains
affordable, with interest rates close to their lowest since the
1950s, employment at a record high and total household net wealth
up over 50 per cent since 1997. Despite global uncertainty, households
remain confident in their own finances.
The Government aims to provide a framework of macroeconomic
stability and awareness of financial issues within which people
can make informed, responsible decisions about how much debt it
is prudent to incur. But the Government is also working to address
the issue of over-indebtedness.
The Consumer Credit White Paper, published in December
2003, set out policy on tackling over-indebtedness, unfair lending
practices and loan sharks, and the quality and quantity of information
available to consumers looking for credit. There are Government
initiatives to help consumers once they get into problems, such
as National Debtline, which gives all consumers free, easy access
to debt advice by telephone and access to debt repayment plans.
The Government is also taking steps to empower consumers by improving
their financial literacy. The FSA has published a preliminary
paper entitled "Towards a national strategy for financial
capability". A Steering Group, on which the Government is
represented by the Financial Secretary to the Treasury, is informing
FSA thinking on this work. This Strategy will present a co-ordinated
approach for the provision of education, information and generic
advice for financial services.
11. The Committee attaches the highest
importance to securing the best possible value for money in public
spending. It is disappointing to note that, despite the welcome
improvements to the control of public expenditure that have enhanced
flexibility, many departments are still failing to manage their
capital spending programmes as efficiently as they should. We
recommend that the Treasury takes action to improve the planning
and monitoring of public sector capital spending programmes within
the financial year. We would welcome a report on any such action
in the 2004 Spending Review. (Paragraph 15)
The Government has instituted a number of reforms
to improve the delivery of public sector capital programmes in
recent years, including reforms to the public expenditure framework
and a number of departmental-specific initiatives, and these are
supporting significant improvements in public services. Building
on these reforms, the Government will be examining the management
of departmental investment programmes in the context of the 2004
Spending Review. As part of this process, it will consider the
scope for further improvements in the framework for delivering
public investment.
12. The Committee is disappointed at
the lack of progress on improving official pension fund statistics.
The health of UK company pension schemes appears to be a major
gap in the information flow into the Treasury's assessment of
the economic outlook. Given its crucial impact on British households,
we recommend that the Government show much greater urgency in
ensuring the provision of regular and reliable official information
on pension fund deficits. We further recommend that the Chancellor
report on this issue expressly in the 2004 Budget. (Paragraph
17)
The Treasury thanks the Committee for its interest
in the complex area of pension statistics. The Government considers
improving pension statistics an important issue, and established
the Pension Statistics Review Committee, comprising academics,
industry experts and officials. It published an action plan in
October 2002, and a recent update on progress in December 2003.
All work planned for 2003 has been completed.
One of the action points was to consider whether
a statistical digest or fact sheet could be produced, bringing
together all available pension statistics. The action points are
being taken forward by the ONS, the Treasury, DWP and others.
The format, content and layout of an initial pension contributions
guide have been agreed by DWP and the ONS. The guide is currently
being developed for publication in early 2004, and will be developed
further as the quality and range of pension statistics improves.
Information has not been collected on defined benefit
pension fund deficits to date. The Government is establishing
a new Pensions Regulator for work-based pensions. The new body
will need to collect data on a wide range of issues to support
its own risk based work and the work of the Pensions Protection
Fund. This will include information about the levels of funding
of defined benefit occupational pension schemes. The exact form
this data is collected in will depend on the nature of the funding
regime for DB schemes that is introduced in the Bill, but the
Pensions Regulator is likely to collect pension deficit data from
April 2005.
The Treasury welcomes your suggestion for an update
in the Budget. We plan to include details on the progress of the
pensions statistics review.
13. The Committee welcomes the improved
transparency in recent years provided by the Treasury's explicit
discussion of issues such as the output gap and the cyclical position
of the UK economy. It encourages the Treasury to explore ways
of further improving transparency, which may include closer involvement
of outside bodies or experts in the judgements made. (Paragraph
20)
The Treasury seeks to be transparent in its approach
and positively welcomes external scrutiny. The Government is keen
to take advantage of external analysis where appropriate, although
in practice it is far from clear that external expertise is ahead
of the Treasury. Indeed, in their 1997 Report ('Market Testing
of the Treasury Forecast', 1997) KPMG Management Consulting stated
that:
"[the Treasury's] detailed evaluations and discussions
provide a richness of consideration that one would expect a Ministry
of Economics and of Finance to conduct. It does not have a parallel
outside the Treasury….(and) this depth of analysis appears
to give the Treasury an edge in forecasting accuracy." [1]
14. Although the Governor of the Bank
of England has indicated that he does not think the switchover
will be of major significance for monetary policy, given the focus
on inflation two years ahead, we note his comments regarding the
need for care in the short term in explaining the switch in the
inflation target from RPIX to CPI inflation and will scrutinise
the progress made in enhancing public understanding of the change.
(Paragraph 25)
The Government agrees with the Committee that care
will be needed in explaining the switch in the inflation target
and welcomes its intention to scrutinise the progress made in
enhancing public understanding of the change. Details of the new
inflation target, including the reasons for the switch in the
target were set out in Chapter 2 of the 2003 Pre-Budget Report
and in the letter from the Chancellor to the Governor of the Bank
of England of 10 December 2003 setting out the new monetary policy
remit. The paper by the Office for National Statistics, The
New Inflation target: the Statistical Perspective, 10 December
2003, will also assist in providing detail on the measure of inflation
that is now used.
The fiscal balance
15. The Committee accepts that the
substance of the golden rule has not changed, but differences
in phrasing in recent Treasury documents may have been a source
of some confusion. We recommend that the presentation of the Government's
progress towards meeting the golden rule should be standardised
and be based on the average annual surplus of the current budget
as a percentage of GDP. (Paragraph 27)
The golden rule has been consistently defined. It
is measured by the average annual surplus on the current budget
as a ratio to GDP over the economic cycle. Page 10 of Budget 1997,
Equipping Britain for our long-term future, [HC85], sets
out figures for the current budget as a ratio of GDP from 1985-86
to 1996-97. Page 47 of the Economic and Fiscal Strategy Report
1998, Stability and investment for the long term, [Cm 3978]
outlines progress against the golden rule from 1997-98 to 2003-04.
Since then, the Government has continued to present performance
against the golden rule on the basis of ratios to GDP.
Improving knowledge of the fiscal framework is important
to building a credible fiscal policy, and while being methodologically
sound, the concept of an average annual ratio expressed as a ratio
to GDP can be difficult to grasp. Presenting figures in terms
of billions of pounds is designed to help people understand the
scale of the margin against unexpected events. That does not detract
from the position that compliance with the golden rule is measured
using ratios to GDP and this has been consistently the case since
the rule was first introduced.
16. The Treasury should make the role
of the cautious case in the fiscal planning process through the
cycle clearer in the Budget and Pre-Budget Report documentation.
(Paragraph 28)
The cautious case provides a stress test for the
public finances, and therefore helps to build a margin against
unexpected events into the public finances. This is supported
by the use of independently audited, cautious assumptions, including
the assumption for the trend rate of economic growth, which is
assumed to be ¼ of a percentage point below the neutral view.
This cautious approach to projecting the public finances is central
to the Government's fiscal framework. Excessive caution could,
however, lead to an unnecessarily restrictive fiscal policy. When
setting fiscal policy, the Government must therefore reach a judgment
about the appropriate level of margin against unexpected events.
In the case of the 2003 Pre-Budget Report, the Government
was able to draw on the margin it had created to safeguard the
increase in investment in priority public services, fully meet
the UK's international commitments and allow the automatic stabilisers
to work in full, while remaining on track to meet the fiscal rules.
The Government will continue report the reasons for its fiscal
policy settings, including the appropriate degree of caution,
in future Budgets and Pre-Budget Reports.
17. We were surprised that there was
no table contained in the 2003 Pre-Budget Report breaking down
the changes in public sector borrowing since the previous forecast
between those attributable to the automatic stabilisers, non-discretionary
factors and policy decisions. We ask the Treasury to re-introduce
such a table in the Budget (and future Budgets and Pre-Budget
Report). (Paragraph 31)
The Government is committed to transparency and openness
and aims to provide full and complete information on the public
finances. Tables 2.4 and 2.5 of the 2003 Pre-Budget Report explained
the reasons for the change in projection for public sector net
borrowing. Table 2.4 explained the impact of changes in the NAO
audited assumptions, GDP components and other forecasting effects;
Table 2.5 explained the changes by individual receipt and spending
item. These tables were chosen as they were best able to explain
the reasons for the change in public sector net borrowing projections.
The Government will continue to show analyses on the public finances
using the most informative presentation including, where appropriate,
information on the automatic stabilisers.
The Treasury's 2003 Pre-Budget Report judgement on
the current and future cyclical position of the economy, as measured
by the path of the output gap, had changed only marginally compared
with the Budget. This means that only a negligible fraction of
the change in public sector net borrowing between Budget 2003
and the 2003 Pre-Budget report would have been ascribed to the
automatic stabilisers. Including a table separating out the effects
of the automatic stabilisers would not, therefore, have been particularly
informative.
18. While the extra borrowing envisaged
since the time of the last Budget means that there is now less
slack, the Government remains on track but will meet the golden
rule only if its central forecasts for economic growth, tax revenues,
spending, and the likely end of the current cycle are met. The
Government will have to remain mindful of the consequences of
any further unplanned increases in borrowing arising from any
shortfall in planned tax revenues. (Paragraph 35)
The Government remains vigilant to the risks to the
public finances and continues to base projections of the public
finances on cautious, independently audited assumptions, including
using a trend rate of economic growth ¼ of a percentage point
below the Government's neutral view. The use of a lower rate of
trend growth means that the public finances are projected using
the lower end rather than the centre of the range for GDP growth.
On the basis of these cautious assumptions, the 2003 Pre-Budget
Report projections show the Government is projected to remain
on track to meet the golden rule over the economic cycle with
an average surplus on the current budget of 0.2 per cent of GDP.
19. The Committee notes that the UK's
fiscal position remains comparatively strong internationally and
should remain so if it strengthens as planned through economic
recovery. (Paragraph 37)
The Government welcomes the Committee's recognition
of the relative performance of the UK's public finances. The latest
OECD projections show that the UK had the lowest level of net
debt among G7 countries in 2003, and is forecast to have net borrowing
and net debt below the average for the OECD as a whole for this
year and next. In addition, the analysis contained in the 2003
Long-term public finance report concludes that the UK is
in a strong position compared to many other developed countries
to meet the challenges of an ageing population.
20. The End of year fiscal report
should analyse the Treasury's performance in the preceding two
years against its forecasting record separately for receipts,
and different portions of expenditure. It should also analyse
the forecasting records of previous Pre-Budget Reports. (Paragraph
38)
The End of year fiscal report is designed
to provide additional, retrospective information on the public
finances. Chapters 3 and 4 of the Report provide analyses of the
differences between forecast and outturn for individual taxes,
other receipts and public expenditure components. The Government
is willing to consider carefully any detailed suggestions for
further analysis, but does value continuity of analysis as this
facilitates comparisons over time.
The projections published in the Pre-Budget Report
have a different status from those presented in the Budget. The
Pre-Budget Report projections are an interim forecast update and
not necessarily the outcome the Government is seeking. Given this
difference in status, the Government does not believe that a full
and detailed analysis of Pre-Budget Report forecasts would add
significantly to the information available in the End of year
fiscal report, which has brought the UK into line with international
best practice.
Tax receipts
21. Receipts have come in weaker than
expected despite growth being on target for the Treasury's forecast.
The factors behind this decline in tax receipts may be structural
or may be cyclical. The Treasury's projections for tax revenues
up to 2008-09 suggest that it does not see the problem as predominantly
a structural one. This is contrary to the view of some of our
expert witnesses. A shortfall in expected receipts for a given
level of GDP is a phenomenon that has also occurred in other countries
including the USA, although compared to countries in continental
Europe the UK's public finances remain in good shape. In the USA
research has been undertaken into why revenues as a percentage
of GDP have declined. We recommend strongly that the Treasury
undertake similar research in the United Kingdom and publish it
as soon as possible. (Paragraph 40)
The Government already investigates the reasons for
any significant shortfalls in receipts, and publishes the results
of this analysis in the End of year fiscal report. Chapter
3 of the Report provides a tax by tax analysis of receipts, detailing
the differences between forecast and outturn and ascribing these
differences to one of four categories. As in the USA much of the
recent shortfall can be ascribed to changes in asset prices and
the effect of distributional and other technical factors on effective
tax rates.
22. We note that the Treasury continues
to project a rise in the ratio of tax receipts to GDP over the
forecast horizon from 35.9% in 2003-04 to 38.2% in 2008-09. We
recommend that the Treasury includes in future Budgets a discussion
of the risks underlying this tax forecast. This assessment should
be informed by the research we recommend the Treasury carry out
at paragraph 40 above. This will be an opportunity for the Treasury
to explain in more detail the assumptions on which it makes its
tax forecasts. (Paragraph 42)
A detailed commentary on all the main tax forecasts
is already provided in Annex B of the Pre-Budget Report. This
includes descriptions of the main reasons for and assumptions
underlying the projected rise in the tax-GDP ratio. Annex B also
includes a section on economic risks that could impact on the
public finance projections. As suggested by the committee, the
assumptions underlying the fiscal projections are largely informed
by the conclusions of the End of year fiscal report.
23. Since the projection forward of
an improved relationship between income tax receipts and GDP in
2001, receipts have consistently come in under the Treasury's
forecast. We note that the Treasury's projections of income tax
receipts, which rise as a share of GDP, imply increasing numbers
of people paying income tax at the higher rate. We would welcome
more information on the proportion of salaries paid in annual
bonuses and how the Treasury is forecasting them going forward.
To improve our understanding of the 2004-05 forecasts we ask the
Treasury to publish the components of the forecast in greater
detail differentiating between PAYE, self-assessment, bonus payments
and income at standard and higher rates. (Paragraph 46)
There are no direct data available on the proportion
of salaries paid in annual bonuses, although inferences can be
made from the pattern of monthly income tax receipts data, which
are available from the ONS.
Inland Revenue data on receipts from large employers
suggest that most of the recent variability in the end year surges
in income tax receipts associated with bonus payments stems from
the financial sector. The fiscal projections assume that the strong
relationship between employee remuneration (including bonuses)
and profits in the financial sector will continue in the projection
period.
The Inland Revenue publishes a large amount of information
on the liabilities of income tax payers and on income tax receipts,
which is available on the Inland Revenue website: http://www.inlandrevenue.gov.uk/stats/income_tax/index.htm.
The Treasury will consider publishing the components of the income
tax forecast in greater detail.
24. To improve transparency and aid
the Committee and other outside observers to understand the forecasts
for tax revenue, we recommend that the Treasury should publish
details of how the receipts from the major taxes are forecast,
including wherever possible the model used and all the economic
determinants that feed into the model. (Paragraph 47)
There are a number of examples of where the Government
has published details on the methodology and models used to forecast
particular taxes:
- Forecasting the public finances in the Treasury
(IFS volume 19, Feb 1998);
- Eason, R. (2000) 'Modelling Corporation Tax in
the United Kingdom', in: Microsimulation in Government Policy
and Forecasting, 2000, Gupta, A. and Kapur, V (editors);
- 'Consumers' Demand and Excise Duty Receipts Equations
for Alcohol, Tobacco, Petrol and Derv' Marcus J Chambers, University
of Essex, November 1998, Revised August 1999. GES Working Paper
No 138.
Transparency is also enhanced by the independent
auditing and reporting of the key assumptions underlying the fiscal
projections, including trend growth, equity prices, and oil prices.
In addition, the End of year fiscal report provides additional
information on the key drivers of projections for individual taxes,
and explains how differences between forecast and outturn for
the economic determinants contributes to differences between forecast
and outturn for receipts.
Even if the Government made all its forecasting models
available, it is unlikely that they would be of much use to other
forecasters as they rely on detailed confidential information
contained in tax returns. The Government will continue to include
in every Budget and Pre-Budget Report an explanation of the main
factors affecting changes in receipts of the major taxes.
The Government will continue to include in every
Budget and Pre-Budget Report an explanation of the main factors
affecting changes in receipts of the major taxes.
At the Pre-Budget Report hearing with Treasury officials
on 16th December 2003 the Committee asked for a note
explaining the reasons underlying the nominal increase in forecast
public sector receipts between 2003-04 and 2004-05, as contained
in Table B9 of the 2003 Pre-Budget Report. This is provided in
the note which accompanies this response.
Public expenditure
25. We note that it is unusual to provide
no margin at all for annual managed expenditure in future years.
An explanation should be given as to why it is envisaged that,
in contrast to previous practice, no AME margin is provided for
the next two financial years. (Paragraph 49)
The forecasts published in the Pre-Budget Report
have a different status from those presented in the Budget. Budget
2003 contained forward projections based on the Government's definitive
fiscal policy settings, and reflected the decision to reset the
AME margin through to 2005/06; the Pre-Budget Report provides
an interim update against those projections. In line with previous
practice, the Government will re-assess the level of the AME margin
in the context of Budget 2004.
26. We note the Regulator's concern
at officials' late intervention [in the access charges review].
It is essential that the allocation of public spending between
capital and current expenditure is carried out in a way that reflects
the substance of the spending. Government funded increases in
capital expenditure on the railways must be correctly treated.
We request that the Treasury provides further information and
transparency in regard to the classification of current and capital
spending. (Paragraph 51)
The Government sees it as important that public support
for the railways is appropriately structured and correctly classified.
The classification of public expenditure in Total
Managed Expenditure as current or capital follows national accounts
principles laid down in international agreements that are operated
by the independent Office for National Statistics. Public expenditure
that supports capital expenditure by the private sector may be
current or capital depending on the mechanism used for the public
sector's payments:
- grants to support investment are capital; and
- subsidies and payments for services are current,
even though some of the money may fund capital expenditure.
The Rail Regulator sets the level of Network Rail's
financial requirement that is funded by Network Grants from the
Strategic Rail Authority (SRA) to support investment and by track
access charges paid by train operating companies, who may receive
subsidies from the SRA. The Rail Regulator also determines the
split between these two sources of Network Rail's funds. The Rail
Regulator has a duty to have regard to a number of factors including
the promotion of efficiency and economy and the financial position
of the SRA. Departments' resource and capital expenditure budgets
are set separately in the biennial Spending Reviews.
The Government agrees that it is important for all
parties to have early and open discussions.
27. This Committee attaches the highest
possible emphasis to ensuring that any increases in public expenditure
are delivered efficiently and result in improved outcomes, rather
than in cost inflation. The current measure of government output
does not adequately reflect improvements in quality and is therefore
a bad measure of public sector productivity. It is absurd that
a reduction in class sizes, for example, should count merely as
an increase in cost and a reduction in productivity, with no account
taken of any improvements in the quality of education. We welcome
the Atkinson review of measures of government output, productivity
and associated price indices. We note that the preliminary findings
of the review are to be published by July 2004, in time to inform
the 2004 Spending Review. (Paragraph 54)
Box A4, on page 184 of the 2003 Pre-Budget Report,
discussed issues surrounding the measurement of real government
output in some detail.
At the Pre-Budget Report hearing with Treasury officials
on 16th December 2003 the Committee asked for a Treasury
response to a Goldman Sachs article on public sector cost growth.
This is provided in the note which accompanies this response.
28. In the light of the review of the
measurement of government output, the Treasury should assess the
extent to which any under-estimation of the real rate of growth
of public sector output could affect estimates of GDP growth and
the output gap. (Paragraph 55)
The Treasury attaches a great deal of importance
to the Atkinson review of the measurement of government output,
and it is looking forward to the completion of the review, its
conclusions and recommendations. The final report is expected
in January 2005. The Treasury will then assess the findings of
the review and their implications for estimates of public sector
output growth and consequently GDP growth overall. For under-estimation
of public sector output growth to affect estimates of the output
gap, it would have to have a differential impact on estimates
of actual and trend output growth.
The housing market
29. The Committee believes that improving
the functioning of the UK housing market has a key role, not only
in terms of stability and growth in the UK economy, but also in
tackling social inequalities by improving the access of families
and others to decent housing at an affordable price. We also note
the important role of the housing market in promoting labour mobility
and regenerating deprived areas. We welcome the interim reports
of the Miles review of fixed-rate mortgages and the Barker review
of housing supply. Alongside any policy recommendations their
final reports should also estimate how long it would take for
any shift to fixed-rate mortgage finance in the UK, and improvements
in housing supply, to produce a detectable difference in terms
of smoothing the operation of the macro economy. We may examine
the detail of any recommendations made as part of our regular
scrutiny of the Budget. (Paragraph 57)
The Government has recognised that reforms are needed
to help increase the supply of housing, particularly affordable
housing, and reduce volatility and promote stability. The Communities
Plan, announced in February 2003 by the Deputy Prime Minister,
places key housing, planning and regeneration policies in the
context of wider requirements for sustainable communities, including
jobs, quality public services, transport, a safe and healthy local
environment and sound local government.
Building on these reforms, the Chancellor commissioned
Kate Barker to lead a review of the factors affecting housing
supply in the UK and David Miles to lead a review of the UK mortgage
market. The Government welcomed their interim reports, produced
at the time of the Pre-Budget Report, and looks forward to their
final reports due by Budget 2004. These are independent reviews
and the Government will wait to see what their final reports conclude
and recommend. The outcome of the Barker and Miles reviews will
be central to taking reforms forward.
30. The Treasury should assess the
extent to which allowing self- administered pension funds to invest
in residential property by buying individual houses, rather than
via any new type of Real Estate Investment Trust, will increase
the sensitivity of the economy to the housing market and create
opportunities for abuse. If the proposals are implemented the
Inland Revenue should ensure that a robust regime is in place
to prevent tax avoidance. (Paragraph 59)
Large pension funds can currently invest in a range
of assets including residential property. Small and self directed
pensions, known as SSASs (small self-administered schemes) and
SIPPs (self-invested personal pensions), cannot currently invest
in residential property. This prohibition is designed to prevent
pension scheme assets being used for the private use of the member
or his or her family, where the rent foregone reduces the growth
of the pension fund.
With the proposal to simplify the pensions regime,
so that a single regime applies to all schemes, the Government
has decided to extend the ability to invest in residential property
to all pension schemes. This change is subject to the overall
decision on pension regime simplification that will be made at
the time of the Budget.
The Inland Revenue is putting in place legislation
to ensure that any non-commercial or personal use of the property
would lead to a benefit-in kind-charge on the individual. Individual
property investment is not likely to be attractive in all cases,
as all income generated must go into the pension pot. All transactions
would need to take place within the pension fund envelope.
An appropriate compliance regime will also be put
in place to identify and audit those schemes that do invest in
residential property.
Taxation of small incorporated businesses
31. We would welcome further details
(in advance of the Budget) of the nature of the Government's proposals
for changes to the way tax is paid by owner managers of small
incorporated businesses on the profits extracted from their company.
(Paragraph 61)
The Pre-Budget Report announced the Government's
intention to bring forward proposals in the Budget to reform the
tax treatment of profits extracted from small businesses; to ensure
that differences between earned income and dividend income do
not distort business strategies, or enable reductions through
tax planning of individuals' tax liability. Further work is continuing
to develop and assess detailed policy options, and it would be
inappropriate to announce specific measures outside the normal
Budget process.
Child poverty and the Child Tax Credit
32. We welcome the Government's action
to reduce child poverty and note the substantial progress made
so far. The approach needs to establish an effective balance between
providing income to the parents through the tax credit system
with expenditure on services aimed at increasing opportunity for
both the parent and the child. (Paragraph 62)
As set out in Tackling child poverty: giving
every child the best possible start in life, published in December
2001, the Government's strategy for tackling child poverty involves
ensuring decent family incomes, with work for those who can and
support for those who cannot, and providing support for parents.
It also involves delivering high quality public services and harnessing
the power and expertise of the voluntary and community sectors.
Budget 2003 announced a Child Poverty Review to examine
the welfare reform and public services changes needed to advance
towards its long-term goals to halve and then eradicate child
poverty. The review is underway, with a series of seminars having
been held during autumn 2003 covering issues such as ethnic minority
groups, educational outcomes, parenting, early years services,
health outcomes, supporting families with disabled children and
deprived areas. In taking forward this work the Treasury will
continue to work closely with outside organisations. The Review
will feed into the 2004 Spending Review.
Savings
33. We, therefore, request an explanation
for [the] apparent contradiction in policy and recommend that
the proposed ISA reductions should be reconsidered. (Paragraph
63)
The Government introduced the ISA scheme in 1999
principally to give people—particularly those who have little
or nothing put away—the chance to save flexibly and tax-free
in a range of different savings and investments including cash,
stocks and shares and life insurance. The Government wants to
ensure that the ISA tax relief is distributed as fairly as possible.
The subscription limits have therefore been set with the objectives
of the scheme in mind.
Originally the overall annual subscription limit
of £7,000 (£3,000 for the cash component) was due to
be decreased to £5,000 (£1,000 for the cash component)
in April 2000, after ISAs' first year of existence. But this decrease
has been deferred until April 2006. This announcement was made
in the 2000 Pre-Budget Report—it is not a new policy. The
Government regularly keeps under review incentives for saving,
including ISAs.
The Inland Revenue Press Release dated 17 March 1998
announced the introduction of the individual savings account (ISA)
from 6 April 1999. This stated that:
"it will have an annual subscription limit
of £5,000, of which no more than £1,000 can go into
cash and £1,000 into life insurance; however, in the first
year of the scheme only (1999-2000), the annual limit will be
£7,000 of which no more than £3,000 can go into cash
and £1,000 into life insurance."
The Pre-Budget Report of 8 November 2000 (p107) extended
the £7,000 overall limit and £3,000 cash limit until
April 2006:
"To build on the success of ISAs, the Government
will retain the £7,000 contribution limit for a further five
years until April 2006. Keeping a higher £3,000 limit for
cash will particularly help those low-income and younger savers
who have saved in mini cash ISAs."
Additional information:
At the 2003 Pre-Budget Report hearings on 16 December
2003 and 18 December 2003 the Treasury Committee asked the Treasury
to provide three pieces of follow-up information. These are provided
in the note which accompanies this response.[2]
HM Treasury
17 March 2004
FOLLOW-UP INFORMATION REQUESTED FROM TREASURY
IN DECEMBER 2003
1) Explaining changes in forecast nominal receipts
(See QQ 124-156)
The Committee asked for a note explaining the reasons
underlying the nominal increase in forecast public sector receipts
between 2003-04 and 2004-05, as contained in Table B9 of the 2003
Pre-Budget Report, and detailed in Table 1 below.
Around two-thirds of the projected increase in income
tax receipts is a result of growth in wages and salaries, growing
broadly in line with money GDP. The remaining increase is explained
by:
- higher projected interest rates, which increase
income tax receipts from interest income;
- fiscal drag. As is standard practice, income
tax allowances and bands are assumed to grow in line with prices.
As earnings tend to grow in real terms due to productivity growth,
this adds to income tax receipts in 2004-05; and
- changes in the distribution of income. The slowdown
in the world economy and weakness in equity markets over the past
few years has had a particularly adverse impact on the profitability
of the financial sector. This has also had a negative impact on
the average marginal tax rate on wages and salaries as it has
depressed the level of bonuses which are generally subject to
the higher rate of income tax. The public finance projections
assume that financial sector profitability will recover from its
current depressed levels and move back towards its historical
trend with GDP. As a result, financial sector bonuses are expected
to increase and have a positive impact on income tax receipts.
The projected increase in national insurance contributions
(NICs) in 2004-05 is also largely explained by general rises in
the level of wages and salaries. In addition, there is a lagged
effect of the increase in NICs rates that came into effect from
April 2003, which boosts receipts. In particular, the new rates
will not feed into NICs from the self employed until January 2005.
The return of financial sector profits towards historical
trend rate described above, together with the rise in industrial
company profits and the impact of the significant rise in equity
prices observed in 2003, explains much of the expected increase
in corporation tax in 2004-05. In addition, the overpayment of
corporation tax by large companies observed since the introduction
of quarterly instalments is expected to decline. There is also
a positive contribution from previous Budget measures.
Stamp duty receipts are expected to rise by £1.8
billion in 2004-05, mainly as a result of expected significant
year-on-year growth in property prices and equity prices. It also
reflects the impact of Stamp Duty Land Tax, introduced in December
2003, on yield from commercial transactions, as 2004-05 is the
first full year it will apply.
VAT receipts are projected using audited assumptions
regarding the ratio of underlying VAT receipts to consumers' expenditure
and the impact of the VAT strategy announced in the 2002 Pre-Budget
Report and extended in the 2003 Pre-Budget Report. These cautious
assumptions result in projected growth in VAT receipts in 2004-05
of 4.5 per cent, despite expected growth in 2003-04 of nearly
9 per cent.
The £2.0 billion increase in fuel duty receipts
in 2004-05 largely reflects the normal forecasting assumption
that duty rates will be increased in line with inflation at the
time of the Budget, rather than in October as in 2003.
The growth in fuel duties in 2004-05 also reflects
general economic growth, and the declining oil prices, which boost
receipts by reducing fuel prices, thereby increasing demand.
The growth in council tax receipts reflects the conventional
assumption that council tax rates will grow at similar rates to
those observed over previous years. However, council tax receipts
have no overall impact of the fiscal aggregates as the projections
assume they are fully spent by local authorities.
The remaining growth in total receipts is broadly
in line with economic activity. It also includes the impact of:
- indexation of duty rates and VED rates;
- higher CGT and IHT receipts, reflecting significant
year-on-year growth in house prices and equity prices; and
- higher VAT receipts from government expenditure.
Although these have no impact on the fiscal aggregates as they
are also included in the spending forecasts.
2) Goldman Sachs article on public sector inflation
(See QQ 198-201)
Goldman Sachs European Weekly Analyst 12/12/03:
"UK Public Spending - Where's the Money Gone?"
This article discusses the increases in public sector
inflation - as measured by the government consumption deflator
- over the past few years, but gives little consideration to probable
mis-measurement. Indeed, Goldman Sachs' analysis suggesting significant
increases in both labour and non-labour cost inflation in the
public sector relies heavily upon real government output being
measured correctly.
Goldman Sachs look at the increase in public sector
inflation, divide this between labour and non-labour components,
and compare their rates of growth to the private-sector. This
approach, however, ignores the underlying issue as to how much
of the growth in measured public sector inflation has resulted
from the mis-measurement of real public sector output. Hence,
without taking into account such mis-measurement issues, attributing
the increase in measured public sector inflation to either a slowdown
in productivity growth or an increase in non-labour cost inflation
has significant caveats.
Indeed, as set out in Box A4 on page 184 of the Pre-Budget
Report, there are reasons to believe that real public sector output
(and hence public sector labour productivity growth) is being
significantly under-recorded, and inflation correspondingly over-estimated.
While the article alludes to the Pre-Budget Report text, it does
not address these measurement problems.
An ONS article published in July 2003 stated that:
"some government spending may have been on things which
improve outcomes but do not contribute to output as measured for
the National Accounts; ONS' measures may not have monitored all
outputs being produced; and ONS' output measures may have failed
to reflect all of the quality improvements made in outputs."
This again suggests that real public sector output growth is being
significantly under-recorded, and hence that both labour and non-labour
cost growth are being over-estimated.
The Goldman Sachs article further argues that "for
the acceleration in costs to be explained entirely by measurement
error, biases in the measurement of public sector output must
have increased significantly in recent years, not just in absolute
terms but also relative to the private sector". There
are strong grounds for believing that measurement bias has indeed
increased in recent years. The pick-up in growth in the government
consumption deflator has coincided with the substantial increases
in growth in nominal government consumption over the past few
years, probably serving to highlight the deficiencies of the real
output indicators and leading to marked overstatement of public
sector inflation (as measured by the government consumption deflator).
3) Local Housing Allowance rates in Blackpool
and Lewisham
(See QQ194-197)
Blackpool LHA rates for November 2003
| Number of Rooms |
LHA |
| 1 room | £ 47.50 |
| 2 room | £ 75.00 |
| 3 room | £ 97.00 |
| 4 room | £101.00 |
| 5 room | £120.00 |
| 6 room | £133.00 |
Lewisham LHA rates for December 2003
| Number of Rooms |
Lewisham Central |
Lewisham Inner |
| 1 room | £ 77.50 | £ 92.50
|
| 2 room | £147.50 | £200.00
|
| 3 room | £190.50 | £252.00
|
| 4 room | £231.00 | £284.00
|
| 5 room | £265.50 | £363.50
|
| 6 room | £381.00 | £437.50
|
1 KPMG Management Consulting, 'Market testing the Treasury's
Macroeconomic Forecasting Function' 9 May 1997, p29 and p42. Back
2
See below Back
| 
