Conclusions and recommendations
The Pre-Budget Report
1. We
reiterate our view that this is an unsatisfactorily short period
of notice for what is meant to be an important event in the economic
calendar. (Paragraph 2)
UK presidencies of the G7/8 and EU
2. The
Committee believes that the UK's joint leadership of the G7/8
and the EU in 2005 puts the Government—particularly as the
international community comes together to address the consequences
of the tragic earthquake and tsunami in the Indian Ocean—in
a strong position to play a positive role in advancing discussions
with our international partners on the reform of key global economic
institutions and ensuring fairer treatment of developing countries
by the world's major economies. We welcome the Chancellor's commitment
to pursue reform of the major international economic institutions
and hope that solid evidence of progress here will emerge over
the coming year. (Paragraph 5)
The economy: the recent past
3. The
Committee welcomes the fact that 2004 has proved to be another
year of solid economic activity in the UK, marking a long period
of sustained quarter-on-quarter growth. The combination of 3%-plus
growth, rising employment, modest inflation and evidence of some
re-balancing of the economy away from household consumption towards
investment is particularly welcome. (Paragraph 9)
The economy: the outlook
4. While
the Treasury's economic growth forecast for 2005 is more optimistic
than the external consensus, the majority of the experts we asked
suggested that the gap between the Treasury's growth forecasts
and those of other major forecasters lay within the bounds of
forecasting error. In any case, the Treasury's recent forecasting
record in the area of economic growth has been good. (Paragraph
10)
5. The evidence the
Committee received in the course of this inquiry indicates that
there is little to suggest that the UK current account deficit
is moving into unsustainable territory in the near term, although
the volatile nature of currency markets does create risks. (Paragraph
11)
6. Recent signs that
the housing market may be cooling and that the household sector
is beginning to rebuild its saving ratio are welcome. In the longer
term, the evidence we have received on the Pre-Budget Report highlights
the importance of work being done in restoring consumer confidence
in long-term savings and reforming the UK's pension system. (Paragraph
15)
7. The Committee notes
the evidence we have received suggesting that migration into the
UK has played a useful role in relieving skill shortages in the
labour market and boosting non-inflationary growth. We welcome
efforts to improve the functioning of the UK labour market by
raising participation rates and agree that raising the UK's skill
base is vital to meeting the competitive challenges posed by the
global economy. The long term nature of labour market reform nevertheless
means that in the near term the evidence many experts detect of
a tightening labour market needs to be monitored extremely carefully.
The amount of slack left in the UK labour market is likely to
be a key determinant of how long the UK economy can continue to
grow above trend without generating inflationary pressure and
is thus an essential element in judging the timing of the cycle
and whether or not the Government has met its fiscal rules. (Paragraph
21)
The fiscal balance and the fiscal rules
8. The
fiscal rules are an important part of the framework for macroeconomic
management and in the Treasury's view will be met over the current
cycle. However, the margin for meeting the golden rule in the
current cycle on the Treasury's forecasts has nevertheless fallen
further since the Budget and now stands at £8bn, or 0.1%
of GDP. On current Treasury forecasts, the golden rule will be
met—by a narrow margin. Many independent forecasters believe
that this is too narrow a margin to be confident that the golden
rule will be met. The Chancellor has assured us that he could
foresee no circumstances in which the Government would not meet
its fiscal rules. We note, however, the narrow margin by which
the golden rule would be met on current Treasury forecasts, particularly
given recent data. (Paragraph 27)
9. The Committee believes
it is important that the operation of the fiscal rules should
be as transparent as possible. Given the significance for the
fiscal rules of dating the beginning and the end of the economic
cycle we believe the Treasury should clearly inform Parliament
in a timely fashion of its preliminary analysis that the cycle
has ended. To delay making an announcement, potentially for several
months, to the next Budget or Pre-Budget Report, would not be
in the interests of informed public debate. (Paragraph 30)
10. The Committee
believes that clear, well designed and well understood fiscal
rules have an important role to play in lending credibility to
economic policy. The current rules have generally worked well
since their introduction but are likely to be capable of further
improvement and refinement in the light of the practical experience
accumulated over recent years. With the start of both a new cycle
and a new Parliament likely within the next year or so we believe
that it is now appropriate to review the current fiscal rules
with a view to initiating any changes that are found to be desirable
early in the next cycle. It should be made clear from the start
that such a review will not consider any proposals that lessen
the UK's commitment to sound public finances or that unduly limit
the ability of fiscal policy to support monetary policy in delivering
economic stability alongside low inflation. (Paragraph 34)
Revenues: overall tax receipts and forecasting
11. Despite
strong economic growth and record employment, tax receipts are
for the fourth consecutive year below the Treasury's forecast.
The growth in receipts has been strong by historic standards but
has not matched the Treasury's optimism at the time of the Budget.
(Paragraph 35)
12. We note that the
Treasury continues to project a rise in the ratio of tax receipts
to GDP over the forecast horizon, from 36.2% in 2004-05 to 38.4%
in 2009-10. We also note that the Treasury is projecting the fastest
growth in receipts over the next two years since 1997. This forecast
implies an acceleration in receipts growth in the final four months
of this year and even stronger growth in receipts in 2005-06.
While there are grounds for optimism, there are significant risks
to this forecast and the Treasury needs to monitor developments
closely. (Paragraph 37)
13. We would welcome
a clearer explanation of how the Treasury forecasts the cyclical
components of tax receipts and how this has influenced their current
projections. This should include how the Treasury estimates the
long-term averages of components such as corporation tax and financial
company profits, what factors it bases these estimates on and
how quickly it expects them to return to their long-run averages.
(Paragraph 38)
14. We recognise the
Treasury's statement that it bases its forecasts on cautious assumptions.
However, following a prudent start in the run up to the year 2000,
we note that the Treasury has now over-estimated the growth in
tax receipts in four consecutive years. Many other countries and
outside forecasters have also over-estimated the growth of tax
receipts during the world economic downturn. However, given that
the economic recovery is now under way it is important that official
forecasts for tax receipts are accurately constructed and avoid
an over-optimistic trend. (Paragraph 41)
Corporation tax
15. We
ask the Treasury to review the assumption that financial company
profits grow as a share of GDP, given the contrast with the assumption
used for the FTSE All-Share index which is that it grows only
in line with GDP. We also ask the Treasury to publish data on
the backlog of unused losses and allowances in the financial sector
which the Treasury notes have "temporarily depressed taxable
profits". (Paragraph 44)
16. There are widespread
doubts amongst experts and outside commentators about the Treasury's
corporation tax forecasts. While it is true that corporation tax
receipts have grown by over 30% in some previous years, this has
typically taken place when the economy was recovering strongly,
or where there was a significant stock market boom. To reinforce
the credibility of the corporation tax forecasts, we recommend
that the Treasury publishes a breakdown of its corporation tax
forecast, differentiating between the various sub-sectors involved.
In the absence of further information, the evidence we have received
suggests that the balance of risks to the Treasury's corporation
tax forecast is to the downside. (Paragraph 48)
Expenditure: current expenditure, end-year flexibility,
investment spending, local services
17. The
Treasury's forecast for central government current expenditure
in 2004-05 requires substantial spending restraint by government
departments over the last four months of the financial year. This
illustrates the importance of the recent reforms aimed at ensuring
a smoother profile of spending over the course of the year. This
is an area we will expect to examine further at the time of the
2005 Budget. (Paragraph 51)
18. We welcome the
continued use of the End-year flexibility arrangements and the
move away from potentially wasteful year-end surges in spending.
We note, however, that the build up of EYF entitlement by departments
has reached the point where it poses at least a theoretical risk,
should there be major calls on their entitlements across departments,
to the achievement of the Government's fiscal targets as the end
of the cycle draws near and the available margin is small. The
Treasury should make clear what arrangements are in place to ensure
that this will not happen. It would also assist transparency and
debate if the figures for outstanding entitlement for each department
(following drawdowns in the Winter and Spring supplementary estimates)
were updated and published at the time of the Pre-Budget Report
and the Budget. (Paragraph 54)
19. This Committee
attaches the highest possible importance to ensuring that the
Government's plans for historically large increases in public
sector investment are delivered efficiently. However, despite
recent improvements it is apparent that some departments, local
authorities and public corporations are still failing to deliver
capital spending at the planned level. We first identified this
problem during our 2003 Pre-Budget Report inquiry and the Committee
is disappointed that it has not yet been resolved. It seems inconsistent
to say that reforms will enable departments to manage current
spending more smoothly throughout the year but yet rely on a very
large surge in public sector net investment in the final quarter
to meet the forecast. We recommend that the Treasury take further
action to improve the management and delivery of public sector
investment and to monitor its effectiveness closely. (Paragraph
58)
20. We ask the Treasury
to provide us with a comprehensive note outlining the sources,
with a breakdown, of the £512m re-allocated from central
programmes to local authorities. We also ask for more detail of
the areas where reduced ring-fencing and increased charges will
reduce the pressures on council tax by £?bn.
(Paragraph 60)
21. We welcome the
announcement that in 2005 there will be an additional £50
payment to pensioners over 70 to help with council tax and other
living expenses, but the level of this payment should be reviewed
at the time of the Budget. (Paragraph 61)
Reporting issues; the National Audit Office
22. We
commend the Treasury on the publication of the End of year fiscal
report. It could usefully be expanded to provide updates on certain
other data which would help debate and scrutiny. (Paragraph 63)
23. We recommend that
the Treasury provide more detail on the process by which key assumptions
are referred to the National Audit Office, including how they
decide which assumptions to refer, and how much notice they provide
to the NAO of the assumptions that are due for audit. We note
the comment of the IMF that it would be worth considering whether
such outside scrutiny of other key variables would enhance transparency
and credibility. This is an issue to which the Committee will
be returning. (Paragraph 66)
Departmental efficiency savings ('Gershon' savings)
24. We
are surprised that advice from the NAO and the Audit Commission
on each [department's] Efficiency Technical Note does not appear
to have been provided directly to the department concerned. It
is not clear what the role of the central scrutiny panel was in
the process, but we consider that its existence sits uneasily
with the evidence we received that it is departments that are
accountable for this process and that individual efficiency proposals
are not a matter for the Treasury to take a view on. (Paragraph
73)
25. It is not possible
under the procedure adopted to determine what advice was provided
by the National Audit Office and the Audit Commission nor the
extent to which this was acted upon by departments. We welcome
the Chancellor's assurance that this is an evolving process and
that the National Audit Office and the Audit Commission will be
asked to provide further advice. We recommend that this advice
and each department's response be published. (Paragraph 74)
26. Given the size
and importance of the overall efficiency programme, we believe
consolidated progress reports [across government] are required.
We therefore welcome the Chancellor's undertaking to provide further
details in the Budget and we recommend that this become a regular
feature of forthcoming budget and pre-budget reports. (Paragraph
75)
27. The Committee
welcomes the Government's clear statement that it remains committed
to ISAs, a commitment which is in accord with our previous recommendations
in this area. But given the lengthy public debate about the future
of ISAs we do not see that any useful purpose will be served by
more consultations on extending the limits on ISA savings. A clear
statement of intent in the Pre-Budget Report to keep the current
higher ISA limits would have been preferable. (Paragraph 76)
Savings and welfare: ISAs, Saving Gateway, financial
inclusion, childcare
28. The
Committee is encouraged to hear that the initial evidence suggests
that the Saving Gateway has been successful in encouraging new,
sustainable saving among the less affluent. Given the importance
of encouraging saving among the less affluent we look forward
to the Government moving as quickly as possible, subject to evaluation
of the initiatives, to national availability of the Saving Gateway
scheme. (Paragraph 77)
29. The Committee
welcomes the funding assistance the Financial Inclusion Fund will
give to the provision of basic financial advice to consumers and
looks forward to rapid progress on tackling financial exclusion
by the Financial Inclusion Taskforce. But the problems created
by financial exclusion and poor access to basic advice when consumers
get into debt or other financial difficulties are entrenched.
We reiterate our earlier recommendation that the possibility of
securing additional funding from the financial services industry
to support the activities of non-profit organisations in this
area should continue to be pursued. (Paragraph 79)
30. We welcome the
indication by the Chancellor that he is prepared to look further
at the proposal to allow lenders to apply for repayment to be
made by deduction from benefit payments in certain circumstances.
(Paragraph 80)
31. The Committee
welcomes the announced doubling of the threshold above which savings
will reduce working-age income related welfare benefits. It would
be helpful to have an indication of how substantial the obstacles
are (financial or otherwise) standing in the way of both this
and other measures designed to help the less affluent in society
being introduced earlier than the proposed date of April 2006.
(Paragraph 81)
32. The Government's
objective of guaranteeing affordable, high quality childcare for
all those who need it is welcome and it is important that the
expansion of childcare provision is adequately funded if the parents
are to be assured of the quality of the care their children will
receive. (Paragraph 83)
Tax avoidance
33. We
note and welcome the evidence that the new tax avoidance disclosure
regime put in place at the time of the 2004 Budget is working
well and is having an effect both in terms of allowing the revenue
departments to close off avoidance schemes earlier than was the
case previously and in having a measure of disincentive effect
on the tax avoidance industry. Without wishing to challenge the
legitimate right of individuals and businesses to manage their
tax affairs in the most effective way for their purposes, we regard
it as an equally legitimate objective for the government to seek
to protect the tax revenue against inappropriate avoidance schemes.
(Paragraph 88)
34. The Paymaster
General's announcement that future legislation to outlaw income/NIC
avoidance schemes not yet identified will be backdated to 2 December
2004 raises significant issues. We support the Government's determination
to tackle unreasonable tax avoidance schemes, which can have the
effect of penalising the general public, but we recognise that
some experts have indicated that their approach could lead to
challenge in the courts. This can only finally be tested as and
when the Government introduces any legislation on the basis of
the announcement. It would be helpful if, at this stage, and without
jeopardising their position, the Inland Revenue were to publish
a paper setting out their thinking on the principles which will
guide future decisions as to whether a scheme is reckoned to be
within or outside the terms of the announcement. (Paragraph 93)
35. We welcome the
Government's decision to reconsider its plans for the introduction
of some of the proposed changes for taxation of life assurance
companies, and look forward to a full consultation process in
line with the principles set out in the Code for Fiscal Stability.
(Paragraph 94)
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