Examination of Witnesses (Questions 140-159)
MR JON
CUNLIFFE, MR
JONATHAN STEPHENS,
MR NICK
HOLGATE, MR
DAVE RAMSDEN
AND MR
CHRIS MARTIN
14 DECEMBER 2004
Q140 Mr Walter: What are the consequences
if you do not?
Mr Cunliffe: As I recall the code
for fiscal stability, if the Golden Rule is not met then the Chancellor
has to explain why it has not been met, but our forecast is that
we will meet in this cycle and the next and I see no reason to
doubt that.
Q141 Mr Walter: So it is just about credibility?
There are no other consequences of not meeting it? It is not like
not meeting the Growth and Stability Pact in the EU where you
might have to pay a fine?
Mr Cunliffe: We do not fine ourselves,
no.
Q142 Mr Walter: It is just about credibility
if you fail to meet it?
Mr Cunliffe: Can I try and answer
that question on two levels? Let me answer on what happens if
you over-achieve it or under-achieve it, because both are possible.
It would depend by what amount, so let us assume we over-achieve
the Golden Rule by five billion. People could argue that in economic
terms five billion is not very much. It will reduce the debt stock
by an extra five billion but is that going to have a big impact
on the economy going forward? The economic effect is probably
quite small. I have seen a number of the commentators that you
have interviewed have said, "Well, it does not really matter
because if borrowing is five billion less or five billion
more these are not huge amounts, particularly given some of the
overshoots we have seen in public finances over the last 30 years".
I can accept that the economic significance of being right or
wrong by less than a billion is small. What I would say, though,
on the credibility point is that it is very difficult—and
a number of countries face this and we have faced this with the
Growth and Stability Pact and we face this with the fiscal frameworks—to
have a framework in which you allow yourself the flexibility to
deal with economic circumstances as they transpire (because they
never behave as you would expect them to and you will always need
some room one way or the other, so you have to allow yourself
that flexibility) but then you still have to have credibility
over the medium term and you need some form of credibility anchor.
In monetary policy that is achieved institutionally. The Bank
of England has flexibility to be away from its target but inflation
expectations are anchored by the fact that it has got an inflation
target and it has credibility around meeting it. For fiscal policy
meeting the medium term fiscal rules, which on the Golden Rule
is borrowing only to invest on the cycle, is quite important.
In terms of credibility and the anchor for the system, meeting
the Golden Rule is important. If you do not meet the Golden Rule
it is important to explain why you have not met the Golden Rule.
In pure economic terms it will depend by how much you have over-
or under-achieved.
Q143 Mr Walter: I am not quite so concerned
about the pure economic terms, although that is obviously significant
in the long term in terms of credibility but, having set that
target, having put a lot of political capital into having that
target, to over-achieve I think everybody would say is jolly good,
but to miss it surely dents the credibility of the Treasury quite
considerably, does it not?
Mr Cunliffe: First of all, the
target is not set up to be over-achieved; the target is set up
to be met. That is quite important. To the extent that we over-achieve
it is because we build caution in in the ways I have described
and we always have, and I think it is important to be clear on
that. Secondly, I cannot comment on political capital.
Q144 Mr Walter: Your professional opinion
then.
Mr Cunliffe: I think it is important,
having set a medium term framework, that that medium term framework
is seen to work over the cycle.
Q145 Mr Walter: Can I go on to the sustainable
investment rule within that of net debt to GDP? Throughout the
forecast period you have got this below 40%, but are the OECD
right to suggest that without, in their words, a "spontaneous
tax rise", there is a danger we could move into more difficult
territory?
Mr Cunliffe: I have not looked
in detail at the OECD forecast but if you look at table B9 on
page 204 you can see that what is happening as we go forward in
the projections here is that net borrowing is stabilising at abut
1.6 or 1.5% of GDP. That is financing part of net investment.
Net investment is 2.25% so you could say that by 2009-10 three-quarters
of a per cent of GDP's worth of investment is being financed out
of the surplus and one and a half out of borrowing. If you make
assumptions on inflation at around 2% and interest rates being
in line with that and economic growth (the economy is on trend
here) being at 2.75%—and it drops to 2.5 here actually because
of demographics—then you can borrow 1.5% of GDP annually
without increasing the debt stock because the economy is growing
and interest rates and inflation allow that to happen. I think
from memory the borrowing amount that stabilises the debt stock
is about 1.9, so I would not expect this to lead to the net debt
stock increasing. It would probably stabilise or come down a little
bit.
Q146 Mr Walter: In percentage terms?
Mr Cunliffe: Yes, as a percentage,
as a ratio of GDP, which is how we have set the rule.
Q147 Chairman: You have suggested that
significant progress has been made in terms of rebalancing growth,
but on your own forecast the two biggest drivers of GDP growth
in 2005 will still be private consumption and government spending
and the economy will still be running a current account deficit,
as you mentioned earlier, of 2.5% of GDP. Rather than rebalancing
would it not be fairer to say that the economy has stopped becoming
more imbalanced?
Mr Cunliffe: The rebalancing judgment
is based not just on what we think is going to happen but what
we now think has happened, and this comes partly back to statistics.
When I first came before this committee in 2002 the latest data
showed that business investment had reduced by 10.5% over the
year. The latest figure for that is that it actually grew by 0.6%.
Investment did decline with the economic cycle, so from about
2000-01 business investment did decline, but it did not decline
anywhere near as sharply as we thought it had. I think it declined
by about 6.75 or 7%. Troughed before it started recovering. At
the same time we thought consumption, both real consumption and
nominal consumption, was higher than it has turned out to be and
so, looking at the past, the revisions have suggested that since
2000 household consumption has grown probably in line with, maybe
just a little bit less than, the trend rate of GDP, whereas we
thought it was growing a bit faster, and business investment has
grown faster than we thought and is now growing at twice the rate
of GDP growth. Looking at in the past, the economy is less imbalanced
than we thought it was. Going forward, it is important to bear
in mind that for all economies the share in the economy of consumption
is normally very large, 60-70%, and the share of investment is
15-20%, so if you like those are the overall weights that you
would apply to those different things so going forward, you would
expect consumption always to be making in absolute terms a
bigger contribution to the economy than investment because it
simply takes a bigger share of the economy, but its rate of growth
is coming down. We have it at 2.5% and dropping for 2005 going
forward. The rate of growth of business investment we have coming
down from nearly 6% this year to about 4.5% next year and 3.5%
the year after, but still growing faster than consumption. Over
time, if business investment grows faster than consumption the
shares in the economy will rebalance.
Q148 Mr Fallon: May we turn to the revenue
side and perhaps give Mr Ramsden a chance to shine. Can I first
of all ask you about table B11 on page 207 of the PBR? I notice
that two years ago in the PBR 2002 social security contributions
were listed separately. You have now put them in alongside income
tax, in the top line there, "Income tax, NICs and capital
gains tax". Is that an admission finally that national insurance
contributions are a tax on income?
Mr Ramsden: I will try and shine
but I lost a tooth yesterday. I will try and speak clearly.
Mr Mudie: Was it a wisdom tooth?
Angela Eagle: It does not look like it.
Q149 Chairman: Do not listen to them,
Mr Ramsden. Just you settle down and answer the question.
Mr Ramsden: Thank you, Chair.
Looking at the presentation in table B11, my understanding is
that we have rolled the elements together that are shown in the
first line because of some issues that we have had with capital
gains tax forecasts and also the apportionment of national insurance
contributions in the monthly data that we have been getting, so
in terms of making a comparison for the first seven months of
the year compared with the last five months of the year we felt
that it gave a more comprehensible picture if we put all the numbers
in one line.
Q150 Mr Fallon: But national insurance
contributions are a tax on income, are they not?
Mr Ramsden: National insurance
contributions are part of the contributory system.
Mr Cunliffe: I think they are
listed separately in tables B12 and B13.
Q151 Mr Fallon: I am just dealing with
table B11 but they are a contribution on income, are they not?
Mr Ramsden: As I explained, we
have had problems with the profiling and in order to give as clear
and comprehensible a picture as we could in table B11 so that
everyone could understand the position to date and what we were
forecasting for the remainder of the year, it made sense to put
them together although, as Jon has pointed out, in other tables
they are shown separately given their specific nature.
Q152 Mr Fallon: Okay. Let us turn to
the position about the first seven months of this year. They increased,
I am told, by 6.9% in the first seven months and you expect that
to increase—this is taxes net and social security contributions—to
7.8% in the last five months. Is not the 6.9% growth for the first
seven months pretty strong by historic standards?
Mr Ramsden: The growth of 6.9%
in the first seven months is consistent with our forecast which
shows a pick-up in receipts relative to GDP in 2004-05. We were
always expecting there to be a strong pick-up, particularly from
corporation tax, but also to a much lesser extent from income
tax. This is the stage in the cycle where you would expect the
growth in receipts to be rather stronger than the growth in money
GDP.
Q153 Mr Fallon: Even so it is strong
by historic standards, is it not?
Mr Ramsden: As you can see, it
is consistent with our forecast.
Mr Cunliffe: I do not think it
is particularly stronger for that stage of the cycle than it has
been in the past.
Q154 Mr Fallon: You now admit in the
PBR that the tax and national insurance contributions receipts
will undershoot by £3.9 billion. That is your latest forecast,
but Professor Spencer told us that he now thinks that the shortfall
will be much larger, around six billion. Why do you think he says
that?
Mr Ramsden: I would not want to
either represent or misrepresent Mr Spencer's forecast. What I
would say about our forecasts and why we are forecasting the undershoot
relative to the Budget that we are is because we expect in the
last five months of this year to see a particularly strong pick-up
in non-North Sea corporation tax receipts but also a particularly
strong pick-up in North Sea receipts relative to the first seven
months of the year.
Q155 Mr Fallon: And for next year you
are predicting a rise in current receipts of 8%. When did we last
have a percentage increase of that kind?
Mr Ramsden: What I would say about
next year is that a big contributory factor to that, as we set
out in table B14, is a marked pick-up in the ratio of non-North
Sea corporation tax to money GDP of 0.5 of a percentage point.
We have seen recoveries in that ratio of at least that amount
in both the 1980s and the 1990s. The biggest increase in the 1980s
was an increase of 0.7 in that ratio and in the 1990s we saw an
increase in that ratio of 0.4 in 1996-97, so I do not think those
kinds of increases are unusual. As I have said, that is a major
contributor to the increase in the overall tax to GDP ratio. As
Jon Cunliffe was saying earlier, underpinning this forecast is
an assumption that the ratio of corporation tax receipts to GDP
will come back to something more like its trend level. The judgment
in a sense is how quickly will it come back. We believe that it
will come back quickly because the factors that have led to the
shortfall this year are temporary and will unwind.
Mr Cunliffe: The speed at which
we have corporation tax coming back is less than at other points.
In the mid eighties and the mid nineties it came back faster.
Corporation tax is a very volatile tax that drops quickly and
historically has come back quickly.
Q156 Mr Fallon: But you are predicting
the highest percentage increase since this government started
and I think a higher percentage increase than in both the years
of the Stock Market boom.
Mr Cunliffe: I actually think
the increase as a share of GDP is less than in the mid eighties.
Is that the Stock Market boom?
Q157 Mr Fallon: The two years of the
dotcom Stock Market boom.
Mr Cunliffe: Yes. It is a lower
increase than 1995-96 by memory, but it is a higher increase than
1996-97 going forward. What one needs to look at is the increase
when corporations are coming back up again, so the equivalent
year to where we are now would probably be round about the mid
nineties.
Q158 Mr Fallon: Looking further ahead
to the medium term, you continue to project a very sharp rise
in the tax to GDP ratio for the next few years. Why is that?
Mr Ramsden: There are two or three
factors that one can point to when looking at the medium term
trend in the tax to GDP ratio which is set out in table B14. If
I might just add this, the maximum level that we are forecasting
for non-North Sea corporation tax as a share of GDP is 3.4%, which
is below the level it reached in 1999-2000, which was 3.6%, and
quite considerably below the level it reached in 1989-90 of 4%,
so that is where we are on corporation tax. On top of that, as
we have flagged up in the text, you have got the conventional
forecasting assumption on fiscal drag and what we assume about
the inflation uprating of allowances, which goes back to policies
that were decided in the 1970s and forecasting assumptions for
successive governments that follow from that. Then we have got
some pick-up, particularly driven by the recovery in equity markets,
which is helping to increase the other taxes and royalties line,
which is the last of the tax lines. Underpinning these increases
over time there are, as well as the economic factors and the forecasting
factors I have mentioned, the anti-avoidance policies. There is
a package in this PBR, and there have been packages in previous
PBRs and Budgets, both on the operational and the policy side
which are still working through.
Q159 Mr Fallon: Okay, but, sticking with
non-North Sea corporation tax receipts, and let us call them company
profits for short, at Budget time you forecast they would grow
by 21.5% this year. Now you are saying they are only going to
grow by 14% but you are still forecasting that next year they
are going to grow by 27.5%.
Mr Ramsden: As you have highlighted
there, the growth that we have seen this year has been significant
already and we are expecting it to become more significant. The
growth rate is not as strong as we were forecasting at the time
of the Budget but it was still in double digits. Yes, we are forecasting
that the growth rate of overall CT will pick up next year. There
will be, as I have said, the financial companies effect, but also
the effect of North Sea revenues which have still to come through
the system because of the lags. There was a discussion earlier
about the fact that the peaks in the economy are less pronounced
now generally than in the past, that volatility of cycles has
been reduced, but when you look at a tax such as corporation tax,
which is driven by profits where there are allowances, both for
capital but also for losses, you still have a longer term trend
and cycle which shows significant amplitude, so, because we expect
that the effect of these losses and allowances will wear off over
time, yes, we are forecasting significant growth next year.
| 
