Examination of Witnesses (Questions 20-39)
21 MARCH 2005
MR ROBERT
CHOTE, PROFESSOR
PETER SPENCER,
MR DAVID
WALTON, MR
MARTIN WEALE
AND MR
JOHN WHITING
Q20 Chairman: You have looked into a
golden ball and you are assuming all these things. If I remember
the press at the weekend, in our golden ball prediction, the Chancellor
in the next year is going to impose £4 billion windfall tax
on the banks. Who are the important people you are talking to
who can tell us that? It could save us a lot of bother in the
Treasury with finding these out pretty quickly.
Professor Spencer: That was unfortunate.
I was simply asked where I thought the Chancellor's axe might
fall and I gave that unguarded response.
Mr Walton: On the point about
war, for instance: we have fought a war and so far it has cost
£5 billion or so. Traditionally, if you look back at the
evolution of public debt, public debt has gone up massively at
times of war. It went up massively during the First World War;
it went up massively during the time of the Second World War.
The code for fiscal stability does not say that you have to adhere
to these rules at all times. In fact, it says that if you actually
breach the rules then the Chancellor has to just explain. It would
be perfectly sensible to say, "We have spent £5 billion—if
that happens to be the margin by which you have missed the rules—"Well,
this was a war that was unforeseen and the ongoing expenditure
was unforeseen." I am not saying that rules are not a good
thing; all I am saying is that you have to keep them in perspective.
If we are just talking about a situation where debt is absolutely
very low, then it would be a bit odd to make too much of it.
Q21 Chairman: We are beginning to get
a wee bit wandered here. Martin, would you put us right on the
straight and narrow again.
Mr Weale: Whether I will put you
on the straight and narrow, I do not know, but could I make two
observations. On the question of the chance of the Golden Rule
being broken in the next economic cycle, I am with, I think, many
other people in believing that taxes will probably need to go
up, that there will be a gap of something between £10 and
£15 billion to be closed, but the margins of error in projections
three or four years ahead are such that if I had to put a probability
on it I would say that with those numbers the probability of meeting
the Golden Rule target is probably about 45%. It is not much less
than evens. With the Treasury numbers it is slightly higher than
that—maybe it is 55%. It is not much above evens simply
because the future is so uncertain. The other issue that I think
needs to be addressed is: Is the Golden Rule tight enough for
the British economy? The point—which I think was due to
Mervyn King—is that the country is not saving enough and
perhaps the Government should be setting an example; in other
words, it should be running a surplus and not be satisfied merely
with balance.
Q22 Angela Eagle: The economic cycle
to come is maybe not subject to staring through a golden ball
but maybe a crystal ball. No future cycle is going to be the same
as a past cycle. Surely the point of these rules is to navigate
us through so that we can get some kind of handle on where we
are and how relatively safe or dangerous it is in terms of good
economic policy. It seems to have worked quite well so far, does
it not? We have had 50 consecutive quarters of growth. We are
not doing so badly, are we?
Mr Walton: I think that is right.
These rules give you very good benchmarks for achieving fiscal
sustainability.
Q23 Angela Eagle: It is a navigation
process.
Mr Walton: But whether or not
at the end of the day, after the end of the cycle, you are a few
billion either side of that objective makes absolutely no difference
in any economic sense.
Mr Mudie: In terms of economic catastrophe,
unemployment, inflation, whatever, the world would move on with
very little change if he did not meet his rules by those. It is
more his credibility. It is self-imposed rules he puts down by
which the City judges him. And if he fails, he has lost a bit
of credibility but it is for him to explain. But the economic
world will go on. I would rather they were broken and we got rules
as Europe treat the rules that seem to defy real life.
Mr Beard: Are the Treasury in the best
position to judge the buoyancy of future revenue? We have just
gone through a period where everybody was scoring the Chancellor's
chance of bringing the revenue up to his forecasts but the answer
from the Treasury was, "Well, we know the Inland Revenue,
we know the customs, we know what is lying in wait." Is that
not the case in looking at the Golden Rule for the next six years?
Q24 Chairman: We have revenue further
on, Nigel. We have completely lost the thread here.
Mr Weale: To pick up the previous
point, if you look at the Treasury's forecasting record of government
borrowing in the recent past, it has not been bad relative to
what might have been expected but it gives you no confidence at
all that their numbers are going to be right and other people's
are going to be wrong looking into the future. To take the navigation
analogy, I think if someone was navigating a boat, they would
tell you how they were going to steer the rudder if they got blown
off course instead of merely asserting that nailing the tiller
to the boat will steer them safely through all possible obstacles
that they might meet. And that is the difficulty that I have with
the current debate about the Golden Rule.
Q25 Mr Heathcoat-Amory: Tax revenues
are projected to rise by over 8% next year. I think that would
make a bigger real increase than perhaps we have ever seen. Is
this realistic? Is it cautious, as the Treasury say? Or is it,
as the IMF say, over-optimistic?
Mr Chote: There is the issue there
about the coming year. I think the IMF as well was referring to
revenues over the next three, four, five years as well. Certainly
our view—and the view of a number of other people here—is
that we are not convinced that revenues are going to be as buoyant
in the absence of the announcement of new policy measure over
the next few years as the Treasury thinks. Our concern principally
in the past has been whether corporation tax will come in as strongly
as hoped. Clearly, the Chancellor had a couple of very good months
on corporation tax in the early part of this year but I think
there still remain doubts as to whether corporation tax revenues
are going to grow as strongly as he hopes. Looking further into
the future, the Chancellor is relying particularly on continued
very strong growth from the financial sector so much depends there.
Linking back to the point Mr Beard was making, when the Treasury
say they have more beneficial information, that may be true over
fairly short time horizons with the sort of information they are
likely to have from HM Revenue and Customs. In the longer term,
you are making judgments about how quickly the tax base is growing,
whether there are other factors that would lead you to believe
tax revenues are likely to grow more strongly than in the past
for a given state of the economy. I am not sure there that the
Treasury necessarily has greater information than any of the rest
of us. It does not mean they will be right or wrong but it may
be true over the much shorter term. I would certainly be sceptical
about their tax revenue forecasts.
Q26 Mr Heathcoat-Amory: I wanted to ask
Mr Whiting about corporation tax because you observed recently
that this tax is vulnerable to the European Court of Justice decisions
which are using single market powers to undermine our tax base.
Do you think this has been tackled or do you think this is a continuing
vulnerability given that corporation tax receipts are due to increase
next year by 28%?
Mr Whiting: That is a particularly
vulnerable forecast. It may come through but it is predicated
on very energetic City type activities which may well happen.
The City is doing well. Whether it will deliver that bounce in
the corporate tax revenues is a very moot point. You are quite
right I still have to point to the impact of a number of the European
Court of Justice cases that show that the UK tax system is at
variance with the freedoms under the European treaties. A number
of those are pending, as we discussed last time I was here. Those
could bring in quite a financial penalty for the UK and indeed
many other countries' tax systems with a forced repayment of taxes
that are found to have been illegally levied. It is not huge in
the absolute terms we have been discussing in terms of golden
rules but it could still put a little dent in. I would also look
at this whole issue from a slightly different point of view or
put another point of view down, which is that if the Treasury
think that they are going to take this sort of money from corporate
tax, particularly the City, I would expect them to be coming forward
with policies and tax changes that are orientated towards making
sure that business comes to the UK, stays in the UK and is retained
in the UK. I think there is a lot of good stuff within this Budget
and in previous statements, but I would expect that to be very
much a policy that one could detect through all budgetary statements.
I am not sure it is there as much as it should be.
Professor Spencer: If we are talking
about the longer term, over that sort of time horizon we are looking
at a lot of other factors which the Inland Revenue's models are
going to find it very hard to pick up. Most obviously, if the
effective rate of corporation tax paid by our companies rises,
as it rises, according to the Treasury towards peaks which we
have only ever seen when the economy has been very strong, we
can expect all sorts of disincentive effects to kick in. We have
to remember that there is this problem of tax arbitrage going
on. Those past peaks were seen at a time when our corporation
tax rates at 30% were relatively low compared to the rest of Europe
but we have seen a lot of competition from eastern Europe, most
obviously Poland and Slovakia who are moving over towards so-called
flat taxes, and in response to that Chancellor Schroeder in Germany
last week brought in a reform package which will see German corporation
tax rates cut, I believe, to as low as 19% for very large companies.
We have to be very wary that we simply will not be able to attain
the kind of share of tax in corporate profits that we have seen
in past cycles.
Mr Whiting: I would agree wholeheartedly.
We have another example on our door step with Irish rates being
12.5%. Corporation tax is being used as a loss leader by some
countries to attract the business in. I am not saying we should
go to that level but it is a factor that we have to be aware of.
Q27 Mr Heathcoat-Amory: Since we are
therefore in an international tax competition, can I ask our witnesses
about the tax take as a percentage of GDP? This is rising strongly,
going up by a projected increase to 37.3%, which is nearly 2%
more than two years ago. Are we now getting out of line internationally
in this respect and are there dangers both to our competitiveness
and our tax base if companies and activity migrate away from us
due to increasing tax burdens?
Mr Weale: No. If one looks at
the tax share in general, I do not think we are very out of line.
Obviously, the numbers move around a bit. The United States tend
to be a lower taxed economy. The continental economies which have
stagnated for the last four or five years tend to be rather higher
taxed economies and we are somewhere in the middle. I would be
surprised if even the general increase that is projected here
would be likely to lead to large tax migration. The issue of corporation
tax competition is a rather different and specific one and that
could be a problem whether there was a general increase in the
tax share projected or not. I think we should focus on that more
than the issue of whether you and I are going to decide to live
in a tax haven rather than in the United Kingdom.
Q28 Mr Heathcoat-Amory: The reason I
ask is that this Committee has been very concerned about tax migration
on excise duties, so we are sensitive to these international comparators.
We also are advised that the tax burden on the non-oil sector
is at a record. Therefore, are we in uncharted waters in that
respect?
Professor Spencer: We most certainly
are. If you look at the notes that I prepared for this Committee
at the time of the pre-Budget report, I first took chart C3, which
is the tax/GDP ratio, on page 255, which shows total taxes as
a share of total GDP. If you look at that chart, we appear to
be nudging up towards the peak that we saw back in the early 1980s.
As my chart showed, if you take out North Sea companies who of
course were paying £12 billion a year or thereabouts in tax
back in the early 1980s, the peak falls back to around about 35-36%.
We are in uncharted waters in terms of the burden of tax on non-North
Sea economy.
Mr Whiting: If you lose business,
it is not just corporation tax that you are losing. You are losing
all sorts of other revenues as well. There is some evidence, because
ours is so much more of a service economy, that businesses are
looking at where should services, particularly electronic based
services, be located. What is the main tax affecting them? Very
often, VAT. I think there has been a certain amount of publicity
and perhaps businesses could put a certain amount of electronic
based business in Luxembourg which has a rate of 12-15% VAT rather
than here at 17.5%. It may seem like a very small shift but it
is something companies are looking at. It is not and never will
be the sole determinant of where business is located but it is
a factor and it is not just the corporate tax revenues that could
be at risk.
Q29 Angela Eagle: There does not seem
to be a great outpouring of service industries offshore at the
moment, does there? It is all rather alarmist, is it not?
Mr Whiting: I would not claim
that—
Q30 Angela Eagle: The whole of our business
is going to flood out to Luxembourg to save 2% on VAT, is it?
Mr Whiting: I do not think I would
try and sound that sort of note, no, but if we are asked by an
organisation, "Where should we locate or relocate?"
there are many factors that they will take into account. Tax is
one of them along with everything else. Many years ago, if a Japanese
company asked, if it was supposedly the quality of the golf courses
that was a factor as well as taxes!
Q31 Angela Eagle: I do not think we do
badly on golf course quality.
Mr Whiting: We do extremely well
on that, perhaps why, we have a lot of Japanese inward investment!
Tax factors are now more important, I think than ever.
Q32 Angela Eagle: Many of you at the
time of the pre-Budget report were very sceptical about the Treasury's
corporation tax forecasts but the Budget papers reveal that corporation
tax receipts came in a billion higher than forecast. Is there
any apology to us for your constant scepticism about the Treasury
forecasts in this result?
Professor Spencer: I do not think
an apology is in order. We give the best advice that we can.
Q33 Angela Eagle: Is constant scepticism
your only gear?
Professor Spencer: When you are
looking at forecasts which appear on an objective basis to be
extremely optimistic, yes, I am afraid a central forecast would
cause you to be sceptical.
Q34 Angela Eagle: The outturn was a billion
better than the forecast.
Professor Spencer: On this occasion
it was.
Q35 Angela Eagle: You were wrong?
Professor Spencer: Yes. That shows
the margin of error that we are looking at.
Mr Weale: Yes, behind any forecast
you can unpick the components. I made the point earlier that the
Treasury continued to underestimate government borrowing or current
account borrowing even into the autumn of last year. It has now
turned out worse than even the National Institute were expecting.
If they did well on corporation tax, they must have done even
worse on some other component of borrowing because overall borrowing
has been £3.5 billion higher than they were forecasting.
You always find swings and roundabouts which perhaps demonstrates
why it is best not to get too excited by any individual number.
Q36 Angela Eagle: In other words, it
is a navigation process, which I was saying earlier, rather than
an exact science.
Mr Weale: We have never claimed
it was an exact science. I would draw the Committee's attention
to the fact that two and a half years ago it asked the Treasury
to produce a fan chart for government borrowing. I would strongly
suggest that you ask them to do that again.
Q37 Angela Eagle: How does the Treasury's
forecast for the level of tax/GDP ratio compare historically in
this country and internationally, because there has been rather
a lot of worry about that in the papers over the weekend.
Professor Spencer: In terms of
our own past history, if we were to push up from the current 37%
of GDP area towards the 39% the Treasury are looking at, we would
be in uncharted waters. In terms of the burden of tax on the non-North
Sea sector, that would be—
Q38 Angela Eagle: I am talking about
the economy as a whole, not only the non-North Sea sector. The
difference between tax and GDP ratios is not that different historically,
is it?
Mr Chote: It would get the tax
burden, if I am right, for the whole economy back to what would
be a 25 year high by the time you get to the end of the Treasury's
forecasting period.
Q39 Angela Eagle: In your Green Budget,
you yourself pointed out that that would be the highest since
the mid-1980s but it would still be lower than the whole average
during all the Conservatives' four terms in government, so it
is nothing to have nightmares about, is it?
Mr Weale: If you are concerned
about tax migration, the only point you might make is that there
is greater international mobility of business than there was in
the 1950s and 1960s.
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