CORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 482 i-ii
House of COMMONS
ORAL and WRITTEN EVIDENCE
TAKEN BEFORE
TREASURY COMMITTEE
THE 2005
BUDGET
Monday
21 March 2005
MR ROBERT CHOTE, PROFESSOR PETER
SPENCER, MR DAVID WALTON,
MR MARTIN WEALE and MR JOHN WHITING
MR JON CUNLIFFE, MR DAVE RAMSDEN, MR TONY ORHNIAL, MS SARAH MULLEN,
AND MR JOHN KINGMAN
Tuesday 22 March 2005
RT HON GORDON BROWN, MP, MR JON CUNLIFFE, MR MIKE ELLAM, MR DAVE RAMSDEN, MS SARAH
MULLEN and MR JOHN KINGMAN
Evidence heard in Public Questions 1 - 312
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Oral Evidence
Taken
before the Treasury Committee
on
Monday 21 March 2005
Members present
Mr John McFall, in the Chair
Mr Nigel Beard
Angela Eagle
Mr Michael Fallon
Mr David Heathcoat-Amory
Mr George Mudie
________________
Examination of Witnesses
Witnesses: Mr
Robert Chote, Institute for Fiscal Studies, Professor Peter Spencer, York University, Mr David Walton, Goldman Sachs, Mr Martin Weale, National Institute of Economic & Social
Research, Mr John Whiting, PricewaterhouseCooopers,
examined.
Q1 Chairman: Good afternoon. Welcome to
the Committee's hearing on the 2005 Budget report. Could you introduce yourselves for the shorthand writer, please.
Mr Whiting: John Whiting, tax partner at
PricewaterhouseCoopers and chair of Chartered Institute of Taxation Tax Policy
Committee.
Mr Walton: David Walton, Chief European
Economist at Goldman Sachs.
Mr Chote: Robert Chote, Director of
the Institute for Fiscal Studies.
Mr Weale: Martin Weale, Director of
the National Institute of Economic & Social Research.
Professor Spencer: Peter Spencer from York
University.
Q2 Chairman: Welcome. Even more than
usual, we are short of time. I am
trying to get everything done within 60 minutes, so we will be short with our
questions and I am sure you will be equally, if not shorter, with your
answers. We will focus on one
particular individual rather than everybody having a bash at the same question,
if you do not mind. It has been
reported that the deterioration in the UK's fiscal position since 1999 was
bigger than that of any other G7 country other than the US. To what extent, therefore, should we thank
this loosening in the fiscal position for the US and the UK's position near the
top of the G7 growth league table?
Mr Walton: Part of this was clearly
planned. It was very useful that the
planned increase in public spending did start to kick in just at the time that
the world economy was going into quite a marked slowdown in economic
activity. It is noticeable that
countries which have eased their fiscal stances quite a lot over this four or
five year period have performed rather better in avoiding some of the worst effects
of the global slowdown than might otherwise have been the case. In particular, it is investment which really
got hit very badly during the global slowdown.
There is not much you could do about that, and so, to have a bit of
extra government spending and a bit of extra private consumption as a result,
that turned out to be quite fortuitous.
Q3 Mr
Fallon: At the time of the pre-Budget report, you said the probability of
the Chancellor meeting his fiscal rules in the current cycle was somewhat lower
than 15%. Now you say it is around
65%. Can you elucidate.
Mr Chote: The distinction there is
between a calculation that simply looks at what the Chancellor should think his
probability is, based on his own forecasts, and the distribution of forecasting
errors that the Treasury has had in the past, in which case the position at the
time of the last Budget was a probability of roughly 60% and the position is
roughly the same now. Our view was that
the current Budget deficit was going to be somewhat larger than the Chancellor
was predicting in the Budget and pre-Budget reports of last year; indeed, it
has turned out for 2004/5, if the Treasury is right, this time to be pretty
much what we said in the Green Budget in January, and we are more pessimistic
than they are about where the deficit is going to be next in the coming
financial year. So, based on our
forecasts and our past forecasting, the probability would be less than 50%;
based on the Chancellor's forecasting and the errors around his forecasts in
the past, it would be greater than 50%.
That is the distinction.
Q4 Mr
Fallon: Peter Spencer, is that your view?
Professor Spencer: About that, yes. We also thought that the current balance for
this year would come in at a deficit of around about £14/£15 billion, and of
course the out-turn has been slightly worse than that. But the real problem, going forward, is that
we really cannot see such a strong economy and such a strong growth in the tax
share of GDP to bring the Chancellor's estimate of £16 billion deficit for this
current financial year down to the kind of figure of £6 billion that he is
talking about for next year. As usual,
it is just possible, but it is right on the margins of error as we see it.
Q5 Mr
Fallon: Does it follow from that, that the Golden Rule cannot be met in
the next cycle without either a cut in spending or additional tax revenue?
Professor Spencer: I think the considerations,
going forward, are slightly different.
We have to assess where we will be in the first year of the next cycle,
which is almost certain to be 2006/07.
On our estimates the cycle will actually begin with a small deficit,
probably around about 0.5% of GDP. I am
afraid that the Chancellor is probably assuming that fiscal drag and a
corporate recovery will gradually erode that deficit and push it into surplus
during the course of the next cycle, and I am slightly concerned that the
Treasury may be planning to go ahead on that kind of basis. It is just possible, if the economy really
is as shock-proof as the Chancellor seems to think it is now, that he might
just get away with that kind of, what I call, "muddling-through" strategy. But, in my view, that would be very
dangerous because I do not think the world economy is at all shock-proof, even
if the UK economy is. We were talking
earlier about the effect of a world recession on the UK's public finances -
even though the UK on that occasion, post-millennium, avoided recession - and I
think it would be just too dangerous to go ahead on that basis - which is why,
I think, on the precautionary principle, a prudent Chancellor after the
election would try to tighten fiscal policy to buy some leeway in case things
go wrong.
Q6 Mr
Fallon: But I asked you not what you think should happen but how likely it
was that the Golden Rule would be met in the next cycle without either a cut in
spending or additional tax.
Professor Spencer: If I am right in thinking
that there will not be a significant tightening over the next two or three
years, then I think it is likely to be broken in the next cycle.
Q7 Mr
Beard: Why should that leaving the tax framework unchanged be described
as "muddling through"?
Professor Spencer: Because the margin for error
would be just so small if we started with a small deficit in 2006/07, then
worked into a balance, and then, assuming that things continued on the rosy
path that we have had, that would move it in to surplus. That is possible - that he would get away
with it - but it would be extremely dangerous.
Q8 Mr
Fallon: David Walton, the ONS looks at roads' maintenance for a couple of
years and then suddenly, four weeks before the end of the financial year, moves
£3 billion of it from one side of the line to the other. The ONS is funded by the Treasury, reports
to the Chancellor and is staffed by a large number of Treasury officials. How damaging to its credibility do you think
that decision is?
Mr Walton: I do not think it was
presented in perhaps the best way it could have been. At the end of the day, if they have made an error - and it looks
as if they did make an error in terms of the way they were treating the
spending on repairs and maintenance - then it is important that it should get
corrected. As I understand it, the ONS
position is that they corrected it at the first possible opportunity.
Q9 Mr
Fallon: First opportunity, after October 2002?
Mr Walton: That is what they claim in
terms of what they have put into the public domain. All I would say is that it does not look very good doing these
sorts of changes so close to a budget.
You would hope that you would be very sensitive to the budget timetable,
so you would either get this stuff out a couple of months earlier or it would
be something that you would ----
Q10 Mr
Fallon: There would be a closed period, in other words.
Mr Walton: I think that would be
desirable. Supposing it had been the
other way round and suppose they had suddenly found that current borrowing had
been somewhat higher, then suddenly to release that a few weeks before the
Budget, a few weeks before a General Election, yes, they are independent, but
it would not really take account of the political sensitivities that attach to
these things. I have no doubt in my own
mind that the ONS is independent. I
would not entertain any thoughts of political shenanigans behind the
scene. But I do not think, frankly,
that they did handle it in the best possible way. I think that when they announced they were going to do this they
should have given upfront some indication of the orders of magnitude rather
than allowing the press that weekend after they said they were going to do this
to speculate about some quite wild numbers which were obviously
inaccurate. So all round I think they
could have done a bit better job in presenting this.
Q11 Mr
Mudie: Have you looked at local authorities and how they treat similar
expenditure?
Mr Walton: No, not in any detail. I presume actually that with some of this
repairs and maintenance spending quite a bit of this is done by local
authorities.
Q12 Mr
Mudie: You get approvals, I suppose, from the Treasury, and I see what
you say, but local authorities spend money on goods, maintenance and road
repair all the time. We must have a
policy. You cannot have the national
Government saying this is capital and local government doing something
different. Or do you?
Mr Walton: The ONS will treat this in
the same way. I am sure they have
looked at both.
Mr Chote: We have had issues in the
past where spending has simply been re-categorised from capital to current or
vice-versa and things have gone in both directions. I think this was a case where they think they have identified
some double-counting, because they have done calculations in two different
ways. So this was identifying basically
a foul-up as distinct from making a judgment that something which you had
hitherto thought was current is now capital.
Q13 Mr
Mudie: That is different, is it not?
That is purely an accounting measure.
Are you sure that is what it is?
Mr Walton: That is what the ONS says
and I have no reason to believe otherwise.
The other point, of course, is that it does underline the fact that,
putting an awful lot of significance on whether this rule is met or missed by a
few billion either way, when these sorts of issues show the blurred line
between current and capital, I think tells you more about the rule than about
this precise case.
Mr Weale: Perhaps it is appropriate to
mention that, although I am not here representing the Statistics Commission,
the Statistics Commission has looked into that. There is some public
correspondence on its website and it is going to report on the issue. But my understanding is exactly the same as
Robert's, that it was double-counting of depreciation expenditure and it was
unfortunate that it was originally described as a miss-classification. That I think added to the confusion.
Q14 Mr
Fallon: Serendipity, then.
Mr Weale: Well, I agree with the view
that the timing was rather unfortunate.
Q15 Mr
Fallon: If he was going to miss his target by as small a gap as £3 billion
and suddenly an extra £3 billion is found, it does make one rather suspicious, does
it not?
Mr Walton: But I think Robert's point
is right, which is that the focus on whether or not you hit the rule by £2 or
£3 billion or you miss it by £2 or £3 billion, economically it makes absolutely
no difference.
Q16 Mr
Mudie: He described that as very dangerous.
Mr Walton: I do not understand how it
can be very dangerous.
Q17 Mr
Mudie: What is very dangerous, as you say, about missing the target by
that amount?
Mr Walton: It is partly the way the
rules are formulated. Clearly the
Chancellor has told people to judge him.
Q18 Mr
Mudie: It might be very embarrassing, but not very dangerous, is it?
Mr Weale: The Committee did say after
the pre-Budget report that it might be a sensible time for the Treasury to look
at re-specifying the rule, and there is an obvious question why should it not
be more like the inflation target, with a boundary on each side?
Q19 Chairman: You did say it was dangerous, Mr Spencer.
Professor Spencer: Yes. There is a distinction between failing at
the end of the day to hit by the odd couple of billion and planning the next
cycle with no margin of error. That is
dangerous because if something comes along like a world recession to knock you
off balance, then that will force you into a discretionary tightening of policy
to offset the effect of the automatic stabilisers. To put it differently: to come back to where we started this
discussion, the current cycle started with some very large surpluses, which is
why the Chancellor was able to fight the last election, to fight a war and to
fight a world recession within the room for manoeuvre that he had. None of that will be possible if he plans to
run the next cycle on the kind of tight margin that we are looking at here.
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 %age 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.
Q40 Angela
Eagle: We said earlier, did we not, that there is no sign of mass
business migration at the moment?
Professor Spencer: It is early days yet. The new EU accession countries only joined
last May and the real impetus for tax competition is coming from the east in
the way that I indicated earlier.
Q41 Angela
Eagle: You think the City is going to decamp en-masse to Slovenia or
something?
Professor Spencer: No, but that is the kind of
risk that we are running.
Mr Walton: Can I make a point about this tax/GDP ratio
and compare chart C3 with chart C4?
Yes, it is true that taxes as a share of GDP are rising back to the
highs that we saw in 1978/9, but if you look at spending it is a long way below
those sorts of levels. Spending still
looks pretty low in a historic sense.
What has really changed is that borrowing is a lot lower now than it was
during much of that period. This is one
of the reasons for the fiscal rule. The
current Budget was persistently in deficit.
The government was persistently running down its net worth right up
until 1997 and since then you have had a much bigger change. Yes, we are in deficit at the moment but the
underlying current Budget position has just been a lot better in the past few
years than it has been through much of the 1970s and 1980s and even the
1990s. If you want prudent levels of
borrowing and achieve these sorts of rules in a way that we did not achieve
them for much of the 1970s, 1980s and 1990s, it is inevitable unless you want
very much lower levels of public spending as a share of GDP that the taxes are
going to have to be higher. Something
has to give.
Mr Chote: We get less non-tax
revenue. The government gets less. The difference between current receipts and
tax revenue is smaller now than it was, so you are not getting as much revenue
from other sources other than tax.
Mr Weale: I remember hearing Mr Kenneth
Clarke saying that he thought a government spending of 40% of GDP was fine and
the sort of thing he was comfortable with.
We now have a different government and that it should be comfortable
with 42% rather than 40% does not seem to me to be the sort of straw that would
be likely to break a camel's back.
Chairman: It will be a big issue for
the General Election.
Q42 Angela
Eagle: The Budget speech contained some interesting strategic comments by
the Chancellor about the challenge of China and India and some investment in
stem cell research science. Do you have
any comment on the strategic positioning the Chancellor is taking in that area
to protect our ability to compete in future in the global economy?
Mr Weale: I suppose they are taking a
deep breath and wondering how far and whether it is possible for the government
to see a long way into the future and to see which areas are going to be the
growth industries that Britain should be aiming to compete in. In the 1970s we had a history of rather
unsuccessful attempts. We are not
talking of the same sorts of things now but the government needs to make people
await the changes. It needs to ensure
that the British economy can function efficiently. Whether and how far it is sensible for the government to pick the
technological winners of the future I am rather less clear about.
Q43 Angela
Eagle: The issue is whether it is appropriate at this moment to be
putting a lot of money into science funding to do pure research, whether you
are looking at things like stem cell research and some of the areas that may
open up pharmaceutical or medical issues.
It does not seem to me that they are picking individual companies but
they are looking strategically in quite an interesting way at what the
government can do to strengthen these sectors.
You are saying you disapprove and it should be left completely to the
market.
Mr Weale: On the contrary. I think supporting basic research is
something that other countries have historically done rather better than
us. I am very glad to see that
happening. I hope it will help us
compete more effectively than if we did not do it against the emerging
economies. We should be doing it
whether we are confident it will or not but the process is a peer process
rather than identifying risk.
Mr Whiting: The commitment to look at
how well the research and development tax credit is working and to make sure it
is aiming in the right direction is very welcome because it is part of making
sure we are supporting the things which you are alluding to, which I think is
very important.
Q44 Mr
Beard: Mr Chote, what factors have led to current spending overshooting
the Treasury's forecasts in 2004/5?
Mr Chote: One of the issues has been
the department's making use of end-year flexibility. As you will recall the traditional problem that there has been
for many years about there being an incentive for departments to rush off and
spend money in the last couple of months of the financial year or willy nilly,
simply in an attempt not to get their budgets cut in the following year, that
was seen to be undesirable. The
government said, very sensibly, that to avoid creating that incentive
departments would be allowed to bank their underspend and to spend that money in
the future so that there would not be this rush to spend things
inefficiently. It looks as though some
departments have taken advantage of that on this occasion. That is part of the explanation.
Q45 Mr
Beard: What implications do the reserves under the end year flexibility
arrangements have on the Treasury's ability to control departmental expenditure
and ensure that the golden rule is met?
Mr Chote: It is awkward for them,
other things being equal, that this has happened at a point when we are
relatively close to the end of the cycle and it is a point at which the margin
of error on meeting the golden rule or not is relatively tight. This is not an ideal time to lose a couple
of billion in that area. One of the question
marks is whether this is likely to continue in future years or whether this
will have released some of those pressures.
From the Chancellor's point of view, not destroying the very sensible
incentives created by end-year flexibility - i.e., not saying, "This is an awkward time for you to
be spending so we do not want you to do it" - there may have been a little bit
of that but the door has not been slammed on that. If it had been, it would have created damaging incentives for the
efficiency of public spending which would have outweighed the danger of the
real underlying significance of whether we meet or miss the golden rule by some
small amount of money or by two billion more.
Mr Beard: Does anyone want to add
anything?
Q46 Chairman: Again, Robert Chote, at the time of the PBR (the pre-Budget report) you
told us that the consistent shortfalls in investment spending compared to plans
were a genuine puzzle. The 2005 budget
indicates that the investment spending in 2004/5 will be around 3.4 billion
less than forecast at the time of the PBR.
Has the Budget thrown any light on why these shortfalls are continuing
to recur and recur and recur?
Mr Chote: No, as
far as I can see it is the same problem and I am no better able to explain what
is happening to you now than I was then.
It is part of a longstanding difficulty. The Treasury has not managed to get the investment spending out
of the door as quickly as it would have liked to. We have seen it again.
Mr Weale: As
Robert has said, it is a very familiar story and it goes on and on.
Q47 Mr Beard: But it is a very strange story considering the complaints, when people
are under tight budgets, that when they are not under tight budgets they cannot
spend the money?
Mr Weale: Yes, on
the other hand, you can be under a loose budget but still looking carefully at
whether the money is being well spent.
Value for money is a different issue from tight budgets, and so wanting
to make sure that money is being well spent may be a factor slowing the process
up, but we have had several years of this happening and one might have thought
that the appropriate processes would be running smoothly by now.
Q48 Mr Beard: Are there any views on what action the Government should to take to
improve the delivery of public sector investment projects? What does the Government need to do about
it?
Mr Chote: I do not
know. Whether there is a case for
looking at the process of approval, whether there are some sort of bottle necks
there which are causing a problem, I do not know, but I guess that would be
something that is worth looking at.
Coming back to what Martin was saying, it is better that this money is
not spent than it is spent stupidly.
You would have imagined that if this were an issue about, "Oh, well,
actually we have decided we are going to think quite carefully about this",
that that might have made a step‑change in the forecast, but it is hard
to see why investment continues to come in underneath if that is basically the
explanation, but it might still be worth having a look.
Professor Spencer: That is surely the point. It is
extremely difficult to know how to solve a problem if you do not understand the
problem. What we need to do is to get
on top of the problem, find out what is doing it and then perhaps we would be
in a position to suggest something.
Q49 Mr Beard: I think there has been a suggestion that it may be because people are
doing a PFI comparison before they get on with the project and that may be
slowing it down. Is that substantiated?
Mr Chote: It is
hard to see, if that were the case, why that would be continuing. If you knew that old people were actually
taking six months longer than had been previously thought to do a PFI
evaluation some years ago, then that might have resulted in a step‑change
in the expectations, but it does not really seem to me to be a plausible
explanation of why it continues to disappoint.
We do not believe that people are now being vastly more careful about
PFI evaluations than they were six months ago or a year ago. They may be but I have no evidence of that.
Mr Walton: This may
be where end-year flexibility is kicking in.
To the extent that departments are not under pressure to do all of their
capital spending in any one year, if they do not spend it they can keep that
money for future years. There is just
that. I do not know the precise
breakdown of the stock of end-year flexibility, but I suspect a reasonable
chunk of it is actually under spend on capital spending. To the extent they still have that, it is‑‑‑
Q50 Mr Beard: It is government spending about which I am talking.
Mr Chote: Yes, but
under spend on the capital bit rather than on current spending. To the extent you can carry that forward to
future years, there is not the pressure to suddenly get these projects out of
the door, but, as the others have suggested here, it would not be very good if
it was done in a wasteful manner.
Q51 Mr
Mudie: I want to take another look at that in this town. At the last PBR time when we were looking at
the books, I think the figure of £10 billion was mentioned. That is the amount of stored up end of year
flexibility there is in the department.
That is a fair bit of spending power when we are getting excited over £2
or £3 million. Say a scenario came
where a change of government was anticipated, maybe thinking of expenditure
cuts, et cetera, tax cuts, you could
see a situation where departments could suddenly become alive to, "We had
better spend this money or we will lose it".
Does nobody worry about a stored up sum that exceeds £10 billion that
the departments have permission to spend.
The Treasury, in other words, cannot stop it?
Mr Walton: That is
another part of this may be: the fact that public spending plans have been
pretty generous in recent years. If
there is an expectation by departments that they are going to be less generous
going forward, then actually having some of this end-year flexibility does
potentially give them scope to smooth the growth of public spending, rather
than doing it very rapidly now and then having to go through a bit more famine
later.
Q52 Mr Mudie: If you are talking about the Golden Rule and we are worried about two
or three billion and the departments have the capacity, the permission, to
spend £10 million if they speed themselves up and get their act together. If they wish, they could spend this
money. That would have affected, for
example, the Golden Rule, which we all get excited about, but it would be a
fair amount of money to spend and inject into the situation, and it is sitting
there deferred at the moment at their pleasure. Does that not worry anyone at that table?
Mr Walton: I
confess, I do not know how much of this stuff on end-year flexibility is
current spending and how much is capital spending ‑ I do not know if
anyone else knows ‑ because clearly, I think, these numbers are
available. Certainly the Treasury in
its own response to your pre-Budget report says where these numbers are
published. I do not have these in my
head, I confess, but if most of it is capital spending, then clearly it does
not affect the Golden Rule type calculation.
Q53 Mr Mudie: But if it is revenue?
Mr Walton: If it is
deferred current spending.
Q54 Mr Mudie: Yes?
Mr Walton: I
suspect it is easier to defer capital spending than it is to defer current
spending.
Q55 Mr Mudie: That is just a suspicion, Mr Walton?
Mr Walton: It
is. That is true.
Professor Spencer: My impression is that the uncertainty lies on the Revenue side, not on
the public spending side, and I am afraid it is not just the odd two or three
billion pounds that we are looking at.
If you just look at the revisions to the Treasury's forecast for the
outgoing financial year‑‑‑
Q56 Mr Mudie: You have got your second wind, have you not? You have been thinking about this?
Professor Spencer: ---the numbers are much bigger. The
revisions over the last three years to this current year's forecast that the
Treasury is making for the current balance add up to £25 billion. That is where the real uncertainty lies, not
so much on current spending.
Q57 Mr Beard: We are not going to do the projects we were intended to get?
Professor Spencer: That is true, but the orders of magnitude on investment are much
smaller than on current spending, and those uncertainties on current spending
again are an order of magnitude less than the uncertainties on tax revenue.
Q58 Mr Beard: This year the under spend 4.1 billion.
That is hardly petty cash.
Professor Spencer: I agree, but that is of the order of the under shoot in tax revenue, and
if you go back a few years the revisions to revenue have been much bigger.
Chairman: For George's information,
the total stock of end-year flexibility carried over to 2004/5 was £11.4 billion of which
nearly £9 billion was current spending.
Mr Mudie: That is interesting, is it
not, Mr Walton?
Chairman: I meant to close it down.
Mr Mudie: You
sound like Gordon!
Q59 Chairman:
Before we go on to the micro‑parts
of the Budget, could each of you briefly indicate what you regard as the most
important non macro‑economic elements of the Budget? Was there anything significant you were
expecting or hoping to come up which did not?
Professor Spencer: I think the help to home owners was very real, and obviously, coming
from Northern Britain, I can hear that from people that I speak to. It is just a pity that the help for
regeneration in urban areas was withdrawn at the same time.
Mr Weale: I
suppose, no, again I worry more about what was not done and said rather than
what was done and said, that the extension of the higher limit on ISAs is
valuable, but I do think the need for the Chancellor to take a coherent overall
look at saving in the country grows stronger by the day, and it is not
there. I also think that, there is
really a major need for a substantial review of the taxation of land and
property in the country. Maybe these
things will come up after the election, but the Budget struck me as one which
was tinkering here and there rather than addressing these sorts of key micro‑economic
issues.
Mr Chote: I have
to say on the overall balance of the Budget, given what we have said about the
structural position and what has been the character of previous pre‑election
budgets, overall it was commendably restrained in the balance between give away
and take away. Clearly the stamp duty
issue is an interesting one. I think
one question though is whether this actually helps first‑time buyers or
does it help the people who already own houses in that tax bracket if it gets
incorporated in the house price. The
tax avoidance issues, others will be more expert on whether these will deliver
the amounts of money that are claimed for them, but I think there is the
interesting accounting issue, that if we are going to claim the benefit or
claim the results of tax avoidance measures as being a fiscal tightening,
effectively, we should have a clear idea of what the Government thinks the on‑going
losses for tax avoidance are in terms of the tax revenue so we know how fast
they have to run to stand still.
Obviously, in terms of the distribution impact, the one‑off
pensioner measure was very interesting.
I merely note that we seem to have rather a lot of one‑off
measures year after year and eventually a lot of one‑off measures become
a large stream of spending on pensioners which may or may not be a good idea.
Mr Walton: I do not
think there was anything too surprising in the Budget. The one thing that I thought was quite
interesting that we have not talked about is just the stuff on productivity and
the narrowing in the gap that has been taking place in recent years ‑
there is a chart on page 43 ‑ so, for instance, output per worker versus Germany, it appears the UK is now
more productive than Germany, which was not the case a few years ago. We have narrowed the gap by ten percentage
points versus France in the past ten
years or so and even versus the US the gap has narrowed a bit. Whether this is due to the Government, I am
not going to say it is, I do not know the answer to that, but it is interesting
that the actual productivity performance of the UK has been improving on a
relative basis over the past decade.
Q60 Chairman: One thing we noticed as a committee is that the Budget has few measures
in the directorate in encouraging more business investment, given the need to
rise to the productivity challenge, I wondered if that was a significant
omission?
Mr Walton: Again,
it is difficult to know, but clearly the Chancellor has not had that much room
for manoeuvre at this time, and so I guess it is not that unreasonable to think
that this close to an election his interests were simply elsewhere.
Mr Whiting: Just to reiterate two points I think have
been discussed before, I would have liked to have seen more in the Budget on
Europe and an acknowledgement that the impact of the European Court of Justice
decisions are being considered. Also
more drive and orientation towards making sure the UK's competitive position is
maintained. I would echo the points
already made on Stamp Duty, and I would point to the North Sea measure, which
sounds as if it was a nice easy measure.
It does arouse some concern as to whether this impacts the viability of
some marginal North Sea fields.
Q61 Chairman: On the issue of savings, apart from the announcement that ISA limits
would not be reduced, there does not seem to be any other initiatives to
promote individual savings. The result
of the consultation process on the proposed changes to taxation of life
insurance companies has now been announced.
Maybe I have been quoted as saying that this proposal would represent a
significant extra charge on the policy holders and contradict the government's
desire to encourage more saving. The
Inland Revenue have been quoted as saying that they are trying to find the
appropriate tax rate for income that is not needed to pay policy holders. I turn to you, John, and ask if you can shed
any light on that for us?
Mr Whiting: It is a difficult area. There
is undoubtedly a change of policy here.
You recall that we touched on this when we were talking about pre-Budget
report. Subsequent to that there has
been quite good discussion between the Inland Revenue and the industry and some
movement has taken place. I think at
the end of the day naturally the companies would rather things were left as
they were because that leaves more money in their hands, money that is not
fully allocated. I think one of the
remaining concerns is that there is still a determination to extract that money
as of 1 January this year, which is seen as a little unfair. Inevitably taxation is all about discussion
and trying to get to about the right answer.
There is still a feeling that the Revenue is still trying to take a
little too much but a recognition probably that something is going to
change. I would hope that the
discussion continues and that maybe somehow there can be a reasonable meeting
of minds. I would also mention the
power that seems to be within the insurance company changes for the Inland
Revenue, or more correctly the Treasury, to make quite a dramatic impact on the
insurance company tax system by way of statutory instrument. The industry is a little concerned about how
that might be used in the future as well.
Q62 Chairman: On protecting tax revenue, the Budget documents give figures for
estimated exchequer yields for individual tax protection measures, and the
estimates over the last three budgets show broadly a rising trend. Is there any medium term strategy in this
area? Can the yield from tax protection
measures continue to increase in future years.
Mr Whiting: There is always going to be a yield from tax protection measures. The amounts that are quoted in the red book
this time seem to be quite significant, and one does begin to wonder if they
can all be delivered. Indeed, some of
them show some very large figures, some of them, for example the changes on
private equity financing, are very small, so there is a bit of a mix here, and one
wonders how robust those figures are and how they are, indeed, measured.
Q63 Chairman: A number of the measures announced relate to international issues such
as place of domicile or business. Can
anyone shed any light on what is the long‑term trend here. Given international obligations and
competitions is this an area in which the UK are likely to be fighting a losing
battle, or, indeed, any other government?
Mr Whiting: All governments around the world are trying
to make sure they increase their share of the international tax cake. There are fights all around the world about
it. The UK is certainly trying to
police its revenues at the moment; the US is as well, although in different
ways. I think we just have to
acknowledge that this is an area where one can see continued pressure from
fiscal authorities around the world with continued attempts to try and take a
share. It does worry me that the UK is
trying to be a little stricter on UK based MNCs - multinational companies -
than it is perhaps on inward investment.
Again, I come back to a point I have made before, that I am just a
little concerned about the design and orientation of the whole UK tax system.
Q64 Mr
Beard: On the question of the change in stamp duty to help first-time
buyers, Kate Barker has argued that if you lower the price of owner-occupation
and more people come in to buy houses then the price is going to be pushed up
again. Do you agree with her?
Mr Weale: I think this is why there is
the question of who actually benefits from the reduction in the tax and why I
was saying earlier that it would be nice to have an overall strategy behind the
tax of land and property rather than the system that we have at the moment
where we have stamp duty because it was introduced, I think, in the 18th
century and so it is still there and it raises revenue. From an economist's point of view, although
perhaps not from a politician's, it would make a lot more sense to tax the use
of house and land than simply the sale and purchase of it.
Q65 Mr
Beard: You do think that house prices might rise as a result of this
change in the stamp duty?
Mr Weale: I do think that the benefit
may well accrue to the existing owners through an increase in prices, yes.
Q66 Chairman:
In
terms of the stamp duty and house prices, the IMF recently described the
possibility of a sharper than expected drop in house prices as "perhaps the
greater near term risk to the outlook".
In its discussion of the outlook for consumer demand, the Treasury does
not even mention the housing market, however elsewhere it talks of an "emerging
revival in sentiment in the housing market".
Is the Treasury being complacent about the domestic risk to growth from
the housing market?
Mr Weale: You always have risks to
growth from one thing or another. The
National Institute has said that there is a very significant risk of a 20-30%
reduction in real house prices over the next three to five years or so, so
there is the possibility that consumer growth will be considerably weaker than
the Treasury is projecting. If that
were to happen, of course, then the Bank of England would reduce interest rates
sharply and the overall impact would be considerably less than simply taking
the housing knock on its own. We have
to bear in mind that if things do turn out badly in that respect there are
offsetting adjustments that will happen.
Professor Spencer: There are worries about both
the housing market and the High Street.
You only have to look at the dip in retail sales, which form 40% of
total consumption, comparing the three months to February with the previous
three months. Again, apparently there is a housing glut emerging. I think that it is reasonable to suppose
when you look at the strength of the economy, when you look at very high levels
of employment and very low levels of interest rates, relatively speaking, it is
most likely that we will get through this without too much trouble in either
the housing market or the High Street.
Q67 Mr
Beard: I am surprised to hear you talk about a glut in housing because
that is the opposite of Kate Barker's analysis when she looked at the housing
position.
Professor Spencer: There is a fundamental
shortage. The underlying position is
one of a housing shortage and, of course, that in itself is a reason for
expecting house prices to hold up unless they are hit by a pretty large
employment shock or something like that.
What I am talking about is essentially the balance of supply and demand
as reported by Right Move, for example, which monitors around about 50% of
houses coming on to the market. Their
report this morning suggests that there is an emerging surplus of houses coming
on to the market this spring, but whether or not that is going to be a problem
is difficult to say.
Q68 Mr
Beard: She was talking about the same thing. She was saying that the reason for house price rises was there
are too few of them so it is the natural process of demand pushing prices up.
Professor Spencer: I think there is a bit of a
difference between the number of houses on the market at any one time, like
this spring, and the underlying balance of demand and supply. One is essentially a flow of houses coming
on to the market and ultimately being taken off the market as they are either
withdrawn or sold, and the other is the underlying stock of housing relative to
the population and the number of households.
Mr Walton: Can I add one thing really
to echo Martin's point which is that housing is just one bit of the
economy. The job of the Monetary Policy
Committee, in particular, is to look at overall aggregate demand. It may well be that if house prices fall
that will weaken consumer spending growth, but we have to remember that
investment spending is likely to be growing rapidly this year, Government
spending is still going to be growing quite rapidly, the drag on the economy
from the external sector is rather less now than it has been, and if those
other bits of the economy are doing well then generally you would expect the
consumer to do quite well, you would see employment growing and wages picking
up. It may well be that to stop the
economy overall from growing too rapidly, a modest decline in house prices may
be what is required to push the savings ratio up a little bit. You can argue it both ways: if it went too far then, as Martin said, the
Bank of England would react to that by cutting interest rates.
Q69 Chairman:
On
the tax revenues protecting them, are you aware of any studies of whether past
estimates for savings from tax protection measures have been accurate? For example, in the year just finishing
(2004-05), do you think the measures brought in in the Treasury 2003 Budget in
the preceding months achieved the £1.4 billion predicted by the Treasury
because Barclays Capital Budget Analysis tell us that they think the revenue
protection measures will bring in less revenue than the Treasury expects? Have you seen any of these schemes working?
Mr Whiting: I am not aware of any
studies that have tried to prove those figures one way or another; others may
be. In general, my observation is that
it is a very difficult thing to get at as to what is the actual yield of these
protection measures. This is not a
recent phenomenon. If we go back a few
years to when Ken Clarke was Chancellor and announced the Spend to Save
Initiative, a certain amount spent to raise such and such an amount, trying to
get at and prove that amount had been delivered proved enormously
difficult. To a degree it is an act of
faith, the monies just tend to get lost in the overall pot. It would be a very interesting thing to ask
the Treasury to try and monitor this in some way, I think we would all be quite
interested in it.
Q70 Chairman:
Have
most of the anti-avoidance measures announced since the new 2004 rules
(requiring disclosure of avoidance schemes) been as a result of those rules?
Mr Whiting: I would say the
majority. I do not think I would say
"most" by any means because there are some, particularly in this tranche, that
have been around for many, many years and are nothing new, particularly in the
international structuring area. Perhaps
it is around 50/50 and when you look to see that one of the anti-avoidance
measures which will bring in extra money is to do with policing red diesel more
carefully, the use of farmers' diesel for everyday use has been there for as long
as I can remember, you can say there is a mix of the old and the new. Yes, the disclosure regime has undoubtedly
had an influence on the measures that we have.
Q71 Chairman:
The
Government is now extending the disclosure obligation to cover stamp duty land
tax on commercial property. Do you know
why this was excluded from the original provisions? What has happened since last year to make inappropriate avoidance
in this area a problem?
Mr Whiting: I think there was an element
of starting with the main taxes - income tax, capital gains tax, corporation
tax - and provision was in the Finance Act for a number of other taxes,
including stamp duty land tax, including inheritance tax, so I suppose it is
just moving on . There may well be an
element of the Inland Revenue feeling that there is avoidance here and that it
needs more information. I think in
particular for stamp duty land tax, what you have is a very new tax, it is just
settling down, and therefore the Inland Revenue are probably just saying it is
now time to see what extra information we can get, so I think it is just a
natural evolution.
Q72 Chairman:
Is
creativity in the tax avoidance industry picking up again since you last gave
evidence to us on it or are there signs of a permanent change of approach?
Mr Whiting: I think there are definite
signs of a permanent change of approach, yes.
I would always say that people will look to minimise their tax bills
within the law, that is never going to change, but the way one looks at it has
changed and is changing. One of the
things we discussed last time, the threat of retrospective action, has had a
certain effect. I think it is becoming
clear in certain sectors of the avoidance industry that they do have to play
within slightly tighter rules than they have perhaps done in the past.
Q73 Chairman:
Since the PBR, the Treasury seems to have pulled forward slightly
its assessment of when the current cycle is likely to end from "early 2006" to
"around the end of 2005". Professor
Spencer, what has motivated that change?
Professor Spencer: There is actually a detailed
description, if I can find it, which I thought was quite plausible without
being able to remember exactly why that was.
It is in Part B.
Mr Walton: Paragraph B38.
Professor Spencer: It is saying that growth
over the second half of 2004, when we had that little dip, has been slightly
below the PBR projection and partially offsetting that cumulative growth over
previous years was a little bit higher.
They are just saying that the balance of those two forces may have
brought the end to the cycle forward a little, but it is hard to see if you
compare chart B3 with the previous one in the PBR.
Q74 Chairman:
Nobody wants to add to that?
Mr Walton: Only to say that there is as
much art as science in this. The IMF
and the Bank of England think the output gap essentially has been closed, the
Treasury think it is about 0.75 % of GDP.
Q75 Chairman:
I
will ask this last question and if we could have very quick answers, if you do
not mind. Business investment is recovering, but the recovery is subdued
relative to the previous cycles.
Indeed, the recent corporate reporting season appeared to see companies
opting to use recovering profits to pay higher dividends rather than invest
more in their businesses. Why do you think
companies are so reluctant to invest?
Mr Walton: This is a global phenomenon,
it is not just a UK issue. First of
all, a lot of investment took place in the second half of the 1990s and
subsequently there was a very sharp correction and it has taken time for
companies to become more confident again about investing. You can look everywhere and see that the
incentives to invest have increased sharply.
The return on capital has increased substantially relative to the cost
of capital and yet the response of investment pretty much everywhere has been
much weaker than you would have expected.
This is much more of an issue in the eurozone economy than it is in the
UK, but there is certainly a global story to this.
Professor Spencer: Having said that, the
downturn in business investment in the UK has been very modest compared to the
kind of downturn that we have seen in previous episodes. It is really only in the manufacturing
sector that there has been a significant fall in investment over the last few years. In that sense there is much less to make up
and presumably fewer opportunities for profitable investment going forward.
Chairman: Thank you very much for your
time, it has been very helpful. We now
come on to the Treasury officials.
Thank you.
Witnesses: Mr Jon Cunliffe, Managing Director,
Macroeconomic Policy and International Finance, Mr Dave Ramsden, Director, Tax and Budget, Mr Tony Orhnial, Director, Personal Tax and Welfare Reform, Ms Sarah Mullen, Director, Public
Spending, and Mr John Kingman, Director, Enterprise and
Growth Unit, HM Treasury, examined.
Q76 Chairman:
Mr
Cunliffe, welcome to you and your colleagues.
I believe you are hotfoot from the ECOFIN meeting on the Stability and
Growth Pact.
Mr Cunliffe: That is right, yes.
Q77 Chairman:
We
will maybe come on to that.
Mr Cunliffe: I bring news from the
battlefield.
Q78 Chairman:
Can
you introduce yourself and your colleagues for the shorthand writers, please.
Mr Cunliffe: On my right is Dave Ramsden,
the Director of Tax and Budget; on his right John Kingman, the Director of our
Enterprise and Growth Unit; on my left Sarah Mullen, the Director of Public
Spending; and on her left Mr Tony Orhnial, the new Director of Personal Tax and
Welfare Reform.
Q79 Chairman:
You
are all welcome. Can you update us on
whether there was a satisfactory agreement at that meeting today or does the
Chancellor want to tell us that tomorrow?
Mr Cunliffe: I think the Chancellor
probably will want to tell you that tomorrow.
Q80 Chairman:
Okay. What a lovely way to
say no. Some commentators complain
about the scale of the deterioration in the UK's fiscal position since 1999,
suggesting that it has been "bigger than that of any G7 country, other than the
US". By how much has the fiscal
stimulus which has been delivered over the past few years contributed to UK
growth?
Mr Cunliffe: I think I would say it has
contributed quite a considerable amount.
I think starting points matter and we went into the downturn of economic
activity led by the world downturn in 1999-2000 with a very strong position
because in the years 1997-2000 we had tightened fiscal policy by 4 percentage
points. Having gone into that period of
downturn and slower growth with a strong fiscal position, having tightened
fiscal policy in the upturn, we were able to have fiscal policy support
monetary policy in 2000, 2001 and 2002.
It is always difficult to be precise about these things but if you look
at what happened in some other countries that suffered the same downturn, the
fact that we were able to have fiscal policy support monetary policy during
that period contributed a lot to ensuring that the UK experienced no quarter of
negative growth and in terms of the impact on the economy we have come out of
that downturn relatively unscathed.
Q81 Mr
Beard: In the Budget you sound notably more confident about the global
outlook than you seemed to in the Pre-Budget Report saying that risks have
diminished because of increasing evidence that high oil prices reflect strong
demand. Even so, oil prices hit a new high
last week and there are growing market fears that the limited production
capacity could leave the market highly vulnerable to disruption. Is not any large surge in oil prices,
whatever the cause, going to be destabilising to the international position?
Mr Cunliffe: Clearly if you had a very
large surge that happened very suddenly, if you had a break in supply, some
incident that knocked out some of the world supply, that sort of risk,
yes. I think the point we were trying
to make was when the oil price is high because the world economy is growing
very strongly and demanding a lot of oil, a higher price will knock down some
of that demand but it is the strong oil demand that is causing the higher
price. When you get the sort of
oil-related problems we have had in the past where the higher price has been
driven by the supply side, it has knocked demand down when demand was
weak. We were not trying to be
complacent in that assessment of global risks, the point was simply that we
have lived with those higher oil prices going up and down - oil prices being
quite volatile - for just a little over a year and it has not caused the sorts
of problems that we had seen in the past.
The judgment was that this was more of a problem on the demand side;
energy intensity had gone down in the developed OECD economies: and even in the
emerging market economies, where you would expect to see a bigger effect that
there has been, a bigger impact because their energy intensity is higher, they
use more energy per unit of output, their debt positions and their foreign
currency reserves have been strong and they have not suffered quite as much as
you would have thought. It was really
looking at what had happened over the last year that made us review the risk of
prices remaining where they are now. With supply being tight, slight or
relatively small problems like a hurricane which take out a little bit of
supply for a while, or some problem in Nigeria, will cause the price to spike -
we will probably encounter more of that - but the world economy seems quite
robust by the evidence of the last year.
Q82 Mr
Beard: After the Pre-Budget Review you told us that the received wisdom
was that when a trade deficit gets above about 5% of GNP it has to
correct. But on Budget Day the US announced
record current account deficit for 2004 of 5.7% of GNP. Is enough being done internationally to
ensure the necessary corrections are being made in an orderly way?
Mr Cunliffe: The 5% figure is based on
IMF research which was done on what had happened in the past. I suppose they tried to look at the levels
at which that correction took place.
Alan Greenspan would say that the world has changed; the international
savings market has become deeper, has become more liquid; it is easier for
deficits to be financed. Nonetheless, I think the US current account deficit
heading or increasing past 5% is a concern.
I think internationally a lot has been done with the US in explaining to
them other people's perceptions of the problem - although, I have to say it is
a perception they share. Greenspan has
said that it is too high and it needs to come down over time and I think the US
Government have said the same thing. So
it is not as if this is a perception they are resisting; I think it is a
perception they share. They also share
the view in part that some of the problem is not on the current account but on
the capital account side, that there is not enough saving going on in the US
and that therefore over time they need to address that problem, in particular
through correcting their budget deficit.
So I think there is some US recognition of the issue.
Q83 Mr
Beard: In what way does the recognition amount to doing something about
it? How far can this go on before this
becomes the chief threat to international stability?
Mr Cunliffe: I think personally that the
most likely outcome is still that this corrects over time.
Q84 Mr
Beard: Corrects, but with what consequences?
Mr Cunliffe: As with all imbalances, if
it corrects slowly, then the US economy is able to adjust and the economies on
the other side of the imbalance are able to adjust. There is a chance - I think it is a minority chance - that you
get a very sharp correction and it all happens at once and then currencies are
affected and economies all around the world are affected. But I personally think that the majority
chance is that the Americans are taking some action; it is starting to
happen. The evidence I would give for that
is if you look at what has happened to the dollar over the last 18 months, it
has come down a long way. That has
caused difficulties for some economies: it has caused difficulties for Europe;
in Asia a number of countries have tried to maintain the value of their
currency against the dollar and that has caused them to build up big dollar
reserves. But we have had a very big
fall in the dollar without instability.
The markets have managed to accommodate it. There has not been a run on the dollar. It has not hit world growth in a material way. World growth is 5% for 2004, which is the
highest in 25/30 years. We have managed
to have a big change in the value of the dollar - which is part of the deficit
- without causing abrupt changes in economies.
I think the likelihood is that that will continue. In the US there were some signs until very
recently that their exports were starting to come back. Generally speaking, when your currency
depreciates your exports do come back, but it takes some time. There were some signs - although recent
evidence is much more mixed - that there was some cooling off on the import
side. But some of the correction has
taken place on the currency side and it has taken place without huge
instability. I do not think it is
unreasonable to think that that might continue.
Q85 Mr
Beard: The IMF recently described the possibility of a sharper than
expected drop in house prices as "perhaps the greatest near-term risk to the
outlook" - this is to the UK economy.
Do you agree with that?
Mr Cunliffe: There clearly is a risk to
the housing market both ways.
Q86 Mr
Beard: What do you mean by both ways?
Mr Cunliffe: House prices have stopped
growing at the very high rates - the 5% a month, 30% a year that they were at a
couple of years back, at the peak. I think they are now flat. It depends whether you take the Halifax or
the Nationwide - there are lots of different measures - but the overall picture
seems to be that house prices are pretty flat.
One school of thought is that they stay flat. One is that there is a downside risk, which is what the IMF
mentioned, and you get an abrupt fall in house prices. But I think there is also a risk that they
could start to move up again. The
housing market is quite a difficult thing to estimate. I think I would agree with the IMF in
part. If we had a very sudden movement
in house prices, of the sort we have seen in the past, would there be a risk to
the economy? It probably would not be
as big a risk as it has been in the past, because one thing we have seen over
the last house-price cycle is that the link between house price increases and
consumer spending is nowhere near as strong as it was in the past. The Bank of England have published material
on this. That relationship between
consumer spending, mortgages, equity withdrawal, house prices that drove a lot
of the UK cycles in the past, no longer seems as strong. Whether if you had a sharp fall in house
prices it would impact on consumption in the way it had in the past, I think is
a very open question. Personally I do
not think it would. There must come a
point at which a reduction in house prices impacts on the economy. I suppose the IMF quotation used is
relative: Is it the largest single risk?
I would say it is a risk. It is
a risk both ways: on the upside and the downside.
Q87 Mr
Beard: They are not mincing words.
They say, "it is the greatest near-term risk."
Mr Cunliffe: It may be one of the most
important single risks, but I am not sure I would have described it in quite
the same way.
Q88 Mr
Beard: The press have suggested that your projection for a decline in the
house price/earnings ratio implies that you are forecasting a small fall in
house prices in the future. Is that
correct?
Mr Cunliffe: I am grateful to you for
using the word "projection" because that is what it is. We do not forecast house prices; we do not
forecast earnings. Our forecast is a
formal document and a formal output which is the basis of the Budget and the
PBR. We do it twice a year. The projection that we published shows the
house price/earnings ratio going down, but of course there are two ends to
every ratio and that could easily be as much to do with house prices not
growing as quickly as earnings rather than house prices falling. I saw something in one of the papers last
week on this which looked to me to suggest quite a low earnings growth figure,
but, without knowing how they worked out from our ratio what would happen to
house prices, I do not know. I assume
they must have used quite a low earnings figure.
Q89 Mr
Beard: Kate Barker, who has gone into the housing position in some depth,
says, "Simply put, a change which increases demand for housing, such as a
beneficial shift in taxation which reduced the cost of owner-occupation, would
cause a jump in house prices to restore equilibrium in the market. What did your pre-Budget analysis suggest
would be the impact on prices, in that tier of the market, of the move to cut
stamp duty on houses under £120,000?
Mr Cunliffe: I do not think our analysis
is that that will have a material impact on house prices.
Q90 Mr
Beard: It will not have a material effect?
Mr Cunliffe: It would not have a large
material effect on house prices. I
think it is quite hard to say there is a one-to-one relationship between any
change in the tax structure and what happens to house prices. But also, as the Barker report a year ago
showed, house prices are driven by a number of things but primarily and
fundamentally they are being driven by an imbalance between supply and
demand.
Q91 Mr
Beard: That is not what she is saying.
She is saying that if through the changes in stamp duty the price goes
down, more buyers will pour into the market and house prices will go up.
Mr Cunliffe: Yes, but I guess the change
in stamp duty here would not be one to cause a huge impact on house
prices. The fundamental drivers of the
housing market are, if you like, basic supply and demand and the things that
drive it are more, to my mind, on the supply side. Obviously if you had a large
enough reduction in house prices, as a result of any change, more people would
be attracted. All other things being
equal, more people will be attracted back into the market, but there are lots
of other factors at work.
Q92 Mr
Beard: Your analysis suggests that house prices would go down on this
stamp duty change and stay down.
Mr Cunliffe: That the stamp duty price
would actually drive them down? I do
not know that we have done enormously detailed modelling on the housing market
because it is a very difficult thing to model, but I think our analysis is that
the effect on the housing market will not be strong.
Q93 Mr
Beard: If it is not strong, then it is not going to help first-time
buyers, is it?
Mr Cunliffe: It might help first-time
buyers come back into the market without having an effect on house prices all
the way up the housing market.
Q94 Mr
Walter: I have a question which relates to my constituency, which has
average earnings 15% below the national average. I looked at the local papers over the weekend and I could only find
three houses below £120,000. Have you
done any assessment on how many extra buyers would be attracted into the market
as a result of this move?
Mr Cunliffe: I think we have done some
analysis on how many buyers are likely to be affected by the change. It is quite difficult to work out how many
would be likely to come back into the market.
If I could turn to my colleague, Mr Ramsden.
Mr Ramsden: I am not wanting to play
pass the parcel, but Tony Orhnial may be able to add further. I think we are looking for 200,000 or
300,000 properties being taken out of stamp duty, of which a reasonable
proportion will be first-time buyers.
There is obviously quite a significant regional distribution to the
incidence of this. I am not sure which
region you live in -----
Q95 Mr
Walter: The South West.
Mr Ramsden: There may be some effect there,
but from what I recall of the analysis the highest incidence was some way from
London, up in the North, in terms of the beneficiaries of this change.
Mr Orhnial: Our analysis suggested about
300,000 transactions would be taken out of stamp duty, and about one-third of
those associated with first-time buyers.
Chairman: As Members of Parliament who have constituencies beyond the Watford
Gap, they will recollect you saying "somewhere up North".
Q96 Mr
Fallon: Could we now turn to public finances and the state of borrowing.
On your analysis you seem to have about £6 billion spare to meet the Golden
Rule if the cycle ends next year. How
does that £6 billion reserve compare with your average error in forecasting
borrowing over one year?
Mr Cunliffe: It is quite difficult to try
to compare those two things because I am not sure they are exactly the same.
Q97 Mr
Fallon: What is your average error at forecasting borrowing over one year?
Mr Cunliffe: The average error of
borrowing one year ahead I think is somewhere round about 1%.
Q98 Mr
Fallon: Which is how many billion?
Mr Cunliffe: I am sorry, how many billion
on what?
Q99 Mr
Fallon: Analysis we have had from the IFS is that your £6 billion margin
is around half the Treasury error at forecasting.
Mr Cunliffe: If I could just finish the
point I was making, we are actually forecasting the fiscal revenues and the
fiscal position on a case which is not our central case. So we have already forecast it on cautious
assumptions, the most important one of which is that we do not use our central
economic projection. Over the years
people have told us that our central economic projections are optimistic,
unlikely to be met - some of your witnesses have been quite strong on that -
but actually over the years they have tended to be met. But we have not forecast the public finances
on them, we have forecast the public finances on a more cautious assumption,
which is 0.25% GDP below that. There
are also a number of other cautious assumptions in the forecast. So to go from an average error which does
not take account of the fact that we already have caution in the picture, is
actually comparing two things which are not quite the same.
Q100 Mr Fallon: Okay, but £6 billion is pretty tight, and of
course you had not had the adjustment to roads maintenance it would have been
£3 billion, would it not? It would have
been half that. Could we just turn to
how you managed to get this adjustment by the ONS to spending on roads'
maintenance and repair. I do not know
if this is you, Mr Cunliffe. Whose
fingerprints are on this one?
Mr Cunliffe: It is a number of us who can
talk about it, certainly. The ONS
removed a double counting. That double
counting meant that the figures that we had calculated up to now had actually
scored the cost of roads maintenance twice, so the correction - and I will call
it a correction - I think is a fairly normal one. There are revisions that go on all the time one way and the other
in the public finances.
Q101 Mr Fallon: This was a revision of some magnitude which had
first been discussed back in 2002, and suddenly, magically, the answer pops out
three weeks before the end of the financial year and a couple of weeks before
the Budget. Was the Treasury involved
in this?
Mr Cunliffe: No. I mean the -----
Q102 Mr Fallon: They were not involved?
Mr Cunliffe: The Office for National
Statistics, the National Statistician, has said - I think on the record - that
it was his decision, that he made it, that the timetable was at his choosing.
When the ONS come across errors that need to be corrected - and this is an
error; this is not a revision of new data; this is double-counting brought
about by a strange amalgamation of two accounting systems - as I understand it,
their policy - but you would have to ask him - is to change it as quickly as
possible. But he has made quite clear
that it is his timing; it is his judgment; it is his decision.
Q103 Mr Fallon: So there was no Treasury role in this? There were no discussions through the
Treasury and the ONS?
Mr Cunliffe: This is his decision
entirely.
Q104 Mr Fallon: That is not what I asked you. Were there any discussions between the
Treasury and the ONS about this?
Mr Cunliffe: The roads maintenance
expenditure on which this change is based - and the expenditure figures on
public spending are of course fed by the Treasury into the ONS .... The ONS are commenting on figures which they
get from us. They get their revenue
figures from us and they get their expenditure figures - for central
government, not for -----
Q105 Mr Fallon: I know where the figures come from. I am asking you: Was there any discussion
between the Treasury and the ONS on this particular reclassification?
Mr Cunliffe: This was a decision, a
judgment, taken entirely by the ONS, for which they are entirely responsible.
Q106 Mr Fallon: But it was not discussed with you?
Mr Cunliffe: It was not discussed with
me, no.
Q107 Mr Fallon: With the Treasury?
Mr Cunliffe: I do not think the Treasury
had any part in the making of this decision.
Q108 Mr Fallon: Could I take you on to the reform of the
fiscal rules. You have said, I think,
that at one stage you will look at the fiscal framework. Are there any
particular candidates there for future improvement in the fiscal framework?
Mr Cunliffe: I think we said we would
keep the fiscal framework under review.
Q109 Mr Fallon: Yes.
Mr Cunliffe: That is a sort of continuous
review, but we have no plans to make any changes in it.
Q110 Mr Fallon: One of the suggestions made by this Committee
a couple of years ago and now by the IMF is that to increase transparency there
should be a link between the probability of meeting the Golden Rule and the
targeted current surplus by way of fan charts.
Is that something you have considered or are likely to consider?
Mr Cunliffe: The IMF produced a fan
chart, I think, some time ago, and I read the piece that they did on it, and I
think the National Institute also had a look at it. I know the concept from the Bank of England, which produces fan
charts. The answer to your first
question is that we have no plans to make any changes. But, on the concept itself, yes, it is one
with which we are familiar. There are
some difficulties with applying fan charts to fiscal policy, some of which have
been acknowledged by the IFS, some of which are acknowledged by the Congressional
Budget Office, which tried to do something like that. I can go into the technical issues if you wish.
Q111 Mr Fallon: In your reply to the IMF, you said that you
doubted whether a "probabilistic approach to fiscal policy" would improve
public understanding or confidence in the framework?
Mr Cunliffe: Yes.
Q112 Mr Fallon: But clearly the Bank are quite happy that it
improves transparency and public understanding of the inflation target?
Mr Cunliffe: There are a number of
different points here. The first point
is that if you want to use average errors and generate a fan chart in this way,
you have to make an assumption about the relevance of past errors to the
future. So you automatically run into
some issues about the sample period and how strong your error is and there is a
difference in the way that monetary policy statistics and fiscal statistics
work. The second issue you have to deal
with - and remember forecasts go over a number of years, so you produce them
five or six years out and the fan chart sort of widens out - is that when you
say a forecast was made in the year zero and the outcome, looking back at the
run of figures, was x % away five years later - in relation to your forecast
five years out - you have a big issue about how you deal with policy
changes. If at any time in those
intervening years policy was changed, how do you strip out the fact that the
forecast and the out-turn actually assume that nothing has happened in between
and that in fact you can have a policy change in between? The IFS acknowledge this is an issue. You also have a problem with stripping out
the economic cycle. If you use past
forecasts in those ways, when you have generated some sort of probabilistic
distribution, you the have to apply judgment to it. The Bank of England apply judgment to it. They set out how they do this in 1999. It is easy for them to apply a judgment
around it because they have nine voices on the Monetary Policy Committee, so
they can discuss it and have different views, but there is actually a
subjective judgment in there. It is not
a purely statistically driven thing at all.
You have problems with the sample period: How far back do you go? There were some major periods of volatility
in the British economy in the 70s, in the early 80s, some around the output gap
in the early 90s and mid 90s, which, you could say, with the Bank of England
operating the way it is, are unlikely to occur in the same way. When you use a past period for monetary
policy, you do not have some of those problems of regime shift. If you do what the National Institute did in
trying to get round these problems, by not assuming that the past is a guide to
the future, by doing random simulations.
They do thousands and thousands of random simulations and they see how
fiscal policy would respond, but they model those random simulations on shocks
which they think have occurred to the economy in the past and you have some of
the same problem again. Personally, I
am not convinced that a probabilistic method based on that is actually going to
give a better understanding of fiscal policy.
Of course, when the Bank of England do it, they have the other issue
which is that they meet every month, they can change policy very easily. There are costs if they get monetary policy
wrong, very major costs, but if they get policy wrong one way when they assess
the probabilities, they can readjust it the other way without too much of a
cost. And they can move policy up and
down fairly frequently if they feel the need and they can reverse their
decisions. Fiscal policy carries cost
because when you change expenditure decisions there can be big costs involved;
when you change tax decisions there are big distortions. And you cannot change it all the time. I think in the 60s and 70s there were some
parliamentary powers taken to allow the government to move certain taxes up and
down without consulting parliament, the so-called regulators. But that sort of power has not been used, so
far as I know, with any developed economy for 20 or 30 years. How you would fit a probabilistic system
like this onto fiscal policy decisions in the way we take them, I am not very
clear. We accept that there is
uncertainty. We use cautious
assumptions. We set out clearly what we
do and we say, for credibility reasons, "This is the rule and we will meet
it." I guess we could come to you and
say, "This is our fiscal outcome on our central projection of the
economy." We would not use the cautious
one of course. "This is our probability
based on the past of meeting it," but I suspect on fiscal policy there would be
much less tolerance for that sort of approach by the legislature than there is
of monetary policy.
Q113 Mr Fallon: This year you asked the Auditor General not to audit the trend
growth assumption. Why was that?
Mr Cunliffe: Because our view is that the
output gap will close around the end of this year. The best way to audit the trend growth assumption is to look at
how much growth there has been between two on trend points and work out what
trend growth has been. We will want
that assumption audited anyway once the cycle has closed, so it seems to make
more sense to wait until we have gone through an on trend point than to do it
now. If you were to do it now, growth
since our last on trend point has been 2.8% and our assumption is 2.5%. Growth in the last cycle, if you calculate
it between the two on trend points, was just over three. All of the evidence is on the high side of
where we are. We are coming up to an on
trend point and it seemed sensible to allow him to audit it when he had an
extra trend point on which to do the audit.
We did something similar on VAT and asked him to delay until we had
reached an evidential point a couple of years back.
Q114 Mr Beard: Does this vision of the cycle ending at the
end of this year mean that you and the Bank of England are converging because
the Bank of England have said that the gap had virtually closed during this
year?
Mr Cunliffe: The Bank of England do not
publish an output gap in the way that we publish one and they do not use it in
the same way that we use it. There is a
difference between monetary and fiscal policy.
The Bank in recent reports saw less spare capacity in the economy than
we do. The amounts are not hugely
different. We are showing an output gap
of about 0.7% of GDP. I do not know
exactly where they are but they may have the economy on trend. The IMF is somewhere between those two
points. The EC is a bit closer to
us. The output gap is something you
cannot observe directly and there is a range of views around where it is and
when it is going to close. Rather than
for me to comment on others, the easiest thing is for me to explain why we hold
the view that we hold.
Q115 Mr Beard: The Treasury is running a budget deficit at
the same time as the Bank of England is running a fairly tight monetary
policy. Are not the two pulling in
opposite directions?
Mr Cunliffe: The fiscal position is
tightening as the economy comes back to trend.
Monetary policy tries to look a couple of years ahead. The Bank of England tries to bring inflation
back to target over the normal operating range of monetary policy, which is
about two years. They are taking action
now to deal with the evolution of prices over the next year or two. We are projecting the fiscal stimulus to be
reduced going forward as the output gap closes. Those two things, to my mind, are quite consistent. If the economy were above trend, you would
expect to see us generating surpluses.
We are not projecting the economy to be above trend. We have a fairly stylised projection that
goes back to trend and stays flat and then we start to generate surpluses.
Q116 Mr Heathcoat-Amory: On receipts, the non-tax receipts are
expected to be about £1.5 billion lower than expected and the Budget report comments
that very little in year data is available in the public corporation sector
until final accounts are available after the end of the financial year. Can you tell us a bit more about these
public sector corporations, why their surpluses are unexpectedly low and why,
unlike ordinary corporations, they do not apparently produce interim accounts
which give you a better feel for what is happening?
Mr Cunliffe: I cannot answer the latter
question. There is a large number of
these corporations ranging from the very large to the very small. We do not know why their surpluses are below
the normal projections. The reason it
says what it says is because we do not know the answer to that. It is a picture made up of a large number of
individual components. There could be
offsets. One of the things that we
think is happening - this goes back to the highways change - is that some of
these public corporations are market but some are non-market like a sort of
highways agency, where they will have been credited with double the income for
roads maintenance, because we were scoring double the expenditure. This is a bit like government buying
services from National Health Service trusts.
You book it on both sides. In
the same way that we are now only scoring the depreciation once, this has
probably affected them by reducing some of their income. That is a proportion of the change but as to
why this myriad of organisations has produced this overall picture I am afraid
I cannot give you an answer.
Q117 Mr Heathcoat-Amory: Have we discovered a rather dusty corner of
the national accounts here that perhaps ought to be subjected to a few more
vigorous disciplines?
Mr Cunliffe: We will certainly have a lot
of interest when the accounts come in as to why this has happened. Whether that will lead to any changes in
future I do not know.
Q118 Mr Heathcoat-Amory: It is a concern given the size of the
undershoot in your revenues which you expect to carry forward to subsequent
years, so we are not talking about pennies here.
Mr Cunliffe: We have knocked some of that
through. Whether we were right to take
as much through the future years as we have done, I do not know the answer to
that yet. Some of these figures are a bit volatile because the accounts are not
in. They are often subject to quite
major revisions as well.
Q119 Mr Heathcoat-Amory: Can I turn to the big tax figures? You were expecting another big increase in
tax receipts next year. Indeed, over
8%. Are you still calling this a
cautious estimate? Our witnesses
earlier on today expressed considerable scepticism about this and I would like
to probe your assumptions on this.
Mr Cunliffe: All of the public finance
projections are cautious in the sense that we project them on a weaker economy
than is our central forecast. We use a
number of assumptions, both economic and others, which we have audited by the
NAO, which are designed to be cautious.
In that sense, all the tax forecasts are a cautious base but the
forecasts themselves are our best estimate of what we think will happen.
Q120 Mr Heathcoat-Amory: Can I be specific? Emboldened by your better than expected corporation tax receipts
- and I give you credit for that - you are expecting a 28% increase in revenue
next year. We know that there are some
very big vulnerabilities here in the legal sphere. The European Court of Justice is having a shot at this and there
are some important court cases pending which may further undermine our ability
to set autonomous tax policy in this area.
What have you built into your estimates on these court cases? What are you expecting there?
Mr Ramsden: I will come on to the court
cases in the ECJ in a moment, if I may.
As we set out in the Budget document, the forecast for overall taxes in
2005/6 is very little changed from PBR time.
You have drawn attention to one of the forecasts where we have revised
up our forecast, which was the CT forecast, but there are other forecasts where
we have revised down our forecast for
in year growth slightly, such as VAT.
These are our best estimates and we try to take account of the very
latest data. The CT forecast is very
important going forward because it contributes quite significantly to the rise
of over 8% in current receipts that we are forecasting for 2005/6. The kind of figures we are talking about, a
26.5% growth rate in non-North Sea corporation tax, and a 28% growth rate
overall, as we discussed with you at PBR time, are not unusual increases in
corporation tax at a time when both the economy overall is growing strongly,
when the financial sector is picking up very rapidly and when we are also
seeing considerable revenues from the North Sea. That financial sector effect also is beneficial to our income tax
forecast and enables our best estimate of income tax to be for significant
growth. As to the effect of the ECJ, as
we point out in the Budget document in chapter five, we are going to defend
robustly any challenges to UK law that come from the ECJ but at present what we
are talking about is potential future challenges. We see much discussion - I think you have discussed it in this
Committee - as to how these challenges might manifest themselves. We are not even at the stage of having an
Advocate General's opinion in some of the high profile ones, so we will have to
wait. Our forecast is rightly based on
recent trends and on the forecast of the underlying economy and what that
implies for future trends for CT. To
try to factor in some hypothetical amount for potential outcomes from ECJ
decisions when we have made very clear in the Budget document that we will
defend robustly the corporation tax system would be a difficult thing to do.
Q121 Mr Heathcoat-Amory: I am sure you will defend it brilliantly, but
this jurisdiction is in Luxembourg. You
seem to be saying that you are anticipating that we win all the cases. I am asking you whether you are building in
perhaps a more realistic assumption that we may win some but we will lose
others and there may be a degradation of our tax base. Are you taking an optimistic or a
pessimistic view there?
Mr Ramsden: We are not taking a
different view from the one we were taking at the time of the PBR. We are producing our best estimates of
forecasts. We have where possible taken
action to remove the uncertainty which was produced in the past by ECJ decisions. There were decisions that we took in April
2004 in terms of changes to corporation tax after the ECJ's decision on thin
capitalisation. There was a response
there but in terms of our forecasts going ahead it would be extremely
difficult. These are very non-linear
things. I am not quite sure how you
would do that through a fan chart or any of the ways of estimating uncertainty
that people come up with. You have to
produce your best estimate of the forecast and then recognise that there is an
ECJ process taking place, making very clear that we would robustly defend the
UK's corporation tax system.
Q122 Mr Heathcoat-Amory: Could I ask about another vulnerability which
is the entry into the EU of east European countries with low, sometimes flat,
corporation tax rates? Germany is
cutting its rate of corporation tax.
There could be another competition opening up here within the single
market. Given that the ratio of non-oil
tax revenues to GDP is going to hit an all time record next year, do you see
that we are vulnerable to migration of tax activity and do you factor that in?
Mr Ramsden: Can I start on the point
about CT because I think next year we are forecasting that non-North Sea CT as
a share of GDP will rise to 3.1%. It
has been higher than 3.1% in 10 of the last 20 years so I do not think that
counts as a record for non-North Sea CT as a %age of GDP. It is a significant increase over this year
and it is forecast to continue rising and to stabilise at 3.5% but even that
3.5% as we discussed with you at PBR time is below the kind of levels that were
reached in the late 1980s. I am using a
different denominator from you for this calculation. That is the share of non-North Sea CT as a %age of total
GDP. That is the equivalent of the
figures that we publish.
Q123 Mr Heathcoat-Amory: I am talking about all taxes here, not
corporation tax.
Mr Ramsden: You were talking about
corporation tax in the context of Germany lowering its corporation tax.
Q124 Mr Heathcoat-Amory: I have widened the debate a little. At least one of our expert witnesses said
that, excluding North Sea oil, which hit a record some decades ago, the rest of
the tax revenue as a %age of GDP was going to reach a record in this
country. We are increasing that burden
and a lot of other countries are reducing it.
I am putting it to you that this is going to create problems in an
increasingly globalised tax environment and I wonder if you factor this in when
you predict your tax revenues.
Mr Ramsden: We can certainly look at
what your expert came up with. The
figure that we have always published - and this is true of previous governments
as well I think - for net taxes and social security contributions as a %age of
GDP - we have a very long back run in table C24 - that series is not rising to
anything like a record level next year.
That series is rising to 37.3% on our forecast and it was closer to 40%
in previous periods. On the German
point, I know that the Germans are announcing that they are going to cut their
federal corporate tax rate from 25% to 19%.
That is an announcement that Chancellor Schroeder has made but you have
to remember in Germany that as well as a federal tax rate they have a
solidarity surcharge of 5.5% and state corporate taxes which range from 13% to
20%. The overall average German
corporate tax rate will be 32%, whereas the UK's main rate of corporation tax
is 30%. You have to bear that kind of
thing in mind rather than just picking out one change announced in one rate at
one period.
Mr Cunliffe: The detailed point is that
it is not just corporation tax rates; it is tax bases and the way it is
applied. One of the things we found out
when we started looking in Europe as to fair and unfair tax competition is that
sometimes the headline rate does not tell you very much about what is
happening. There is a shift going on in
the world economy generally. The
general point is that we have always said in Europe we are in favour of tax
competition. We have always made clear
that rather than a tax harmonisation approach we believe in tax competition,
because that is a way of allowing countries to compete, provided they compete
fairly - by competing fairly I mean you do not offer tax breaks for foreign
companies that are not available to your domestic companies. Tax competition is
one of the ways that countries compete.
Before investment decisions are made and before people decide to put
capital in one place or another, they look at a range of issues. Economies compete in that way for
international investment, not just on tax.
The UK had the highest number of FDI projects last year on the normal
survey and the UNCTAD figures suggest that FDI is growing again to make us the
leading recipient in Europe. Our stock
of FDI is very high. Some of that is
tax. If some countries want to run a
very low tax, very low spend economy, provided they do it in a fair way, that
is competition one has to live with.
There are also high tax economies -
Sweden comes to mind - that are very successful in attracting certain
sorts of investment. One has to broaden
this out from the tax question and say where, when there is a secular shift in
global production, will the UK's comparative advantage lie and how do we
maximise that. Tax will be an element
of that but it is only one element.
Mr Heathcoat-Amory: Can I clear up this issue
with Mr Ramsden? I am looking at a
table here from the pre-budget report which is headed "Net Tax and NICs as a
share of GDP." It quite clearly shows
that for the non-North Sea sector next year will be an all time record. This is your table, B14 and B26.
Chairman: This is from Peter Spencer's
evidence.
Q125 Mr Heathcoat-Amory: It is a Treasury table. We must get to the bottom of the fact here.
Mr Ramsden: I am very happy to report
back to the Committee to get to the bottom of whatever Peter Spencer has
provided you with.
Q126 Mr Heathcoat-Amory: It is not Peter Spencer. It comes from the Treasury. It is one of your tables. It is slightly alarming that you come here
saying it has been exceeded many times in the past when your table quite
clearly shows it has not.
Mr Ramsden: Which table?
Mr Heathcoat-Amory: The source is the PBR,
tables B14 and B26, Inland Revenue statistics.
This is our report but we did not make this chart up. It comes from you. The non-North Sea sector is predicted to be a record.
Q127 Chairman: It is Peter Spencer's chart but your data.
Mr Ramsden: Which page of your report?
Q128 Chairman: It is just coming to you. Evidence 82.
Mr Ramsden: It looks to me as if he has
derived the non-North Sea series from what he says are PBR data so we will
check on that derivation as quickly as we possibly can.
Q129 Mr Heathcoat-Amory: Assuming that is right, we all know that
things like the quality of our golf courses is a factor in attracting Japanese
investment but tax is tremendously important and that was emphasised by our
witnesses again. Whichever way you look
at it, we are becoming a high tax jurisdiction here as a %age of GDP. This is, according to our witnesses,
beginning to have a deterrent effect in investment decisions being made at the
minute on the basis of these projections.
To what extent do you factor in or attempt to calculate the possible
damage to the economy and to future revenues of highly mobile tax investment
decisions being made to the detriment of the United Kingdom in view of this
rising trend which, to some extent, conflicts with what other countries are
doing?
Mr Cunliffe: Of the EU countries, our
nearest geographical competitors, we are one of the lowest in tax GDP share and
one of the lowest in corporation tax.
My guess is it is taxes on capital that matter here, not overall
tax. Secondly, you have to look at all
the things in the equation. The thing I
hear most of all about London - I apologise in advance for a southern
orientated view - is about investment in London and the south-east into
transport infrastructure. One hears
that in other major conurbations and that is also very important to investment
coming in. You hear also that the
education system is extremely important.
It is difficult to look at just the tax side of the equation. Our tax GDP share is fairly low in relation
to our European partners. The US is
more difficult because you have state taxes to add on to federal taxes. It is certainly lower in most of the Eastern
Europeans, I will grant you that, but you have at the same time to say: what is that tax financing? Is it financing the sorts of things that
might actually make internationally mobile companies want to come to the
UK? Is it financing public infra structure? Is it financing education? Is it financing the things that actually
allow you to compete? Otherwise you
might decide the best thing to do would be to reduce taxes to the absolute
minimum, but then, of course, you would have to do something on the other side
of the account.
Q130 Mr Mudie: Your DEL expenditure, current expenditure, was two billion over the
figure you gave us at pre Budget time only three months ago. We will forgive you for that, but what could
we say.
Ms Cunliffe: Three months and one week, I think.
Q131 Mr Mudie: There is some suggestion that you have been leaning on departments over
their spending of end of year money so that that did not rise higher. Is there any truth in this?
Ms Mullen: I will
answer that.
Q132 Mr Mudie: Is this what you came here to answer, Jon?
Ms Cunliffe: No. I will give you a general
answer, if you like.
Ms Mullen: Just to
explain the estimates that we now have in the Budget and the increase since the
PBR, 340 million of that increase was an increased allocation to the special
reserve to meet our costs for Iraq and other international obligations. The remaining 1.7 billion was consumption of
EYF stocks by departments, and this is a result of the system we have in place
which allows departments to draw down that EYF and retain it going
forward. What has been happening
historically is that, in fact, although departments have drawn down significant
stocks of EYF at winter and spring supplementaries, the out‑turn data has
shown that departments have under spent against their DEL allocations. This year in the Budget we are making an
estimate that there will be an increase in DEL and some consumption of EYF, but
obviously we will not have the out‑turn figures until the out‑turn
white paper in July.
Q133 Mr Mudie: That was one of my questions, what international commitments there
were, because I could not find them reflected in any departmental
spending. Where would I pick up that
figure in a departmental figure?
Ms Mullen: In terms
of money that is then allocated from the special reserve to departments, are
you saying?
Q134 Mr Mudie: Yes.
Ms Mullen: It will
appear in potentially a number of different departments, DEL lines, obviously
MOD, but also some others.
Q135 Mr Mudie: Is the total explanation for that international commitments?
Ms Mullen: It
covers costs in Iraq plus other international obligations, like Afghanistan, I
believe.
Q136 Mr Mudie: What has Iraq now come out at?
What are we spending extra in Iraq?
Ms Mullen: Let me
see if I have got the actual figure for that.
I understand that the out‑turn figure for MOD has been 843 million
in 2002/3 and 1,311 million in 2003/4, and our anticipated out‑turn this
year is about 950 million. That covers
resource and capital costs - the special reserve covers resource
costs ‑ but again we will not know the out‑turn until July.
Q137 Mr Mudie: Apart from your first figure, the big one, I am not sure I see those
figures reflected in the defence budget either as capital or revenue. Should I, or have there been other savings
that mask the fact they are spending more in Iraq?
Ms Mullen: We do
not give a detailed break down of MOD's DEL, if that is what you mean.
Q138 Mr Mudie: No, I am just looking at the figure along
three years. If you put additional
money in it should show.
Ms Mullen: It may
be there have been some offsetting changes, but they should appear in the MOD
DEL line, I believe.
Q139 Mr Mudie: That detailed technical explanation, wonderful as it was, takes me off
my starting point, which is on good authority from none other than the Daily
Telegraph, March 14, that you are leaning heavily on some of our defence
officials not to spend money. Is there
any truth in this, Mr Cunliffe? I
cannot believe it.
Mr Cunliffe: I do not think that is true. I
do not think the Treasury ever leans on any department not to spend money. It is a myth. Certainly, but more seriously, I think we have an end year
flexibility system that has been running for a number of years. Personally, I think it is a good system
because it has enabled departments to‑‑‑
Q140 Mr Mudie: Is it for both capital and revenue - current and capital - or is it
just capital?
Mr Cunliffe: No, they can use it for capital and revenue.
Ms Mullen: The two
are separate.
Q141 Mr Mudie: I understand the two are separate, but there was a reference here to
saying you allow capital and I wondered if current was not, but carry on?
Mr Cunliffe: The pattern up to now, as my colleague has said, has been for
departments to under spend. It has also
been for departments to draw down EYF in the winter and the spring and then to
return it. That is on average. Some departments have used it; others have
cautiously drawn it down.
Q142 Mr Mudie: I am sorry; Ms Mullen was speaking about this. What do these initials stand for?
Mr Cunliffe: End Year flexibility. I
apologise.
Q143 Mr Mudie: So they draw it down?
Mr Cunliffe: They draw it down because they think they are going to need because
they do not want to over spend, so they need to draw it down, and they are
allowed to draw it down ‑ Parliament approves it ‑ and
then it turns out that they do not need it, some of them, and they pay it back
again. Some do and some use it. As a way of stopping those end-year surges in
expenditure which are bad for value for money and which the Treasury always
used to get concerned about, it has been quite a powerful way of doing
that. This year, for the first time,
more of them on average, because it is an average, have done that. As that situation started emerging...
Q144 Mr Mudie: What did you do?
Mr Cunliffe: We obviously started, because one gets reports in, we need to know
where we are at the end of the year, so if the situation was going to be
different to previous years, we obviously wanted to know what their plans were,
not just what their draw down was because you can see that in the parliamentary
draw down, but how many of them are going to return it and how many of them are
going to spend it. There was a lot of
discussion with departments about, "This year are you going to spend it?", and
in the end the sum of that was that some departments said yes.
Q145 Mr Mudie: Is that the context of the discussions? Is the context of the discussions, "Are you going to spend
it?" with heavy overtones that, "If you are, we do not want you to
spend it"?
Mr Cunliffe: By the time these end-year discussions took place, if they needed it
they had to spend it: because had they not spent it, had they not drawn it
down ‑ and they are entitled to draw it down and spend it ‑
they would have over spent. So there was no sense that you cannot spend it.
Q146 Mr Mudie: Mr Cunliffe, thanks to the technical brilliance of our Chairman, we
know that this end of year spending - current spending - is something in the
region of £9 billon. Can you afford to
have all £9 billon drawn down? You must
impose some limits on them, must you not?
Mr Cunliffe: The stock is about £8 or £9 billion, I think.
Ms Mullen: At the
beginning of 2004/5 the stock was 8.8, I believe. We obviously will not know how much of that stock has been used,
but‑‑‑
Q147 Mr Mudie: That is big enough, though is it not?
Ms Mullen: ‑‑‑historically
departments have added to the stock rather than taken away from it, and we have
no reason to believe that there will be significant consumption of that stock.
Q148 Mr Mudie: No, but it is a pretty recent policy introduced recently, not recently,
but in this administration's lifetime, of allowing end of year flexibility.
Mr Cunliffe: Yes.
Q149 Mr Mudie: So the 8.8 has been built up over that period of time. Are you rationing the ability of departments
to spend that, and, if you say "No" to me, what happens if
departments decided to spend it in one splurge? What would happen to the Golden Rule this year? Take the two questions first. Are you rationing them per year?
Mr Cunliffe: We do not ration them in the way they spend it. They have to explain what they want to use
it for, they have to come to Parliament, et
cetera, but it is not‑‑‑
Q150 Mr Mudie: So if education, social services and health came this year and had
said, "Look, there is an election coming. There is some question that other parties might want to cut public
expenditure. We had better get this
money spent", you would have just allowed them to spend that 8.8 billion
in this financial year?
Mr Cunliffe: But actually they do not do that.
What they do is they have three‑year expenditure plans, they have
programmes. This change went along with
trying to make the whole public expenditure system‑‑‑
Q151 Mr Mudie: No, what you said is that this 8.8 billion that is stored up, deferred
spending, is extra to the three‑year public expenditure?
Mr Cunliffe: No.
Q152 Mr Mudie: So they cannot spend it?
Mr Cunliffe: No, I am not saying that. What
I am saying is that if you look at how departments spend, what they spend on,
they have programmes. They do not suddenly
run in at the end of the year and say, "We want to spend X". But the
other thing, which I think the system has proved pretty much, is that‑‑‑
Q153 Mr Mudie: Jon, when you say that, though, take education, education will have
built up in those figures a good proportion of that 8.8 billion. If education wished to spend that money in
any given year, is it negotiated with you or do they have the permission to
spend it automatically?
Mr Cunliffe: As I said, they have to discuss it with us; they have to discuss it
with Parliament. With all the
incentives in the system, all of the history and the evidence is that actually
what they do is they use it sometimes to smooth out, and this seems to me what
they have done this year, but they tend to accumulate it because they like to
be in control, and, if you like, it goes the other way but it builds up. This hypothetical case of them all deciding
in February that they all have something they want to buy urgently I think is theoretical,
but it is not real.
Q154 Mr Mudie: There is no truth in the rumour that the Treasury are stopping
departments such as defence spending some of this brass to keep the expenditure
level down?
Ms Mullen: No.
Q155 Mr Mudie: That is reassuring. There is a
reference in here to some of this money moving from health's DEL to the AME for
foundation hospitals. What is this all
about? Why are you raiding the
mainstream budget for these foundation hospitals?
Ms Mullen: I do not think the change has any impact on
the fiscal aggregates. It is just a classification
change, I understand.
Q156 Mr Mudie: Could you give us a note about that?
Ms Mullen: Yes.
Q157 Mr Mudie: There is some wording in paragraph C63 that I would like to clear with
you. Maybe it is just written as it
should be, but it says something like, "Net payment to the EU were higher
than expected payments in 2004/5, being offset by lower expected payments in
2005/6". That could read one way
or it could read another way. The other
way is you have been hit by higher than expected payments this year to the EU‑‑‑. Let me put it a different way. Are you guaranteed to get those back in the
next financial year? Is that what this
means?
Mr Cunliffe: Pretty much. There are two
things happening here. One is the EU
operate on a calendar year basis, not a fiscal year basis, and they are able to
call forward some of the assessed contributions in the first quarter of the
year, which is the last quarter of our year, so there is some calling forward,
but that will be offset from the future.
The second thing that happens is that we pay out structural funds and
they pay us back. The time lag between
those two things happening‑‑‑
Q158 Mr Mudie: So the figures are not, "We have spent more this year than we
expected"?
Mr Cunliffe: No, it is the timing. I think there is something in C77 also about
this.
Q159 Mr Mudie: The last thing is under spending by departments on capital. The last three years, our brief says, you
have under spent to the tune of £10 billion.
In view of the fact that public expenditure is very important to make up
the shortfall from previous years, what action are you taking to do something
about this and who are the major culprits?
Ms Mullen: Our
estimated out‑turn in the Budget is now 18.3 billion. That figure is still 20% higher in real terms
than the figure for 2003/4 and I believe it is the highest real figures for net
investment going back some time to the mid seventies. There are two things going on, I think, firstly, central
government. Historically we have been
reasonably good at meeting our forecast on central government. This year we have been slightly less good,
and the reason for that is that we have not actually allocated the capital
reserve. We also have a capital reserve
as well as a resource reserve and we have not allocated that this year. That is the reason why central government
investment is coming below where we were expecting it to be at the PBR,
although I think it is still broadly in line with where we were at the last
budget. The other factor is local
authorities and public corporations which, of course, are subject to more
devolved decisions, and, in fact, they make their decisions on the basis of
what they think makes sense from a value for money point of view. On the local authority side, apparently
asset sales have been financing quite a lot of their activity and net
investment is net of asset sales. That
is why the public sector net investment figures for local authorities is lower
than expected, because they have sold more of their assets than expected which
has been financing the activity.
Angela Eagle: How much extra has been
spent on pensioners since 1997 by government changes?
Q160 Mr Mudie: If you cannot answer, the Chancellor will answer cheerfully tomorrow?
Mr Orhnial: Certainly in this budget the measure that we are putting in as a
council tax refund is 800 million. They
stack up on top of what was in the PBR, which was another 250 million, so the
numbers are indeed large. I cannot
supply it for you right now.
Mr Cunliffe: The figure of 11 billion a year.
You want the total?
Angela Eagle: Eleven billion a year?
Q161 Chairman: We are getting it.
Mr Orhnial: At paragraph 5.69 of Chapter five as a result of measures implemented
since 1997, 11 billion a year more on pensioners.
Q162 Angela Eagle: That would be eight billion a year more than if it had simply been
spent by linking the basic state pension to earnings?
Mr Orhnial: Yes.
Q163 Angela Eagle: Can you tell me how you are going to work the free bus‑pass for
pensioners throughout the country; particularly also how you will treat those
authorities that currently already offer that?
Are you going to refund money?
Ms Mullen: What was
announced was that the statutory requirement will increase from 50%, which is
what we assume in our allocation to local authorities, to 100% funding. Under the new burdens principle we will be
funding all local authorities for the increase from 50% to 100%.
Q164 Angela Eagle: So those authorities that currently provide a full bus‑bass, and
there are some, will get a rebate from central government to pay for 50% of
that?
Ms Mullen: They
will. We have done it that way because
of the new burdens policy and also because it would not be fair to penalise
those local authorities that have‑‑‑
Q165 Angela Eagle: Sure. My authority is such an
authority, so I am not particularly interested in your reply. Can you tell me how many people are
currently accruing entitlement to the second state pension and how much that is
costing?
Mr Orhnial: I do not have that number to hand.
Q166 Angela Eagle: Perhaps you would write to us about that?
Mr Orhnial: I will.
Q167 Angela Eagle: Not everybody knows about the second state pension, but it is quite a
significant issue. I also saw from the
announcements in the Budget that the free bus‑pass is going to apply to
some two million people with disabilities.
Can anyone enlighten me as to how those two million will qualify, who
they will be?
Ms Mullen: I do not
know the answer to that. I do not know
if anyone else does. We can send you a
note on exactly how that is going to be implemented.
Q168 Angela Eagle: In terms of the work towards ensuring that child poverty is reduced to
meet the government's target, can somebody explain to me what progress has been
made there and what, if any, policies there are in the Budget announcements
that help us make that target?
Mr Orhnial: As you know, I think, we are on target to meet our current PSA of
cutting the child poverty numbers by a quarter. Since then, in the Budget last week the Chancellor announced that
we would be up-rating the child elements of the child tax credit by earnings
until 2007/8. We are also working as a
result of the Child Poverty Review last year with a number of departments to
try to improve on some of the measures on material deprivation that form part
of our three‑tier target.
Q169 Angela Eagle: So there will be more policy announcements on that in due course. There are working parties going on?
Mr Orhnial: I would expect more policy announcements as we go through to 2009, 2010
in order to keep on track for that, but our quarter way target is set, or we
are set to meet that, and independent commentators are also satisfied as far as
that is concerned.
Q170 Angela Eagle: In terms of the announcements on having children's centres in every
community, can you tell us what monies have been laid aside in this budget to
expand the Sure Start scheme and create more children's centres in local
communities to give children a better start in life?
Mr Orhnial: We are set to reach a figure of 1.8 billion in 2007/8 devoted to Sure
Start childcare and early years, but the bulk of that was agreed in the
spending review last year. That is the
bulk of what we have.
Q171 Angela Eagle: Will that money pay for the expansion or is there extra money for the
expansion that the Chancellor announced?
Mr Orhnial: He has also announced an additional 35 million in 2006/7 and 2007/8 for
parenting and early learning which will help towards that.
Q172 Angela Eagle: Could I also ask briefly about what is happening in the labour market,
because there is disagreement between independent experts and Treasury
forecasts about how tight the labour market is? Many independent forecasters seem to think that the labour market
is basically so tight that we are risking wage inflation if we continue
creating employment, but the red book actually talks about creating another 5%
of people in employment, taking it from 74.9% to 80% of the working age
population. Clearly the Treasury and
the forecasts there are not so worried about a tight labour market, but can somebody
explain what the difference of approach is that is leading to this difference
of interpretation?
Mr Cunliffe: First upon the tightness of
the labour market, there is a range of evidence and some of it is mixed but I
would highlight a number of points.
Earnings growth is around 4.5% for the economy as a whole and I do not
think people could say where the sustainable rate, the rate at which inflation
would start increasing, occurs but it is probably above that rate. It has grown remarkably slowly over the last
couple of years. Going through that, if
you look at price inflation, that is remarkably low as well. If we had a really tight labour market you
might have expected to be seeing some of those pressures coming through in pay
growth. Unit costs for the last couple
of years have been a long way below the long run average when the economy is on
trend. That said, there are some areas
where recruitment difficulties are being faced and there are some firms
reporting capacity constraints but, of course, you will tend to find regional
pockets within the labour market and certain skills shortages in other
pockets. If you look at it from the
other end and say are there more hours in the economy to be worked - if we
assume we are going to have more people working are there more hours to be
worked - I remember I was asked this question about a year ago and I think I
said the Treasury's view was hours worked had declined in 2000-01 when the
economy grew more slowly. We knew that hours worked generally were declining,
that was a social trend, but we thought there were more spare hours in the
economy to come back. I know a number
of the other commentators said the trend in declining hours, the social change,
was more pronounced and the economy was tight as there were not more hours to
come back. In the last quarter or so,
and we covered this in the Red Book, hours have come back quite sharply but you
have not seen an increase in earnings, which is what you would expect if hours
were coming back, but that was because people are working more and more
overtime and the labour markets are very tight. Our overall view is that there is still a little bit of slack in
the labour market. The last point I
would mention is one that was covered in the PBR, we did not cover it in the
Red Book that rate of unemployment which is consistent with low inflation ----
Q173 Angela Eagle: The NAIRU?
Mr Cunliffe: The NAIRU, yes. You cannot observe it, you have to estimate
where it is. Clearly it has come down
in recent years but it may well be below the current rate of unemployment. If that is true then unemployment could come
down further without creating inflation.
In all our calculations of when the cycle ends and the output gap we
have not put that down, but there is a chance, and a number of commentators
have mentioned it, that actually the NAIRU is a bit lower. All of that suggests there is a bit more in
the labour market. You can read the figures
the other way but I would say looking on the pay unit cost hours data, I do not
see a very strong story for an extremely tight labour market. Could we increase labour force
participation? Yes.
Q174 Angela Eagle: You have said you are going to try by 5%.
Mr Cunliffe: Some of it is around
inactivity, some of it is around single parents. There is some evidence that what has happened to single parents
has increased participation and also the pilots on inactivity have reduced the
time that people spend on disability benefits and get them back into work more
quickly. I think there is some scope
there, yes.
Q175 Angela Eagle: Do you think these active labour market
policies are structurally bringing the NAIRU down?
Mr Cunliffe: Yes.
Q176 Angela Eagle: Do you think you have made a structural
change because of the active labour market policies and that future changes to
Incapacity Benefit and continuing work, for example, on the New Deals has got a
chance of bringing the so-called natural rate of unemployment down further?
Mr Cunliffe: Yes. If one assumes there is a stock of long-term
unemployed who stay in unemployment then the rate of unemployment that you
could sustain without inflation is the temporary one around that, but you have
got this stock that find it very difficult to get back into work. If you bring the stock of long-term unemployed
down then you ----
Q177 Angela Eagle: One final question which is on
productivity. There seems to have been
some kind of sea change in productivity and evidence of us catching our
competitors in terms of productivity gaps that have persisted for very, very
many years. Can you explain what you
think has been going on and how we can accelerate it further?
Mr Kingman: Certainly there has been
some very encouraging data over the years, both in terms of the UK performance
and in terms of narrowing the gaps. We
say in the document that the gap with France has narrowed from 22% in 1995 to
10% now; we have closed the gap with Germany; the gap with the US has
narrowed. We think it is too early to
say definitively, as it were, that we think something has changed in relation
to the UK's own performance, although, as we say in the document, the data on
performance between trend points is rather encouraging. In terms of what we think is necessary to
sustain it, I think the Budget itself set out some important measures and we
will be pursuing those.
Q178 Angela Eagle: On training and lifelong learning?
Mr Kingman: On training, on investment,
on enterprise, on competition and so on.
Angela Eagle: Thank you.
Q179 Mr Walter: I have got one question on savings. We have discussed in these sessions before
the whole question of ISAs and ISA limits and so on, but obviously there is a
reduced attractiveness of ISAs, particularly for standard rate taxpayers
because of the tax changes to the underlying funds. There was confirmation in the Budget that the ISA limits were not
to be reduced but some would say freezing them was a real terms decrease
anyway. I want to move on to a slightly
different point about savings because, according to an Inland Revenue document
that was issued on Budget Day, the tax rate on the income produced by orphan
assets - those are investments held in with-profits funds but not earmarked for
payment of policyholder bonuses - is to be brought into line with corporation
tax. This means that the tax paid on
those assets could rise from 20% to 30%.
The Norwich Union says the changes could drain its with-profits fund of
about £140 million over the next decade.
The Inland Revenue was adamant that it will only impact on life
assurance companies rather than on policyholders. Gary Withers, the Chief Executive of Norwich Union Life, said it
would fall squarely on the shoulders of policyholders because: "Under FSA rules
the assets of our with-profits fund are entirely separate to the assets of
Norwich Union as a corporation. This
tax change affects policyholders and not shareholders." It is not Norwich Union special pleading
because the ABI - the Association of British Insurers - has said: "This
proposal would represent a significant extra charge on with-profits policyholders...." These are exactly the same people who have
had problems with endowments, endowment mortgages and shortfalls on
returns. What can you say to reassure
these life assurance policyholders?
Mr Cunliffe: I think it might be best if
we gave you a note on that.
Chairman: I thought that was going to
be the answer.
Q180 Mr Fallon: On public service pensions, in the Pre-Budget
Report you reported the net figures on an FRS17 basis but in the Red Book at
page 260, in the Budget, you decided to report them on a national accounts
basis. Why?
Ms Mullen: This is table C11. In this table we are reporting on a national
accounts basis. The reason why is
because this table is about the fiscal position and the relevant presentation
for the fiscal position is national accounts.
Previously we had shown these figures on an FRS17 basis, which was in
accordance with GAAP. However, that
then involved a number of technical adjustments to the figures to get to the
right fiscal aggregates, so we are now presenting the figures on a national
accounts basis because this is a fiscal table.
The figures will still be set out on a GAAP FRS17 basis for scheme
accounts and they will also be set out on that basis in PESA, the Public
Expenditure Statistical Analysis document that will come out in April. For the purposes of this table we have
presented it on a national accounts basis.
Q181 Mr Fallon: That is rather misleading. The last time you officially estimated the
total amount of net unfunded public sector pension liability was back in March
2003 and that figure was £425 billion.
Consulting actuaries have recently estimated that has now risen to £690
billion. When will we see the official
figure updated?
Ms Mullen: I believe that figure may be
in PESA but I guess we can provide a note on ---
Q182 Mr Fallon: When will it be updated?
Ms Mullen: We can provide a note on
that. The figures that will appear in
scheme accounts will still be on an FRS17 basis.
Q183 Chairman: The Budget documents give figures for
estimated exchequer yields for individual tax protection measures. The estimates over the last three Budgets
show, broadly, a rising trend. Is there
a medium-term strategy in this area? Do
you expect to be able to continue increasing the yield from tax protection
measures in future years?
Mr Ramsden: I think it is fair to say
that having revenue protection measures has been a feature of Budgets and PBRs
through the years. What we have tried
to do over the last year in Treasury, and in Revenue and Customs as they are
brought together, is to take a more strategic approach to the issue of
avoidance. Alongside the work that
particularly Customs have done at the illegal end of the compliance spectrum on
evasion, which your Committee has recently published a very helpful report on,
if you look at what we have done over the past year on avoidance, a year ago we
introduced the disclosure rules which, as we said when we discussed this
before, were to take a more proactive approach. We then went further in a kind of second phase by taking an innovative
approach on employee remuneration at PBR and now in the Budget we have
introduced two targeted anti-avoidance rules on double taxation relief and
arbitrage. Whilst it does yield, all of
this activity is in the context of trying to think how we can stop being one
step behind the avoiders, can get more in real time with avoidance activity and
also take more account of the global trends that we are seeing in the economies
whereby avoidance pops up in different places and we need to respond to it. If you look at the billion or so that is
raised from anti-avoidance measures in the Budget in 2006-07 onwards, a lot of
it is either from the disclosure rules or from these new targeted
anti-avoidance rules. It is consistent
with the past in the sense that there are quite a lot of measures but I think
we would argue we are trying to take a more strategic approach.
Q184 Chairman: I hope you will act on our recommendation in
our excise duty fraud report and get your Customs personnel away from Hong Kong
up to Beijing. Are you going to do
that, Mr Cunliffe?
Mr Ramsden: I would say on that, the
evidence that you saw in China is a very interesting example. If cigarette fraud is becoming so prevalent
in China we need to look at how we can respond working with HMRC and trying to
be more proactive and being up with, if not ahead, of what the fraudsters or
the avoiders are up to.
Q185 Chairman: You should not need the Treasury Committee to
go out to China to give you that recommendation, that was what surprised us.
Mr Ramsden: Obviously the Government
will be responding to your recommendations in the normal course.
Q186 Chairman: It was very clear to us. Judging from the measures announced in this
and earlier Budgets, the emphasis in respect of direct taxes seems very much to
be on addressing tax avoidance rather than fraud. Is that correct?
Mr Ramsden: Certainly the measures that
we have introduced are principally on direct tax avoidance. It is easier with indirect taxes to know
when it is illegal and when it is fraudulent behaviour. Definitions differ as to what is avoidance
and what is fraud or worse. Principally
the measures are on direct tax, yes.
Q187 Chairman: The Government has accepted the
recommendations from the Better Regulation Task Force that it adopts the Dutch approach
of reducing the administrative burden of regulation and its cost by first
measuring the administrative burden and then setting a target to reduce
it. The target in the Netherlands is to
cut the administrative burden by 25% over four years. Is that the sort of figure that will be set for the UK? Are cuts of this magnitude feasible?
Mr Kingman: I do not think we have any
idea yet. The purpose of the BRTF
recommendation being in two stages is very much that we need to do the work
before we can establish the target.
There is some reason to believe that when they started down this road
the Dutch economy was more regulated than the UK economy is now, but we have an
open mind and the purpose of the work that the BRTF has recommended and we have
agreed to do is very much to establish what is feasible.
Q188 Chairman: Why have the Treasury taken the decision to
end the stamp duty exemption for commercial property in enterprise areas?
Mr Orhnial: This was introduced in 2001.
Q189 Chairman: We know that.
Mr Orhnial: It was one of those reliefs
that was time limited as a state aid and it was due to end in 2006. What is being done is to replace it with
some other measures that are rather more targeted and ---
Q190 Chairman: So it has not been very successful?
Mr Orhnial: Not at all, that is not the
reason, we have simply found other measures to replace those ones. The measure was going to die out in any
case.
Chairman: That does not seem a very
convincing answer to me.
Mr Mudie: What other measures have you
got? There is a fear now that we will
not get development in regeneration areas because you have stopped it and we
are not sure what you are replacing it with.
Chairman: Exactly. That is a good point and, if I may add to
it, during our inquiry into regional productivity we heard that this incentive
was poorly targeted and the definition of deprived areas included parts of
Holborn in Central London and Canary Wharf.
With hindsight, could that not have been targeted and done better?
Mr Mudie: East Leeds, Dumbarton,
Liverpool.
Q191 Chairman: Somewhere north of the Watford Gap.
Mr Kingman: Can I say something about
the measure that we are bringing in to replace it which is something we are
consulting on in this Budget: the Local Enterprise Growth Initiative Scheme. The proposition is that this should be
available to local authorities in Neighbourhood Renewal Fund areas which will
be particularly deprived. This is
something that we expect to be particularly geared to getting local authorities
with the most imaginative proposals for using this money to drive enterprise in
deprived areas. We think it will be
much better targeted. Also, we think
there are significant sums of money that we are putting on the table rising
from £50 million to £150 million.
Mr Mudie: With the greatest of
respect, the only difference is you have put a lot more money in and you have
mentioned targeting, but it could have been targeted in the first place. Any area indices will tell you where deprivation
is, we do not need one withdrawn and another Act of Parliament or whatever
coming through with a gap in between.
It was successful, maybe the targeting needed tightening up, but why the
hell withdraw that and not just tighten it up?
Q192 Chairman: As someone coming from north of the Watford
Gap, like a few of us here, was it not foreseeable all along that property
transactions, such as those we have seen involving the sale of offices occupied
by London investment banks and law firms, would benefit from that relief? It was a bit dumb in the first place, do you
not see that?
Mr Orhnial: One could not predict
precisely what ----
Q193 Chairman: We end up on another controversial note. On you go, just give us an answer.
Mr Orhnial: One could not predict
precisely what would be attracted by this particular relief but, as John and I
said earlier, we have replaced this with a more effective relief and in any
case it was about to expire.
Q194 Chairman: We are not convinced, is that correct? We ain't convinced. Maybe you will grow into the job as you come
before us more, Mr Orhnial. Best of
luck with that and give us a better answer tomorrow if you are here. Thank you very much, we look forward to
seeing you tomorrow.
Mr Cunliffe: Thank you very much,
Chairman, for putting this session back.
Chairman: No problem. Thank you.