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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 138-i House of COMMONS MINUTES OF EVIDENCE TAKEN BEFORE TREASURY COMMITTEE
Thursday 9 December 2004 MR ROBERT CHOTE, PROFESSOR PETER SPENCER, MR DAVID WALTON and MR MARTIN WEALE MR ROBERT CHOTE, MR JOHN WHITING and MR MARTIN WEALE Evidence heard in Public Questions 1 - 115
USE OF THE TRANSCRIPT
Oral Evidence Taken before the Treasury Committee on Thursday 9 December 2004 Members present Mr John McFall, in the Chair Mr Michael Fallon Mr Jim Cousins John Mann Mr James Plaskitt Angela Eagle Mr Robert Walter ________________ Memoranda submitted by Mr David Walton and Professor Peter Spencer
Examination of Witnesses
Witnesses: Mr Robert Chote, Institute for Fiscal Studies, Professor Peter Spencer, York University, Mr David Walton, Goldman Sachs, and Mr Martin Weale, National Institute of Economic & Social Research, examined. Q1 Chairman: Good morning. May I start this session by welcoming you and asking you to introduce yourselves for the shorthand writer, starting with Robert? Mr Chote: I am Robert Chote, Director of the Institute for Fiscal Studies. Professor Spencer: Peter Spencer from the University of York. Mr Walton: David Walton of Goldman Sachs. Mr Weale: Martin Weale from the National Institute of Economic & Social Research. Q2 Chairman: May I look at the UK economic outlook first in an international context. How does the UK's likely broad economic performance in terms of growth, inflation and unemployment over the next couple of years look relative to the rest of the G7? Mr Walton: I think it looks reasonably favourable. The UK economy seems to be reasonably close to trend. There are no great imbalances in the economy in contrast to economies like the United States. There seems to be a reasonable amount of momentum in domestic demand in contrast to the euro-zone area and there is a lot of flexibility as far as monetary policy is concerned with interest rates of 43/4 per cent. The Monetary Policy Committee is able to cut interest rates aggressively or raise interest rates aggressively as needs be depending on just how the economic environment unfolds and that is not a luxury available either to the US Federal Reserve or to the European Central Bank. So I would say that the prospects for continued and steady growth in the UK are actually pretty good relative to most other countries. Q3 Chairman: Even on relatively cautious UK growth forecasts, such as those from the OECD, the UK looks set to remain in the top half of the G7 growth table over the next couple of years. How unusual is that historically speaking? Mr Weale: Obviously it depends what period you look at. From about 1950 until about 1980 the United Kingdom was one of the poorest performing economies. In the 1980s we stopped growing more slowly than our major particularly European competitors and since the early Nineties we have tended to grow faster than our major European competitors. At the same time, of course, Japan was the star economy really from soon after the Second World War until about 1990 and now I think many of us look at Japan and think we are glad we do not have its economic problems. Q4 Chairman: Robert, does the UK's fiscal position look anomalous by the standards of other G7 countries? Mr Chote: No. In terms of the debt to GDP position, the UK is relatively in the middle of the league table as far as the older industrial countries are concerned. I think the contrast, if you wanted to say that we are very much out‑of‑sync, would be to look at countries like Australia and New Zealand, for example, where the debt to GDP position is much smaller, but by the standards of the G7 as a whole it would be hard to say that the UK is an outlier, although we tend to look less favourable compared to Anglo‑Saxon economies than to the Continental European ones. Q5 Chairman: What about the debate on other G7 countries, does that mirror the debate in this country? Mr Chote: Over the fiscal position? Q6 Chairman: Yes. Mr Chote: Martin may have a clearer idea on the comparison. I guess the US would be a fairly obvious recent comparator where you have concern about the size of the deficit there and the turnaround that one has seen following a period of consolidation under the Clinton administration, but now things have gone very sharply in the other direction, so that would be a markedly larger change than the UK. Q7 Chairman: The need for further fiscal consolidation, Martin, is that debate relevant elsewhere in the G7? Mr Weale: I think it is. The sort of question one asks looking at the countries that have broken the Stability and Growth Pact is whether their fiscal problems are cyclical, as they seem to hope, or structural. If they are cyclical then it is sensible to wait for an upturn to solve those fiscal problems. If they are structural, as I must say I think they are and I think Britain's deficit is, then the sooner you do something about it the better. Q8 Chairman: Peter, the Treasury's growth forecasts for 2005 are higher than most independent forecasters and so were their growth forecasts this time last year for 2004, but they turned out to be correct. You are now quoted as saying that if you believe the Treasury's assessment of the outlook "you will believe anything". I think that is what was on the front page of the Financial Times recently when we woke up. Are the Treasury's growth forecasts for 2005 any less credible than the original forecasts for 2004 that ultimately turned out to be correct? Professor Spencer: Obviously there is a margin of error around any forecast. Last year the Treasury's forecast came in bang on the nose of 31/4 per cent growth. This time the odds are against the Treasury's forecast coming in correctly for a variety of simple arithmetic reasons. Last year growth accelerated through the previous year, 2003, and that made it relatively easy to get the growth in 2004. This year the growth has decelerated through the year and we are looking at very weak figures already for the third quarter and possibly for the fourth quarter as well. Arithmetically it is very difficult to get the year‑on‑year averages growing at 31/4 per cent. Q9 Chairman: So the Treasury is living in 'fiction land' according to you? Professor Spencer: No, I am not saying that. Q10 Chairman: To say if you believe this you will believe anything sounds very robust. Professor Spencer: I stand by those words. That was an instant reaction on the afternoon in question. Q11 Chairman: Is there a difference between instant reactions and measured reactions? Professor Spencer: Yes. As you can see from my note, when you delve into the Treasury forecast there are a lot of things which do not really make much sense to an economist. For example, the Treasury are taking a lot of tax revenue apparently from the North Sea, £1.7 billion, but all of the models, including their own, tell us that for every pound raised in the North Sea when the price of oil rises there will be something like a pound lost in the rest of the economy, most obviously, as Digby Jones keeps on reminding us, through the effect of high energy prices on the non‑oil company sector. When you then go and look for all the consequentials that you would normally expect from an oil price rise, including the deleterious effects on overseas economies and all of the rest of it, it is very difficult to find those in the Treasury forecast, they are simply not there. You can go through a variety of influences like that, including the dramatic slowdown in government current spending in the last five months of the year which is highlighted when it comes to the fiscal arithmetic. When you look at the consequentials for the economy you find that, miraculously, public sector managers are able to increase the investment at a rate that they really have found very difficult to achieve in the past. That actually means that the public sector gives an even bigger boost to demand next year, 11/4 per cent on GDP rather than this year's 1 per cent, and miraculously, despite the problems with the dollar and the fact that it seems we have got no benefit from the higher world trade this year, the world trade next year, which is slower, produces a 7 per cent rise in exports. Q12 Chairman: We will have to call in the Pope because there is nothing but miracles needed here. Professor Spencer: I am not saying it is not going to happen; I am saying that this is not a central forecast. Q13 Chairman: Our expert witness, Professor Heald, said to us, "The Treasury's recent forecasting track record means that it would be unwise to bet against it." Do you think that was an instant response from Professor Heald or a leisurely, more measured response? Professor Spencer: No, I do not believe it was an instant response. Unfortunately some of us are in the business of giving a reaction on the day and that was my reaction and it was a considered one. Mr Weale: Our forecast for next year is for growth of 23/4 per cent and we give estimates of the margin of uncertainty round that. I put the chance of growth being as the Treasury forecast or better as probably being about one in three. If you are forecasting exactly their growth rate then the chance of something better would be one in two. So a sensible assessment of the Treasury forecast is that it falls well within the margins of uncertainty that other, I hope, reputable forecasters have round their forecasts. In that sense I do not think it is sensible at this stage in the year to get terribly excited about differences of half a point. Mr Walton: I wanted to say something about the framework in which the forecasts come together. The Treasury essentially takes a view of what the economy's ability to supply output is and it also takes a view of where the economy is at the moment relative to potential, and on those two things it thinks that potential growth is around 23/4 per cent a year and growth on average over the past decade has been around that rate, if not fractionally faster, and the Treasury also thinks that the output gap is about 1 per cent below potential. If you buy into those, and I certainly buy into the first very fully, the second I would question a little bit more, then the Treasury view would be that unless monetary policy is set then in order to deliver these kinds of growth projections that they have the concern would be that inflation would tend to undershoot persistently the 2 per cent target. To put it another way, if the Treasury were on the Monetary Policy Committee it would probably be a dove at the present time thinking that you could run a more explanatory policy in order to achieve this faster growth and in order to take up the slack that it believes exists in the economy. It is a judgment as to whether you think there is potential growth and what you think the potential growth rate is. Q14 Chairman: Robert, could you answer that point and include the issue of the Treasury's comment because that argues that both HM Treasury and independent forecasts have tended to under‑predict GDP growth more often than they have over‑predicted it in recent years. Do you agree there has been a general tendency to underestimate growth? Mr Chote: That is not really our territory as we are not macro forecasters. I would have thought that would have been the case, although colleagues will correct me. As to David's point about the crucial question being whether you believe there is this still remaining amount of spare capacity which then obviously gives you the scope to have relatively strong growth next year without there being an inflationary problem, the Treasury clearly thinks that is the case. One question is that if the Bank of England does not believe that there is that same spare capacity then it is not going to set interest rates in such a way that would allow the economy to grow that quickly as its ideal outcome. You do have this slight problem in that that may be what the Treasury is predicting, but if the Bank does not believe it then they are unlikely to ratify that with interest rate policy. As Martin said, the difference of half a per cent is well within the bounds of forecasting error and the fiscal implications of whether growth turns out to be half a per cent higher next year or lower is not enormous. Q15 Mr Walter: We have had a pretty dull period in export growth: in 2003 there was no expert growth, it is forecast for this year that the outturn will be about 21/4 per cent according to the Treasury, but then for the next three years, 2005‑2007, they are all over 6 per cent, it is 6.5 to 7 per cent in 2005 and so on. The Treasury are forecasting this sort of fairly strong rebound fuelled by strong willed trade growth and also sterling's decline. You have suggested this is implausible. I wonder if you would like to expand on that. Professor Spencer: I believe it is hard to see that kind of growth given what we have seen this year. This year we have seen world trade growing at around about 8 per cent and normally we would expect UK exports to rise by a very similar percentage amount. In other words, our share of world markets tends to be fairly stable. For example, if you go back to the Millennium year, 2000, you had a huge 13 per cent growth in world trade and UK exports rose by 11 or 12 per cent. That is the normal kind of relationship that you would expect even if the exchange rate is relatively high, as it was during the Millennium year. It is quite surprising that this year we have seen such large growth in our world market and our share has been cut back to produce the 2 per cent, 21/4 per cent, 21/2 per cent rise in exports. Against that kind of background, which I think is explained by our producers deciding that they cannot really manage to supply those markets competitively and therefore making various adjustments in the UK and elsewhere, off-shoring, re‑engineering, these sorts of things, I think that makes it clear that the weaker growth that we see in our world markets next year, down to 7 per cent, will not generate anything like a 7 per cent rise in exports. For that to happen we would have to hold on to our market share and in the current environment, particularly given what has happened this year, I think that is very unlikely. Q16 Mr Walter: How much of a factor is the relative strength of sterling against the dollar and weakness against the euro? Professor Spencer: I think that may be a factor going forward, although it was not really a big factor in the Millennium year when we held on to our share of export markets. I think what may be more important is the composition of our export markets. This year we have seen very weak growth in Europe and that depends on exactly how you define "in Europe". If you look at the European Union, it takes 58 per cent of our exports and I think going into next year what would worry me would be that this combination of a high oil price, a high euro and very weak domestic demand in the euro‑zone will mean that we continue to see very slow growth in our major market and consequently very slow growth in our exports. Q17 Mr Walter: I wonder if I could just look at the UK's current account position. Alan Greenspan has warned that the US current account deficit is "increasingly untenable". The Treasury expects the UK deficit to stabilise at around about 2.5 per cent of GDP, which I think equates in money terms to about £40 billion, half the US figure in terms of GDP. How far away do you think the UK is from having an untenable current account position? Professor Spencer: I think we are some way from that point at the moment. Historically we have been able to run current account deficits at 2 or 3 per cent of GDP for several years before there was a problem. The regrettable feature is that these deficits are sustained by capital inflows, as in the US, and the problem comes when the overseas investors decide to invest somewhere else and at that point the adjustment comes and unfortunately, certainly in the UK context, these adjustments have been quite rapid and quite dramatic. When confidence turns in the foreign exchange markets the currency can fall quite rapidly. Q18 Angela Eagle: Are you saying that the deficit that we are running at the moment, which is historically low, the lowest in the G8, is somehow a big problem? Professor Spencer: No, I am not. I am saying that we are quite some way from an unsustainable situation. Q19 Angela Eagle: We are further away from an unsustainable situation than anyone else in the G8, are we not, if you look at the figures? Professor Spencer: Certainly Germany and France have smaller current account deficits than we have. Q20 Mr Walter: David, did you want to add something? Mr Walton: Although export performance has been disappointing, import growth has also been a lot weaker than you would typically have expected and so net trade volumes have actually contributed slightly positively to growth in the second quarter and it appears that they contributed slightly positively to growth in the third quarter as well. You have to go back a long time before you find two quarters in which net trade volumes have contributed positively to growth. In terms of the way the dynamics have been evolving, there is certainly not really a sustainability question in the sense that things appear to have stabilised in volume terms. Since the summer the pound has depreciated on a trade weighted basis by about 3 per cent and so that would tend to support export growth next year. Q21 Mr Walter: Just looking a little bit at that export growth, we have talked about the euro‑zone being fairly sluggish and I think 58 per cent of our exports are going there, but obviously we have a booming Asian market. Both exports and imports from China have risen by 30 per cent in the past year, but sterling has risen against the dollar and the Chinese currency is pegged to the dollar. Is that going to pose a threat to the Chinese trade position? Professor Spencer: The UK's exports to China are very low. We only export 1.2 per cent of our exports to China and a similar percentage to India. Even if you include Japan and the East Asian tigers, you are still scratching around to get 10 per cent of our exports going to that area. Regrettably we have missed out on a lot of that growth and I think we probably will continue to do so if those economies continue to grow strongly next year, but by the same token, if the Chinese economy slows dramatically then we will not be a big loser certainly in terms of exports. Mr Weale: Could I make two points? First of all, some work that we have done has suggested that the appreciation of sterling over the medium term has been greater than the official trade weighted index shows. The question is how you take account of trade of services as well as trade of goods and when you do that then sterling looks higher than the published Bank of England figures show. It does not explain what David said about the slow growth in imports, but it may be a factor behind why exports have apparently been disappointing. The second point I wanted to make is a much more general one. My view is that the question is not whether the balance of payments deficit is unsustainable but fundamentally whether the country is saving enough. You then have the question of whether those savings are invested at home or abroad. If we are doing the investment we need and we are not saving enough there will be a balance of payments deficit. If we are saving enough to pay for it there will not be a balance of payments deficit. In the United States people have started to realise that the United States has a problem with aggregate saving and I think Britain is in the same position. Q22 Mr Walter: I want to talk about stability in the currency markets and exchange rate volatility. When Mervyn King was here the other day talking about the inflation report, he said he hoped that the UK presidency of the G7 would provide an opportunity for us to talk about a set of issues that have not been talked about for a very long time, such as the international monetary system, in order to stave off any crisis caused by a flight from the dollar by the Chinese or whatever. The Chancellor did not mention anything about international monetary reform. Do you find that surprising? Mr Walton: I personally think you do need reforms in the sense that a lot of what the G7 talks about are usually things which are well beyond its control, so oil prices, whether or not China should revalue. None of the players that are going to implement those recommendations is actually there at the table at least in a formal sense. It seems to me the G7 is a pretty outdated body for the management of the world economy. Q23 Mr Plaskitt: May I just come back to David and your comments about if the Treasury were on the MPC they would be "hawkish". What is your assessment of the position of monetary policy at the moment? If you take a string of indicators which you have to look at to get some measure of which direction the economy is going in, where would you say we sit in the monetary policy cycle? Mr Walton: I think we have probably plateaued for a while on interest rates and it is unclear whether the next move in rates is going to be higher or lower. My own gut feeling is that probably we have not yet seen the definitive peak in interest rates. The underlying growth in the economy the Bank of England feels is somewhat stronger than the statistics show, particularly for the third quarter and it would not be at all surprising if at some point we were to get some upward revision to Key 3 GDP which would clearly help the Chancellor in terms of achieving a stronger growth forecast for next year. If you look at the situation the economy is in, we are in a rebalancing phase. Net trade is no longer a big drain on the economy, so that has taken away a big negative that we have seen in recent years. Investment, which was hit very hard by the global downturn, has clearly started to recover, so business investments have been 5 per cent or so over the past year. Government spending is still going to grow quite rapidly. Those bits of demand are all doing quite well. You would expect the consumer generally to do quite well in that environment. You would expect employment and wage growth to be picking up, as indeed it is. In that context the challenge for the Monetary Policy Committee has been to get the consumer to slow somewhat in order to keep overall growth in the economy somewhere close to a trend rate and that is really where the housing market has come in. To get the consumer to slow in the face of pretty strong income growth you need to get some negative wealth effects to push up the savings ratio and a decline in house prices is actually one way of achieving that. Q24 Mr Plaskitt: We are seeing exactly that, are we not? Mr Walton: Absolutely. Q25 Mr Plaskitt: There is evidence of deceleration in house price inflation and acceleration in the savings ratio. Mr Walton: Absolutely, which is why I think policy is on a plateau at the moment, because what is not yet evident is whether or not consumer spending growth is going to maintain this slower growth path that we have seen in recent months. If it does then rates are high enough. There is also a risk, particularly if the world economy does reasonably well next year, that people get used to interest rates at 43/4 per cent, which historically is still very low, and that you could start to see the housing market begin to recover again next spring. I do not think that would be out of the question either. If that were to happen the MPC would probably turn hawkish again quite quickly. I suspect we are in this period where rates are somewhere closer to neutral and they may not be quite at neutral yet. The economy is a little bit uncertain as to how things are going do develop, the world is a bit uncertain and the MPC has got a lot of flexibility to move in either direction on interest rates depending on just how things turn out in the next few months. Q26 Mr Plaskitt: Do you think, after such a long period now of low inflation, that there has been a significant change in the transmission effect and that now we might be in a situation where quite small changes in interest rates could quickly have an effect on consumer activity? Mr Walton: I think the economy is more stable, I do not think that could be denied at all, and I think inflation expectations are very stable as well. The Bank of England, by achieving that stability in inflation expectations, has the ability to signal intentions to do things and it does not have to carry out the threat in quite the same way as used to be the case when by and large people did not believe policy makers and so policy changes had to be that much more dramatic in order to get the desired effect on expectations. I am not sure the economy itself is necessarily any more or any less interest rate sensitive than it used to be, but I think the stability in inflation expectations is such that if you get a shock you do not tend to get thrown off course quite as easily as used to be the case in the Seventies and Eighties. Q27 Mr Plaskitt: It is clear that inflation expectations have shifted dramatically. If you look at wage settlements, for example, and how people now react to that, there has been a marked change. So why should you not also expect to see that resulting from various changes in interest rates, the same quick sensitivity? Monetary people used to say to us it took two years to get an effect visible from the movement of interest operates, but have we not seen the recent four small upward steps quite quickly producing an over‑reaction in the housing market and in consumption? Mr Walton: You have seen a slowdown, but the slowdown has not been as dramatic as the survey data have been suggesting and at the same time you have seen, arguably, a more pronounced slowdown in Continental Europe where you had the economy growing pretty strongly in the first quarter, at around 3 per cent, and it slowed towards 1 per cent in the third quarter. I think you have seen some marked slowdown in Britain's main export markets at the same time which has also probably had some effect, ie there has been some synchronised global slowdown in the industrial sector during the course of this year. I do not think anyone doubts that if you raise interest rates you do not have to wait one or two years before you see the effects, you tend to see the effects coming through after three to six months or so. So that has certainly played its part. You have had this synchronised slowdown in industrial activity and in the world economy since the summer and that has also played its part. If you look at where the slowdown has been in the UK, it has really been in the industrial sector. The service sector has continued to grow pretty strongly during the course of this year. Q28 Mr Plaskitt: How should we read the substantial under‑shooting of inflation on the consumer index? It has come close to the point where the Bank would have had to lick a stamp and write a letter to the Chancellor because it was so far under target. What should we read into that? Mr Walton: If you take the Treasury view in the Pre‑Budget Report, they read that as evidence that the economy is operating below trend and therefore there is scope for growth to be stronger. Q29 Mr Plaskitt: Is that right? Mr Walton: I think the shortfall is slightly more fortuitous. If you look at other measures of inflation, they do not look to have undershot quite so dramatically. New labour growth costs is running at just over 2 per cent, the GDP deflator is running at over 2 per cent, and RPIX is running at just over 2 per cent. On a broad range of inflation measures the undershoot looks to be a little less marked as on the CPI. You do tend to get a little bit of divergence in these measures from one month to the next. Q30 Mr Plaskitt: Finally, I wanted to ask about the savings ratio which is now back up to about 61/2 per cent. Do you think, given everything else going on in the economy, that that is about the correct level for it to sit at? Mr Walton: If you look at the very long‑term average for the savings ratio, it is more like 8 per cent and quite probably we will get to that level again, particularly if these other bits of the economy which have been quite depressed in the past few years grow quite strongly and policy may well need to be set to get the savings ratio to rise a bit more. There is also a more fundamental question that I am sure Martin has more of a view on, which is that particularly when you looking at pensions there is a savings shortfall. I do not think people have necessarily realised that companies are making a much smaller provision for their future retirement than was the case just a few years ago and to fill that gap is almost certainly going to require people over time to devote more of their income into savings. That would tend over time to push the savings ratio up. Whether it will happen next year or whether it is something that will happen over the next five or ten years is a much more uncertain point. Q31 Mr Plaskitt: They either have to save more or they have to save in different ways because there are lots of means of saving. Maybe it is the proportion of total saving going into pensions that needs to rise at the cost of other forms of saving rather than the overall level of saving having to go up. Mr Walton: I think the basic problem at the moment is that that bit of income that is left and that is going into savings is not sufficient given the likely prospective returns on assets, both financial and housing for that matter. The flow of savings is not sufficient at the current time to keep people's net wealth stable as a share of income. Q32 Mr Fallon: Martin, maybe I could probe a little further into this rather rosy Walton‑esque view of the balance of the economy. Government spending was originally scheduled to contribute 0.75 per cent in 2005 to GDP. That is now increasing to 1.25 and it now looks as if the rate of growth of spending will be higher in 2005 than it was either in 2003 or in 2004. Is that sensible at this stage of the cycle? Mr Weale: I think the fundamental question is whether we are collecting enough taxes to pay for the government spending and the prospective growth in government spending that is described in the Pre‑Budget Report and my view is that I do not think we are. So in that sense I do not think that that rate of growth of government spending is desirable. Q33 Mr Fallon: So the economy is not now better balanced as the Pre‑Budget Report claims? The Chancellor's claim is that it has already undergone a significant degree of rebalancing. Would you not accept that? Mr Weale: It obviously depends what you mean by rebalancing. There are two related major imbalances in the economy: one is the government fiscal position and the other is the low level of overall saving. Q34 John Mann: Gentlemen, I want to ask a couple of questions on something that does not seem to have been too prominent in what you have said and in the papers you have presented, which is that in my area, which is a former coalfield area, it is not in a large city, it is not growing as fast as the rest of the economy, the only issue that employers raise with me is the problem of the labour market and the fact that people are having great problems in finding sufficient people to work. I wonder whether you would like to comment on this. Certainly the biggest problem in my area is that the economy is rather too strong at the moment. Mr Weale: Obviously in particular areas there may be local labour shortages. In the economy as a whole if there was a genuine excess demand for labour we would see wage pressure accelerating. There are just possibly the very beginnings of that happening, but I am comfortable with the position that overall supply and demand are roughly in balance at the moment. I do not see the output gap that the Treasury recognise as being there to be filled, but equally I do not think we are yet at a position where there is substantial excess demand. Professor Spencer: I would agree with that. I think it is very telling that the number of hours worked in the economy, which has fallen back quite dramatically over the last couple of years, has not yet picked up. So there are quite a few indicators that you would expect to see turning before you saw serious shortages of labour working through into higher wages and salaries. Part‑time working and relatively low hours worked are all things which could improve and which employers who want to increase output could adjust in order to get the extra output before they actually have to go and recruit new staff. Q35 John Mann: In other words, the flexibility of the labour market allows the labour market to expand without necessarily working through in the official statistics? Professor Spencer: This is an uncertain situation and it is curious that hours and part‑time working have not picked up more than they have. Some of the indicators coming from Incomes Data Services (IDS) and people like that who survey the pay scene is that wage settlements are now picking up, but we do not quite know whether or not that is in response to the tight labour market or to the relatively high retail price index inflation. Q36 John Mann: I have not received any suggestions of any industrial relations problems from any of my local employers. Is there not a void in the economic analysis in that if people are working two or three part‑time jobs that is not being sufficiently taken account of in terms of the way that the economy can suck in additional labour? Mr Walton: I think in the end it is going to be wages that is the determinant of whether or not there is slack in the labour market. Hours worked have been on a declining trend in the UK since the Industrial Revolution with very few pauses in between and indeed since the introduction of the Working Time Directive in October 1998 there has been a bit more of an acceleration in the pace of decline. One area where I would question whether or not there is slack in the economy is whether there really is the ability to get people to work more hours. Certainly when they are asked in a labour force survey hardly anyone says they are working part time because they cannot get a full‑time job. My own view is that the labour market is pretty close to balance. There are the first signs of wage pressures beginning to creep through. January and April are the key months for pay settlements, so it is a little bit early to know for sure. If you look at non‑bonus average earnings, that has been keeping up towards the 41/2 per cent level. All of that suggests that the labour market is just beginning to tighten and it is at a point where if it were to tighten much more you could potentially generate a bit more inflationary pressure. Q37 John Mann: My final question is about the ability of the economy to bring in migrant labour and the economic consequences of that. Is that something we can continue to do? Professor Spencer: The new accession countries to the European Union are countries which have very high educational standards and a very highly skilled workforce. It would be very surprising if companies who were short of specialist staff, like the National Health Service, were not able to organise themselves to recruit from those areas. It is a fact that that is what they are now doing very successfully and in very large numbers. Q38 John Mann: Are there any economic consequences of doing that in your view? Professor Spencer: It does not really help the housing market, particularly since migrants tend to come to London in the first instance and that adds to pressure on the London housing market and social infrastructure, hospitals, schools, that sort of thing, in London and the south‑east where, of course, the pressure is already at its greatest. These are problems that can be managed. They do not really offset the benefits to the economy from that highly skilled labour coming in. Q39 John Mann: Do you agree with that? Mr Weale: I agree that obviously if there are areas which are congested then if the south‑east has more people working in it it becomes more consequential whether they move from the north of England or from Poland. To attract an efficient and effective addition to the labour force is a good thing for the economy. Mr Walton: Quite often people hold up the United States as being an economy that grows very rapidly. A large part of that is because it has a lot of immigration. If you look at EU accession, the UK was one of very few countries which allowed migration to take place from the word go. There are anecdotes. In the hotels in Berlin your laundry gets shipped 50 miles across to Poland to be done and it gets shipped back in the morning. In the UK the people are brought in from Poland in order to do the laundry. There is a different way in which the labour market works here than in Continental Europe. Q40 Chairman: The Bank of England Inflation Report indicated that business orders were increasing around the country, that factory output prices were increasing, but that prices on the high street were coming down. What are the implications of that? Mr Walton: I think a lot of this is China again. If you look at what has happened to the terms of trade in the UK, they have improved substantially. People often say there has been a consumer boom in the UK. Well, nominal consumer spending growth last year was only 4 per cent which was the lowest at any time in the post‑war period. Real consumer spending for some time has been growing at pretty healthy rates and a lot of this is basically imports coming in from China which each year cost less than the previous year, so people with their own fixed budgets, with their own incomes, are able to buy more and that is a positive thing for the economy. It is terrible if you happen to work in the clothing and manufacturing sector, that part of the economy has been decimated in the UK, but the consequence for everyone else, which is 98.5 per cent or 99.5 per cent of the population, is that they are able to buy clothes a lot more cheaply than used to be the case. Professor Spencer: It not just procurement in areas like China that has enabled our retailers to keep their costs down but very good supply chain management is another factor in that equation. Q41 Angela Eagle: Obviously people are able to buy more goods and prices are being kept down because of international trade and the development of a sophisticated manufacturer in Asia, etcetera. The Monetary Policy Committee did note at some length how well the terms of trade in our comparative advantage as an economy had helped this process. Do you think that the Chancellor's announcements on a knowledge economy, looking forward to specialising for future strategic placing, are in the right kind of area to maintain that comparative advantage going forwards as manufacturing in Chinese and Indian economies rises? Do you think it is strategically in the right place? Mr Walton: I do not think anyone can argue that it is wrong. In principle, if you can have the most highly educated skilled workforce that is going to make you the most adaptable to anything that happens in the future. Clearly you have countries which have got rapidly growing populations. In the case of China a very large population is in agriculture waiting to move into the industrial sector. That is going to happen. There is nothing we can do about that. So you would want people in this country to be able to move on into more highly skilled, highly value added production. One prerequisite for that argument is that they need to have the skills and the education to be able to do that. Q42 Mr Walter: I wonder if we could move on now to the public finances and look at borrowing, the fiscal rules and the Golden Rule. Mr Chote, your organisation said that you thought at best the Chancellor had a 62 per cent chance of success, but given the trends of the first seven months it was probably a 34 per cent chance of keeping borrowing within the Golden Rule limit. I wonder if perhaps you could all tell me whether or not you think the fiscal rules will be met in the current cycle. Mr Chote: In the current cycle my guess is it is touch and go and I would put the probability at somewhat lower than 50 per cent. As you say, the Chancellor was expecting at the time of the Budget to narrowly meet the Golden Rule over the first seven months of the financial year rather than halving compared to where it was last year. The current budget position has been roughly in line with where it was last year. If that continued through the whole year then you would be probably borrowing about £12.5 billion more this year than was expected at Budget time on the Golden Rule measure and that would have wiped out the room for manoeuvre which the Chancellor had said he had at Budget time. The Treasury has obviously said that they do not expect the deterioration to persist at anything like the rate it has done over the first seven months of the year. They are expecting both the pace of spending to slow and the tax revenues to pick up in part because of the lagged effect of oil prices. Given that you would expect the Treasury to have better knowledge than independent forecasters about the detailed breakdown of the tax take and of the profile of departmental spending, I think you have to take those claims seriously. On the other hand, I think it is important to note that in the past three years when the Budget has been over‑optimistic about the public finances so, too, has the PBR. The percentages you referred to were simply an exercise saying, "Forget what the IFS or anybody else may think, let's just look at what the Treasury's forecasting errors have been in the past and basically what will the situation be when we get to the Budget and there is one year still to go?" If the PBR forecast is right and the borrowing projection they have this year is correct, they will get to the Budget and with the standard forecasting errors they would have a 62 per cent chance then. If, however, the trends we have seen since March were simply to continue, ie the PBR was wrong entirely and we simply take an extrapolation of what has happened to date, then you would be at the lower figure. It seems sensible, therefore, to say that true probability is somewhere between the two and I would put it at somewhat less than 50 per cent at this stage. We will do a proper forecast next month. Professor Spencer: I think it is very hard to see how the Chancellor can make the Golden Rule in this cycle starting where we are with the data for the first seven months. The improvement in the last five months of the financial year and going into the next financial year would have to be very dramatic indeed for him to meet his figures. For example, to get the £12.5 billion current account deficit projected for this year we would have to see a surplus on the last five months of £4.7 billion when last year we had a deficit over those last five months of £5.5 billion. Now that is a turnaround of over £10 billion which means that each of those months have to come in at around about £2 billion better than last year, which I think is possible but highly unlikely. Again, as we go into next year it is not just the growth in the economy that is looking a little bit shaky, the 5.7 per cent growth in GDP next year he may well get, but he is saying it will lead to an 8 per cent growth in tax revenues which implies a very large rise in the share of tax in GDP, which again is hard to see. As you build one thing on top of another you are looking at everything having to go absolutely right indeed for the Chancellor to make the Golden Rule. As you go out in time from this year into next year and then ultimately into the next cycle everything has to go right for the Treasury's forecast to be met. Q43 Mr Walter: Do you think we have a credibility problem here? The Golden Rule is to some extent determined by the Chancellor. He determines when we start and when we finish the cycle and he determines what the sustainable investment is and so on. Do you think that perhaps it would be better if we could get to a measure that was more like the inflation targeting which we give the Bank of England and the Monetary Policy Committee, a sort of independently measured Golden Rule or whatever we want to call it? Mr Weale: My view is that the Golden Rule should be replaced with a similar but different targeting scheme. There are a number of problems with the Golden Rule. One is that, as you have drawn our attention to and indeed as the Treasury mentions in box 8.3, the timing of the cycle is inherently uncertain, it can be established only with the hindsight of several years and that strikes me as an arrangement which is of almost no use for running fiscal policy in real time. Secondly, you have the issue of the uncertainty surrounding budgetary forecasts which is very real. I am always impressed when I hear the certainty that emanates from the Treasury, but I do wonder why they are so certain and it is never explained. Given that uncertainty and given the uncertainty over the cycle, my view is that a rule defined to achieve a target over the medium term would be more suitable. Obviously if it is defined in as vague a way as the medium term then it becomes even more unsatisfactory if the Treasury or the Chancellor are saying what balance over the medium term means, so it would then be desirable to have some sort of independent interpretation. Finally, I would mention that with the inflation target it is widely described as a good thing that there is a central target and a band round it. With the fiscal rule, instead of having a central target and a band round it we have an asymmetric target. Again, I have not come across an account of why symmetry is a good thing for the inflation target but is a bad thing for the fiscal target. I do not know whether you could call those changes revisions to the Golden Rule or replacing the Golden Rule with something that was more flexible. I think what we are seeing at the moment are the problems created by a framework which is flexible at the start of the economic cycle but becomes very rigid as you get to the end of the economic cycle. For example, comparing it with the Stability and Growth Pact, in the Stability and Growth Pact you are allowed to miss your target for two or three years before anything very much happens. With the fiscal target, if the target is missed this year or next year then the rule would just be broken. What happens after that no one quite knows except that we have moved on to a new cycle so perhaps it does not matter. Given those problems, I would welcome it if the Chancellor were to take a long hard look at the Golden Rule and think about how it could be refined into something more useable in the real world. Mr Walton: Can I just add to that because I agree with a lot of what Martin said there and I think it is time actually to look fundamentally again at the fiscal rules. They really did serve their purpose. When Labour came into office in 1997, they inherited quite large budget deficits and it was absolutely imperative to put the public finances on to a sustainable path again. Public finances are on a completely sustainable path at the moment. I would argue that you have got one of the best fiscal positions in the G7 and if the Golden Rule is missed, and my own estimate is that on the Treasury's definition of the economic cycle, it will be missed by 0.02 per cent of GDP on average over that six-year period which is about £5 billion, which is about the money which has been committed to the Iraq war, the code for fiscal stability just says that if you miss, you have to explain. It would be quite straightforward to say, "We've missed because we have had to set aside this money for this unforeseen war". If you do miss, the economic consequences of that are almost negligible, it seems to me, and, as you look forward, and perhaps I could draw an analogy from the monetary policy framework, when inflation at the moment is running at just over 1 per cent, nobody really says to the Monetary Policy Committee, "You must cut interest rates aggressively in order to get inflation back up to 2 per cent as soon as possible", nor indeed do they say, "Because inflation has been running at around 1 per cent, you must aim for inflation to be around 3 per cent at some point in the future in order to keep the average close to 2 per cent". I think you could actually aim for something similar in the fiscal rules. Just because last year you had a current budget deficit of 1.9 per cent of GDP and this year it is likely to be just fractionally over 1 per cent of GDP, so it is moving in the right direction, if to the extent that these errors are just genuinely due to forecasting errors, and the Monetary Policy Committee makes forecasting errors as well on inflation, if they are genuinely due to forecasting errors and if these errors are symmetric in both directions, then the aim should be to aim back to a current budget balance. If you get that, then you are going to have a perfectly sustainable fiscal position over the medium term. Q44 Mr Fallon: Robert Chote, could we just look at some of these assumptions that are audited by the National Audit Office and one that is not. Would it not strengthen the credibility of the Golden Rule if it was independently audited by the National Audit Office or some other outside body because at the moment we are in a position where the Chancellor is a bit like a football manager in that he decides when the match ends? Mr Chote: Well, you are talking there specifically about the point about the economic cycle. Q45 Mr Fallon: Yes, the timing of the cycle. Would it strengthen the credibility of the rule if the timing of the cycle was independently audited? Mr Chote: Yes, I think the first point to make is that both with determining where the cycle is and determining the forecast itself, there is not a magic group or potential committee out there that is going to come up with the right answer if we assemble them in a way in which the Treasury has not managed to do, so the justification is to say that this is an independent group of people who are coming up with a view to which the Treasury commits itself rather than a group of people who are necessarily more likely to be right than the Treasury, so in that sense I think there is an argument for saying that you could have an independent scrutineer to which the Treasury makes a commitment. Whether the NAO is equipped to do that job in its current form is not that clear. I think more important though is the fact that ---- Q46 Mr Fallon: But the Bank could do it, could they not? Mr Chote: Well, it would be interesting to ask Mr King whether his enthusiasm for the output gap is sufficient that you could tie him down to reaching a commitment on the two ends at that time. I think the other important point of course is that credibility is generally improved the greater the transparency of the system is, so the more we know about how the forecasts are being generated, the more we know about some of the assumptions, for example, which are not publicly announced. The Treasury does not tell us what it is assuming about average earnings growth, for example, and nor have previous governments of course in the same position, and that is crucial to knowing what your income tax projections are going to be, so a greater transparency, where that is possible, for everybody might be just as important or more important as having some new group that is sort of burnished and given the official title as the scrutineer, not to say that would not be an improvement on the status quo in itself. Q47 Mr Fallon: Can we turn to revenues now. Professor Spencer, in your memorandum, you point out that the PBR projects an undershoot in revenues of about £3.9 billion. You say it is going to be nearer to £6 billion. We have got growth faster than the Treasury's initial estimate and you have spoken about record levels of employment, so why is it for the fourth year running that tax revenues look like coming in short of forecast? Professor Spencer: I believe that it is because the Treasury's assumptions are just too optimistic on the revenue side and it does not surprise me to see, for example, that the Treasury forecast of 21 per cent growth in corporation tax, which was discussed here at the time of the Budget, is being undershot. What does surprise me, however, is despite everything that we know about onshore companies being hit by higher oil revenues and all the rest of it, despite the very weak outturn for the first seven months, the Treasury are now forecasting another very strong growth in the last five months, another 21 per cent, and, as we go into next year, another 25 per cent growth again, so I think it is fairly clear ex ante that these forecasts are not still too optimistic and will be undershot. Q48 Mr Fallon: Why does the Treasury believe that corporation tax receipts will suddenly jump in the last five months? There is a commentary on their table B14 where they talk about recovery in receipts arising from financial company profits. That is the same as corporation tax, is it, or is it a wider definition? Professor Spencer: No, what happens is that companies that have made losses over the last few years apparently in the financial sector can basically claim those losses against profits that they are making currently and thereby reduce their tax bill. We actually had a good look at financial company profits a few months ago and certainly I was very surprised to see what the Treasury wrote about this because if you go through all of the major clearing banks, and we looked at the top ten clearing banks in this country, they are saying that they are going to be giving the Treasury an extra £1.6/£1.7 billion of revenue this year, so unless something has gone very badly wrong in the investment banking sector, I do not see how the Treasury argument about unused tax losses applies. It certainly does not apply to the major clearing banks of this country. Q49 Mr Fallon: What they always tell us is that they construct these forecasts bottom-up from information which you do not have, but which they have company by company, sector by sector. Is there any evidence by which we can challenge that kind of approach? Professor Spencer: Yes, that is precisely why, when the Chancellor said that is how they were forecasting corporation tax revenues to this Committee after the Budget, I started to look at individual company reports and the kind of spreadsheet analysis that is done in the City by equity analysts and, looking at those projections, it is very hard to see where the Treasury or, in this case, the Inland Revenue are coming from with their spreadsheet models. If you speak to any City analysts who cover the major companies of this country and ask them what their profit and of course tax projections are and try and start to add them up in the way that I did for the clearing banks, you get quite a different picture. Q50 Mr Fallon: Perhaps we should ask the Treasury to publish them. They cannot publish the individual forecasts, but is there a case for asking them to publish some of these assumptions about sector receipts? Professor Spencer: I think it would be a very good idea to start to ask the Inland Revenue to break down past data between financial and non-financial companies and within financial companies between investment banks, which I suspect are not paying very much and never have, and the domestic clearing banks who, when you talk to their CEOs, see it as part of their social responsibility to pay taxes in this country, so it would be nice to have a breakdown there and within non-financial companies of course a breakdown, and we already have a non-North Sea/North Sea breakdown, it would be very interesting to see a breakdown of the onshore companies between manufacturing and services. Q51 Mr Cousins: Just to follow that up, Professor Spencer, if, as you say, people are very keen to pay their taxes in this country, and here we are talking about the financial services sector which you were referring to, why do you think the shortfall arises? Professor Spencer: It is very hard to know without the kind of detail that we have been talking about. It is entirely speculation, but I strongly suspect, seeing the way the economic models work and hearing what Digby Jones and others are saying about the effect of high energy costs in industrial and other companies, that what has happened is that yes, the higher oil price is generating more corporation tax, petroleum revenue tax, et cetera, royalties from the North Sea sector, but that has been offset, possibly more than offset, by lower profits and lower corporation tax revenues in industrial companies. Q52 Mr Cousins: We were talking about financial service companies. Professor Spencer: Well, as I said earlier, I cannot really see where the shortfall is coming on the basis of the analysis that I have done. I do not think there is any shortfall when it comes to the sorts of clearing banks that you and I would use. If the Treasury are right, it must be that investment banks are using the losses of previous years to cover their profits of this year. That is the only way that you could make it add up arithmetically. Q53 Mr Cousins: What do the rest of you think about the reasonability of the projected increases in corporation tax receipts, non-North Sea of course? Mr Chote: I think we have pointed out for some time that if you look back at what corporation tax revenues you would have expected to get as a share of GDP from the current set of tax rates and tax rules, so you have to extrapolate that back to imagine what history would have looked like if policy had been the same over that period, the Treasury is projecting a move to levels of corporation tax receipts as a share of national income which have only ever been achieved in the past either when the economy has been clearly overheating or when the financial sector has been doing particularly well in the height of the Stock Market boom. My sense is that there may be a problem of having been lulled into a false sense of security by how things were moving at the time of the Stock Market boom and, therefore, the Treasury may be over-optimistic about what it thinks of some sort of steady-state position to which we are going to return. The other point to bear in mind, which comes back a bit to Mr Fallon's question, is that the Treasury in part bases its long-term optimism for corporation tax on an assumption that the profits of financial sector companies are going to rise as a share of national income on a straight-lining trend looking forward, and that is clearly a debatable question. We would certainly see the corporation tax revenue forecasts both in the short and the medium term as being one of the most questionable elements of the fiscal projections. Q54 Mr Cousins: Of course over longish periods of time, say, over 15 years, income tax receipts have risen by about 250 per cent and corporation tax receipts have risen by about 30 per cent, so this is a very profound trend that the Treasury is trying to wrestle with. I just wondered whether you or your colleagues had any accounts for the reason for this. Mr Weale: Sorry, this is not directly answering your question, but late last year the Inland Revenue did do a study comparing bottom-up and top-down forecasting. I do not know whether it was published or not, but I should have thought that study would be the place to look to answer your question about how the two relate. Q55 Mr Cousins: I wonder if I could tempt you to regard this not as a forecasting issue, but a behaviour and receipts issue. What do you think the causes are of this shortfall in corporation tax revenues and do you think it is something that the Government can put right in a short period of time? It is not just an issue of forecasting; it is an issue of long-run patterns of behaviour. Mr Weale: Yes, my inclination is to agree with what Robert Chote said on that, that the late 1990s were a very unusual period. We know that Stock Market booms only happen when the people who remember the previous crash have, if not died, faded out of the business scene and I agree with Robert Chote that that was probably a factor behind considerable buoyancy and, therefore, it is relative to that sort of perception of normality that we are, therefore, likely to see continuing shortfalls. Mr Walton: The other thing on a longer-term perspective is that throughout the European Union corporation tax rates are coming down. If you want to attract companies and if you want businesses to grow, I do not think, as a government, you are going to be able to tax them more heavily. The prospect, if anything, is that governments are probably going to have to accept lower taxes from companies or else they will lose those businesses. Q56 Mr Cousins: Of course, as you will, I am sure, recollect, Nigel Lawson's great contribution in understanding tax receipts was that you could reduce corporation tax rates and increase revenues, the great 1984 corporation tax reform which I think of constantly! Against that background, let's not talk rates or forecasts, but let's look at this long-run behavioural trend that leads income tax receipts to increase so much faster than corporation tax receipts. What could possibly be the explanation for it? Professor Spencer: Well, in part, if we switch the discussion to income tax and the buoyancy there, in part that is our old friend, real fiscal drag. Quite simply, if you do not index the personal allowances and the various thresholds, in particular, the threshold at which you move up to 40 per cent tax, if you do not index those to earnings, but you index them to the RPI, then you are going to see a rise in the number of people in the higher tax bracket and you are going to see a rise in the average rate of tax paid generally, so that, I think, is why you get the up-trend in the share of personal incomes going to the Inland Revenue. Mr Walton: Also, and more fundamentally, if you are going to spend more money as a government, then under the fiscal rules you have to match that through increased tax revenue and realistically there is a limit to how much you can raise from companies. Most of this in the end, if not all of it, is going to fall on individuals either through income tax or through VAT, so I do not think it should be a surprise if public spending is starting to rise as a share of GDP that it is going to be individuals that in the end are the people who are actually paying for those extra services. Mr Weale: I think we have seen a number of specific measures and perhaps the most obvious one was the reintroduction of double taxation of dividends which have supported the income tax base and I cannot think of analogous measures that would have supported the corporation tax base. Q57 Angela Eagle: One of the things that we knew people had not had a lot of practice in by 1997 was the public sector being able to invest because it had not had much chance to do so. We have now been in a period where large amounts of money have been sent the public sector's way and there are year-on-year shortfalls in the amount of money that they are being able to use in the time allocated, and we see another one of £2.5 billion this year. Do you think, first of all, there is any sign that the public sector is getting better at investing in a timely fashion because it has got this opportunity to do so and, secondly, why is there not more work being done to measure more sensibly public sector efficiencies, since the measures we have got at the moment are clearly totally inadequate, so that we can try to get some idea of value for money? Mr Chote: Picking up on the first part of your question, in terms of why it is that the Government has promised or said or intended to increase public investment and yet year after year has not managed to do so to the degree it would like I think has been a genuine puzzle and I wonder whether the hurdles that have to be gone through to consider PFI schemes, for example ---- Q58 Angela Eagle: But it is not only PFI though. Mr Chote: No, but the fact that any investment scheme might have to be thought about in that context before it goes through, so maybe there is some sort of grit in the machine from that source, which would be a possibility. Q59 Angela Eagle: Do you think it is just lack of experience with investing because prior to that the public sector just spent all of it on cutting things and did not actually ---- Mr Chote: Yes, clearly you were moving from a position where the share of public investment as a share of GDP had dropped enormously to the point at which the Government came in. Now, the big explanations for that are the fact that we have much less social housing and fewer utilities in the public sector which have big investment needs, so moving those out of the public sector would in any way shift down the amount of net investment you would expect in the public sector, but even then central government investment was relatively low and this was one of the reasons, coming back to the earlier question, why I think that the realpolitik behind the Golden Rule was to try to say, "Well, here they are ring-fenced and it won't be the easy option to cut back net investment in the future when savings are necessary", but, as you point out, it has been a tougher climb getting that to come up. I think in the latest figures and the downward revision for this year, the Treasury has said that local authorities and public corporations are to blame for the lion's share of the investment which is not happening this year that they thought might, so whether there are different mechanisms going on there, I am not sure. Q60 Angela Eagle: Does anyone else have an insight? Mr Weale: Could I say on the question of measuring public sector performance that both the Atkinson Review and work that the Department of Health has commissioned at the National Institute and the University of York are addressing these questions. That said, there are very real conceptual questions, so, if I can give some examples, what is the function of the Health Service, how much of it is to cure people and how much of it is to have shorter waiting lists, they are not necessarily the same thing, nor do you have any clear idea of how much people value the one relative to the other. In order to produce single measures of efficiency, is the efficiency of the Health Service increasing or decreasing and by how much, then there have to be, I suppose, not completely satisfactory answers to these questions, but some sort of consensual way of addressing them. Q61 Angela Eagle: But it is not necessarily the case that there would be one measurement for the very reason that you are talking about. There is also a balance surely between measuring quantity by which often efficiencies are measured and quality is often an issue rather than merely throughput and it is not production in the same way as you might measure manufacturing, so clearly we have to have a more sophisticated approach to measuring efficiency and outputs in the public sector. It seems such a neglected area of endeavour for economists. Mr Weale: Well, quality issues also arise in the private sector in very substantial ways, for example, changes in the nature of computers, but certainly I would welcome any more effort that the Government and the research councils do put into encouraging work in this area and I agree with you that measurement issues are terribly important and it is very difficult to establish any sort of consensus before you have got on to a consensus about measurement. I think the Minister of Health has said that measuring the output of the Health Service is one of the most important issues facing us and I agree with that. Q62 Angela Eagle: Does anyone have any view that we will be able to come to a fairly sensible approach to this measurement issue since £13 billion of extra money is being spent investing in the public sector this year, although not all that was allocated has been used, and it is clearly important that we can get a handle on how well that money is being spent and some views of value for money that enable us to have confidence that this investment is being used properly and efficiently? Mr Weale: Well, I agree with that. Q63 Angela Eagle: When are we going to be in a situation when we can make some of that assessment? Professor Spencer: It is inevitably very, very difficult to develop macroeconomic figures generally, but in particular when you are trying to aggregate and average out over all of these various different indicators for something as nebulous as the output of the healthcare industry, it is very, very difficult to produce one number which is as solid as the number of cars produced by the car industry and we are never going to be in that situation. We can do our very best and there is plenty of room for improvement and there are all sorts of new methodologies that could be tried, but ultimately this comes down to the consumer test and that is why the kind of focus groups that are being set up right the way across the country to look at the experience of ordinary people with the National Health Service and to monitor their reactions to those improvements, that may be a little bit more informal, but that is the kind of measure, that is the kind of information that is going to tell you whether we are getting value for money or not. Q64 Angela Eagle: Yes, the Holy Grail might not exist in the form of one number. Professor Spencer: Yes, exactly. Q65 Angela Eagle: What do you think of the technical efficiency, the efficiency technical notes that departments have been asked to produce? Have you had a chance to look at them to see whether they are assisting and casting light on this area? Mr Chote: They do not go to some of the fundamental problems that Peter has mentioned, and I think another one is that with many public sector services there is obviously a social and redistributional element in the quality of the output as well, so, for example, it is quite hard to think about how would you define the output of a library service. You could well imagine that if you did have some sort of clear idea about what the output of it was, presumably politically you would not be indifferent between one possibility which had one large library serving a very large area, but marketed very heavily at people around it, so heavy use was made of it, versus having small ones that people could access closer to them. Now, the latter might be less efficient, but you would presumably value its output more highly for social and equitable reasons, so I am not sure that any measurement will get you away from those sorts of trade-offs which are inevitable in deciding what you actually want out of these services. Q66 Angela Eagle: But perhaps it just highlights them, so at least people would know about the implications of the choices they are making. Mr Weale: I think also in many cases we do not have a completely clear consensus on what, say, the Health Service is for. For example, there is increasing pressure on it to provide alternative therapies. Now, I am not a doctor, but one could quite easily imagine that some of those have no medical value at all, but, nevertheless, the focus groups that Peter described suggest that consumers are happy with them because these treatments are available. Now, is that money being wasted or is it a sensible use of taxpayers' money? It is a difficult judgment. Q67 Angela Eagle: Do you have a view on the efficiency technical notes? Mr Weale: I am afraid I do not, no. Chairman: On Martin's point about the Health Service, I was at a meeting a couple of years ago when someone advocated that we have suntan cream for people going out to Spain just in case they get any illnesses, so what the Health Service is used for is a big question. Thank you for that and now we will move on to the micro issues. Mr Cousins: Or insect cream if they go to Scotland! Witnesses: Mr John Whiting, PricewaterhouseCoopers, examined; and Mr Robert Chote, Institute for Fiscal Studies, and Mr Martin Weale, National Institute of Economic and Social Research, further examined. Q68 Chairman: Mr Whiting, could you introduce yourself, please. Mr Whiting: I am John Whiting. I am a tax partner with PricewaterhouseCoopers and also Chair of the Chartered Institute of Taxation's Tax Policy Committee. Q69 Chairman: We have got a few issues on tax, but the ones for Martin and Robert I think we will start with. Following the PBR, there has been wide discussion of a number of tax announcements mostly to do with anti-avoidance, which we will come to shortly, but apart from those, Robert, what struck you as the most important elements of the non-macroeconomic parts of the PBR? Mr Weale: Well, I suppose what struck me was in some senses what did not bark. I mentioned earlier the issue of savings, which is tied into the issue of incentives, the provision of pensions and so on. Now, obviously the Chancellor is likely to say that he is waiting for the final report on the Pension Commission, but on the whole issue of savings and incentives to save, there is really very little discussion beyond sort of tinkering here and there. I thought in some places there was actually a misunderstanding of what saving actually is and I suppose I would have liked to have seen perhaps a more thorough look at the combination of incentives to save and incentives to work. We have built up over this period of government a range of specific ad hoc measures and one gets the impression of something of a patchwork where there is a coherence and the aim is to lift people out of poverty and so on and a lot of progress has been made with that, but I still think that there is no coherent view about essentially where the high marginal withdrawal rates apply, how they affect incentives and structuring the tax benefit system in a way that minimises the disincentive effects without increasing its costs. What struck me most was what was not there rather than ---- Q70 Chairman: The sort of medium- to longer-term issues which have not been sorted out. Mr Weale: Yes, but the PBR would be a place to air discussions on those. Mr Chote: I guess the package of childcare measures was interesting. I do not know whether you want to pick up on those specifically, but obviously there were a variety of elements to those and there are pros and cons to the different parts of it. In terms of what is important in the sense of impact on winners and losers ---- Q71 Chairman: Angela is coming to that at the end. Mr Chote: Okay. The key measures would be the £50 one-off winter payment for the over-70s, the raising of one of the tax credit thresholds in line with inflation, an increase in the limit on the childcare credit and the postponement of the fuel duty measures. All of those add up to create a not untypically progressive pattern in the sense of being of relatively greater benefit to people towards the bottom of the income distribution than at the top. Then there is also the issue about the allocation of extra money for local authorities on council tax and obviously there is a debate there about how much of that would actually feed through into lower council tax bills or whether it will get swallowed up elsewhere, so I guess in terms of monetary magnitudes, those would be the important ones. Q72 Chairman: I wonder if somebody could give me a short answer to the proposed property investment funds. As you know, they have been delayed further and I think the Government have promised a further discussion paper in 2005. What are the differences of opinion between the industry and the Treasury on this, if any exist? Mr Whiting: This is the property investment funds, or real estate investment trusts, as they are sometimes termed, REITs. I think generally industry is keen on them and, frankly, picking up something Martin said, in a sense it is one of the dogs that did not bark and it was disappointing that they were not at least committed to, so whether they are now seen as something that might cost the Treasury a significant sum and, therefore, they are just slowing down progress, I am not sure, but I think you would find generally that the property industry is disappointed that they are not coming forward and also from the savings industry because they are seen as a good vehicle for getting more money into property in a more flexible format, so I think there is disappointment that there is not a commitment. All right, at least there is another document to come. Q73 Chairman: On the Chancellor's announcement about his plans not to introduce a general anti-avoidance rule, that has been followed by statements in the PBR with the Treasury saying that they will intervene to stop any avoidance scheme related to rewards from employment. Is that just another way of putting the anti-avoidance in place? Mr Whiting: I think that could be a very shrewd observation, Mr Chairman. It is one that we are slightly concerned about because, as you are well aware, because we have not had the general anti-avoidance rule, the route followed was tax avoidance disclosure which a huge amount of effort has gone into and I think the number of avoidance-blocking measures which have come in is testament to the fact that the system is working. The Inland Revenue is, by all accounts, perfectly happy with it. However, as you point to, we do seem to have this threat of retrospective legislation which very much flies in the face of how we do law and tax in this country and one of the concerns, apart from whether this is a slippery slope into retrospection in all places, is whether this sounds a bit like general anti-avoidance rules. Q74 Chairman: You are on record as saying that there is at least one other area in terms of retrospection. What is that area? Mr Whiting: Well, there was some discussion with interest allocations within that area as to whether the Revenue could look at it there, but the out-and-out statement clearly of the Paymaster General was in terms of employment law. In past history there has only been one actual use of retrospective legislation which I think was 1978 with a particularly artificial scheme, known as the 'Commodity Carry Scheme', so that is the only example I know where it has been used, but the threat we have here is clearly something that is very worrying about the principles in which we do tax. Q75 Chairman: The legislation emphasised that the avoidance schemes would be closed down "where necessary from today". First of all, is that sufficient time for the tax planners and, secondly, what about the Human Rights Act here? Mr Whiting: There is never any objection to the Government, the Minister standing up and saying, "As of today, we are going to block such and such", so let's get that clear, that is just known. The idea that you can stand up and say or put a written statement down and say, "Right, if something turns up in the future, we don't know what it is, but we reserve the right to come back to today and basically change the way the tax law operates", let's be clear, the system of tax we have in this country is that you are taxed on the basis of what the law says. If, therefore, there is a possibility of retrospectively altering your tax bill, then it does have very interesting human rights implications and it has been mooted that this idea of retrospection could now be vulnerable to human rights challenges if we go that far. Q76 Mr Cousins: Who has that been mooted by? Mr Whiting: I have seen plenty of commentators. Q77 Mr Cousins: By people like PricewaterhouseCoopers? Mr Whiting: We have certainly sort of speculated, but we are not experts in it, though I have certainly seen plenty of commentary. Q78 Mr Cousins: Who is faster on their feet in dealing with avoidance issues - firms like yours or the Inland Revenue? Mr Whiting: I think all of us ---- Q79 Chairman: Is not the nub of it, as Jim said, that the Inland Revenue feel, "There are some really smart guys out there. You are a bit smarter than us and you're always a yard ahead of us, so this is why we are announcing this"? Mr Whiting: Well, of course I am very pleased that we are deemed to be extremely fast on our feet. Q80 Mr Cousins: No, I was asking you, do you consider that you are faster than the Inland Revenue? Mr Whiting: We do not think we are faster now. We will think up ideas, we will put planning ideas to our clients, and of course now we have tax ----- Q81 Chairman: Yes, but you are not dim, are you? You are pretty clever. Mr Whiting: Thank you. I will take that as a compliment, Mr Chairman. Mr Chote: It was not intended to be! Q82 Mr Cousins: Do any of these ideas for your clients involve recasting figures to the previous year? Q83 Mr Whiting: No. We would never go into something that would depend on concealment or on rewriting history as that is not appropriate. You just cannot do that. What we have to do of course now is if we think of an idea, if I bring to you an idea, Mr Cousins, then I have to tell the Inland Revenue about it, and I would be very pleased to bring you some ideas. Q84 Mr Cousins: What - for free? Mr Whiting: Possibly so, but we would have to disclose it to the Inland Revenue within five days and that gives the Inland Revenue the ability to close the device. They have tax avoidance disclosure, they have all the information that flows in there, and there is evidence from the Pre-Budget Report statement that they are acting on that and acting comprehensively, so one has to say why do we then need the threat of retrospective legislation? Chairman: I think you want to ask some questions, Jim, but I would just like to know that we are getting Mr Whiting for free this morning! Q85 Mr Cousins: Just to follow up on that, what is your view on the disclosure provisions of tax litigation and tax avoidance schemes which were introduced in this year's Budget. Are they working? Mr Whiting: I think they are working. It has taken a lot of work to make them work and I think we are actually quite pleased with the way that the tax authorities have engaged with us and I think there has been a very constructive dialogue between practitioners, advisers, business and the tax authorities to try and get a good working system. There are rough edges within all of it and there are problems still and I hope the dialogue will continue as to making it work, but disclosures are going on and, as I say, the fact that there are a number of blocking measures in this year's Pre-Budget Report, I assume that shows that the tax authorities are happy the system is working. Q86 Mr Cousins: Do you have any view yourself or have you done some exercise that looks at the revenue involved potentially in the group litigation order cases that are being brought to the European Court of Justice? Mr Whiting: Yes, we have. Q87 Mr Cousins: What would the total amount of revenue involved be, do you think? Mr Whiting: Inevitably it is speculation and I would stress that and it is back of the envelope, but that is a very important feature. Again it is something that one wonders why there is no comment on it, but a guess might be £10-20 billion riding on some of these cases, but of course it could be beyond that spectrum. Q88 Mr Cousins: So in these items, we are talking about something that is non-trivial? Mr Whiting: Very much so. That is of course a potential one-off hit, but it is undoubtedly a non-trivial amount of tax and might be something that I would have expected to see commentary on within the Pre-Budget Report. Q89 Angela Eagle: Surely you do not expect them to comment on cases before the courts in the Pre-Budget Report? That would be nonsensical. Mr Whiting: What I would expect, and I totally take your point in terms of you cannot comment on litigation, but in view of the challenges, in view of the number of areas where the UK corporate tax system does look to be out of line with European law in terms of the freedoms in the European Treaty, I would have expected to hear more about basically what are we doing about it to make the system robust. Q90 Mr Cousins: But you do recognise that a sum like £10-20 billion, which you have given to the Committee and which I think is an interesting one, is a significant item in the tax base of the country? Mr Whiting: Very much so. Q91 Mr Cousins: And it would not be unreasonable to expect the Government to attempt to defend its tax base? Mr Whiting: I fully expect the Government to do so and that guesstimate is on the basis that the various challenges, and of course these are not just UK challenges, but there are challenges to all, or virtually all, Member States' tax systems and aspects of them, that was on the basis that most, or all, would go against the State rather than against the taxpayer. It is quite possible that some will be found in favour of the State and, therefore, my £10-20 billion would come out considerably lower. Q92 Angela Eagle: I wonder what your view is, Mr Chote, about the announcements on the ten-year strategy for childcare, particularly if you could consider what you think its impact will be on labour market flexibility, employment and work/life balance? Mr Chote: The key elements we are thinking about are the extension of paid maternity leave, the extension of free nursery provision, reforms to the childcare elements of the working tax credit, more children centres and improvements in quality of childcare and early-years provision. I would say we are obviously concerned about the two things you describe, but also ---- Q93 Angela Eagle: And the increases in nursery entitlement which are factored in as well. Mr Chote: We are also of course concerned for the outcomes of children as well, so we are taking the balance of those things together. For example, the extension of paid maternity leave, there is strong empirical evidence that the sort of one-to-one care in the first years of a child's life is an important determinant of future outcome, so in that sense that would seem to be a sensible move. The ability to transfer from mother to father would potentially be a more flexible arrangement and transferability could presumably reduce the incentives for employers to discriminate against women if it reduces the extent to which they think they are more likely to take up that option than fathers are. The extent to which in practice that balance does change and whether that section changes is of course perhaps rather more debatable, so it is not going to remove that entirely. Obviously not all families would benefit there as some mothers do not qualify for statutory maternity pay anyway if they gave up work after a first child, so there would be limitations on the extent to which people would benefit. Q94 Angela Eagle: But presumably they would, in theory, benefit from being able to think about getting back into the labour market even with subsequent children and with some of the support that is available? Mr Chote: They will benefit, yes. Q95 Angela Eagle: That ties into the labour market flexibility and hopefully it gives them options that they did not have before because of the impracticality of maybe doing quite modestly paid jobs, but having high childcare costs. Mr Chote: As you say, you have to see it as part of the overall package of measures. On the extension of free nursery provision, there is an interesting issue there about the extent to which you are trying to target these issues specifically on those perceived as being most in need versus more generally. That extension of free nursery provision is not a particularly targeted measure. Q96 Angela Eagle: No, I think it is for everybody. Mr Chote: Exactly, and it would have a broader effect on families as a whole. It is not clear necessarily what the costs of those reforms would be. Reforming the childcare element of the working tax credit, so increasing both the amounts of childcare that the childcare tax credit would cover and also the proportion of subsidy, you would expect, I think, that increasing the limits on childcare that can be supported in this way might have a relatively modest impact because an awful lot of people who are claiming the working tax credit do not exploit the full amount of that anyway, so increasing it further ---- Q97 Angela Eagle: Is that a supply problem though? Mr Chote: That is an interesting question. I do not know to what extent that would be and if it is obviously a supply problem, the supply problem is not addressed. Q98 Angela Eagle: Well, the supply problem is addressed surely in the new duty on local authorities to ensure a sufficient supply of childcare to meet the needs of families and there is a modernisation fund of £125 million a year from 2006 which will give 150 local authorities the chance to do that. That should begin to address surely some of the supply issues. Obviously you have to train and recruit, but the supply side is being addressed by that, I would have thought. Mr Chote: Whether that amount of money is large enough given the number of local authorities you are looking at and whether extending the amount of time for which childcare is supposedly being offered makes it more difficult, for example, if you have a situation where a facility is used for three-year-olds in the morning and four-year-olds in the afternoon and whether that no longer becomes a viable model and, therefore, there are significantly greater costs, so I think the question of how quickly supply can be brought on and at what cost remains an important one, notwithstanding the £125 million. Q99 Angela Eagle: And what about in terms of labour market flexibility and unemployment because we have a tight labour market at the moment? Mr Chote: Yes, we have not looked specifically at the implications on that. Clearly there is the issue over the labour market for the providers of childcare themselves and, as you say, whether both in terms of physical capacity and the capacity of available qualified people to do that, there are obviously question marks there, but in terms of the general impact, I do not know whether Martin might have any views on the wider economic benefits of that, but my guess would be that they would be very hard to quantify at this stage. Q100 Mr Cousins: Could I just ask for your views about the likely extension of the ISA, the present higher ISA limits for a further three years - do you welcome that? Mr Weale: Could I come to that from the general proposition that taxes have to be collected and one could imagine a society where people were subsidised to save and subsidised to go out to work and, taken to its extreme, there would not be any tax base, so I am rather nervous about this, and the ISAs are an example, the existence of these tax reliefs for particular activities which seem to be a good thing, but people might be doing anyway. That said, given the way I drew attention to the overall shortfall of saving, I am pleased that that is being addressed to some extent, but I suspect that it would be more fruitful to go to the root causes of why people are not saving very much. For example, should the Government diversify the sort of savings media that it offers and could offer at low charges? I would rather see a more holistic view taken to address the questions of what is it that deters people from saving, whether it is that they cannot afford to save, whether it is that they are playing essentially a game with the Government where they know that if they do not save for their old age, then future generations will have to bail them out and will bail them out, so there is rather little incentive to save. Against that backdrop, the extension of the current limit on ISAs I think is rather small beer. There is of course the general observation at least with equity ISAs that the only people who get benefit are those who pay 40 per cent tax because dividends are taxed at the standard rate anyway, so there are questions about whether the distributional effects of it are desirable or not. I would rather the Government took an overall view of savings, savings structures and savings incentives instead of this piecemeal approach. Q101 Mr Cousins: When somebody says to me, "I think we need a holistic approach", I always translate that in my mind as meaning, "I don't know quite what to do right now, but come back in three years". In your earlier remarks to the Committee, you see, it was a rise in the aggregate savings rate in the country, if I understood your argument, that was actually going to sort out the structural deficits on the balance of payments, so I would have thought that this would have been an important issue for you, and the only practical thing that you have said, which is interesting of course, is an increase in the range and robustness of National Savings products, if I have understood you correctly. Mr Weale: Well, could I air another, and probably rather unpopular, suggestion, that until the early 1980s the charges on some financial media, say, unit trusts, were regulated by the Department of Trade and since they were deregulated, they have become much higher. I do not think the performance of the products has improved relative to the market and there is, therefore, a very substantial question whether, and how, the industry is actually serving the saver. Now, people like Sandler have looked to that to some extent and recommended simple products that can be sold without giving people expensive advice about how they work and so on, but I think fundamentally a look at why the industry is so expensive and more expensive than it used to be, whether the Government could introduce competition in the industry, say, by selling index-linked pensions through post offices as just another means of national saving, another way of financing government borrowing, and I suspect that if you look at the sorts of charges that appear in the industry, whether ISAs are extended or not has relatively little impact except for the cash ISAs where the amounts that people are allowed to save are relatively small. Q102 Mr Cousins: Well, the deregulation of charges in the financial services sector and the renationalisation of savings - how does that grab you, Mr Whiting? Mr Whiting: Being instinctively something of a free market enthusiast, I am not too keen on regulations, so, therefore, I would not particularly wish to see charges regulated totally. Some sort of government oversight structure is very sensible to make sure it is properly run, but, going back to your original question of ISAs, I found the announcement a little disappointing because personally why not just get on and say, "All right, ISA limits will go this way until 2009", because, as Martin says, it is a relatively small thing and it removes uncertainty, and actually now start to think of what is going to happen post-2009 when ISAs possibly come to an end. Q103 Chairman: On that issue, as a Committee we did push on that, for a limit and, like yourselves, we would like some clarity on it. Mr Whiting: It would seem to be a fairly simple and easy thing to say the limit goes ahead to 2009, let us think about the bigger issue. Chairman: We will raise that with the Chancellor. Angela Eagle: There is an interesting little development which I think could be significant and I would be interested in your view on what I have called wealth benefits rather than income benefits. The Child Trust fund, for example, there is now a consultation on whether to introduce a payment at seven and the first payment will go into the fund this coming April. There is also an extension of the saving gateway pilot where the Government matches pound for pound savings of people on very low income to try to allow them to build up a very, very modest but perhaps important amount of wealth in an area of the income distribution, the lower end, where there is almost no saving since it is very, very difficult to save and the financial services industry has virtually abandoned doing anything for people at that end of the potential market. Any views Martin, Robert or John on whether this is a good development which ought to be extended? Q104 Chairman: Could we have brief answers because we have a number of questions to ask you. Mr Weale: I think the question for people on low incomes is how much you want to give what is a very high rate of return created by a subsidy rather than just make sure that they have more income available for saving and their other needs. I do not buy the argument that climbing on the saving ladder is difficult, it is quite different from climbing on the housing ladder because you can go into a building society and open an account and put a very small amount of money into it. It does suggest that the policy does encourage people to think more about saving but I would like to know more about the balance of costs and benefits. Q105 Chairman: Are you really pressed, do you want to answer it? Mr Chote: No. Angela Eagle: It is a very negative answer, is it not? Q106 Chairman: John, on the tax issues, on the avoidance disclosure requirements, including the June 2004 Finance Act, what has been the Authority's typical response to disclosures and how often have they announced an intention to legislate against this scheme and how often have they indicated that the announcement will take immediate effect? Give us very brief answers to a half a dozen questions. Mr Whiting: The disclosures that have been put in as a result of the Finance Act 2004 started effectively to go in during August but really September. The announcements that we had with the Pre-Budget report were the first time that we had any action on them. I think we are all slightly surprised that nothing happened immediately in October, after the first tranche of disclosures went in. This may come back to something Mr Cousins was tackling me about, the speed of response, I do not know. This was the first tranche of 2 December and of course all of them were to take effect from that day. Q107 Chairman: Okay. Is there any evidence though that the new disclosure rules are having a significant disincentive effect on the tax industry's efforts to devise new tax avoidance schemes or is it Popeye getting spinach "Phew! They are off again!"? Mr Whiting: I think it is having an impact because there have been some very clear signals both with disclosure and the statements that have been made that the Government, the tax authorities, are very determined to crack down on what it sees as unacceptable avoidance, and in particular totally artificial avoidance. Genuine routine planning, advising somebody --- Q108 Chairman: Yes, but does industry get energised with that, that is what I am saying? Mr Whiting: It has caused us to sit back and think very hard about where is the dividing line. To that extent it has slowed the whole industry up; it has created a little more uncertainty. Has it stopped people trying to think of tax efficient products? No, I do not think it has, you would not expect it to have done. Has it caused a slow down in the marketing of them, a slow down in the attempts to devise new products, yes it has because obviously things have closed down and you have to bear in mind that the tax authorities are going to know somewhat sooner. Q109 Chairman: Creativity is still alive and well in the industry? Mr Whiting: I think the creativity is still alive but whether it is as well as it was, I do not think it is. Q110 Chairman: Following the problems of introduction and withdrawal of the zero per cent corporation tax, as you know the Treasury has now published a discussion document on small companies, the self-employed and the tax system. Now we have discussed this with you previously in your visits here but what is your view on the discussion documents? Does it affect and address the right areas? What factors is it important for the Treasury to consider when proposing changes to the tax system for small businesses? Mr Whiting: If I am honest, Chairman, it does not really address anything. It starts the debate and I think that is helpful. I had a sudden phone call a moment after the Chancellor had sat down from somebody in the Treasury explaining to me that this was meant to be a very wide ranging document. In the conversation I said "What is the timescale for any changes?", it was emphasised to me that there is no timescale because it is gathering the evidence. I think, to be fair, that is constructive, let us have a big, wide ranging debate. I think it is good that we have at least got it. I think an important parallel step is the revenue customs, a new body having a dedicated small business unit to focus on small businesses. I would hope that in the debate that follows this we will be able to look at things like the zero per cent corporation tax, like many of the other burdens but not just the simple amount of tax burden. Q111 Chairman: Do you think the Treasury could learn from that and avoid any debacles that they have had in the past? Mr Whiting: I would hope it is. As I say, the slight disappointment that I have with this is simply that it is nothing more than starting the ball rolling but providing the intention is to range widely, I think it is constructive. Q112 Chairman: On the tax regime for leasing, that has attracted particular criticism from experts, others have claimed it is a loophole widely abused by multi-nationals. What is your view? Mr Whiting: I think leasing is a perfectly sensible way of funding people's acquisition of plant/buildings. The competitive nature means that if there is an attempt to go into a lease because it moves the capital allowance benefit from the putative buyer to the bank or finance house, the benefit of that lease capital allowance is always passed back in the rates. I think it is worrying that the tax authorities' attitude has always been or seemed to be that this is an avoidance devise rather than just part of a way of doing business. If we are to have further changes, one merit of them is at least they are to only change for leases following the introduction of the rules. I think we are all a little disappointed because of the possible international implications. Q113 Chairman: Last question, Legal & General have said that the changes in insurance company taxation will cost them £20 million this year. Do you believe the new regulations have been announced in a way that is appropriate for such far-reaching changes? Secondly, the Revenue has indicated that these proposals are still in draft form and that they are open to comment from the industry. Is there an opportunity for adequate consultation or is it fait accompli? Mr Whiting: There are a lot of questions. You may have seen, also, that Norwich Union have commented on the impact on them. There are a number of changes affecting the life assurance industry under the banner of anti-avoidance. Within those is something affecting shareholders' funds and what are known as orphan assets, that is very definitely not anti-avoidance and it is that which has aroused the concern. Frankly that was slipped in to the package under a power which allows regulatory changes by Statutory Instrument. There was indeed the possibility of consultation on it but given that the announcement was on Thursday, the consultation period has closed already because we were allowed three working days for what was a substantive change rather than the blocking of an avoidance measure. Frankly, this seems inappropriate. It is interesting to note that it is proceeding under a power introduced some years ago to bring in Statutory Instruments and when that power was mooted and brought in, in 1990, the then spokesman for the Opposition really did object to the potential wide range of this power to bring in regulation. The then Treasury Minister gave him assurance that it would never be used in a wide ranging way. The then Opposition spokesman was a very promising young MP, Mr Paul Boateng. Q114 Mr Cousins: He has done well since then. Mr Whiting: I believe he has moved on. Q115 Chairman: He gets slick answers and moves on, does he? Mr Whiting: That is a power to make tweaks and twiddles, it is not a power there to make substantive changes to the rules. The consultation is minimal and frankly not real and it is of deep concern to the industry. Chairman: On the bell, I think we will finish. Can I thank you for your attendance and Robert and Martin for staying the whole course this morning. Thank you. |