Select Committee on Treasury Second Report


Scrutiny of the Pre-Budget Report
1.We will continue the practice of our predecessors of examining and reporting upon Budgets and Pre-Budget Reports. (Paragraph 1)
2.Although the Treasury was faced with unusual circumstances in 2005, the House of Commons is entitled to reasonable notice of the date of the Pre-Budget Report. We recommend that the Treasury should announce the date of the Pre-Budget Report at least four weeks before the statement is due to be made and, in any case where this target is not met, give an account of the reasons. (Paragraph 3)
The United Kingdom Presidency of the G7/8
3.We welcome action taken during the United Kingdom's G8 Presidency to tackle global poverty, including the increases in aid and the provision of debt relief. It is important that there is clarity about the level of aid and debt relief commitments and clear monitoring to ensure that the G8 delivers on commitments at Gleneagles. We recommend accordingly that the Treasury include reports on G8 progress on the Gleneagles commitments in each Budget and Pre-Budget Report, as well as seeking to strengthen international mechanisms for tracking and delivery such as the Africa Partnership Forum. We also welcome the launch of the International Finance Facility for Immunisation and encourage the Government to continue to explore how innovative financing mechanisms such as the broader International Finance Facility can be used to provide the additional aid necessary to meet the Millennium Development Goals. It is disappointing that the Hong Kong trade talks failed to deliver the hoped-for trade deal; progress in 2006 will be important if world economic growth is to be supported and market access for developing countries is to be increased. (Paragraph 7)
The recent past
4.After above trend growth in 2004, growth has moderated during 2005. A number of reasons for lower growth were put forward by witnesses, including high and volatile oil prices, rising interest rates, weak eurozone growth, slower growth in real government consumption, increasing tax revenues and weak earnings growth, as well as national accounts revisions. Overall GDP growth for 2005 is now estimated by the Treasury at 1.75 per cent, significantly below the Treasury's forecast of 3 to 3.5 per cent at the time of the Budget. We note evidence from the labour market and business surveys suggesting growth might be revised upwards and that non-oil output growth has strengthened from the trough at the start of 2005. We also note that, despite its relatively large forecast error in 2005, overall the Treasury has had a good forecasting record for GDP growth in previous years. (Paragraph 10)
Macroeconomic stability
5.We note the confirmation that over the past six years the United Kingdom has been the most stable economy in the OECD and G7, a record that international institutions have described as "impressive". We note evidence that the institutional arrangements for monetary and fiscal policy have played an important role in delivering this stability. (Paragraph 11)
Monetary policy
6.In a period of high and volatile oil prices, the Monetary Policy Committee of the Bank of England has so far managed to keep inflation close to the target. So far there is little indication that inflation expectations have become dislodged or that there are significant second round effects stemming from the rise in CPI inflation. However, this is a risk that will require close examination by the MPC in coming months, particularly as the results of pay rounds filter through in the early months of 2006. (Paragraph 15)
Measuring service sector output
7.Measuring output in the service sector is inherently more complex than in the manufacturing sector. We recommend that the ONS make it a priority to review the measurement of service sector output, and devote more resources to improving measures of service sector output. Any such change should be accomplished as far as practicable within existing budgets and without increasing overall compliance costs on business, by rebalancing coverage away from sectors of the economy of declining importance. (Paragraph 16)
Consumer spending and the housing market
8.Consumer spending growth slowed sharply during late 2004 and early 2005. The evidence we have received indicates that this was due to rising interest payments, lower than expected wage growth, higher petrol and energy prices slowing disposable income growth, and an increase in the ratio of tax to household disposable income. The MPC cut short-term interest rates by 25 basis points in August 2005 and the tax ratio is not expected to continue to increase at recent rates. This may lead to a moderate recovery in consumption growth, but to a rate that is still below its long-term average. (Paragraph 19)
9.We note that the Treasury's forecasts for consumption growth are based on an assumption that the savings ratio will stabilise at 4¾ per cent, which is around its current level. (Paragraph 20)
10.The recent signs that the housing market is cooling, with house price growth slower than earnings, are welcome and this, so far, has come without the abrupt adjustment predicted by some forecasters. In the longer term, the implementation of the recommendations from the Barker and Miles reviews should improve the stability of the United Kingdom housing market. We note evidence that, while the majority of households can manage their debt repayments, there is a small, but significant, minority of households with problems with increased mortgage arrears and unsecured debt on credit and store cards. (Paragraph 22)
Business development and pension funds deficits
11.The growth of business investment has been modest in recent times compared with previous periods of economic recovery. The need for companies to devote additional resources to pension funds may have been a factor in this. Initial evidence from the Bank of England indicates that, in the years leading up to 2002, companies mainly adjusted to these financial pressures by reducing dividends rather than cutting investment. The Pensions Regulator and the Treasury need to assess carefully the impact of the new regulations on pension funding and of other requirements arising from the Pensions Act 2004 and the effect they could have on investment by and the solvency of companies affected and place a copy of their assessments in the Libraries of both Houses. (Paragraph 24)
Oil and gas prices
12.We recommend that the Treasury investigate the extent to which the negative effects on growth of higher oil prices were greater in the United Kingdom than in the other major G7 economies and report on the outcome of those investigations at the time of the 2006 Budget. (Paragraph 25)
13.Ensuring adequate energy supplies, without unnecessary volatility in prices, is essential to the health and strength of the United Kingdom economy. We look forward to learning of the outcome of OFGEM's call for an investigation into the use of import capacity for gas and consider that the Government should accelerate its work with the European Commission and other Member States to encourage liberalisation of continental energy markets. (Paragraph 27)
The labour market
14.The United Kingdom labour market continues to perform strongly, with employment growing despite the slowing in output growth. We note the anecdotal evidence we have received suggesting that migration into the United Kingdom has played a role in relieving skills shortages and moderating wage pressure. We recommend that the Government consider commissioning research into the economic effects of migration and the extent to which it has relieved skills shortages and moderated wage pressures in individual sectors. We further recommend that the Government report on the initial outcome of such research no later than the 2006 Pre-Budget Report. (Paragraph 31)
15. We note the conclusions of the Leitch report that, despite improvements in recent years, the "United Kingdom does not have a world class skills base". Evidence suggests that there is particularly room for improvement in the areas of intermediate and vocational skills and we welcome the roll out of the National Employer Training Programme. This is likely to require long-term solutions and we welcome the opportunity offered by the Leitch report and the Comprehensive Spending Review to examine and take forward those solutions. (Paragraph 32)
The degree of spare capacity (the output gap)
16.There is considerable uncertainty about the amount of spare capacity in the United Kingdom economy. This is due to recent developments in a number of areas including international migration, oil prices and the measurement of government output. The Treasury believes that the slow growth during late 2004 and early 2005 has led to the emergence of a sizeable negative output gap. Other forecasters including the IMF and OECD believe that the output gap is smaller. The Treasury should continue to take a cautious view of trend growth. We note that the Treasury has departed from its previous practice of a three year rolling review by delaying the NAO audit of the trend growth assumption until Budget 2006. It is important that, regardless of any future changes to the Treasury's assessment of the timing of the economic cycle, the NAO is invited to audit the trend growth assumption at the time of Budget 2006. This audit should assess whether developments between the fourth quarter of 2001 and 2006 support the Treasury's assessment of trend growth of 2¾ per cent over that period. (Paragraph 36)
The fiscal policy framework and the fiscal position
17.The sustainable investment rule complements the golden rule in that, at least as far as the current cycle is concerned, it is subject to annual measurement rather than measurement over an economic cycle. (Paragraph 49)
18.We welcome the decision of the Treasury to invite the NAO to examine the reasonableness and caution of the Treasury's view on the end-date of the last cycle and the Treasury's intention to ask the NAO to conduct a similar exercise when the Treasury has made a firm judgment about the close of the current cycle, but this should be conducted and published alongside the Treasury's announcement of that judgment. We note the view of the IMF that the NAO's involvement puts the United Kingdom "on the frontier of institutional development". However, the limitations of the NAO's involvement must also be recognised in that the scope of the NAO's activities is determined by invitations from the Treasury. (Paragraph 54)
19.The start of the new cycle now seems less imminent than when our predecessors last considered the matter, but a review of the fiscal rules in the near future would be timely. There is strong evidence to suggest that clearly stated and measurable rules assist in the conduct of fiscal policy and help to enhance transparency. Although the golden rule has proved of considerable value to date, there is a risk that, as the final years of the current economic cycle are approached, too much emphasis is placed on immaterial or technical matters rather than the rule being used to assess whether Government policy has been broadly appropriate and fair over the medium term. The golden rule's focus should be on ensuring that fiscal policy is sustainable on a forward-looking basis, rather than encouraging changes to tax levels or spending now as a consequence of data revisions relating to levels of growth several years ago. There may be merit in seeking to supplement the golden rule with a rule or statement of policy that governs fiscal policy during the period when it seems likely that the economy is passing from one cycle to another. (Paragraph 55)
20.While criticisms of the arbitrary level of the limit imposed by the sustainable investment rule as interpreted during the current cycle have some merit, these do not outweigh the essential role that the rule plays in ensuring that Government expenditure and investment today do not lead to an unfair or unsustainable burden on future generations. Before the current economic cycle is declared closed, we recommend that the Treasury state whether, during the subsequent economic cycle, it proposes to interpret the sustainable investment rule as requiring that net debt be maintained below 40 per cent of GDP in each and every year of the next economic cycle. (Paragraph 56)
21.The overall shortfall in tax receipts for 2005-06 compared with the level of receipts forecast in Budget 2005 appears moderate given that the Treasury's forecast for GDP growth for 2005 was reduced from 3 per cent to 3½ per cent at the time of the Budget to 1¾ per cent at the time of the 2005 Pre-Budget Report (Paragraph 57)
22.Given that uncertainties remain in the global economy, we encourage the Treasury to monitor developments closely to ensure that its forecasts of corporation tax receipts remain realistic. (Paragraph 58)
23.Given the uncertainties over oil prices and oil price volatility during 2005, an estimation error of only around £3.7 billion (or 0.8 per cent of current receipts) appears to be an improvement on the Treasury's forecasting record in recent years. However, the Treasury has now over-estimated receipts for five consecutive years. It is important that official forecasts for tax receipts avoid any systemic bias either to exaggerate or underestimate revenue receipts, particularly towards the end of the economic cycle when forecasts are likely to come under particular scrutiny. (Paragraph 61)
24.We note the Government's commitment to a sustained increase in capital spending in the period to 2007-08 and we look forward to examining proposals in the Comprehensive Spending Review to maximise the effectiveness of capital spending. We will continue to monitor how the Government delivers on its plans for increased net investment expenditure. (Paragraph 63)
25.In terms of ensuring the effective control and use of public expenditure, we think that the maintenance of substantial end-year flexibility stocks by departments is an encouraging development. There seems no reason to believe that these stocks will be used quickly or unexpectedly. However, we share the view of our predecessors that the House of Commons should be kept abreast of the position with regard to such stock more than once a year. We recommend that provisional estimates of end-year flexibility stock held by each department be published as part of each Pre-Budget Report and Budget, taking account of amounts proposed to be drawn down in the Winter and Spring Supplementary Estimates respectively. (Paragraph 66)
26.Although it would be inappropriate to expect Government commitments on the level of public spending between 2008-09 and 2010-11 at this stage, the overall fiscal situation suggests that the Comprehensive Spending Review may take place at a time when public expenditure is not expected to grow at the same pace as during the current planning period. In this context, we welcome the Government's commitment to a two-stage process, with a report on spending challenges to be published in the summer of 2006. We recommend that this report be framed so as to maximise opportunities for discussion within the House of Commons and consideration by its select committees on the spending options and challenges before final decisions are announced in 2007. (Paragraph 70)
Efficiency savings
27.Delivering the efficiency savings identified in the Gershon review represents an integral element in ensuring the effective deployment of public money during the planning period covered by the 2004 Spending Review. The headline figure of savings of £4.7 billion reported by the end of September 2005 presented in the Pre-Budget Report is encouraging, but the information in support of this figure should be enhanced in order to strengthen parliamentary and public confidence in the progress achieved. We recommend that future Budgets and Pre-Budget Reports include a breakdown of reported savings by department and by financial year, as well as an analysis of local authority savings which distinguishes savings by sector and by whether or not they are cashable. We further recommend that departments be required, in future departmental annual reports and autumn performance reports, to set out targets by financial year and by programme or theme for meeting their overall targets and to report on progress in relation to such intermediate targets. (Paragraph 74)
28.We recommend that, in Budgets and Pre-Budget Reports, the Treasury report on progress towards the Gershon workforce reduction targets from a single baseline in April 2004 and ensure that information is readily available to enable departmental reductions reported on different baselines to be reconciled with such totals. (Paragraph 75)
SIPPs and pensions simplification
29.In view of the concern voiced by our predecessors and others about the possible impact on the housing market of the previous proposals to permit investment in individual residential property by SIPPs, the revised policy appears appropriate, but the reversal came very late in the day. We recommend that the Treasury examine this episode to ascertain why the likelihood of misuse was not more apparent to it at an earlier stage and whether any unnecessary costs were incurred by the timing of the change of policy. We further recommend that the Treasury report on the outcome of this examination and any lessons it has learned for the future conduct of tax policy in its reply to this Report. (Paragraph 79)
Tax avoidance
30.We welcome the Government's announcement that the non-corporate distribution and zero rates will be replaced with a new single banding set at the current small companies' rate of 19 per cent. We are pleased that the Government has recognised the need for both certainty and simplicity in this area, although it is unfortunate that it has taken it over three years to do so. We recommend that the Government issue clear guidance on the tax rates applicable to small business as soon as possible. This guidance should provide sufficient information to enable those running small companies to assess whether the cost of continuing to operate as a company will now outweigh the available tax savings. It should also provide clear information about the steps to be taken to wind up a company. We also welcome the Chancellor of the Exchequer's announcement that the zero and non-corporate distribution rates will be replaced with a rise in the investment allowances for smaller businesses to 50 per cent. The Pre-Budget Report indicates that, while abolishing the starting allowance is expected to increase tax revenues by £930 million over the next three tax years, the rise in the investment allowance is expected to benefit companies by only £45 million over the same period and there will be a further benefit of £55 million by 2007-08 from the VAT annual accounting scheme. We urge the Government to assess what further measures it can put in place to encourage small companies to retain and reinvest their profits for growth. (Paragraph 83)
31.We look forward to the Government providing further detail about its proposals to extend the tax avoidance disclosure regime to "all of income tax, corporation tax and capital gains tax". We trust that HM Revenue and Customs will ensure that it consults fully and appropriately on the proposals, to ensure that the optimum balance is struck between protecting tax revenue against inappropriate avoidance schemes and ensuring that the disclosure regime does not place an unreasonable administrative burden on businesses. (Paragraph 84)
32.In view of the broadening of the disclosure regime, we recommend that the Treasury state whether it now has any intention to introduce a general anti-avoidance rule. (Paragraph 85)
Other tax issues
33.We welcome the Government's announcement that they are to consult on the introduction of PGS, which should help to deliver the necessary new housing growth in a sustainable fashion. We trust that the Treasury will ensure that it consults fully and appropriately on the proposals, to ensure that the optimum balance is struck between raising revenues to improve local infrastructure, whilst not deterring landowners from selling their land for housing development or compromising appropriate planning safeguards. In particular, we expect the Treasury to give full consideration to applying lower rates (or a total exemption) for PGS applied to brownfield sites. We also consider that, regardless of the eventual decision on introduction or design of the PGS, Government should continue to accord a high priority to securing improvements to the planning system, which currently inhibits the growth in housing supply necessary to keep house prices at an affordable level. (Paragraph 88)
34.We welcome the Treasury's promise of no further increases in North Sea oil taxation during the life of this Parliament, not least because any subsequent increases might increase uncertainty around future taxation of oil companies and might serve as a disincentive to future investment in the North Sea. (Paragraph 89)
Tax credits
35.We are concerned that the Government has yet to provide clear and detailed information about precisely how it has concluded that its proposed package of reforms to the tax credits system will produce a combined saving of £250 million in 2007-08 and 2008-09. We accept that the more stringent requirements for claimants reporting information to HMRC should save money. However, it would also appear that the ten-fold increase in the disregard for increases in income, from £2,500 to £25,000, will be costly. We recommend that the Government provide us with a detailed breakdown of the calculations involved in reaching the estimated £250 million saving. (Paragraph 92)
36.We welcome the fact that the Government is seeking to improve the operation of the tax credits system by introducing a package of reforms. The reforms are intended to redesign the tax credits system so that, where income rises, tax credits entitlements will almost always remain fixed for the remainder of the year and, where income falls, tax credits entitlements should be responsive to such falls. In effect, the Government is seeking to strike a different balance between an income system which is simple and one which is responsive, with the balance leaning a little more towards a fixed awards system than has previously been the case. Most of the planned reforms will take effect between April 2006 and April 2007. We will continue to monitor the operation of the tax credits system during this period, to assess the extent to which the reforms address the significant difficulties associated with the operation of the system to date. We also welcome the Chancellor of the Exchequer's undertaking that he will continue to review the effectiveness of the tax credits system. We note his statement that he is prepared, if necessary, to adopt a fixed awards system in which tax credits awards are based on last year's income. (Paragraph 93)
The Pensions Commission
37.We recommend that, as part of Budget 2006, the Treasury publishes a table comparable to Table 4.2 of the 2005 Pre-Budget Report but relating to people that are retired. (Paragraph 95)
38.We expect to consider the challenges faced in encouraging saving in communities that have not been engaged with financial institutions or savings products and do not have access to basic banking facilities further during our forthcoming inquiry into financial inclusion. (Paragraph 96)
Combating fuel poverty
39.We warmly welcome action taken in the Pre-Budget Report to provide pensioner households with central heating and insulation. While substantial progress has been made in reducing fuel poverty since 1997, the Government needs to assess the impact of recent price rises carefully and take further action where necessary, considering the full range of households that might be in fuel poverty. (Paragraph 97)
Public sector pensions
40.It is essential that public sector pension schemes ensure value for money for taxpayers. We ask the Treasury to provide more details of the cost savings made under the framework agreement, compared to those projected under the original proposal to increase the pension age to 65 for all public sector workers after 2013. In view of the significance of such schemes and their cost to the economy, we want the Government to provide a summary of progress in each of the sector-by-sector negotiations in its response to this Report. (Paragraph 98)
The Operating and Financial Review
41.We welcome Government measures to reduce the amount of "red-tape" faced by businesses. However, part of the Better Regulation agenda relates to proper consultation with businesses and others, and it does not appear that best practice in this regard has been followed with regard to the recent change of policy on the Operating and Financial Review. We urge the Government to consult widely before changing or abolishing reporting requirements and, where relevant, the Better Regulation Task Force should be involved in the consultation process. (Paragraph 99)
Unclaimed assets
42.   We welcome the announcement of a voluntary scheme for the investment of unclaimed banking assets. We may examine the progress of this scheme in due course. (Paragraph 100)

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