Select Committee on Treasury Second Report

Conclusions and recommendations

The economy

Business investment

1.  We welcome the recent rise in the growth rate of business investment, although we note that, given the supportive conditions at the time, the previous weakness in business investment remains unexplained. In these circumstances, although there may be an upside risk to the Treasury's forecast for business investment, it needs to be borne in mind that there is also a downside risk in that the previous weakness remains unexplained, and it is possible that this period of weaker than expected performance may be resumed. (Paragraph 9)


2.  We note there are several risks around the consumption growth forecast. These include the potential for house prices to fall, for an increase in the influence of insolvencies on consumer spending, and for an increase in the overall saving rate of households, which then dampens consumption. We note the rise in the numbers of households using official forms of insolvency, especially Individual Voluntary Arrangements. We may return to examine matters relating to the regulation of the marketing of Individual Voluntary Arrangements, as well as further considering the economic implications of the rise in personal insolvencies. (Paragraph 14)

The labour market

3.  The rise in the employment rate is welcome. However, the lack of robust statistics on migration means that it is difficult to assess the overall functioning of the labour market. We note that the Office for National Statistics is undertaking work on these statistics, and we recommend that the Government summarise the results of that work in the 2007 Budget. (Paragraph 19)

The trend growth assumption

4.  The change to the trend growth rate assumption, post-2006, though audited by the National Audit Office, is mainly based on migration statistics of questionable quality. We note that any significant error in this assumption will have implications for the Government's assessment of its compliance with its fiscal rules. (Paragraph 20)

The public finances

The overall fiscal position

5.  Despite the improved forecast for economic growth in 2006, the Treasury has not forecast an improvement in the fiscal position compared with its forecasts in the 2006 Budget, partly as a result of downward revision of forecasts for tax receipts in future years as a percentage of GDP. The Treasury's current fiscal forecasts may well be realistic, but they indicate the medium-term constraints that will form part of the context for the conduct of the 2007 Comprehensive Spending Review. (Paragraph 22)

6.  We welcome the fact that the past concerns of the Treasury Committee about the apparent over-optimism of Treasury forecasts of tax receipts, and of corporation tax receipts in particular, appear at the moment to have been addressed. We note the significant downward revision of forecast North Sea oil revenues in 2007-08, and look forward to seeing whether the more cautious forecast proves to be accurate. (Paragraph 24)

The golden rule

7.  On the basis of its current forecasts of the length of the current economic cycle, the Government appears to be on track to meet the golden rule in the current economic cycle. However, the Treasury's forecasts also indicate that the Government will start the next economic cycle with its current budget in deficit, compared to the projections outlined in the 2006 Budget, which foresaw the Government starting the next economic cycle with its current budget in surplus. (Paragraph 28)

8.  We understand that forecasting the start and end of the economic cycle is a complex matter and that there are no clear cut answers. We recommend that, in future Budgets and Pre-Budget Reports, the Treasury provide a fuller explanation of its current forecast of the start and end dates of the current economic cycle. Such an explanation should include, if applicable, the reasons why any movements in economic growth above or below trend have not been interpreted as marking the beginning or the end of an economic cycle. (Paragraph 32)

9.  There is a tension between fiscal planning, which is a forward-looking process, and the assessment of whether or not the golden rule stands to be met in the present cycle, which is primarily a backwards-looking exercise. We recommend that the Treasury review the golden rule and consider the merits of whether that rule could be made more forward-looking and its application less dependent on estimates of the dating of the economic cycle. We further recommend that the Treasury clarify in its response to this Report whether the last year of the economic cycle will count as the first year of the next economic cycle, for the purposes of judging whether the golden rule has been met. (Paragraph 35)

The sustainable investment rule

10.  We continue to believe that the sustainable investment rule has considerable value in helping to assess the sustainability of public sector investment and the potential burden on future generations. However, with the Treasury now forecasting that a new economic cycle will begin in 2007 and the Comprehensive Spending Review underway, we believe that the time is ripe for the Government to clarify how the sustainable investment rule will operate in the next economic cycle. We therefore recommend that, either in the 2007 Budget or in reporting the outcome of the Comprehensive Spending Review, the Government—

a)  state whether it proposes to interpret the sustainable investment rule over the next economic cycle as requiring that net debt be maintained below 40% of GDP in each and every year of that economic cycle;

b)  set out an analysis of steps it has taken to ensure that the sustainable investment rule does not operate so as to prevent the implementation of appropriate public sector investment projects with positive rates of return; and

c)  clarify its position as to whether possible changes to the measurement of net debt would necessitate changes to the sustainable investment rule. (Paragraph 39)

Other issues

Efficiency savings and the Civil Service workforce

11.  We agree with the Chief Secretary to the Treasury that a high level of transparency in the Gershon efficiency programme would improve its chances of success. There is likely to be a correlation between the quality and effectiveness of reporting on the efficiency programme by the Treasury, the Office of Government Commerce and individual departments and the extent of parliamentary and public confidence in the true extent of the progress achieved. We are not persuaded by the Treasury's contention that departmental totals for reported efficiency gains can be issued only by departments themselves because they are responsible for delivery: departments are accountable for their expenditure, but the Treasury is still expected by Parliament to report on departmental expenditure performance. We recommend that future Budgets and Pre-Budget Reports provide a breakdown of reported efficiency gains by department. (Paragraph 46)

12.  We welcome the steps taken by the Office of Government Commerce, in consultation with the National Audit Office, to establish a new framework for assessing and reporting efficiency gains, but we continue to believe that the quality and consistency of reporting could be improved. To enhance transparency and enable effective scrutiny, we recommend that the Treasury require departments, in their departmental annual reports and Autumn Performance Reports in 2007 and subsequent years, to provide consistent and comprehensive information on progress against efficiency targets, including by "work stream" in each case, and to classify all reported gains as preliminary, interim or final. We further recommend that Budget and Pre-Budget Report documents provide a comprehensive breakdown of all reported gains by "work stream" and according to their classification as preliminary, interim or final. (Paragraph 47)

13.  We are concerned that the Treasury and the Office of Government Commerce, in their oversight of and reporting on the Gershon efficiency programme, may not have made sufficient allowance for the risk that claimed efficiency savings might not be delivered without a reduction in the quality of service. Departments have every incentive to assert that reductions in service have been avoided in order that efficiency savings can be recorded and targets can be met. If the Government simply asserts that service quality has been maintained if efficiency savings are reported and then accepted by the Office of Government Commerce, there is a risk that the credibility of the overall efficiency programme might be undermined. We recommend that the Treasury and the Office of Government Commerce undertake research into the quality of measures in place within departments to provide assurance that efficiency savings do not lead to a reduction in the quality of services delivered or products provided, and publish the outcome of such research no later than the 2007 Pre-Budget Report. (Paragraph 51)

14.  We note that there are significant divergences between reported progress against overall efficiency targets by some departments and their progress on workforce reduction targets agreed as part of the same programme; for example, the Home Office claims to have very nearly met its overall efficiency target, but needs to secure a further workforce reduction of 1,466 in order to meet its headcount target. We support the recommendation of the Committee of Public Accounts that the Treasury provide a reconciliation of claimed headcount reductions arising from the Gershon efficiency programme with data from the Office for National Statistics on changes in the overall size of the Civil Service, and we recommend that such a reconciliation be included in future Budget and Pre-Budget Reports. We further recommend that the Office of Government Commerce undertake a formal review of future departmental returns on headcount reductions to satisfy itself, Parliament and the public that such returns are being reported on a consistent and comparable basis. (Paragraph 54)

Expenditure on education

15.  We recommend that, in reporting the outcome of the Comprehensive Spending Review, the Treasury report on the economic benefits of relocation to the receiving locations and on the extension of locally flexible pay in the public sector, and estimates the contribution of both factors to achieving Treasury targets on reducing the differences of Gross Value Added per head across regions and countries. (Paragraph 56)

16.  We are seriously dissatisfied at the lateness and vagueness of the information supplied to the Committee subsequent to our oral evidence, which fails to meet the detailed questions put to both officials and the Chancellor of the Exchequer at the meeting. It would be premature to reach an assessment of the overall trend of public expenditure on education in advance of the announcement of the outcome of the Comprehensive Spending Review. However, the early announcement of capital spending plans for education up to 2010-11 provides a welcome opportunity for the path of expenditure on an annual basis up to 2010-11 on major capital programmes, including the Building Schools for the Future Programme, to be set out at an early stage. We recommend that such information be provided at the time of the announcement of the outcome of the Comprehensive Spending Review. (Paragraph 61)

Child poverty

17.  The Chancellor of the Exchequer told us that the Government had "actually met" the first of its targets to reduce child poverty—namely, to reduce the number of children in low-income households by at least a quarter between 1998-99 and 2004-05. This conflicts with earlier statements by the Secretary of State for Work and Pensions, the Rt Hon John Hutton MP, acknowledging that the Government had not achieved this target. Given that the Government has previously accepted that, although significant steps were taken towards achieving the target, the target was not met, we expect the Chancellor of the Exchequer to explain the basis of his statement in the Government's response to this Report. (Paragraph 70)

18.  The Government's initiative to end child poverty is now focused on its second target—to reduce child poverty by 50% between 1998-99 and 2010-11. We are concerned that the 2006 Pre-Budget Report fails to set out clearly how the Government proposes to meet its target to halve child poverty by 2010-11. We recommend that, either in the 2007 Budget or in reporting the outcome of the Comprehensive Spending Review, the Government outline its strategic position with respect to the 2010-11 target. The Government should both set out its progress to date towards achieving the target, including the measures it has implemented to date, and specify how it intends to achieve the target, including the extent to which it expects various measures to contribute towards achieving the target. (Paragraph 71)

19.  The announcement in the Pre-Budget Report that child benefit will be extended to every mother-to-be from week 29 of her pregnancy will lead to a welcome boost in income for all mothers-to-be. However, we are concerned that the changes to child benefit will not come into effect until April 2009. Both universal and means-tested benefits have a legitimate contribution to make towards the Government meeting its target to halve child poverty by 2010-11. If the Government is to meet the 2010-11 target, it will need to channel additional resources directly to low-income families, for example by increasing the child element of the child tax credit or the Sure Start maternity grant. Such measures would allow the Government to achieve its aim of assisting parents financially in the final weeks of pregnancy: eligibility for the child element of child tax credits could be extended to 29 weeks, and the Sure Start maternity grant is already available from week 29 of pregnancy. (Paragraph 72)

20.  We have previously noted the significant reduction in households facing marginal tax rates of 70% or more between 1998 and 2006-07, while recommending further Treasury analysis of the characteristics and income distributions of households facing marginal tax rates in the region of 60% to 70%. We are disappointed that the Treasury appears to have taken no action about this recommendation. At the very least, we expect the Treasury to notify us if it does not intend to act on one of our recommendations, giving reasons why. We intend to return to the issue of high marginal deduction rates when we examine the 2007 Budget, by which time we expect the Treasury to have published the findings called for in our earlier recommendation. (Paragraph 74)

Delays in improvements to the tax credits regime

21.  We are concerned to learn that HM Revenue & Customs has failed to meet its original timetable of applying, from November 2006, automatic limits on recovery of excess amounts paid in cases where tax credits awards are adjusted in-year following a reported change. We will be watching closely to see whether HM Revenue & Customs manages to comply with the Paymaster General's instruction to introduce such automatic limits in April 2007. We are concerned by the Paymaster General's announcement that the timetable for migrating the remaining 330,000 families who receive income support or jobseeker's allowance—some of the poorest families in the country—to the child tax credit has slipped yet again, given that these families were due to be migrated from April 2004. We intend to take these matters up with the Government in the first half of 2007, when we follow up our June 2006 Report on The administration of tax credits. (Paragraph 79)

Other taxation issues

22.  The scale of Missing Trader Intra-Community fraud appears to have tripled between 2004-05 and 2005-06, to between £3.5 billion and £4.75 billion in 2005-06, with an estimated negative impact on VAT receipts during the year of between £2 billion and £3 billion. We welcome the Chancellor of the Exchequer 's announcement that the United Kingdom Government has reached an agreement with France to secure a derogation from European Union VAT law to combat such fraud. We trust that the European Union will now act promptly upon this measure and we will make our own representations to our opposite members in other national parliaments. The Government has predicted that the reverse charge will move the mechanism for stealing VAT from around 90% of the goods currently traded in Missing Trader Intra-Community fraud. Following the implementation of the measure, we will look for the emergence of evidence that the Government's prediction has in fact been borne out. (Paragraph 88)

23.  We welcome the measured way in which the Government is consulting on and taking forward proposals for a Planning-gain Supplement. (Paragraph 91)

The Leitch Review on skills

24.  We welcome the Leitch Review Final Report's aspiration of making the United Kingdom a world leader in skills by 2020. We expect to comment further on the economic importance of skills training when we report on the outcome of our inquiry into Globalisation: its impact on the real economy. (Paragraph 93)

The role of the Pre-Budget Report

Fiscal consultation

25.  We welcome the Government's decision to commission and publish a range of reviews informing future economic policy, including tax policy. However, it is important that the Pre-Budget Report retains a focus on consultation on fiscal measures that may be included in the forthcoming Budget. Although the 2006 Pre-Budget Report is accompanied by a considerable volume of material on technical tax changes, there is less discussion on more substantive tax measures under consideration for inclusion in the Budget. We wish to see such consultation more to the fore in future Pre-Budget Reports. (Paragraph 95)


26.  We continue to believe that the effectiveness of the Pre-Budget Report as an instrument of fiscal consultation would be enhanced if Parliament and the public were given greater notice of the date of the Pre-Budget Report. We re-state our recommendation that the Treasury 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 the target is not met, give an account of the reasons. (Paragraph 96)

The implementation of new rates of Air Passenger Duty

27.  Where tax changes carry a significant risk of forestalling activity or could distort market behaviour, it is often appropriate for those changes to come into effect immediately upon their announcement, even if formal parliamentary approval cannot be granted for some time thereafter. However, we have received no evidence to suggest that such considerations apply to the changes to the rates of Air Passenger Duty announced in the 2006 Pre-Budget Report. As a general rule, we consider that, where increases in rates of duties or taxes are proposed in the Pre-Budget Report, those increases should not come into force until after the House of Commons has had an opportunity to come to a formal decision on the proposed increase following the Budget. We draw the attention of the House of Commons to the unusual timing of the implementation of the increases in Air Passenger Duty, for which the Treasury has not cited any relevant precedents. (Paragraph 100)

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Prepared 25 January 2007