Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 20-39)

MR ROBERT CHOTE, PROFESSOR DAVID MILES, MS BRIDGET ROSEWELL AND DR MARTIN WEALE

11 DECEMBER 2006

  Q20  Mr Gauke: So that is the difference, the 60,000 people?

  Ms Rosewell: Yes.

  Professor Miles: My rough, back-of-the-envelope calculation would say that this set of forecasts now assumes that net immigration for the foreseeable future is of the order of 60,000 a year higher than they had been expecting in the forecast back in March.

  Ms Rosewell: Which is about 250,000 people net. If memory serves, that is about 450,000-500,000 in and 200,000 roughly out, and I do not know how it is balanced out for every year but I think that is roughly the current position.

  Q21  Mr Gauke: Can I ask if anybody wants to jump into this one?

  Mr Chote: This document on trend growth says estimates showing net inward migration of 185,000 in 2005, so I think, as Martin was saying, it is based on an assumption that that continues. That is probably the number they are looking at.

  Q22  Mr Gauke: Dr Weale, you have already mentioned your concerns. This seems to be going contrary to the Home Office's policy on Bulgaria and Romania and trying to control numbers. How uncertain do you feel this is and does this throw into question the Treasury's overall assumption about trend growth?

  Ms Rosewell: Trend growth could not be higher. If we are underestimating these numbers and we are underestimating the extent to which there can be a continued inflow of people who both can and do work, then we will be underestimating the amount of trend growth. We may be overestimating productivity, however, if we have been underestimating the number of people in the past. We have been saying there is more productivity because we have got the output but not the people, so there are some swings and roundabouts in all of this. If you look at the long term performance of the economy, the 2.5% looks pretty solid. 2.75% over the forthcoming cycle looks to me to be optimism.

  Q23  Mr Gauke: Are there any other views on the 2.75%?

  Dr Weale: Could I just make the point that if that is indeed the trend rate delivered by immigration then one ought to be thinking about the extra public spending that will be needed given the immigration, and that seems to be discussed nowhere in the Pre-Budget Report.

  Q24  Mr Gauke: I was going to come on to that. I know you mention it in your submission to us, Mr Chote.

  Mr Chote: Indeed. The assumptions are still based on the same real growth in spending despite the higher trend growth rate, so if you have 1.9% a year real growth in spending over the CSR period and now push the same rate forward into the following year. If, as Martin says, you have got more people coming in, presumably that spending is being spread over more people.

  Q25  Mr Gauke: And presumably creates demands on public services and so on, so therefore if we do stick to the—

  Mr Chote: It depends where the constraint moves.

  Q26  Mr Fallon: Mr Chote, the Chancellor changed again the end date for the cycle and then said he would meet it with eight billion to spare. What would be the effect if he had not changed it? Would he have missed the Golden Rule?

  Mr Chote: It would have been very tight. He was originally saying that the cycle would proceed through to 2008-09. If you look at the impact of, as it were, the nasty surprises that have come along since the time of the Budget, inflation being slightly higher than expected with an impact on, for example, the costs of social security benefits lower, a lower North Sea oil revenue and other revenue changes, that lot taken together would have probably removed the £16 billion cushion that he was talking about over the cycle at the time of the Budget. However, on top of that he would also have given himself back a bit of cushion by the increase in air passenger duty and other taxes, so he would still probably have been forecasting that he would meet it on a 2008-09 finish.

  Q27  Mr Fallon: But it would have been very close?

  Mr Chote: It would have been very close.

  Q28  Mr Fallon: Martin Weale, you say in your note to us that the cycle did end almost certainly in 2003.

  Dr Weale: Sorry, 2003-04; it depends exactly how you do it. If you look at the chart on page 198, that shows the output gap and although the period in 2004-05, in which the economy was above trend on these data, is not very large, nevertheless it is plainly there, and were it not for the inconvenience of having what had been one cycle suddenly split into two, I think most people would be saying that the cycle ended in 2003 or the start of 2004 and now we are in a second cycle which is likely to draw to its close next year, and a three-year cycle is slightly rapid but it is much closer to the normal sort of business cycle than the protracted 10-year cycle that the Chancellor is describing.

  Q29  Mr Fallon: So if he had not protracted the cycle what is the answer to the same question: by how much would he have missed the Golden Rule?

  Dr Weale: I cannot give you the numbers but he would have missed the Golden Rule by large amounts because, as we know, the Budget has been in deficit, I think, in every year since 2003, so it could not possibly be realised now.

  Q30  Mr Fallon: This is the third change, I think, to the cycle. Have any of these changes hampered the Chancellor's chances of meeting the Golden Rule?

  Dr Weale: No, I think they have all made it easier.

  Mr Chote: If I could just add, it is interesting that in a document of this length there is no explicit statement anywhere that says something convenient like, "And all these projections are on the basis that the cycle ends in 2006-07". There is some airy phrase about, "Oh, it is going to end some time early next year", and the only way you can work out what the final fiscal year of the cycle is is by inferring it from various paragraphs. Another question you may wish to ask officials is where whether they stick to the view that the last year of one cycle is also the first year of the next cycle when you are considering the Golden Rule.

  Q31  Jim Cousins: There is no consistent pattern on under-shooting tax receipts and the reasons for this appear to be different from year to year. Mr Chote, you have just mentioned North Sea oil corporation tax receipts. Do you think this volatility will continue?

  Mr Chote: With regard to the sorts of problems that we would have been citing through many previous sessions such as this from 2001 onwards, the main concern was that the Treasury was over-estimating the speed with which financial sector corporation tax receipts and the earnings of relatively well off people in the financial sector and the income tax payments they make would rebound after the hit that that sector took at the time in of the stock market decline. Our view was when we met this time last year was that much of that damage had been undone by the fact that the Chancellor raised taxes, pencilled in spending cuts and made his underlying corporation tax revenue forecast look more sensible. This, I think, is a different set of bad luck that has come along for him this time, particularly the North Sea oil sector and the inflation effect, so you are right: there has been a continuous run of over-optimism on tax revenues but I think what we have had this time certainly was not something that we would have predicted and it clearly was not something the Chancellor had predicted and is slightly different from the story we have been telling in recent years.

  Q32  Jim Cousins: Bad luck—perhaps I could ask you, Bridget Rosewell, about this. Do you see this as being bad luck or do you think there are maybe complexities in the system that are causing a shortfall of revenues?

  Ms Rosewell: I think Robert is right, that the particular example this time has got an element of bad luck in it, as it were, but I think that there is generally still a lot of complexity in that system. If you look at the proposals which are in the Pre-Budget Report, which look rather more like a Budget Report, I have to say, in some aspects than a Pre-Budget Report, which I thought was supposed to make proposals rather than announce things, there are a lot of announcements around quite detailed level areas of the corporation tax system in particular, or the business tax system perhaps, rather more accurately, as well as this announcement of a change in the air passenger duty. He is expecting to raise an extra two billion next year, of which a billion is the APT, and the other billion is all about quite complicated changes to a whole raft of corporate and business tax systems, and it seems to me to be completely unknown whether those are actually able to bring in the revenues that he expects. They certainly do not seem to be simplifying it.

  Q33  Jim Cousins: Professor Miles, do you think that some of the measures to reduce tax avoidance, and indeed some of the cases that are presently now in front of the European Court to be decided on, for example, the taxation of overseas subsidiaries, will make a meaningful difference to future revenues?

  Professor Miles: I think on the overseas subsidiaries thing the numbers are not trivial and I am sure there is concern in the Treasury about how the judgments may go and it may have material impacts on the flow of corporation tax coming in. I think these are things that the Treasury will understandably worry about and are very uncertain.

  Q34  Jim Cousins: Dr Weale, Bridget Rosewell has already mentioned nervous consumers. Do you think that this nervousness of consumers could be reflected in an undershooting of tax receipts from things like VAT?

  Dr Weale: If nervous consumers do decide to spend appreciably less than we are expecting, then there will be an undershoot of revenue from value added tax and also from the other taxes associated with expenditure. That said, the household sector has, more by luck or more by rising house prices than anything else, acquired quite a lot of wealth over the last 10 years and it is showing a willingness to spend some of that wealth so I believe it has a cushion of wealth which, if you like, protects consumer demand from the sort of nervousness that you are talking about.

  Q35  Mr Gauke: Can I ask Mr Chote a question about the next economic cycle and the Golden Rule there? The Chancellor appears to be optimistic about meeting his Golden Rule in respect of that. Can I ask what your view is and where you see the potential risks?

  Mr Chote: In terms of working out what the Treasury itself thinks is going to happen, as I say, the first thing it would be nice to be clear about from them is what they believe the first financial year of the next/current economic cycle is. If they were following the example of the PQ that I think that Mr Boateng replied to some while ago, saying that the cycle in terms of the fiscal policy analysis goes from the point at which you include the same financial year both at the beginning and at the end, it would be nice to know whether that was still the case. If it were to be, and the forecasts were to work out as the Treasury expects, you would need the next cycle to be four years long on their basis for the deficits expected in the current fiscal year and the next fiscal year to be outweighed by the deficits surpluses in the two subsequent years. as well, So it depends, crucially, on what you assume to be the length of the next cycle. As the Treasury has basically got output moving back to trend and staying there, that is obviously not giving anybody a very useful guide to how policy might need to adjust, if at all.

  Ms Rosewell: I think that is a very important question: what the Treasury view is of the next cycle, because they are saying they are looking at a trend rate of growth. What they actually mean is what the average rate of growth is over the next cycle, so far as I can see from reading the report, and yet their projection shows essentially that you could take the view that on the chart that they have got on the output gap, in fact, the current cycle never ends because we move back to a position of balance and then stay there, in which case, since you are never going above the line, as it were, into a position where you have squeezed the output gap, you never get to a position where that cycle has ended. Therefore, since the amount of judgment which is required to show where a cycle is actually going to begin or end under these circumstances is very great, then better clarity on what judgments are actually being made is really important and we just do not get it from this report.

  Mr Chote: Or much better, of course, would be to abandon the idea of trying to meet the Golden Rule over a fixed cycle but to say where do you want to be over a sensible time horizon of three or five years and to approach it in a forward-looking way as the Bank of England does.

  Q36  Mr Gauke: As both the IFS and I think this Committee have argued in the past. Can I ask about public expenditure? The assumptions—and I think they are assumptions—within the PBR about this seem to suggest that growth in public expenditure is going to be extremely tight. May I ask you, and I do not know if anyone has a particularly strong view on this, as to whether those assumptions are realistic, particularly given the remarks earlier about immigration? As a whole do you think those projections are realistic?

  Mr Chote: It depends what quality of public services you are prepared to have as a response We are talking basically about going to 1.9% growth in real public spending as a total and that would compare with 3.3% on average under Labour to date. Obviously, that included a very tight squeeze in the first three years and then, as it were, the six years of plenty that followed that. Obviously, the Chancellor has announced some tight squeezes in some (albeit relatively small) departments already, so I think the key question comes down to what do you believe to be a plausible medium-term growth rate for social security and tax credit expenditure, and then the issue is how do you basically deal with what were the big winners in the years of plenty: health and education? Together they will do less well presumably than they did during the years of plenty but as to which does better than the other and who bears the pain is a political decision, obviously, as much as an economic one.

  Ms Rosewell: But can you turn the tap off at all?

  Dr Weale: We did, of course, have three years of very tight public spending at the beginning of the Labour Government and I was taken by surprise then that it was actually made to stick. Having been surprised once, I am not going to be surprised again. It is plain that governments can limit growth in public spending if they set their mind to it and the fact that we have had a period of rapid expansion is not an obstacle to that. On the other hand, I do think it would be better to have stable growth rather than feast followed by famine.

  Mr Chote: That early period was, of course, helped by falling unemployment and falling debt interest payments which we do not have this time.

  Q37  Mr Gauke: As a rule, what have we learned about the state of public finances as a consequence of this PBR that we did not know last week and where would you summarise we are?

  Ms Rosewell: I am just wondering what I have learned about the state of public finances. I have learned that, according to the Chancellor, the cycle is about to come to an end but I am not sure that tells me anything about the state of public finances. I have learned perhaps more than I want to know about a number of small schemes and I find it extremely hard in this PBR to winnow out any wheat from the chaff, so I am not sure I have learned very much.

  Professor Miles: I think one has learned that the situation in the eyes of the Treasury is a little bit worse than they had thought. GDP is higher, growth in GDP is stronger than had been forecast, borrowing is slightly higher, the stock of debt is projected to be a little bit nearer the 40% limit. It strikes me as quite a realistic assessment but it is a more pessimistic one than was made at the beginning of this year.

  Mr Chote: The underlying position is that borrowing is roughly five billion a year higher along the forecast horizon than we would have thought a week ago. The Treasury has made up roughly half of that by increasing the trend growth assumption and almost the other half of it through the increase in air passenger duty and tax avoidance measures, so the two have roughly cancelled out. The fact that the Chancellor is in a tight position I think is clear both from the fact that he did not offset the rise in green taxation with a cut in other taxation, as he might have found appealing given the political debate, and he has not found any money for child poverty in this Pre-Budget Report, which has been a priority in previous ones.

  Dr Weale: What I have learned is that the Treasury has gradually moved in line with everyone else. Before the election in 2005 the Chancellor was saying that the forecasts produced then were deliverable and that there was not a fiscal problem. Everyone else was saying that there was a fiscal problem. He has now moved much of the way towards the position that people like the National Institute were saying a year and a half ago, so what we have learned is that the Treasury is becoming more realistic.

  Q38  Mr Todd: If I can turn to another of the Chancellor's rules, the sustainable investment rule, first of all is there anything magic about the 40% that he has chosen?

  Ms Rosewell: No.

  Mr Chote: No. It is at roughly the level that Labour inherited. There is not much more significance to it than that.

  Q39  Mr Todd: The PBR appears to indicate that it will be a little bit tighter to that rule than before. Is there any particular reason for concern there? If you said that the target did not matter very much then presumably the answer to that question is no.

  Dr Weale: My view is that fundamentally whether investment projects are a good idea or not depends on the returns they deliver relative to the costs of providing them, including the costs of collecting the taxes to pay for them. Extra taxes, discourage labour but one could reasonably suspect that with a 40% limit we may be losing investment projects that would be well worthwhile.


 
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