Examination of Witnesses (Questions 20-39)|
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
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
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
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
Q25 Mr Gauke: And presumably creates
demands on public services and so on, so therefore if we do stick
Mr Chote: It depends where the
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
Q28 Mr Fallon: Martin Weale, you
say in your note to us that the cycle did end almost certainly
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
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 luckperhaps
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
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 assumptionsand I think they are
assumptionswithin 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
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.