some default text...
Budget 2010 - Treasury Contents

Examination of Witnesses (Question Numbers 20-39)


29 MARCH 2010

  Q20  John Mann: How big a reduction in public sector employment could the economy sustain in the next 12 months, without having major knock-on impact, in your view?

  Mr Weale: Unlike the previous witness, I expect unemployment to resume its rise fairly shortly. I am sure that is even on the assumption there are not large job losses in the public sector between now and, say, the end of the year.

  Q21  John Mann: Mr Chote, government borrowing: remind me what your projection was a year ago in terms of what the public sector borrowing would be now?

  Mr Chote: I cannot remember from a year ago. We certainly assumed, on the basis of the pattern of government borrowing through the year so far to date, that it was likely to come in below the 178 million for this year that the Treasury predicted in the Pre-Budget Report. That is reflecting in part the fact that tax revenues have been more buoyant than anticipated. So that did not come as a surprise to us. I think the fact that the Treasury is assuming that pretty much that saving persists into future years as a permanent improvement, slightly offset by a lower growth forecast for 2011, we would be a bit more sceptical about that. When we produced our last set of public sector borrowing forecasts we agreed with the Treasury for this year but we thought that part of that good news would be, as it were, given up because revenues would not grow as quickly as anticipated over the next five.

  Q22  John Mann: I saw one forecast a year ago suggesting that the figure was something like 225 in terms of Government borrowing. How do you think people could get it so wrong?

  Mr Chote: One factor, which came as a surprise to the Treasury as well, between the Budget and the Pre-Budget Report was that the economy had shrunk by much more than it had anticipated at the time and yet the public finances did not appear to deteriorate by as much as you would have anticipated in the face of that. If they had gone in parallel then it would have been reasonable to justify much higher borrowing forecast. In the end the Treasury had to significantly downgrade its growth forecast between the Budget and the Pre-Budget Report but only pushed up its forecast for net borrowing by £3 billion. In a sense we have had a similar sort of good news between the Pre-Budget Report and the Budget now. The growth has not been wildly different from what the Treasury anticipated at the time of the Pre-Budget Report and borrowing has come in lower so we have had two favourable pieces of good news in that sense of good luck, how we want to describe it, between the Budget and the PBR and the PBR and now.

  John Mann: Final question, can any of you name a eurozone economy which you would regard as significantly better positioned at the moment than the UK in terms of the next 12 months? No? No more questions.

  Chair: Nobody can think of it then! I will give you your starter for 10! Nobody. Okay.

  Q23  Ms Keeble: I wanted to ask about the deficit reduction and the speed of it because quite a lot of commentators have been saying, "This is a phoney Budget, we will get the wrong one with the cuts after the election". What do you think of that?

  Mr Chote: I do not know about a phoney Budget, I think this close to an election, realistically with the Chancellor being tugged in one direction by the sort of demands that you describe for having a more ambitious, more in detail deficit reduction plan and on the other hand the concerns of the voters, the most likely outcome was always going to be that those two pressures would largely offset each other and we have in effect had a very neutral Budget. There is a very small net giveaway in the next year which is effectively covered by the unexpectedly large receipts from the bank bonus tax and then in the longer term there is a very modest net tax increase. Overall it is not changing the pattern of the deficit reduction plan very much at all. I think you are right that a bigger change is going to wait until after the election.

  Q24  Ms Keeble: Obviously what that looks like depends on the outcome of the election. Last time when we spoke I asked about what the sharper reduction would look like and both you, Robert, and Martin talked about the impact on pensions. Do you still hold that view, if there was to be a sharper deficit reduction than the one which the Chancellor has projected that the main area which would take the hit would be pensions?

  Mr Chote: I am not sure I would have said that pensions was most likely to take the major hit.

  Q25  Ms Keeble: You talked about the removal of the earnings link.

  Mr Chote: Yes, that would not change and the time at which the earnings link happened does not make an enormous difference in terms of the timing. You are looking at the moment from the Government for a tightening of a little under 5% of GDP over the period through to 2016-17 taking the policies which have been signalled after Budget 2008. If you were to go a bit further than that, you could certainly make the point that already implied in the Government's own figures is such a large squeeze on spending on public services that if you were going to go further beyond that it may well be that the pressure leads you more in the direction of cutting the welfare budget, about which there has been very little discussion or debate, or in the direction of further tax increases.

  Q26  Ms Keeble: If it is the welfare budget then it is pensions?

  Mr Chote: If it is the welfare budget then there are basically three ways you could do it. One is you could freeze or limit the generosity of benefits across the board, that saves you money. You could effectively means test some benefits which are not currently means tested or you could means test some means tested benefits more aggressively. There would be a variety of ways of approaching that. At the moment implicit in the Treasury's documents is that benefits and tax credits continue to go up unless otherwise specified in line with the normal usually inflation-linked basis. I think after the election I would not be surprised to see more adjustment on that side.

  Q27  Ms Keeble: Martin?

  Mr Weale: Could I just make a very general and simple point. The Treasury estimates rightly or wrongly that the country's income has fallen by 5% as a consequence of the crisis. I think most people if they found their incomes had gone down by 5% would expect, at least as a reference point, to think of reducing their expenditure by 5% across the board. If one did that obviously welfare budgets would be reduced as well as spending budgets, but actually what we have seen has been lots of discussion about what is not going to be cut at all and that of course means that the things which are cut have to be cut much more sharply. My general sense is that in discussing what is or is not going to be cut politicians and others have lost sight of the fact that the country is now probably about 5% poorer than we had expected before the crisis.

  Q28  Ms Keeble: Robert, I wanted to ask some more questions about the very interesting paper you did on the proposals for not raising National Insurance where you said that would leave around about £6 billion extra of cuts, and the largest unprotected area would be schools. I wondered if you would like to elaborate these points.

  Mr Chote: This is on the Conservative announcement today?

  Q29  Ms Keeble: Yes?

  Mr Chote: Yes. The announcement is effectively saying that the Conservatives would seek a £6 billion saving in 2010-11 in central government spending on public services outside the NHS, outside defence and outside overseas aid. If you can find the £6 billion cut to that set of unprotected areas, you are right that schools would be the largest one of those. Effectively it amounts to cutting that area of unprotected spending by about 2.8% next year below what would be implied by the Government's existing plans. That is the magnitude of it.

  Q30  Ms Keeble: What does that look like in terms of if people are looking at what happens to their services?

  Mr Chote: The Conservatives have today said that their advisers, including Sir Peter Gershon, have identified a number of efficiency savings that would ensure that cut could be achieved in effect without the public noticing it in terms of the quality of public services. That is always a debatable claim, as it is when any party, and all of them do, makes claims about efficiency savings of that sort.

  Q31  Ms Keeble: That £6 billion would be on top of the already increased pace of fiscal tightening, would it not?

  Mr Chote: At the moment in 2010-11 we are withdrawing, looked at in aggregate, the measures since Budget 2008, we are withdrawing the fiscal stimulus that is in place in 2009-10 in 2010-11. Then you have a pause for breath for a year and then the tightening proceeds thereafter. The implication of the Conservative proposal would be that you would increase the size of the net tightening between this year and next because in addition to having the removal of the stimulus package you have a modest additional tightening in 2010-11 which then goes away largely in the following year because you are spending it on a tax cut. It does further frontload in that sense the overall tightening.

  Q32  Ms Keeble: Compared with what people have experienced, what would it look like? What set of previous tightenings would it look like?

  Mr Chote: Looking at tightenings in particular years, it is hard to get a very clear picture. If you look at what is in prospect over the likely period for the next spending review, then that is already, under the Government's plans, looking like a real squeeze on public services' spending of the sort that we have not seen since the mid-1970s. Having an additional cut in public services' spending at the beginning of that period would obviously make that relatively eye watering picture look even more so.

  Q33  Ms Keeble: The biggest unprotected area would be schools?

  Mr Chote: The biggest unprotected area would be schools, but that is not to say that it would see the biggest hit, that remains to be seen.

  Q34  Chair: I think Sally was looking for a nastier answer! You mentioned the deficit, Martin, how would you go about reducing the deficit if you were in No 11?

  Mr Weale: I suppose I would start off by thinking about reducing spending broadly in line with the reduction in national income but, of course, there are some types of spending which are contractual: debt interest is one, existing Civil Service pensions is another. That means that you have to reduce other types of spending slightly more. Beyond that we have the problem that the tax take is not as large as we had thought, in particular there is less tax from the financial sector although the Treasury is expecting some buoyancy in that. To the extent that the problem comes because the tax take has fallen, then my first thought would be about what taxes I might think of putting up to replace the taxes that are no longer delivering the golden eggs.

  Q35  Chair: Admirably vague, I have to say, but there you are. What about the banks' perspective?

  Mr Clarke: Just to put the thing in context, the planned narrowing the deficit is roughly just over 1% of GDP per year for the next four or five years with the exception of next year, it narrows by 2%. That is roughly in line with the average of post-war fiscal consolidation, so it is respectable. I think probably you could do 1½% of GDP ever so slightly more to get it done quicker because I think people lose patience after six or seven years. What would I do to do that additional ½%? VAT I think is very lucrative, it will earn an extra £10 billion per year. It did not hurt the economy, I do not believe, putting it up and I do not think there were huge benefits from the cut in terms of consumption growth a year ago. I think VAT would be a prime candidate to narrow the deficit quicker.

  Q36  Chair: You taste their palate further.

  Mr Hayes: I actually agree with that. I think particularly on the issue of credibility, I am concerned that the current set of plans on spending cuts are insufficiently detailed and also difficult to assess the credibility of some years ahead whereas if you implement tax increases it is pretty straightforward to work out what they are going to raise in terms of cash. In terms of the current mix, looking for some additional tightening, then I certainly think a rise in the rate of VAT to 20% would get you very sufficiently there in terms of accelerating the degree of fiscal tightening in the way that financial markets would then maybe be satisfied with it. It is a relatively straightforward thing to do, and I agree I do not think it would be that damaging for the recovery so long as it was appropriately timed.

  Q37  Chair: The £10 billion, that is VAT going up to 20%, is that correct?

  Mr Clarke: Yes, I went on the conservative side, I think the ready reckoner says it should be more like £12½ billion. Relative to continental Europe in terms of the VAT rate, 20% would be reasonable.

  Q38  Chair: You mentioned the markets, how did the markets react to the Budget announcement?

  Mr Hayes: There was very little reaction overall just because I think there was no great expectation that we were going to see a big shift in the macroeconomic outlook because of the Budget, and that indeed was what happened. There was a marginal positive to take away from the fact that the Chancellor used the extra windfall gain on revenues to lower the debt and deficit rejections but the numbers were small and so the reaction was very muted.

  Mr Clarke: There was a bit of a move on 10-year government bond yields, about a 6 or 7 basis point rise in yields, so there was a bit of disappointment, I gather, particularly overseas gilt investors were selling positions afterwards. They were a bit disappointed. The consensus of economists, which is not the same as the investment community, it is just a guide, thought gilt issuance would be in the region of £180, maybe close to £190 billion. The markets were looking for something a little bit lower than that and were a bit disappointed. Six basis points is not a lot but the day-to-day movement is substantial.

  Q39  Jim Cousins: Mr Clarke and Mr Hayes, just to follow that last point up, are you telling us the future pattern of fiscal consolidation that it is a bit like British Airways—I must not say picking a fight—having a fight with its workforce which sends the share price up so that in terms of fiscal consolidation you would prefer a big VAT rise nice and early to any uncertainty about fiscal consolidation and how it would be done down the track?

  Mr Hayes: I think that would be seen very positively by financial markets. One of the issues that we are trying to address here amongst all of these things is minimising our future debt costs. People talk about downgrades and so on, that is not really the issue whether you are Triple-A or Double-A, it is how much are you paying for debt servicing costs because the more you pay on that front the less there is to devote to public services. What you do not want to do is find yourself in a situation where you are implementing some adjustment after the event which if only you had done it a few months earlier you could have avoided any crisis situation. The attractive thing at the moment, I am afraid, about tax increases is that they are straightforward, they can be pre-announced, they are credible and you have a reasonably good idea of how much money they will raise.

  Mr Clarke: I have sympathy with that. Ireland is a great example. It is not really the best demonstration of fiscal austerity but, put it in context, they have had four or five budget rounds where they have announced measures worth 6-7% of GDP. They have taken the bull by the horns and fixed things and the market has rewarded that. When government bond yields for peripheral Europe were exploding in the last couple of months, the Irish bond yields' relative to Germany were flat as a pancake. The market saw the government was dealing with it quickly and rewarded it for that. In the context of what that would cost the Government if UK bond yields rose by, say, ½ percentage point, which is a fair estimate of what would happen if we got downgraded or if the market thought we would be downgraded, that is worth roughly an additional £10 billion in interest costs to the taxpayer. I think there is a premium for fixing things earlier rather than letting the market hurt you and force you to do it at a later stage.

previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2010
Prepared 16 April 2010