UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 897-ii

HOUSE OF COMMONS

ORAL OF EVIDENCE

TAKEN BEFORE THE

TREASURY COMMITTEE

BUDGET 2011

MONDAY 28 MARCH 2011

PAUL JOHNSON

GILLIAN GUY and MATTHEW SINCLAIR

JOHN WHITING, FRANK HASKEW and ROBIN WILLIAMSON

USE OF THE TRANSCRIPT

Oral Evidence

Taken before the Treasury Committee

on Monday 28 March 2011

Members present:

Mr Andrew Tyrie (Chair)

Michael Fallon

Mark Garnier

Stewart Hosie

Andrea Leadsom

Mr Andrew Love

Mr George Mudie

Jesse Norman

John Thurso

Mr Chuka Umunna

Examination of Witness

Witness: Paul Johnson, Director, Institute for Fiscal Studies, gave evidence.

Q79 Chair: Thank you very much for coming before us this afternoon. Do you think the OBR is over-optimistic in its forecast that the Government will meet the fiscal mandate?

Paul Johnson: The main issue is how optimistic it is about growth in the macro-economy, which is, as you know, not something that we at the IFS take a particular view about. Given the OBR’s views about where growth in the macro-economy is going, its estimates seem to be a fairly fair reflection of the most likely path for the public finances. There are clearly risks. The risks are largely around inflation and the level of growth going forward. There are some risks around the extent to which tax revenues will rise as expected, given any level of growth. Finally, there’s a substantial risk, which clearly is outside the OBR’s remit to model, that the spending cuts will prove too difficult to deliver. But should growth, inflation and spending cuts go as it expects, it seems to be a reasonably fair description of the likely path of the public finances.

Q80 Chair: So you’ve treated growth as a black box. You’re saying that you’re just taking growth as a given.

Paul Johnson: When we do our public finance analyses, we usually use the OBR assumptions on growth and show also what the public finances look like under different assumptions-in particular, those assumptions used by other modellers.

Q81 Chair: Therefore, in looking at The Plan for Growth, you have no view on whether it will improve the supply side of the economy.

Paul Johnson: Oddly, those are two very different questions. The question about what the short-term path of the macro-economy might look like is a very different question from the question of what is likely to be the long-term impact of some supply-side changes to the economy. There is clearly a range of things you can do on the supply side that might have a positive impact on the long-term path of the economy. Some of those are in the areas that the Government have looked at. If you can significantly simplify the tax system, you might expect the economy to move slightly faster-

Q82 Chair: That is to suggest that the measures in The Plan for Growth won’t have any impact until the next Parliament.

Paul Johnson: It’s very difficult to change the path of growth in the short run. All Governments have found that.

Q83 Chair: You’re defining that as five years-four years.

Paul Johnson: Four years. It’s difficult to change the path of growth over a three or four-year period. That’s not to say that some of the measures enacted in this Budget or, indeed, measures that have been enacted over the past 10 years, will not have some impact. It has to be said, even ex post, that it’s pretty hard to evaluate what that impact was, so we still don’t know, for example, what impact the substantial competition regime reforms that the last Government brought in have had on growth, even though there might be some good reason to think that they might have had a positive impact.

Q84 Chair: So a judgment of the coalition’s performance at the next election will be determined, in this respect, by the inheritance it received from the last Labour Government on supply-side reform?

Paul Johnson: There will certainly be an element of that.

Q85 Chair: I am asking you whether it is an element of that or whether it is entirely that. I have just asked you whether The Plan for Growth will have any impact over the next four years, and you have sucked your teeth and pretty much said no.

Paul Johnson: On the overall level of growth, it is pretty hard to say, sitting where we are today, that it will definitely have some impact on growth over that period. It may have some impact on particular areas and particular elements of the economy, but, on a measurable increase on the size of the economy three years out, I certainly couldn’t sit here and tell you yes, I think it will do that.

Q86 Chair: You think it is likely to be immeasurable.

Paul Johnson: I think it is certainly going to be very hard to say in four years time, "The economy is now x amount bigger than it would have been had you not put these things in place."

Q87 Michael Fallon: Going back to the Chair’s question on the fiscal mandate, the Government have made much play of sticking to the courses chosen. Do you think that they are right to have stuck to this course?

Paul Johnson: There are two questions there, really. One is about the fiscal mandate, which is to have a cyclically adjusted balance within the five-year period of the forecast. That is still being done, even though things are looking a little bit less comfortable than they were at the time of the spending review, because the risks around that have grown a little and the forecasts have got a little less good. Whether it is the right thing for them to do depends on a judgment on the risks you think are being put in place by not making the fiscal retrenchment swiftly. I think that the biggest risk around not making a swift fiscal retrenchment relates to the credibility of that retrenchment, particularly given the political cycle. The risks of doing it more quickly are that the spending cuts are so significant that they become genuinely difficult to put in place, so you move away from it and then you lose credibility. I think that, given where we were in the spending review, given what the Chancellor has said, given the extent to which his credibility depends on sticking to the plan that he made then, and given that despite one quarter of rather poor growth, very little has actually changed, frankly, since the spending review, it would be rather odd of him to step back from that commitment.

Q88 Michael Fallon: I understand the risks. You said this was a matter of judgment. I want your judgment as to whether sticking to the course was the right decision last Wednesday.

Paul Johnson: Given that he had set out a course and given that, in our judgment, not a huge amount has changed-there is not a huge amount of new information-he probably should stay there at the moment. The question then becomes: what point and what new information would lead him to change course?

Q89 Michael Fallon: But, at the moment, is he right to stick to the course?

Paul Johnson: Given what we know at the moment and given the course that he has set himself, he doesn’t have enough basis on which to change course.

Q90 Jesse Norman: Lord Turnbull suggested to us in his testimony last year that one of the weaknesses with the golden rule was that it encouraged the Government to feel more optimistic than they should have done, because it carried with it some gains in the early part of the cycle that they could expend in the latter part. Therefore, one of the effects of the golden rule was to worsen the bust when it happened, because the Government had continued to spend in advance on the back of it. Is that your view?

Paul Johnson: It certainly was a weakness of the golden rule that it was backward-looking and, therefore-particularly given the way in which the last cycle worked and particularly given that it is difficult to judge where you are in the cycle-a lot of gains early on were banked in terms of spending later on. That was a risk with using the golden rule.

I think that that analysis is essentially right. One thing I would add-and this applies both to the golden rule and the fiscal mandate-is that one should not underestimate the power of having some fiscal rule. In a sense, any fiscal rule is not going to be precisely the right one. There is an element of judgment about what the rule is. What is important is that it imposes some level of constraint. Both the golden rule and the fiscal mandate will impose some constraint. There are problems, especially when that constraint is determined by things that happened many years ago.

Q91 Jesse Norman: One of the advantages of the golden rule was that it was a fiscal mandate of a kind. Its disadvantage was that it had a structural weakness by which the Government allowed themselves to be seduced. What are the weaknesses in the current fiscal mandate?

Paul Johnson: The advantage of the fiscal mandate relative to the golden rule is that it is explicitly forward-looking, so you can’t build up that credit from things that happened in the past-that seems to be a clear advantage. There are two things that you might think about, especially with the way in which it is phrased. The description of how it is phrased is that you are looking for the current budget balance, cyclically adjusted, at the end of the five-year forecast cycle. In principle, that five-year point never arrives because the mandate changes each year. We will have to wait to see how the Government interpret that, which is itself a potential weakness.

A second factor, which is both a strength and a weakness, is that it seems appropriate to look at the structure of the cyclically adjusted balance, but it is never actually observed. Quite a lot of uncertainty and estimation goes into the cyclically adjusted balance as opposed to the actual balance. There is a similar problem with measuring the golden rule when you have to measure things over the cycle. All this depends on a very fine judgment about where the cycle is in the first place and what the structural deficit is in the second. In principle, that is the right thing to do, but in practice that makes it very hard to be sure.

Q92 Jesse Norman: There is a concern about the uncertainty over how it is applied, and there is concern over the composition of what it is applied to. Do you see any malign policy implications from the way in which it has been presented?

Paul Johnson: I think that it is a sensible response to the problems associated with the golden rule, but I certainly would not describe it as malign.

Q93 Jesse Norman: I mean you cannot see any problems with it.

Paul Johnson: There are the problems that I have just stated. Beyond those, I don’t see anything, no.

Q94 Jesse Norman: You gave an extremely interesting analysis of vulnerability to interest rates internationally in the green Budget. Have you costed the effect of putting in an austerity package last year? In other words, what would have happened to interest rates and to our global borrowing costs, given the amount of money that has to be raised over the next few years, if that package had not been put in?

Paul Johnson: No, and I think that that is a counterfactual. It is very hard to know what the answer would be. There are clearly risks. You see that in the spreads that some countries have over the interest rates paid by Germany, for example. We have a small spread over that, while places such as Portugal and Spain have quite substantial spreads above that. That is a measure of the risk, but the probability of that risk occurring is something that we have not put any estimate on.

Q95 Jesse Norman: A final question. It seems self-evident that not all growth is the same. You can have growth that comes from an increase in consumption or from investment in other parts of GDP. You can have growth that is short term or long term. How do you characterise the kind of growth that the growth strategy is aiming at?

Paul Johnson: I see two types in there. There are a number of fairly long-term measures aimed at investment in long-term outcomes-changing the planning regime or simplifying the tax system, for example. That is the long term and the investment-driven nature that you are describing. The enterprise zone measures may be more about growth in particular areas than about growth across the economy.

Q96 Mr Umunna: Looking at the distribution impact of the Budget, would you say that this is more of a regressive or a progressive Budget, or neither?

Paul Johnson: This Budget did almost nothing to household incomes. There are two significant changes: one is the cut in fuel duties; the other is the announced increase in the personal allowance. Overall, those are a give-away to households. Proportionally, the increase in the personal allowance will help those in the lower middle of the income distribution-those who are low income earners but are paying income tax. That group will gain from that particular change. The petrol tax change will be fairly steady across the income distribution. Most of what is happening over the next two years is not stuff that was announced in this Budget. A vast number of things announced in the spending review and last year’s Budget will come in over the next year or two.

Q97 Mr Umunna: In the wake of the CSR, you were involved in-how can I put it?-some public debate with the Deputy Prime Minister over the fairness or the unfairness of the Budget.

Paul Johnson: Institutionally.

Mr Umunna: I certainly think your conclusions after the emergency Budget and the CSR were that, as a whole, the measures that had been introduced by the Government were regressive. Given that you said that this Budget doesn’t change things, is that still your analysis of the accumulated effect of the measures that have been introduced since May 2010?

Paul Johnson: There are two things that I would add to that. If you look at the totality of things that have been announced and that are being introduced during this Parliament, from May 2010 onwards, you clearly find that those who are hit hardest are those in the top 10%, and indeed the top 2%, of the income distribution. There’s higher-rate tax and all that-it is not terribly surprising-and also the NI changes. If you look further down the distribution, you see a pattern where, proportionally, those towards the bottom are hit somewhat harder than those towards the middle. That’s the range of things that have now been announced in Budgets and spending reviews. There has been an additional announcement on the universal credit. We can’t model that in quite the same way as we can model everything else, but if you add that in, it does flatten off that distributional effect, because it is aimed at increasing the incomes of people right at the bottom, and it takes a bit away from people towards the middle of the distribution.

Q98 Mr Umunna: One thing that you-I think it was you-said last week was that the Budget took with one hand and gave back with another.

Paul Johnson: That was before the Budget; it was about the whole set of things that came in.

Q99 Mr Umunna: Is that still your view? One example that has been used-you mentioned this-is that the personal allowance will go up by £630, but some have argued that changing the uprating of the threshold, so that it goes up by CPI as opposed to RPI, means that the Government essentially take all that money back again. What is your analysis now that you’ve seen the Red Book?

Paul Johnson: The original comment I made came, in a sense, fairly straightforwardly from the sheer number of measures that were put through in last June’s Budget. The Red Book doesn’t use numbers, but letters, but I think that more than 70 tax benefit changes were announced. The net cost to households of about £5 billion is made up of a very big net give-away and a very big net takeaway. In a sense, there are lots of things that will make some households better off, and even more things that will make them worse off-that’s from last year. If you look at the set of things announced last week, you’re right that the increase in the personal allowance will be beneficial, particularly to basic rate taxpayers and those on relatively low incomes. Over a long period, the change to CPI indexation of allowances will clearly have the reverse effect, so the national insurance lower earnings limit, for example, will rise less quickly than it otherwise would have done. Over a long period, that may be quite a big change to the tax system. The Red Book suggests that even if we do not take account of the long-term impact on, for example, the personal allowance or income tax, that measure will raise £1 billion a year by the end of this Parliament. That number will rise year on year going forward, and it will result in more people being brought into the NI system and higher amounts of tax being paid by people further up the distribution.

Q100 Mr Umunna: May I go back to some of the questions that Mr Fallon and Jesse Norman asked? In your green Budget, towards the end of the executive summary, you corporately-it may not have been you personally-said that there was a need to have a contingency plan in the event that growth was lower than forecast. You should correct me if I am wrong on that, but is that still your view? Is there a need for a plan B if circumstances change and the economic conditions are more adverse?

Paul Johnson: Broadly speaking, yes. There are clearly things that could happen in the world that would lead you to want to change what you are going to do, or the time scale over which you are going to do it. There are two things that might happen. One is that growth forecasts go down just a bit, but in a way that means you are not going to meet the fiscal mandate. You may then decide that you want to tighten things further to make sure that you meet the fiscal mandate, or we may go into some kind of double-dip recession that relates to a significant additional problem with the economy. In order to meet the fiscal mandate then, you would really need to put on the fiscal tightening in a period of recession, although it seems unlikely that a Government would choose to do that. I guess what we are saying is that you could increase your credibility by making it clear that there are states in the world that are not going to follow this model. It is very clear that there will be states in the world that could not possibly do what you are currently saying you are going to do.

Q101 Mr Umunna: Do you think it is therefore sensible for the Chancellor to make such a virtue of keeping to his fiscal mandate-his plan for fiscal consolidation-regardless of the circumstances, because if you talk up the problems and credibility, and if you need to change course as you’ve described, you will get doubly hammered by the market?

Paul Johnson: There is value in being clear that you are not going to change course as long as the world does not change dramatically.

Q102 Mr Umunna: That has not been added as a condition.

Paul Johnson: I think that is right. The world is uncertain about what defines a dramatic change in the state of the world-it may expect change, it may think change will happen when it won’t, or it may think change won’t happen when it will have to happen. So, as I say, that may decrease credibility or increase uncertainty, rather than the reverse.

Q103 Chair: Coming back to distributional issues for a moment, a couple of years ago-correct me if I am wrong-the IFS produced an analysis to show that the revenue maximising point for the top rate of tax was 45%. Is that still the IFS’s view?

Paul Johnson: Just to be clear, our analysis certainly didn’t show that we were certain that 45% was the revenue maximising rate. What I think we said was that given the evidence from changes some time ago and internationally, 45% is at the centre of a wide band of uncertainty about where the revenue is-

Q104 Chair: The most likely revenue maximising rate. Are you happy with that phrase?

Paul Johnson: Indeed, but subject to the fact that that depends on the tax base. We know that the tax base has changed because the pension contribution limit has changed. That will increase the revenue maximising rate. On the basis of the best evidence available, the best guess of what the centre of the possible set of tax revenue maximising rates would be was 45p, and therefore we said that having a top rate of 50p was taking a bit of a punt in terms of whether that would actually bring in any more money.

Q105 Chair: But you now think it is higher?

Paul Johnson: It will have increased because of the broadening of the tax base.

Q106 Chair: But you’ve not developed what that might be?

Paul Johnson: We don’t know because we have to estimate off data, and we don’t have any data on the impact.

Q107 Chair: A little higher or a lot?

Paul Johnson: Probably. Not vastly. I couldn’t put numbers on it.

Q108 Chair: Have a go.

Paul Johnson: I really couldn’t. The 45p is estimated with such imprecision that to put a number on top of that as a result of a recent policy change is something that I can’t do, other than I can tell you what direction it will go in.

Q109 Chair: You were suggesting that it needed to be done, not me.

Paul Johnson: But I can’t tell you by how much.

Q110 Mr Mudie: I just want to follow on from what Chuka and Michael said. As I understand it, your answer to Michael is, yes, he’s right to stay on the same course for two reasons. One is that, because he was the architect of this policy, it would damage his credibility if he had to change. He has expressed no desire to change nor any willingness to consider change. The only reason that that is a decent stance at this point in time is that the things that went wrong did not go wrong in such a major way and there would still be time to see how the next year develops before he would even have to consider the need for changing. When I think of the coming year, with the cuts and their effect on demand and tax revenues, would his position of, "Because I am Chancellor and I have said I am not going to change", be a defence for watching his policy just fall apart? Surely he would have to change, as you have said to Chuka. As you also said, he has not left himself any manoeuvring room at all by accepting that the world out there enforces changes on Governments whether they like it or not.

Paul Johnson: As I said, if the world changes dramatically and we end up with three quarters of significant negative growth, it may well be appropriate for him to think about that.

Q111 Mr Mudie: Even the stuff that is on the table now should start you worrying, because it is just after November and it has changed so significantly. Maybe you wouldn’t say so, but some factors have changed adversely. It is not that it might hurt people out there, or that it might be bad for the economy. It is because of his stated policy. He has pinned himself to that stated policy and the attitude is, "It’s my credibility, so I will not change it."

Paul Johnson: I think that it is not quite that. The point is that we start from a deficit of £147 billion. The Government have said, "Here is our plan for reducing that to an acceptable level." If you swerve from that course three months after you set that course-

Q112 Mr Mudie: It is a question of whether you should have started that course, without qualifications.

Paul Johnson: Okay. So there are two separate questions there. Once you have set that course, if you change it significantly three months later, that would clearly cause concern, in terms of the interest rate that is being paid and the markets, for example. There is a separate question about whether that course was the right course to set in the first place. As I think I set out in an earlier answer, there is a genuine balance of factors that you need to consider in that regard.

Q113 Mr Love: I am sorry to continue in this particular vein, but as a result of the answers that you gave to Mr Fallon we want to probe just a little further. How sensitive is meeting the fiscal mandate to a further deterioration in the economy? In other words, how low a rate of growth would we need to have and how high would inflation have to be for the fiscal mandate not to be met?

Paul Johnson: I think that the OBR sets that out in the document. You will have to check this, but I think that it thinks if growth in the next four or five years is 1.5% less than it expected, or in other words the structural deficit is 1.5% less than it thinks it will be, that would cause problems for the fiscal mandate. But that is an OBR number that is worth checking in there.

Q114 Mr Love: I know that you have this relationship with Barclays and that they do some of the number crunching in terms of the economy. We were told last week by Barclays that even if you don’t accept their view that they won’t meet the fiscal mandate, the sensitivity to changes of this nature is very small. The changes only need to be very small. Would you disagree with that?

Paul Johnson: It depends what you count as "small".

Q115 Mr Love: You used the word "dramatic" earlier on-I think that it was when you were answering Mr Umunna and Mr Mudie. You said that the Chancellor changing course would need a dramatic-

Paul Johnson: That is a different question from the question, "What would allow him, on current policy, to meet the fiscal mandate?" In terms of meeting the fiscal mandate, my understanding from the OBR numbers is that the structural deficit would have to be 1.5% less than it currently considers it to be. Now, there are clearly a set of possible worlds in which we do not meet the fiscal mandate-growth is lower, inflation is higher, spending cannot be kept under control, the tax revenues come in lower than expected. There are a whole range of possibilities under current policy that would lead the Government not to hit that mandate. Then, under current stated policies, there would have to be an additional fiscal tightening in order to meet that mandate.

Q116 Mr Love: Let me set out two scenarios that were put to us last week by the forecasters, one from Barclays, which comes in with a lower growth forecast and is particularly critical of the OBR in years 2013 and 2014, suggesting, about spare capacity, that growth will not be that high. How do you respond to that? Would you sympathise with that viewpoint?

Paul Johnson: I genuinely do not have a view as to what the most likely outcome for the economy in 2014 is likely to be. What that difference reflects is a difference in their assumptions about what the spare capacity in the economy is at the moment. Coming back to my answer to an earlier question, one of the difficulties with the fiscal mandate is that it is targeting something that you can’t observe, which is the cyclically adjusted deficit that depends on the amount of spare capacity in the economy, and macro-economists have different views about what that is. At the moment, the way that the OBR takes account of uncertainty is to provide probabilities of meeting the mandate, but the way that it provides those probabilities is based on forecasting errors going backwards over the past 20 years, if you look at Treasury forecasting errors.

One thing that the OBR could do in addition, and it would be interesting, would be to show explicitly: this is what we think the impact would have been on our models of growth being different; or it could actually build up some of these uncertainties from the bottom up, as the Bank of England does in its forecasts, rather than using the average of how wrong things were in the past. Both of those are useful and interesting, but, in a sense, a lot of the questions that you have been asking me here could be quite readily, or with complexity, provided as part of this OBR document, if it was to show, on different sets of assumptions, what the outcomes would be.

Q117 Mr Love: I read that in terms of the OBR report. Let me carry on. Last week, the National Institute of Economic and Social Research criticised the OBR figures in terms of a greater reliance on consumer expenditure, because it has a good capacity to produce revenue for the Government. How do you respond to that particular criticism?

Paul Johnson: I don’t feel qualified to comment on that at all. I’m sorry.

Q118 Mr Love: Let me ask you then about the OBR forecast for tax income-higher tax revenues in 2011-12. Although the OBR accepts a lower growth forecast, it seems to be suggesting that the tax take in those years would hold up, rather confounding quite a lot of the pundits. I don’t know what the Institute had to say about that, but this is a question that has been raised with us. How do you respond to that particular concern about OBR figures?

Paul Johnson: My take on the forecasting changes is that they have a fairly significant reduction in revenues coming in as a result of wages and salaries. The two big things that have changed its forecast are: increased inflation, and lower wages and salaries, so I am not sure that I quite follow your question.

Q119 Mr Love: We all accept that the OBR has lowered its growth forecast, because of what happened in the last quarter of last year, but it is suggesting in its taxation revenues that in 2011-12 the take will be as high as it was previously. In other words, it does not appear to be taking into account the lower growth forecast and lowering the tax revenues that will result. There seemed to have been quite a lot of comment about that. I am surprised that you have not heard about it.

Paul Johnson: I haven’t come across that. The figures that we’ve extracted from the OBR document suggest that it is reducing its forecasts of revenues by over £4 billion as a result of that, so perhaps we just need to check what the different figures all mean.

Q120 Mr Love: Let me leave that. Clearly we’re not on the same page as far as that’s concerned.

I wrote down a quote from the green report, and it was commented on by Mr Umunna. It is a comment on the Chancellor that "having alternative plans to hand could prove useful." That does not quite suggest an option B, but what did you mean by that statement, and do you still stand by it?

Paul Johnson: Yes. Hopefully, I said this just now, but it is clearly the case that there are possible states of the world in which it would not make sense to carry on down the current path. If we had three or four quarters of significant negative growth, the chances of meeting the mandate would depend on a dramatically more dramatic fiscal tightening than we currently have in the pipeline. If you go into that kind of dramatic recession, then you will change what you do. I think it’s very hard to disagree with that as a fact. So then the question becomes-I suppose this is a judgment both economic and political-how much do you say about the situations in which you would change your plans.

In many states of the world in which the macro-economy does not change that dramatically, it is probably helpful to have a simple message that there is no world in which we will change. You can see the benefits of that, but the risks are that, as I’ve just stated, it is obvious, and everyone must realise that there must be states of the world in which you would move away from that plan. The question is whether it is helpful to be clearer about what those states of the world would be.

Q121 Mr Love: I am coming full circle. I am trying to resolve use of the words "dramatic change in the economic outlook", with the suggestion that they ought to be considering what would happen. If it needs a dramatic change, I would assume that there is no need to consider what any alternatives might be. But if you’re close-in other words, if meeting the fiscal mandate is very sensitive to even small changes in the economic fundamentals, clearly you would need a plan B. I am trying to get your view on that.

Paul Johnson: I think we may be talking at slightly cross-purposes. I think there are two separate and separable issues. One is about the probability of meeting the fiscal mandate. It may turn out that in a year or two, for all sorts of reasons, including changes in forecasts, changes in growth, changes in inflation, failure to rein in public spending or what have you, we might need to do more to meet the fiscal mandate. Given that the fiscal mandate is what the Chancellor has set his aims at, in all those states of the world I would expect the Chancellor to do the additional stuff that’s necessary to meet the mandate. On the other hand, it could turn out in two years’ time that instead of some of those changes occurring, there’s been a severe recession. In that world, I would expect him to think again about whether the fiscal mandate is the right place to aim for in the period that he is aiming for it. I think those are two quite separable kinds of questions.

Q122 Stewart Hosie: I come back to an earlier question about growth. You basically said that the OBR growth figures were given, and I want to probe that. Given that meeting the fiscal mandate, economic recovery and the public finances are predicated on 6.5% to 11% business growth in every year for the forecast period, are you certain that those figures are robust or can be met?

Paul Johnson: No. As I’ve tried to say in answer to many questions, that’s really not my area of expertise.

Q123 Stewart Hosie: But when you are assessing the public finances, you are looking at these assessments-those assumptions. You must also be seeing a near 0.5% fall-a 0.4% fall-in gross fixed capital formation in the last quarter of last year. Surely that has a bearing on the way you look at the numbers and the assumptions, doesn’t it?

Paul Johnson: We are modelling the public finances on the basis of a given level of growth. We do not have a macro model. We aren’t macro economists and we are not modelling the likely path of growth. These are good questions, but I am not sure that I am the right person to ask.

Q124 Stewart Hosie: I am trying to get to what the IFS is doing and how it is looking at this in relation to the public finances. Again, there is a set of assumptions that drive the work you do, for example that the economy will be driven by exports. We start off with a £97 billion deficit in the trade in goods, and that had a net negative impact on GDP growth in the last quarter of last year. All those negative pressures are there. Are you taking any cognisance of those when you look at the growth figures that are assumed when you look at the public finances?

Paul Johnson: Again, the way we model the public finances is to take the breakdown of growth as provided previously by the Treasury and now by the OBR, and use our models of the responsiveness of tax revenues to that. We use what we know about the path of spending and tax over past years to look at what the outcome is likely to be. You can clearly re-do that using different growth forecasts, which we do in the green Budget. As you would expect, if the growth forecasts are less positive than the OBR is saying, you have a bigger problem with the public finances. I am sorry to sound a little unhelpful, but that really is as far as we can go. I cannot offer you any help on whether estimates of exports are good or not, because that is simply well beyond my area of expertise.

Q125 Andrea Leadsom: We are slightly going round in circles. The IFS is very much seen as incredibly influential and having a big say in whether the coalition Government are getting this right or not at the moment. In effect, you are saying that bearing in mind the mandate it has set itself, it probably couldn’t have done anything different. On the other hand, you appear to be judging whether it has made the right decision, and you suggest that potentially some of the changes from May 2010 and onwards are in fact regressive. You seem to be saying that it all depends on whether there was the right mandate to start with. Can I just try a different question-you see what I am getting at? You seem to be very influential in the media, and the media seem to suggest that you have a view on whether the coalition Government are getting it right, but you are claiming that you only see one side of it. You take as a given all the macro forecasts and expectations, and given those, you simply say what is going to happen to the public finances. Which do you think is the bigger risk to public finances-lower growth or higher inflation?

Paul Johnson: I think there are a lot of risks to the public finances. Both lower growth and higher inflation are risks. Higher inflation directly feeds through-there is a £170 billion social security bill, a £30 billion tax credit bill, public sector pensions and the index linked parts of Government debt. Higher inflation goes directly through into that, and we saw a significant impact in the Budget forecasts. It also-in the long run, this may be even more important-makes the spending plans more difficult to put into action. Higher inflation clearly makes the real cuts involved in the current cash plans higher, and it makes public sector wage freezes more difficult to keep to. Those are all clearly very substantial risks to the public finances.

Q126 Andrea Leadsom: May I interrupt you there? So is, surely, the cost of inflation in terms of the likely interest rate that would then be incurred on our borrowings. Is that not another potential impact of higher inflation? There will be higher costs as well as public spending cuts that are harder to achieve.

Paul Johnson: Yes, so depending on how the Bank of England responds, higher inflation could increase the Bank of England base rate. Whether that necessarily increases the rate that the Government pay on gilts is not such a direct link.

Q127 Andrea Leadsom: Okay, that’s fair enough. So, in your opinion is lower growth a higher or a lower impact than inflation?

Paul Johnson: Forgive me if I haven’t got this right, but I think that if you look at the OBR numbers, the changes to each have been of a fairly similar magnitude in terms of the impact. Obviously, if growth is lower because it turns out that the structural element is a bigger problem than we thought, in other words if there’s less spare capacity in the economy, that means that the equilibrium point that we’re heading to will be the wrong one, and we’ll have to close that and that will just require more policy action-higher taxes or further reductions in spending. Higher inflation doesn’t change that equilibrium point of where the economy might be heading. So, in a sense, lower growth, if it’s reflecting the fact that there’s less spare capacity, would be a more fundamental problem I suppose, but clearly both of them are going to have pretty significant effects.

Q128 Andrea Leadsom: So, is it your belief that there should be a plan B at this point?

Paul Johnson: I’ve answered that question three times before.

Mr Mudie: Just say yes, Paul.

Q129 Chair: If you were the Chancellor and were thinking about preparing one, would you let anyone know about it?

Paul Johnson: I might not.

Q130 Chair: I am asking: "Would you, yes or no?" My questions are generally "yes or no" ones.

Paul Johnson: If I was the Chancellor I would definitely have one, and I’d think very hard about giving some sense of the circumstances in which I might move to it.

Q131 Chair: So, you’d have one but you wouldn’t talk about it, and you’d work out the circumstances in which you might move to it.

Paul Johnson: Yes, and I might tell people.

Q132 Chair: Was that "yes" to those three?

Paul Johnson: I would have one, I wouldn’t say exactly what it was, and I might tell people.

Q133 Chair: You wouldn’t say what it was, or that you had one?

Paul Johnson: I’d probably say that I had one if I could think of the exact right words about the circumstances in which I might put it into play.

Q134 Andrea Leadsom: Yes, but isn’t there also the case that you don’t just have a plan B, you also have a plan C? There is one scenario in which growth continues but inflation continues and therefore you need to make more cuts or higher tax rises or whatever, and there’s another scenario in which you go into a double dip recession and you need to spend more. So you actually don’t just need a plan B you need a plan C as well. So, isn’t the fundamental problem that if you’re the Chancellor you need to sort of have plans A to Z? Or do you simply stick with your central thesis?

Mr Mudie: But you don’t lock yourself into saying in the first instance, "I will not make any changes," and that’s what this Chancellor’s done. Margaret Thatcher: "There is no alternative." The world will not let you do that. There you are Paul, I’ve answered the question.

Q135 Andrea Leadsom: Changing the subject slightly, what is the IFS’s view of the proposed merger of national insurance contributions and income tax? Bearing in mind that it is obviously very complicated and the Chancellor has said that he doesn’t plan to take away the contributory element, do you think that’s its worth continuing to look at merging those two taxes?

Paul Johnson: What I think the Chancellor said was that they wanted to look at merging the operational structure of the taxes rather than merging the taxes. Exactly what that’s going to involve is unclear, but I guess it could involve, for example, the period over which they are assessed, the way in which HMRC assesses them and some of the definitions of income on which they are assessed. All of that seems like a move in the right direction and, in the medium run, of value to business, particularly if, as I say, they are done on the same definition of income and over the same time period. But exactly what it means, I don’t think we currently know.

What you won’t get from that, and what the Chancellor made very clear, is that we’re not looking at merging the systems altogether. We’re not looking at charging the same rates of combined income tax and NI on all forms of income, and we’re not looking at getting rid of the contributory principle. You are moving one step down a possible and very long escalator towards a full merger. So yes, it looks like what is being proposed is a good first step, but the next several steps seem to have been ruled out for the time being.

Q136 Mark Garnier: We won’t go on to plan C, D or anything else, you’ll be pleased to hear. I want to ask about corporation tax. You said in your presentation that going from 28% to 23% is a substantial cut, which should have some impact on corporate activity in the UK. Can you quantify that at all?

Paul Johnson: I think the OBR suggested last year that this might increase national income by something like 0.1% over the long term. The short answer is that we don’t know with any precision, and that’s why neither the Treasury nor the OBR has said with any precision, "This is what we think the effect will be." The academic literature in this area suggests that cuts in corporate tax rates have some effect on the level of investment and some effect on the level of profits in the economy, although not to the extent that profits are grown by so much that you have as much corporate tax revenue as you otherwise would have done. The headline rate seems to play a particularly important role-perhaps a more than rationally important role-in decisions that some companies make about where to make their investments and where to locate.

If you look over time, headline corporate tax rates have fallen across most developed economies, but that has not been accompanied by a fall in the importance of corporate taxes in the share of income in most economies. On the whole, corporate taxes have remained as important as they were 30 years ago, contrary to the predictions and expectations of very many people 30 years ago, as capital has become much more mobile and despite the fact that headline corporate tax rates have gone down. In part, that’s because corporate profits have done quite well over that period. In part, it’s because the tax base has become broader over that period. We saw that, again, in last June’s Budget, where we saw a reduction in the headline rate but a broadening of the base in terms of reducing some allowances.

Q137 Mark Garnier: The interesting point is that if you have a closed economy, the Laffer curve argument comes into play, but as you said in your answer, we have a very international economy and capital is very portable. To what extent do you think that the comparison between the rate of corporate tax in the UK and the rate internationally is a very important point, and do you think that by having a lower corporate tax rate here, we will be successful at attracting new businesses or international businesses to locate in the UK?

Paul Johnson: It’s clearly an important issue. It’s one among many important issues that companies consider. As I said, the academic literature does suggest that a differential in corporate tax rates has some impact on the decisions of firms about where they invest. That’s one reason why corporate tax rates across the world have gone down.

Q138 Mark Garnier: This is a slightly more philosophical question. Clearly, when a company is looking at locating to a country, it is looking at things such as the legal system, the language that’s spoken, the time zone, access to things such as European markets, as well as the corporate tax rates, financial regulation and so on. In the mix of everything, how important do you think the tax rate is? Do you think an international business would put up with, for example, a much more restrictive financial regulatory regime if the trade-off was far lower tax rates, or do you think that tax rates are the No. 1 consideration?

Paul Johnson: As you say, the trade-off would have to be far lower tax rates. We know that the Irish regime, for example, has attracted a lot of company headquarters to Ireland, but that’s at a tax level that we couldn’t, certainly in the short run, think of being able to afford to introduce in the UK. The Irish started from a world where they didn’t have very much in the way of corporate profits to tax, so in a sense it was all gain from having a low rate and bringing more people in.

Q139 Mark Garnier: Do you think we’re too mature an economy to be able to do something like that?

Paul Johnson: It would clearly be a very expensive thing to do except over a very long period. You need to be clear that you could raise the tax elsewhere. One of the interesting things about corporate taxes, of course, is who actually pays them. Companies don’t pay anything. In the end, it’s all paid by people, so it’s paid by the customer, the shareholder or the employee. The basic economic theory suggests that where you have sectors of the economy, some of which are traded and some aren’t, it’s the workers in the domestic sectors who will bear a lot of the final incidence of the corporate tax.

Q140 Mark Garnier: Do you think the Chancellor would have done better to have targeted tax breaks on certain areas, rather than just having an overall cut in the corporation tax rate? Do you think there are any winners and losers from what he has done?

Paul Johnson: In terms of the corporate tax changes, one can, fairly clearly, in broad terms, say who the winners and losers are. We are having a reduction in the corporate tax rate and a broadening of the base by reducing capital investment allowances. The immediate consequence is that those companies with low levels of investment and high levels of profit will gain, and those companies with high levels of investment and low levels of profit will lose. That is a fairly straightforward trade-off.

Q141 Mark Garnier: So should he have targeted those businesses looking to invest-

Paul Johnson: If they are looking to invest but aren’t expecting high profits, you might wonder whether that is the right way of directing revenue. One thing he has chosen to do-reducing the tax rate on income from intellectual property through the patent box-is, in principle, aimed at a particularly mobile form of corporate income that is associated with patents or ideas. Although I do not think that we would expect it to have a significant impact on the level of innovation in any particular country, given that some of this stuff is pretty mobile, it may attract the post-innovation activity.

Q142 Mark Garnier: Turning to high-energy-using companies, do you think that the proposed increase of the climate change levy discount for energy-intensive industries from 65% to 80% will be sufficient to offset the impact of the carbon price floor on those industries?

Paul Johnson: The carbon price floor will increase certainty in the level of the carbon price. It may increase the carbon price, depending on the level of the ETS, and it is currently expected to do so somewhat. I don’t know the specific figures on how the increase in that cost will relate to the particular industries that are affected by the reduction of the climate change levy, but the carbon price floor itself will clearly increase the cost of power across the economy, including to households, and it will clearly increase the certainty with which energy producers can make plans with regard to other forms of power.

Q143 Mark Garnier: The discount is quite a big deal, if we look at brick manufacturers and tile manufacturers in terms of the construction industry. They work in that important part of the economy with high-tech ceramics and that kind of stuff. All this discount is doing is going back to where it was prior to 2009, I believe. It is quite a big deal. Do you plan to do any work on this?

Paul Johnson: You may be right. That is not something we have looked at specifically, but we will think about it.

Mark Garnier: Will you think hard about it?

Chair: We would like you to look at it.

Q144 John Thurso: You described the Budget as a fiscal non-event. Is there anything in particular that you think we should be concerned or worried about?

Paul Johnson: In the Budget? In a sense, it was always going to be a bit of a non-event after the two huge events that we had last year-the Budget last June and the spending review in October were colossal. On one level, it would have been very surprising if we had had a very big set of changes in this Budget. I suppose the place you might have looked for more is the level of sense of a long-term plan for tax reform, for example. There was some of that in the national insurance statement, but there was, perhaps, less of it than there might have been at this point. This must the Budget of the Parliament where you would start setting out that plan for reform, but, broadly speaking, it was not different from what we would have expected in terms of its scale.

Q145 John Thurso: Apart from-we have talked about this-the concern about the growth rate and the concern about inflation, are there any other areas where you think we should be probing, or other concerns that we should be looking at?

Paul Johnson: Clearly we’ve talked about the specifics of the growth rate and all that. Whatever happens, it’s pretty clear that that we’re going to move-we have a plan that will move us from a colossal deficit down to a much smaller one. The question is what that depends on. Overwhelmingly, that depends on delivering some substantial public spending cuts, and, as I said, those have become more substantial because inflation is higher. If I were the Government, the thing that I would be most worried about, in terms of delivering what they said they are going to deliver, is how they are going to make those public spending cuts happen, particularly given the degree of political difficulty that’s going to be involved in that.

At the moment there is a plan, but almost nothing has happened. Tax rises have happened and we have a bit of a spending cut this year, but most of it-nearly all of it-is over the next four years. The interesting question is to understand the detail of how that’s going to happen right across all the spending Departments.

Q146 John Thurso: One specific question: there was one event in the Budget-the cut in fuel tax-which although trailed was probably bigger than expected. That was quite a fiscal event, and it needs to be paid for. The OBR has not had the chance to look at that; do you think anybody has properly understood the consequence of what has happened in the North sea, particularly with regard to gas prices and gas exploration?

Paul Johnson: I don’t know the answer to that question. The basic economics is fairly straightforward. Were this a tax entirely on the profits above a certain price per barrel of oil for an industry that had stopped investing, then this would be rather a good tax. It would be a tax on rents. To the extent that is not-to the extent that it is a tax on an industry where investment is still being carried out and you’re not just getting at rents-it could have an impact on investment. I don’t know where that sits in the balance, but that is the question that you need to be asking.

Q147 John Thurso: It needs to be teased out whether this thing all holds together, with a bit of hard analysis.

Paul Johnson: As I understand it, oil prices are internationally set; with gas prices, the question is to what extent they are internationally set.

Q148 John Thurso: Everybody talks about the oil price, but the gas price is considerably lower. A large part of our investment in the North sea is in gas not oil.

Paul Johnson: Yes. The direction of the questioning needs some focus from Treasury officials. There is this element which is clearly a good tax, and another element that clearly would not be a good tax. It depends on the structure of the industry.

Q149 John Thurso: One last question. The Chancellor described all that as a fair fuel stabiliser. Do you think it was any such thing?

Paul Johnson: The element that impacts on households is, you know, going to do something to stabilise the amount that they spend on petrol, and frankly is very similar to what the last Government did over a 10-year period. We continued to have announcements that fuel duty would rise next year, but it never did. This Chancellor has very much followed in those footsteps. The way he has constructed this fair fuel stabiliser is very different from what we were expecting, given previous announcements. It will have that effect on motorists, but, as your last question implied, it rather depends on how it affects investment in the North sea. It depends on that balance.

Q150 Chair: Those were very balanced replies. We’ll look carefully at the transcripts to see how many questions you gave full answers to, but if there is anything that you think we should be asking the Chancellor that we have not already touched upon, do let us know before tomorrow afternoon.

Paul Johnson: Sure.

Chair: Thank you very much.

Examination of Witnesses

Witnesses: Gillian Guy, Chief Executive, Citizens Advice, and Matthew Sinclair, Director, TaxPayers Alliance, gave evidence.

Q151 Chair: Thank you both for coming. I am sorry that we are slightly behind schedule. May I begin with a question to Matthew Sinclair? The Government have published something called The Plan for Growth. What contribution do you think it will make to the underlying rate of growth in the economy?

Matthew Sinclair: The measures in The Plan for Growth, distinct from the main headline measures in the Budget, will make a fairly minimal contribution. It seems to be a document motivated essentially by severe limitations in terms of action on tax and on regulation because of EU policy. It means that a lot of the policies in that plan are extremely micro-managing. There are six fellowships in there; individual fellows are being created in this document.

At the same time, that is compounded in the sectoral plans. Again, the Government are setting out a series of very minor policies. Almost following the example of the last Government, they set out a policy position that will attempt to look at each sector and ask what fiddles to policy will help it best, as distinct from looking at the overall environment for business. Although it is more difficult to do if you are trying to operate without affecting the major direction of policy, it is more productive in that it distorts less between different regions, industries and even companies.

Q152 Chair: What would you have put in to raise the long-run growth rate?

Matthew Sinclair: First, the Government need to acknowledge the centrality of the two major macro policies. Lower spending will, over time, lead to lower growth, and that will probably do more to improve growth than anything that is in the growth plan. I think they could have been more aggressive on corporate tax. The way that the plan is costed in the Budget policy decisions suggests that those costings took far too little account of the likely supply side effects of the corporate tax changes. While small businesses are very important, the most important businesses are those that start small and aim to become large-those high-growth gazelles-which are what a lot of policies try to isolate. What actually has been isolated in a lot of these changes are small business stakes. A lot of the measures that extend to SMEs could have been broadened out considerably in terms of trying to limit new regulation and to deregulate.

Q153 Chair: Have you any specific measures?

Matthew Sinclair: Sure. I think the measures on regulation that apply to SMEs should extend to a much larger range of companies. I think corporate tax can be cut considerably faster. We have looked at specific plans, but the broad structure has to be a lot quicker because of the extent to which that tax attracts footloose international capital. More than anything, trying to be as comprehensive, large and detailed a document as this one is not helpful. I think that a lot of that improvement to growth will come from the retrenchment in spending over time, because that will lead to a stronger association, which we have seen from academic research.

Q154 Chair: Gillian Guy, was this a Budget to help our most vulnerable people, or did it make their life worse?

Gillian Guy: Much has been said about there being winners and losers in the Budget, and I think that either term sounds bit triumphal in some sense. We should remember that, in reality, the Budget is fiscally neutral, if not a non-event, as has been said. Some people have undoubtedly benefited, and some have lost out, but this is all in the context of inflation and the increase in VAT.

As always, the Citizens Advice mantra is that benefits, even where they come through, are not in isolation and are not very great. So the two tranches of increased personal allowance, for example, will reduce or, in some cases, eradicate tax liability, which would help in a situation of constrained finances, but we should remember that it is likely that the people most affected will be on the lowest incomes and will be eligible for housing and council tax benefit. So for every pound that is put back in their pocket, 85p of that will be drawn back in their benefit, because of the tapering effect, which leaves the benefit to be very small indeed.

Support for mortgage interest is also welcomed in terms of its extension, but, again, the rate at which that is supported is not the rate that people are actually paying. There is a great degree of reliance on forbearance by mortgage lenders, which may indeed change if the market does pick up, and we would see an even greater need coming through our doors for debt advice as a result of that. We also welcome attempts to increase affordability around water, for example, and people in south-west will benefit from that. Affordability generally is an issue and a discrepancy. Of course, charities have benefited as well, which I feel that I ought to mention from a Citizens Advice point of view. In total, there are minor things coming through, but, in the whole context, they really aren’t helping the most vulnerable people.

Q155 Chair: So is it neutral or negative?

Gillian Guy: The overall situation is severely negative. It’s not a remedy Budget; it’s about tidying up some pieces and giving something back, but, I would say, not enough. Families on very low incomes will be hit very hard by the benefit cuts and this will not ameliorate that. They will be hit by inflation. They will be hit by VAT. Employees of small businesses could also lose out on some important rights. I recognise, as we as an organisation do, the need to encourage growth and entrepreneurs, but not at the cost of people’s rights. I am particularly thinking about the impact on those in minority groups, who are most likely to be involved in those small companies.

The single-room housing benefit rate rise from 25 to 35 years of age, which, as the Committee will know, Citizens Advice has been set against for some time, because of the impact that it will have, is now being brought forward, so that will have a detrimental effect on recipients of that benefit. We are waiting to see what the warm homes discount will do to replace the benefits previously received under winter fuel payments.

Q156 Chair: If you think that the overall effect is severely negative, why did you put out a press release saying that "it may well be that the final effect on the living standards of our most vulnerable people is…neutral"?

Gillian Guy: I believe that I did not-although the record will show this-say that this Budget had severe financial problems for people. I said that the overall situation, when taken in the round-

Q157 Chair: I am just reading from your press release.

Gillian Guy: I understand the press release. I am explaining it.

When taken in the round, the overall effect is severely detrimental when the welfare reform provisions are taken with the Budget, which does not offer enough to alleviate that impact.

Q158 Mr Mudie: As I understand your situation, you were commenting on this Budget, which is seen as neutral, against the background of the last Budget and the spending review. We bandy phrases about, but this all comes down to people, doesn’t it? Your organisation sees the people who are hurting. What has happened in the past 12 months to the people coming in through the front door of your branches asking for help?

Gillian Guy: The numbers of people coming through the front door have increased significantly. The numbers of people coming through in serious debt situations and benefit problems-the two, as you will appreciate, are often linked-have also increased, and we are seeing that trend increasing. At the same time, of course, we are trying to ensure that the public service cuts do not impinge on our capacity for giving advice.

Q159 Mr Mudie: You are as bad as us in terms of phrases, because you use the word "significantly". Now, significance to somebody around this table might be 5% or 50%. What is the sort of percentage work load increase seen in the past 12 months?

Gillian Guy: I can certainly give the Committee not only the percentage work load increases but the trends that we are showing. I will present those to the Committee if that would be helpful.

Q160 Mr Mudie: You speak so softly I am not sure I got that, but I will read the transcript.

One of the worries, and I do not know whether you share it, is that a lot of the measures that would normally be in this Budget, and it would not be seen as neutral, were taken at the last Budget but operate from this week-1 April. Do you think your organisation will cope with the effects of the various benefit and tax changes and the public sector cuts, in terms of the more significant number of people who will inevitably come in your direction during the next 12 months?

Gillian Guy: To reiterate, I will provide the Committee in full detail the trends and the increases in figures. In terms of the increase and whether we can cope, clearly we are working very hard to increase our capacity in order to do that. We make a promise to the public that we will give them free independent advice when they turn up and need it, and we do not want to break that promise. We are trying to put pressure on to make sure that our funding continues, and indeed increases, and we are looking to make sure that we are as efficient as possible to make the best use of our resource. We do not want to turn people away, but the pressure is enormous. We need more and more volunteers, as well.

Q161 Mr Mudie: Gillian, this is not a criticism, but what I have found in Leeds is that you do turn people away. I do not mean that in a bad way, but you just cannot cope with the people coming through the front door. Have you started any discussions? I was with somebody who was being repossessed on Friday, and the girl was almost suicidal. I just thank the Lord that the CAB and other organisations are there, because when that hits people-unemployment, and all that-they just need somebody to talk to and help them through it. Obviously, you are going to get a vast increase in work load in the next 12 months when the real cuts start biting. Have you started any discussions-have you been invited to have any discussions-with the Government about increasing your capacity to help ordinary people through the next couple of years?

Gillian Guy: There are three parts to this answer. First, one of the things we do is engage in discussions such as this and others around policy as that develops. What we attempt to do in that is to make known the impact, particularly on the most vulnerable people in society, to try to manage the demand. Clearly, some of those things are listened to and some of them are not.

Secondly, in terms of capacity, yes, we have tried to put-as I have said before-pressure on local authorities, particularly for their funding for our bureaux, and on central Government. We are taking on some more functions, as I am sure some of the members of the Committee have heard, around the consumer landscape, and we will make sure that we get resources to undertake those functions so that we can keep our promise to the public.

Thirdly, we are revising our whole business model. If we just continue to allow people to queue up for face-to-face advice, we will not be able to get to all the demand. We are looking at extending our telephone advice, extending our triage and being able to refer people on much more quickly and much more effectively to the kind of support they need.

Q162 Mr Mudie: Do you think you will be able to meet the demand without additional resources from central Government?

Gillian Guy: The demand includes additional functions, and I am very clear that we will need additional resources to carry those out.

Q163 Mr Mudie: I am less interested in that, because if the Government ask you to do something, they should provide the resource, and I think they usually do. I am thinking of the person next week who will get benefit taken; the person who is made unemployed; and the person who is being chased by a building society. Are there any negotiations or discussions going on to help you cope and help ordinary people through those difficult circumstances? I am sure the Government do not want to see people lose their home, and Ministers always say what a great job your organisation does. Have you been invited into discussions, because everybody around the table knows what is going to hit you in the next 12 months? Have you been invited into discussions?

Gillian Guy: Discussions are going on on a daily basis both with central Government and local government. Some people in that entire landscape are listening more than others to the need for resources and additional resources to meet additional demand. There is a recognition that the investment in early intervention and early advice is well worth making in order not to get the extra costs of the problems that can ensue. The question is whether the money is actually available.

Q164 Mr Mudie: A last question now. My experience of local authorities is that they are going through horrendous cuts themselves, and charities and the like say that they see the council stopping the resources that come from that area. Have you or your organisation any experience of local authorities pouring out money simply because they do not have it?

Gillian Guy: Yes, we do, and some of those have received quite a lot of publicity. What we try to do is ensure that there is provision for those people in that area. We will continue to put pressure on so that that happens. One of the arguments has to be that it is a false economy not to give people intervention and advice at an early stage.

Q165 Chair: What efforts are you making to plug what you perceive to be a potential shortfall with voluntary giving?

Gillian Guy: We are endeavouring to increase both voluntary giving and the involvement of corporate organisations that benefit from that early advice.

Q166 Chair: How optimistic are you that that will plug the gap?

Gillian Guy: We are a very optimistic organisation, and we need to be there for those people. There are some areas at the moment in which there is severe risk of the advice not being available, but we are making every effort that we can. It is fairly obvious to Members of Parliament that a lot of pressure has been put on to ensure that that advice is there. Our confidence increases once people accept that it is a false economy to take out that advice and that we need to pull together to ensure that we have the resource there.

Q167 Andrea Leadsom: Matthew Sinclair, may I talk to you about SMEs? Obviously, they employ more than half the people in this country and there has been a lot of talk about the need to get an SME-led recovery. Do you think that the measures, particularly the enterprise zones, and the exemption from new domestic regulation for small companies for the next few years is a step in the right direction, and what more could be done?

Matthew Sinclair: You have to distinguish between two types of SMEs. There are SMEs that like to remain small-the classic ones would be restaurants or cafes that have no particular desire to grow. People set them up because they want to work for themselves or because they have a particular service to provide, and they do not want to become a major business. There are then those that are SMEs for now, but would like to cease to be-in the right direction-an SME in the future. The former will not respond particularly strongly to any incentive to grow but can take some of the benefits, such as tax breaks. That is far from a bad thing in itself, but it does mean that the effect of the policies will be severely diluted if they are focused across the SME sector and based purely on size. Also, if a policy is based purely on size and the benefit is lost once a firm exceeds a certain size, you necessarily start to make it less of an attractive option to firms that are looking to grow.

The response from SMEs to the Budget seems to have been positive and we should not carp about that. The danger is if the businesses that expect to remain small businesses respond well to it. Those SMEs that are growing and are massively economically important, even in relation to the large businesses in terms of employment creation, have not done as well in the Budget. Too many policies have been focused on stable SMEs.

In enterprise zones in particular, there is a huge danger that SMEs will redistribute. There are a number of Government policies for which I think that is also the case, but this is one example of where economic activity is likely to be redistributed rather than encouraged to grow. That is a massive risk with enterprise zones. In some cases, you can see it coming. In terms of other policies, another example would be the attempts to create an east end technology cluster. They’ve made a massive mistake in trying to marry a successful project in and around the Olympic park with the media city, where they’ve just built this capacity. It is almost like Malaysia’s bio-valley, which is this long valley full of empty facilities created for biotech firms. That is the kind of fate that the media centre is heading for. On the other hand, you’ve got a very successful-and largely unprompted by Government-cluster around Shoreditch.

The attempt to construct a single cluster is probably an attempt to lead an economy down a route that it does not naturally want to go, and therefore I think will be relatively unproductive. In other parts of the country, you’re just giving a lot of advantages to firms in one place. I am sure we will see a lot more firms in that place, but that doesn’t mean we’ve actually achieved anything. If we’ve just moved them down the road, that’s not a success. I don’t see anything, particularly in the enterprise zones or in how they are constructed, that will avoid that particular fate. That is the reason behind my scepticism about the enterprise zones. Beyond that, there is a simple question of why, if we expect some of these measures to be effective, we would restrict them to enterprise zones.

Q168 Andrea Leadsom: But isn’t it the case that there are specific structural benefits to the enterprise zones-for example, superfast broadband, which you simply can’t roll out across the country in an instant? There is also the fact that if you get clusters of businesses, you can, for example, target the areas of greatest need, where perhaps public sector reliance has been too great. Perhaps you can have businesses together that can support one another and so on. That is the reason for having those clusters, isn’t it?

Matthew Sinclair: Sure, but one very specific warning in the literature-and indeed one that they claim to have respected in The Plan for Growth-is that although, obviously, the attractions of trying to target areas that are particularly deprived are clear, it is very risky in terms of effectiveness. That is why The Plan for Growth says that it will try to avoid areas of particular dereliction. The risk with doing that is that you are trying to will a cluster into existence in a way that isn’t possible. I understand that superfast broadband is targeting that to a certain extent, but it is best for that to follow demand. The risk of trying to establish these clusters is that you are torn between these two objectives. You can see it in the tech city. It is the objective of enabling where you see an opportunity, and creating zones where you wish there was an opportunity. The tension between those two objectives is what could lead to a real challenge allocating enterprise zones effectively.

Q169 Andrea Leadsom: Okay. So do you think that the measures in the Budget will help those people who are thinking of starting up a business? You have talked about small businesses and those that want to grow, but not about those who want to start a business for the first time.

Matthew Sinclair: Entrepreneurs’ relief is by far the best single measure in there. If one were to create a tax system from first principles in a more radical way, there might be different ways of changing capital gains tax, but entrepreneurs’ relief is a very good sticking plaster for the present system. Certainly, that is the thing that will do the most to improve the economic attractiveness of entrepreneurship. To the extent that that is in there, that alone makes the Budget a good one for people looking at establishing new high-growth businesses. That is a very valuable measure.

Q170 Andrea Leadsom: So you recognise the letter from 39 venture capitalists in The Daily Telegraph today talking about the value of the Budget for new business start-ups?

Matthew Sinclair: There are some very good measures in there. Entrepreneurs’ relief is good because it attempts to target certain categories of firms in terms of what they do and the fact they grow very quickly, but it doesn’t attempt to target particular areas or sectors. That is why it is likely to be a more productive measure.

Q171 Andrea Leadsom: Changing the subject slightly, in looking at how the Government’s own expenditure can improve the economic picture, do you think that large projects such as High Speed 2 are in the public interest-the taxpayer’s interest-or not?

Matthew Sinclair: High-speed rail, and High Speed 2 in particular, is a very, very serious mistake. It is a huge amount of money to put into a single project. It will have some immediate costs. It is a £17 billion project, and then an over £30 billion project. It is a massive mistake to focus our investment on a high-speed line rather than on lots of capacity improvements that can be delivered more quickly, that can do more to reduce overcrowding and that can address the immediate shortcomings on the transport network. It would be very good to cancel that and focus resources elsewhere. It is not the right way to use the transport budget, on which there will be a lot of pressure. We are neglecting a lot of other things because of that plan, and that project in particular is a bad one.

I do not think you can assess big Government projects on anything but a case-case-basis, and because they are big, that is worth doing. We do not need a generalised rule for big Government projects, apart from the fact that they go over budget-that is where we start from-although, to be fair, there is a big contingency in HS2.

Q172 Andrea Leadsom: Can you comment on the value, if any, of the employment created by a project of that size?

Matthew Sinclair: There are a few things to note. First, a lot of the benefits will be in moving jobs, just like enterprise zones. Something that has been seen in other economies is that jobs that appear to have been created have actually been moved. Secondly, the jobs will not necessarily be where you want them to be. Most of the jobs that the Government expect to create with HS2 will be in London, not in the midlands or the north. Thirdly, job creation claims are not as impressive as they sound. If you were to try and burn £17 billion, you would need a lot of people to do it and that would create employment. Those jobs would not be permanent-well, some of them would be. It would be a spectacle. The question is: does this create a lot of jobs compared with what could be expected with that volume of capital on average in the wider economy? Our research suggests that if you compare the wider economy, you will get roughly four times as many jobs per pound. This is a very capital-intensive entry. That in itself does not mean it is a bad project-don’t get me wrong, there are other reasons why it is a bad project-but that is not the only yardstick to judge it by. If we are to judge it as a job creation scheme, however, it is a really, really bad one.

Q173 Andrea Leadsom: A final question. In spite of all your negative points, do you think that High Speed 2 will regenerate the north in the way anticipated?

Matthew Sinclair: I don’t think so. We are not looking at the situation that has occurred in other places in Europe where very long journeys have been dramatically cut. There is a very significant cut, certainly, in some of the areas, but only one area really fits the optimum in terms of being far enough to get a big enough time saving, without being too far because this can never compete with air. London to Aberdeen on the railways is not going to compete with air anytime soon. Equally, London to Hertfordshire is never going to be worth while because it is not far enough. That swing spot is roughly Edinburgh, but there is not enough demand to justify it. It is not going to have a transformative benefit. The journey time to Manchester-I took a train to Manchester last weekend-is not far enough to be a serious obstacle. Equally, people are not going to start commuting from Manchester. The main barrier to people taking that train every day is cost. The train to Edinburgh is not markedly slower than flying, but it is much more expensive. This is the wrong project.

Q174 Chair: The cost of energy inputs to business is often cited as a disincentive to our competitiveness. Have you done any work on that?

Matthew Sinclair: Yes, we have looked at this quite extensively. A lot of the talk about the carbon floor price in the Budget document is extremely misleading. I have no particular reason not to believe the price rises through to 2020. I think they will be a significant but not huge increase on what is already an existing huge increase under present policies on energy prices. It will be a straw that will break a few camels’ backs. This is not in itself a huge amount, but it is a significant increase considering the existing increases. I think the prospect that it will reduce bills in the late 2020s, which is the Government’s response to this, is extremely dubious. You have to ask what kind of low-carbon generation they’ll bring through with this. With regard to nuclear, even EDF, which is the big lobbyist for this measure, has backed off. It needs protection against construction risk, so it’s not going to be enough to get nuclear. Renewable energy already has massive existing support elsewhere, and this won’t make a big difference to renewable energy.

Equally, the compensation, which was asked about earlier, is almost farcical. In PBR 2009, the discount was reduced from 20% and you paid 35%. It’s now going back from 35% to 20%, which means that it’s almost like Gordon Brown turning up and hitting you, and then George Osborne turning up and hitting you again and saying, "Here’s a tissue for your bloody nose from Gordon Brown." You haven’t actually had any improvements on the CCA discounts on the climate change levy; you are just back to the position before the pre-Budget report 2009.

The energy-intensive industries will welcome getting back there, but they’re still net worse off because this measure, which is supposed to be compensating for the carbon price floor, is actually just restoring their position from the drastic increase in their CCL that they faced in PBR 2009. At the same time, because that discount has gone down and up so dramatically, I think they’ll welcome it, because it means they have to pay less, but I cannot think that any business can invest on the basis of a discount that can be cut from 80% to 65% in a PBR with no warning whatsoever, and then goes up again. They won’t be able to credit that. I can’t imagine that any business will invest. They will think, "Well we may have this discount under the CCA, but it could be gone again tomorrow." If they are responsible, they must plan on the basis that it will be gone, and I don’t think that CCA discount can be effective compensation for the real cost of the carbon price floor.

Q175 Mark Garnier: To carry on with that, what do you think would be the right policy for the Government to take on the CCA discount?

Matthew Sinclair: I think the CCA discount is almost a busted flush now; not to the extent that you could get rid of it and people would not notice, but to the extent that increasing it further has lost credibility. That is the danger. In the energy policy field, everyone understands the importance of credibility when it comes to encouraging low-carbon generation, as we have had these extremely stable policies. The same goes for energy-intensive industries, but that policy is now unstable.

I do not think that a sensible energy-intensive business would invest in the UK on the basis of a special favour to energy-intensive businesses because it has now been rendered so clearly politically vulnerable. Short of trying to create things like they are trying to do on the renewable energy side and creating contracts for difference and so on, which are extremely difficult, or of something to create a sort of legally defensible guarantee for these businesses, I think the only thing that can be done is to look to the-this is the other thing-distributional side, because it doesn’t just affect industry. In fact, I think the carbon price floor is the most important measure for low-income families in the Budget as well, because it is the second largest revenue raiser of any in the Budget, and half of it will be paid by electricity consumers and it will be deeply regressive.

I think the only thing that can be sensibly done now to help energy-intensive industries is to look at the overall affordability of our energy policy, which has been formed essentially with little regard to affordability. They might not be for it, but it will at least give them a better deal. In terms of encouraging investment and making that industry-sustainable, I think we need to look to the overall affordability of energy policy. I can give you chapter and verse on how to do that, if you like, but in terms of specifically trying to mitigate the harm to the industry, it has been a busted flush since the PBR 2009.

Q176 Mark Garnier: When you’re talking about that industry, given that there is quite a lot of variation in it-brick manufacturers, tile manufacturers, steel manufacturers, and also the high-tech ceramics industry, which is the other end-which bit are you talking about, or are you talking about all of them?

Matthew Sinclair: All of them that are very energy intensive. The average household bill is expected by Citigroup to go up by 50%. If that kind of change happens, I don’t think any firm that has a third of its costs in energy can see them go up by 50%. In terms of the particular harm of the carbon price floor, the one slight insurance we had was that other European countries were doing the same as us. The carbon price floor means we double the impact of the emissions trading scheme-it’s going from £15 to £30, assuming it wasn’t going to go up anyway-in a way other European countries are not. We had that problem anyway, because in terms of investment to meet environmental targets, Britain has to invest more than Germany, France and Italy combined, given the way the targets were drawn up. If we add to that the carbon price floor, Britain is being singled out to a great extent. You could focus particularly on measures that create a competitive disadvantage, like those, but beyond that, we have to look at the affordability of policy overall.

Q177 Mark Garnier: Gillian Guy, do you share Mr Sinclair’s concerns about the impact on domestic energy?

Gillian Guy: We are concerned about that because the trend has been towards an increase in household bills for that energy. Since 2008, fuel bills have gone up by 38% for households, and the poorer the household, the greater the proportion of disposable income affected. In 2020, we expect gas to go up by 18% and electricity to go up by 33%. Clearly, that will have a devastating impact. We are pleased to see that there is a cap in the Budget on the levy funded for energy and climate change policies, and we hope that that won’t be passed on in another way.

Matthew Sinclair: I am not sure how that cap will operate. Does it include a renewables obligation? Does it include the emissions trading scheme? Or does it just include things like the feed-in tariffs? The renewables obligation and the emissions trading scheme are the two big policies and the two where the scale we are talking about could seriously and materially affect public finances. Saying you will cap that levy is a lot easier than actually doing it, given the money the main policies are going to cost. The other quick question I have, which needs to asked, is whether the distributional analyses in the Budget document include the impact of the carbon price floor, because, long term, it is a very significant revenue raiser, and I wonder whether that will be included.

Q178 Mark Garnier: Can I just turn to the headline corporation tax rate? Matthew, you were here a bit earlier when we asked the previous witness about this. Obviously, the Government have set huge store by their intention to have the cheapest corporate tax rate in the G20. Do you think that is a viable proposition for growth? Do you think that’s going to encourage businesses to move into the UK? Alternatively, do you think there’s a philosophical question about the various other elements that make this country attractive or otherwise? Do you think that the cut in the tax rate to 23% by 2015 will bring about a net increase in tax receipts, be that from companies moving in or just from companies being more productive as a result of that cut?

Matthew Sinclair: We asked the Centre for Economics and Business Research to calibrate its main model of the UK economy to estimate the supply-side effects of the cut in the corporate tax rates. It found that a much more aggressive policy than this-one that was heading towards Irish-style rates; not pretty quickly, but in a phased way-would increase revenue in four to five years. There is a lot of evidence out there, and you can see it in the overall picture, which is that corporate tax rates have been falling and revenue has not. Part of that will be about more profits, certainly in some firms. While I think that in some ways there are downside risks to the public finances in here, and I am not sure whether it is actually revenue-neutral, some of what they expect to tackle on avoidance will actually redistribute avoidance. On the corporate tax side, it reveals how static the Treasury-OBR model is, given that it is expecting the negative impacts on revenue due to the corporate tax cuts to keep increasing over the forecast period and to remain well over £1 billion. I think it will have a positive impact on revenue by the end of the forecast period.

Q179 Mark Garnier: You said earlier that you would prefer a more aggressive corporate tax rate. Could you quantify that?

Matthew Sinclair: I think we should be heading towards the Irish kind of rates sooner rather than later.

Q180 Mark Garnier: Over what sort of period?

Matthew Sinclair: Over five to six years-over the kind of period they are looking at. I think it is telling how hard the Irish are fighting to keep their rate. We can say that their economy is smaller than ours, but you would expect good policies to get tried in smaller economies first. I would say there is a pretty huge windfall to be gained from being the first major economy to spot this opportunity, although all have seen it, to a certain extent. I think we are less vulnerable to losing firms than the Irish are because we have a bigger economy. There is a very big opportunity to attract firms.

Q181 Mark Garnier: Looking specifically at some sectors, do you think that the tax measures that the Chancellor has announced will help with the goals of stimulating the manufacturing sector?

Matthew Sinclair: The one thing to be careful about with manufacturing is the extent to which the headline rate is lowered rather than the effective rate, because part of that undoubtedly has been a redistribution, as the IFS said, from high-investment, low-profit firms to low-investment, high-profit firms. To that extent, it is not such good news for manufacturing. The effort on corporate tax cannot be restricted entirely to the headline rates. It has to include trying to reduce effective corporate tax rates, which obviously is not the same, and is very different from trying to reduce revenue.

Q182 Chair: Gillian Guy, you said earlier that energy prices for homes had increased by 38% since 2008. Have you attempted to estimate what proportion of that is attributable to increases in fossil fuel prices or input prices, as against specific Government policy measures of both the previous Government-since 2008, obviously-and the current Government?

Gillian Guy: I don’t have that separation. What I do have is our estimates of what has been passed on to the consumer that is attributable to the environmental costs, and that is about 4% for gas and almost 10% for electricity.

Matthew Sinclair: I think that that is low. The present Government estimates of the effect is about 14% for electricity and about 4% for gas. I would say that the critical thing now, though, is 2020, when Citigroup expects it to be about 52%, if the Government achieve a loss on energy efficiency. They can cut that to 35%, but that is not taking account of the fact that energy efficiency creates further short-term costs. Disentangling short-term fluctuations that result from fossil fuels and policy is difficult, but I would say that we have good evidence that a very substantial part of the costs is the result of policy, and that that will rise very substantially in the years to come.

Gillian Guy: The point for us, of course, is that it is welcome to say, "However, it might work"-and we will be very vigilant as to whether it works or not-but there is a cap on being able to pass costs on to the consumer. Having about 4.5 million people in fuel poverty is not a comfortable position for the country to be in.

Q183 Chair: Mr Sinclair, we heard your earlier evidence suggesting that that might not work.

Matthew Sinclair: You cannot limit what a company passes on to the consumer without stopping investment. The simple reality is that if you want to pay for £200 billion of investments, you would need to double profits for energy companies. I think that this is the political direction that we are going in-we’re going to see rising profits and rising prices, and it will end in strong calls for a windfall tax or some other measure to change policy drastically with respect to the energy sector. As a result, investors are very wary. The value of energy companies has been very poor compared with the wider market, and investors are very wary because they can see an affordability crisis coming.

You can try and socialise it. The Treasury will want to try and cap the extent that it is passed through to consumers. Basically, the Treasury will step in and pay for all that above a certain level. That can work to the extent that the problem is for the very poorest in fuel poverty, because you can socialise it across the income distribution. It can’t work if your problem is that it is becoming unaffordable for middle-income families. We are looking at the stage where there will be an affordability problem for middle-income families. At that stage, you can’t socialise the issue away, because it’s fundamentally very expensive. At the same time, it puts a lot of pressure on public finances when you make promises in this area.

Chair: If either of you have numerical evidence to suggest that this effect is going up the income scale, we would be very grateful to see it in writing. I am particularly concerned by some of the points you’ve made, Gillian Guy, about energy affordability at the bottom end.

Q184 Mr Love: The Government’s Plan for Growth seems to be picking sector winners. Mr Sinclair, what you think of that idea?

Matthew Sinclair: To a certain extent, they are named sectors that they want to help, but it is very hard to work out why they have chosen the sectors that they have. To that extent, it is possible that they have not picked winners so much as picked all the sectors for which they could think of a programme. There is no obvious set of sectors that were chosen. For instance, there is no obvious way you could think of a set that encompasses tourism, construction and space. They are a disparate set of sectors. The only antidote to the fact that they have picked sectors is that they seem to have picked them almost at random. They certainly have picked sectors to some extent, yes.

Q185 Mr Love: But you don’t object to them picking sectors? What happened to the classical argument that it should be left to the market?

Matthew Sinclair: I absolutely do object to that. I don’t object to them talking about different sectors in the report; what I object to is them trying to single out sectors for lots of special attention. That is a mistake. It is particularly a mistake because often what happens is that you won’t pick the sectors in which there are the greatest opportunities but the sectors where there are the most obvious opportunities. The problem is that by picking the most obvious opportunities, you pick the same ones every one else is going for. As a result, you wind up with-this is what happened to Malaysia. It saw that Singapore had had a huge success creating a biotech sector and tried to create its own, and it ended up producing a huge number of white elephants.

I absolutely do have a problem with the attempt to pick sectors, because I don’t think they will pick the right ones. As I said, the only mitigation against that is that I’m not sure how seriously they’ve singled them out, as opposed to reporting on all the sectors that they could think of and producing a plan to put in the report. I don’t know how serious that picking is; but, yes, it’s certainly a problem.

Q186 Mr Love: Looking across the names of the sectors that have been chosen, do you think that they were chosen because they think the UK has some comparative advantage in those sectors, or that they’ve been successful if they are domestically oriented industries?

Matthew Sinclair: Maybe. One which comes up a lot is low carbon-the green investment bank and things like that. I’d say that’s one where Germany, China and, to a certain extent the United States, have a comparative advantage, and we very much do not. That does not apply across the board. That is where they think we have a comparative advantage, but it may not be where our comparative advantage lies and where there will be the most potential for us to exploit our future comparative advantage.

Q187 Mr Love: I would love to get into a discussion with you about comparative advantage, but let me move on to manufacturing. Although the Government have professed their commitment to manufacturing, as the previous Government did, there didn’t seem to be much in the Budget. Is there anything that you can think of that will help manufacturing, or will we just suck it and see whether the depreciation in the exchange rate will help boost exports?

Matthew Sinclair: I don’t think that there is anything that would compare to the improvement in the exchange rate to help. It is mostly environmental factors that are the biggest for manufacturing. Indeed, in some of what we have talked about, whether on corporation tax or on energy cost, manufacturing is getting a relatively raw deal. There are lots of measures focused on manufacturing, such as education and skills and parts of The Plan for Growth, but I have questions about their significance. Some of them seem to be interfering even in decisions in what kind of fellowships will be offered by science and university grant programmes. I think there are lots of measures to address manufacturing in there, but I am not sure how significant any of them are.

Q188 Mr Love: So how do we promote the manufacturing sector? I come back to the question. Do we just leave it to the wishful beneficial effects of a depreciation in the currency?

Matthew Sinclair: So what should we do?

Mr Love: Yes.

Matthew Sinclair: What we should do is look at overall measures-helping to ensure that manufacturing gets a decent deal in overall measures to address the tax burden, such as looking at capital gains tax and corporation tax and ensuring that they are effective rates as well as redistributing away from allowances; and looking at things that we have touched on already, such as energy costs and the extent to which they hit firms. I think that there are measures that we can take, but in other areas they are heading in the wrong direction. It will be that direction, in terms of lowering the overall cost of businesses, to ensure that manufacturing gets a decent shake of it.

Chair: Thank you very much for coming to give evidence this afternoon. It has been a brief session, of necessity. You may have points that you wanted to make but did not have an opportunity to do so. If you could set them out in writing as quickly as possible-the close of play tomorrow is the latest-please come back to us. We are particularly interested in some of the American examples that we have been discussing. We will now take a five-minute break, and then begin the third session.

Examination of Witnesses

Witnesses: John Whiting, Director, Office of Tax Simplification, Frank Haskew, Director, Tax Faculty, ICAEW, and Robin Williamson, Technical Director, Low Incomes Tax Reform, gave evidence.

Q189 Chair: Good afternoon. Thank you very much for coming. As you know, we as a Committee have produced a report on principles of taxation. Perhaps I can begin by asking all of you whether you agree with its main conclusions, or whether we got it wrong.

John Whiting: I think, Chairman, that I agree with your conclusions. You have come up with some well stated points and principles. To pick out a few, you talk about things like the pace of change being something that one needs to control, and about fairness being a principle. You also look at the growth sector and at trying to have a tax system that is competitive. They all resonate very well with me. I think you also go on to talk about the need for certainty, predictability and stability. They are all important features in a tax system.

Q190 Chair: Does anybody disagree with any of that or want to add anything of substance before we get on to some tougher questions?

Frank Haskew: No, we would certainly concur with that. The Committee has set out some very important principles that echo the 10 principles that we have had for many years.

Chair: I am glad that we have got it right for once.

Robin Williamson: I would only add that it is important to apply these principles not only to the tax system in itself, but to the tax system in the way in which it interacts with NICs, tax credits and all the various DWP benefits, which can impact on the financial situation of low-income households. That was a recommendation made by this Committee four years ago.

Q191 Chair: We have established that we broadly agree with those principles. Let us take simplicity: do you think that these tax measures, overall, simplify or complicate the tax system?

John Whiting: I tried to do a little scorecard, because, as you would imagine, Chair, simplification is a major interest. I think that, overall, there is a good deal to simplify in this Budget. After all, the Budget picks up a reasonable volume of the OTS’s recommendations on simplification. As the Chancellor said, 43 abolitions are proposed. When I heard that, I thought, "Gosh, I wonder where he got that number from," because it seems to get you down below the magic 1,000 reliefs-it got us down to 999. Of course, 10 or 11 more reliefs are introduced in this Budget, so it has gone back a bit. We are abolishing some legislation, but it is clear that there is a heck of a lot more legislation coming in. I think the trend is towards simplification, but it is not exactly a simple one-way street. It’s quite a hard struggle.

Q192 Chair: We have been told that 100 pages of tax code have been removed. How many do you reckon have been added?

John Whiting: It remains to be seen before we see the Finance Bill. The draft of the Finance Bill that was published in December-admittedly, that is Bill and notes-amounted to 532 pages.

Chair: That doesn’t sound like good news.

John Whiting: Obviously, the notes don’t count, but I would guess that the Bill, which will be published in a few days’ time, will be comfortably in excess of 100 pages.

Q193 Chair: So the tax code has grown as a result of this Budget?

John Whiting: I would think it is still growing.

Q194 Chair: So we have cut the rate of increase?

John Whiting: That might be one way of putting it. It is like all those graphs that are still sort of peaking. Of course, the length of the code is only one measure. If you can at least read it easily and understand it-

Q195 Chair: We can’t judge that until we have it.

John Whiting: No, but anybody who looks at a disguised remuneration draft will be scratching their head as to what it all really means.

Q196 Chair: So you think it might have got worse?

John Whiting: One points to the disguised remuneration because that is a particularly complex thing trying to tackle a complex area, but when, on one reading-if I’m allowed to say this-it could affect MPs and their expenses and how they are assessed, you begin to wonder whether we are getting over-complex rules and not really thinking them through properly.

Chair: That is pretty clear evidence.

Frank Haskew: I think, again, that I would pretty much concur with what John has said. You have to look at this as more of a direction of travel, and if you look at it in that way-I think I would agree with you that we’re talking here about rates of change-it’s very difficult to go overnight to a simple tax system. It takes time, and it requires a lot of consideration. So, I think that what we’re seeing is a direction of travel that’s going the right way, but I think that John is probably right and I suspect that the volume of tax legislation will be higher at the end of this. But we’re seeing the direction of travel, and John’s excellent work in the Office of Tax Simplification is showing the way forward, but it will take time to see results come through.

Q197 Chair: Still, the Chancellor claiming that he had removed 100 pages from the tax code and then our finding that we’re probably going to be adding back more than that doesn’t sound terribly good, does it?

Frank Haskew: Well, if you look at it on the basis that if he hadn’t done that we’d still have 100 more pages in the tax code, then we have made progress, and I think that we will see progress continue.

Robin Williamson: Looking, again from the perspective of low-income households, at the tax and the benefits system combined, things are going to get more complicated before they get simpler. We’ve got the universal credit coming in, which will simplify things in terms of abolishing seven or eight of the main benefits and replacing them with one, so that there will be just one benefit to throw into the computation of household income rather than several-

Q198 Chair: And you think that’s doable.

Robin Williamson: It’s doable, but perhaps not on the time scale that is projected. It depends very much on the IT systems and how they function over the transitional period. But in the meantime, as a result of this Budget we’re getting the rate of personal allowance increasing by leaps and bounds up to £10,000, which is prima facie a good thing. At the same time, we’ve got age-related allowances going up by RPI and the primary thresholds of NIC after 2012-13 going up by CPI. You’ve got these different indicators progressing at different rates and none of them really being linked to one another in any coherent way.

John Whiting: Could I just give one example of this whole area of simplification versus length of legislation? We have an announcement in the Budget that we’re going to have a statutory residence test; personally, and I think as a body, we think that that is a good idea, but it is undoubtedly going to add to the length of the tax code, because there isn’t anything in the tax code at the moment to define residence. So, whether that ends up as 10 pages, or whatever-I don’t know-it will add to the tax code, but I think that it will, in the long run, be a simplifying measure.

Q199 Mark Garnier: Mr Haskew, I don’t know if you were listening to the earlier session, but I’ve been asking the same question all the way through, so I’ll carry on with you. The Government have set a great deal of store by having the lowest tax rate in the G7 and one of the most competitive in the G20. Do you think that this international comparison thing is such a big deal, or do you think that it’s a bit of a red herring?

Frank Haskew: Ultimately, of course, questions about rates are policy questions for the Government of the day. In our work in 1999 we indentified 10 fundamental principals, but one of those was competitiveness, and I think that there is an emerging consensus that the UK needs to have a competitive business corporation tax system. That is important going forward. What that rate will be and where you have it in the band is probably another question. The Government is going down a growth agenda and we have seen businesses relocate from the UK. When you add all that up, we clearly need to have a reasonably competitive tax system at the international level, to encourage growth into the UK.

Q200 Mark Garnier: Can you expand on what you mean by "system" as opposed to "rate"? Obviously, we are talking a lot about the rate at 23%, but you are talking about a system. Do you want to expand on that?

Frank Haskew: Yes, ultimately it is not, of course, just about the headline rates of corporation tax. A very important part is what investment incentives you have. For instance, in the UK we have capital allowances. That is all part of the mix, but the mix also includes the administration of the tax system, how people perceive that that is carried out and how difficult it is to comply with the tax rules. The general view is that the UK has been fairly uncompetitive in terms of the complications of the tax system and also, certainly, in terms of HMRC’s efficiencies, which the Committee has an open inquiry into. When you add all the indicators together, there has been a view that the UK is not as competitive as perhaps it should be.

Q201 Mark Garnier: John Whiting, to continue that point, the tax rate may be one of the most competitive in the G20, but is the tax system just far too complicated? Can you quantify how complicated we are in relation to the rest of the G20 and the G7?

John Whiting: There are various attempts to try and get a relative measure. When I was at PricewaterhouseCoopers, we did a lot of work with the World Bank on the World Bank "Doing Business" guide-the Committee will be aware of the sort of results that the UK was getting out of that-and that emphasises that the rate is the shop window. I always liken it to the price of baked beans in Tesco or Sainsbury’s, which perhaps attracts you in, but there’s a lot more to it than that, because of the base that that rate is applied to. If you reduce the allowances, as Frank was alluding to, then the bill may be going up.

When it comes down to it, I find that what businesses, large or small, most want is certainty. With OTS, as we went round and talked to, admittedly, smaller businesses, the big thing that came out more than anything else was, "Give us certainty. Let us know where we are." They wanted less change, because they wanted to know for certain how they would be affected by tax. That comes over very much on the international scene, too. If a business has certainty in terms of getting the rate, getting clearance from the Revenue, knowing that there will be no changes and knowing that the thing is fixed, cleared and done, all of that is a very major factor. It is that side that the UK has fallen down on in recent years.

Q202 Mark Garnier: So, on that basis, the point that was made by the previous witness, Matthew Sinclair, about the movement of the CCA discount from 80% to 65% and back to 80% again is the exact-

John Whiting: It is that sort of chopping and changing that is not good. It is far better to get some measures in and say, "That’s it." A relevant thing here-not specific to corporation tax, but relevant to it-is about non-domiciled changes. The Chancellor promised changes, but he then said, "That’s it for the Parliament." At least, therefore, we know that those are the rules for four or five years. People can work with that far better. A few years ago, we had moves on corporation tax to cut the rate and radically cut the allowances. That was not good, because that damaged people’s investment plans.

Q203 Mark Garnier: The report that PWC did with the World Bank put the UK and its system at number 16 in terms of competitiveness. That’s not terribly exciting is it?

John Whiting: When I was there, I think it was out of 183 countries, so in one sense it is pretty good-it’s better than we seem to be doing at cricket, for example-but should we be aspiring to the top 10? I think we should. However, as with all ratings, you have to look at this with care. I think number one used to be the Maldives, because that system only had one tax payment in the year, and we’re not necessarily going to beat them. A key theme with that rating is that the UK has slipped in recent years. It hasn’t slipped that much, but it has just slipped, and that is partly because our system has stagnated, whereas others have made a big effort to try and improve.

Q204 Mark Garnier: This is quite an important point. From what you see coming through in the Budget and the Government’s general messages, do you think that they are doing the right thing to reverse that?

John Whiting: Yes, I think they are. I think many of the changes on the core corporate tax system are good and the message is there-the talk of a framework that we’re sticking to and the idea that there is a plan and it is long term. It is almost that the mood music coming out signals that the Government seem to have got the message on the need to communicate that we have a stable tax system that will not chop and change.

Q205 Mark Garnier: I have just one final question. Mathew Sinclair suggested that our corporation tax policy should be much more aggressive. He suggested an approach that was closer to an Irish corporation tax rate over a six or seven-year period. Do any of you agree? Do you want to comment on that?

John Whiting: My main point would be that, historically, we, as a country, have raised a lot more of our revenue from corporation tax than the Irish have. We have a much bigger base. Going back to my baked bean analogy, their policy was about cutting the price of baked beans to attract you in to do the rest of your shopping. I think it has been very successful.

Q206 Mark Garnier: Could it be successful here?

John Whiting: I think you would have to go very radically low. It is very interesting in the context that Northern Ireland is contemplating doing it. Personally, I think Ireland got the classic first mover advantage. A good thing would be to aim for a 20% rate-lower than that is a bit risky.

Frank Haskew: Given that we are facing the biggest budget deficit in the UK’s history, it is imperative that the Government secure their tax revenues and do not increase the risk of tax revenues being jeopardised in some way. Therefore, the UK Government need to be cautious in terms of their corporation tax rate. What is set out is certainly a direction of travel, and John is entirely right to say that one can ultimately probably see rates converging on 20%, but the Government have to be cautious at the moment.

Q207 Mark Garnier: Mr Williamson, do you have anything to add?

Robin Williamson: Not so much on the rate, but more on the regulatory burdens, particularly those faced by very small businesses or one-man or woman stores with perhaps a single employee or no employee at all, perhaps run by someone elderly or disabled. In this Budget, there is more of a relentless march towards online communication with HMRC than there has been before. That seems to run counter to Cabinet Office policy on digital by default, which is that nobody should be left behind, or at least that’s part of it, and that Government services should be equally available to all whether they’re online or not. That is all I would add. Allowances should be made. Of course it’s convenient and makes administrative sense to move towards online communication as far as possible, but allowances should be made for parts of the country where there is no or very limited broadband access and for people who find it difficult or impossible for reasons of disability or cost to sign up to broadband.

Q208 Stewart Hosie: The Government increased the supplementary charge on corporation tax on oil by 60%, from 20% to 32%. That brings in about £2 billion a year. In terms of the practice of changing tax rates and allowances thresholds, do you think that a swingeing increase like that should have been made with no discussion with the industry in advance?

Frank Haskew: As we said at the beginning, tax rates are a question for the Government, but it is clearly important to have stability and certainty, and that goes back to the principles that the Government, this Committee and ourselves have outlined. I entirely endorse what John said-the message we always get from business is that the one thing they need more than anything else is certainty. "No surprises", was the mantra from people at the time, and it still is. When you measure it against that, you clearly have a surprise. Governments need to be careful about these sorts of tax increases that are made at very short notice with no consultation. It does go against our fundamental principles.

Q209 Stewart Hosie: That is interesting because it also introduces volatility. This has put up the marginal rate of tax for some mature oilfields by up to 81%. I am not quite sure what the impact will be if the price of a barrel falls below $75 or rises above $90, but it has introduced a heck of a lot of volatility into the tax code for that sector. In more general terms, what would any tax practitioner make of an 81% marginal tax rate on a sector that was already growing, investing and exploring?

John Whiting: I am old enough to remember 83% and even 98% income tax rates. It was not terribly constructive. It provoked a lot of people to ask, "Why should I bother?" That is the risk, metaphorically, with continually ramping the rates up on what is a mature situation. It is as if you are saying to somebody who has invested-I know enough of the oil business to know that it is a very long-term business-"Ah, that is looking very good. We’ll have a bit more of that."

Q210 Stewart Hosie: You make that comparison with the very high personal marginal tax rates in the 1970s. Based on that experience, if the sector was saying that this could seriously jeopardise investment, growth, jobs and exploration, it would not be a scare story in your view. Those sorts of rates would at least have an impact on investment decisions.

John Whiting: I was talking to a businessman, not in the oil sector but in another sector, just before the Budget last week. He said, "Look I just want to know what the rates are. In many ways, I don’t care what they are. Just tell me what they are and I will factor the figure into my investment. I will work out whether that will give me the return that I want, what prices I can charge and I will take my decision." That is what they want. The oil sector is exactly the same. Okay, it has to cope with a fluctuating oil price, which is another issue, but the big thing is, "Tell me what the tax rate is and stick to it." It is almost as if they are thinking, "Can I do a deal for this field for its lifetime? Then, when I come to do the next piece of exploration, let’s talk about a new rate."

Q211 Stewart Hosie: Let me ask you a philosophical question. Given that the Red Book of 2010 spoke about stability and a fair tax regime for the UK oil system, and given what happened in the Budget with a supplementary charge, do any of you believe that it is realistic now to expect Governments to live up to their promises of stability in taxation?

John Whiting: I go back to Frank’s comment about no surprises. I wonder whether that was discussed at all with the oil industry. I should imagine that there are a number of oil industry people asking similar questions. I know that there is the argument that the price has gone up and they make more money when the price is going up, but has the real impact been discussed and has it been done with full understanding? I would like to think that it was the result of a good dialogue, but I am not sure that it was.

Q212 Stewart Hosie: No, I am not sure that it was either. I have one other question. It is not on oil, it is on the enterprise zones. The Government have set aside £80 million for 21 zones in 2015-16, which amounts to £4 million per zone, to compensate for the loss of business rates. For those enterprise zones to work, I have always taken the view that they would have required the extensive use of capital allowances, as was the case in the past. If we were to go down that route, what sort of capital allowance would you see as being the most beneficial to make enterprise zones work and work well?

Frank Haskew: I’ll have a crack at that first, and then perhaps John can have a go. I am old enough to remember the previous enterprise zones from the 1980s. It was a good scheme to start with, but by the end it almost involved marketed capital allowances, industrial buildings allowances, 100% in enterprise zones, guaranteed returns, and often no recourse loans. It effectively became a marketed investment opportunity, almost to encourage speculation in property in those zones. When the property bubble started to burst, people lost a lot of money on them. So, from our side of the fence I am not necessarily sure that looking for enhanced capital allowances again is the right approach.

John Whiting: Yes, and of course in those days we were giving allowances on buildings. We no longer give allowances on buildings. The simplest answer would be to go and accept 100% allowances at least on plant and machinery, in other words virtually taking the lid off the annual investment allowance, which might be the simplest way forward if you want to give an incentive through capital allowances.

Q213 Stewart Hosie: That is a very interesting answer, and I will certainly look at that as an option. However, I want to probe one more time on this issue. Are you effectively saying that the old industrial buildings allowance system is not the sort of thing that you would want to return to, except that there is some evidence that it was hugely successful in getting that sort of capital investment going?

Frank Haskew: The scheme came to an end and there was a general view at the time that 100% allowances for buildings probably wasn’t the right way forward for a lot of those zones. Seeing it this time, the emphasis seems to be much more on manufacturing. Echoing what John said, there is probably more mileage for capital allowances in things like plant and machinery. If you are going to go down a capital allowances route, investing in the means of production is probably a better alternative.

Q214 Michael Fallon: I will go back to tax simplification. John Whiting, you looked at more than 1,000 reliefs. Is that right?

John Whiting: We identified 1,042. Then to give ourselves a manageable amount, given the number of our staff and everything else, we picked 155 to report on. That obviously leaves nearly 900 that we didn’t look at, for one reason or another.

Q215 Michael Fallon: What is the position now? The 40 reliefs that you recommended for abolition are being abolished. What about the remaining 110-odd that you looked at, and then the remaining 800-odd that you didn’t look at?

John Whiting: That is for further discussion. We looked at-

Q216 Michael Fallon: I want to be clear about this, because the Budget says "The Government…intends to abolish only those reliefs set out below." Does that mean that they do not expect you to recommend further reliefs for abolition?

John Whiting: We have a meeting coming up to discuss the remaining 800-odd reliefs that we put to one side. For example, we quickly identified that inheritance tax and capital gains tax have a raft of reliefs, and we suggested that it might be better to do things on what you might term a top-down rather than a bottom-up basis. But of the 155 reliefs that we put in our report, we assume that that is the decision on what is happening to those ones that we identified for abolition or improvement. Of course, with some we recommended improvements and indeed that has come through on the enterprise investment scheme, entrepreneurs relief and others.

Q217 Michael Fallon: Sure. When you say that there is a meeting coming up, I just want to know who is in charge of all this. Are you directing the programme, or is it actually the Minister who is directing it?

John Whiting: We are directing the programme, but we have completed the brief that we were given and given the Chancellor the report. We intend to sit down with the Chancellor shortly to agree the next stage of our work, which is coming up with our proposals. Naturally enough, however, we want to hear the Chancellor’s views too.

Q218 Michael Fallon: So he has to agree your work programme. Is that right?

John Whiting: We are independent, but my stance is that if there is something that we want to do and the Chancellor says that he is not interested in it we will go back and have a think about that, because at the end of the day we are putting up recommendations that have to be taken forward by the Chancellor, so it’s more productive to look at areas that he would be interested in.

Q219 Michael Fallon: I see. So you are not systematically working through 1,000 reliefs?

John Whiting: We did a quick cull on the 1,042; we identified 155 to look at in detail, which we have done, and one of the things that I want to pick up is what we are going to do about the other 800-odd. So, although I am comfortable that we have discharged our objective of giving a report on the reliefs, there are clearly a lot more we could look at. We could, for example, look at a lot of VAT, which we had put to one side, just to get to a manageable list, partly because it has such a European override. It would be very interesting to look at a lot of the VAT reliefs, but it might then get us into issues with Europe. Is that something we want to spend time on?

Q220 Michael Fallon: Sure. You said "manageable"; you have how many staff?

John Whiting: We have seven. If you add it up in full-time equivalents, including myself, it is probably less than six.

Q221 Michael Fallon: So if you had the same number of staff as the OBR, you might have been able to do VAT reliefs and lots of other stuff.

John Whiting: Yes. We could certainly do more. We might have put more strain on the Treasury, of course, and the parliamentary draftsmen, who might have to carry through the recommendations.

Q222 Michael Fallon: I am sure they would cope. Mr Haskew, I want to turn to tax avoidance. I noted in the Chancellor’s speech that he twice linked tax avoidance with evasion. Did you attach any significance to that? He coupled them together.

Frank Haskew: Tax avoidance and evasion are often linked together, but of course they are completely different.

Q223 Michael Fallon: But has a Chancellor linked them together in that way before?

Frank Haskew: We have had linkages before, yes. I don’t attach anything significant to that, because the words seem to be automatically linked.

John Whiting: I think this Chancellor is beginning to see the difference far more than has been the case latterly. The fact that they are at least there means that evasion is getting, we think, a more equal degree of attention with avoidance, whereas arguably in recent years it has slipped below the radar screen somewhat.

Q224 Michael Fallon: Just to come back to avoidance, the Chancellor said, "We are doing more today to clamp down on tax avoidance than in any Budget in recent years." Is that right, Mr Haskew?

Frank Haskew: It would be fair to say that the Government have set out a very clear strategy in their approach to tackling tax avoidance. You probably saw that the Exchequer Secretary put out a discussion document on Budget day that set out quite a number of pointers.

Mr Mudie: Could you speak up please?

Frank Haskew: Yes. Sorry.

Mr Mudie: This is valuable stuff and you mustn’t let it be lost to the world.

Frank Haskew: The Exchequer Secretary set out in that document a number of important areas that the Government are looking at. There was a four-pronged attack on tax avoidance that included, obviously, specific targeting of various tax avoidance schemes. There is also the study that has been announced in relation to the general anti-avoidance rule, which is being undertaken under the auspices of Graham Aaronson. That will report later this year and we will look to contribute to that work. It is also having a look at some particular high-risk areas of tax avoidance to see whether they might introduce further rules, or possibly principles-based rules there as well. So, when you add it all up it is quite a chunky tax avoidance programme.

Q225 Michael Fallon: Do you welcome it? Is it bad news for your profession?

Frank Haskew: We have always supported the Government in tackling tax avoidance through properly targeted tax anti-avoidance legislation. So to that extent, the Government have a perfect right to tackle those areas and we clearly welcome their steps to counter tax avoidance.

Q226 Michael Fallon: So are you going to work with them on this programme?

Frank Haskew: We have worked with the Government consistently on tax avoidance. For instance, on the disclosure of tax avoidance scheme rules in 2004, we were heavily involved in making sure those rules worked, and we continue to work with the Government. They have been refined virtually every year and we have been very involved in that process.

Q227 Michael Fallon: So you are on the right side on this?

Frank Haskew: As I say, we always support the Government in countering tax avoidance. The key thing, which again is picked up here in the Exchequer Secretary’s report, is that we need rules that are properly targeted and don’t place undue burdens on ordinary compliant businesses.

Q228 Mr Mudie: I am not sure I caught that last bit, but they talk about prioritising the work. There is a great fear that the approaches are going to be directed at pay-as-you-earn and so on, and affect people out in the community, rather than at the big non-payers, avoiders or evaders. What impression do you get about where the emphasis is going to be?

John Whiting: The good thing about this document on tackling tax avoidance is that there is a better strategy there. To pick up on some of the things that Frank was saying, in recent years there has been a heavy attack on avoidance, but it has been piecemeal and reactive rather than proactive. One of the things I like is that there seems to be a strategy and a plan looking at the high-risk areas, for example, and at how to tackle those. One of the results should be better-focused efforts.

Q229 Mr Mudie: Sure, but how would you define high-risk areas? What do you think that is aimed at?

John Whiting: That is a question you have to ask the Revenue.

Q230 Mr Mudie: I should ask the Chancellor.

John Whiting: Well, you have to ask HMRC what it thinks are the high-risk areas. To sort of reflect back one of your points, I would not say that the ordinary PAYE taxpayer is a high-risk area. They are far more at risk through HMRC errors, which I am sure Robin would echo.

Q231 Mr Mudie: I think we went over that the other week. Do you think that the Chancellor has helped himself? Richard Murphy said that "Lawyers and accountants all over the country must be jumping for joy this afternoon." He pointed to a number of areas and said that the new charity rules "sound open to massive abuse." He then went on to say, "A new 5.75% tax rate on the treasury functions of large corporations in tax havens…will see corporate money flowing out of the UK faster than it will be possible to count." Do you think Richard’s got something on those two matters?

John Whiting: On charities, the first point is that that idea is going to be developed for introduction next year. I am quite sure that over the next year, rules will be developed to make sure it is not a complete giveaway. That starts you worrying about whether it is going to be so complex as to be unusable. It is an interesting idea; let’s see how it goes. The corporate tax measure-let us put it into context-is trying to reform the CFC rules to get to a sensible working solution. I think we are getting to exactly that, and it has been through so much-

Q232 Mr Mudie: It is a pretty generous rate though, isn’t it? You get nothing and that sounds good. Is that what you mean?

John Whiting: Well, there is a strong argument that 5.75% of something is a lot better than 23% of nothing.

Q233 Mr Mudie: That’s a view. I would rather that they paid their full whack.

John Whiting: I don’t think it will apply to something located fair and square as a tax haven. We are talking about operations in reasonable jurisdictions.

Q234 Mr Mudie: That is something to come to another day. Let me ask you a last question while we have you-I hope that it’s the last question. There has been a departure that is puzzling and worrying everyone concerning senior figures in HMRC conducting personal negotiations and reaching figures of settlement. I see the sense of that and what may have been delivered, but in your experience, is this a departure? Are you aware of whether it has been codified in terms of behaviour, reporting and transparency?

John Whiting: That is a very good question.

Mr Mudie: Thank you, John. It’s not often you say that.

John Whiting: Credit where it is due. There have always been negotiations over difficult areas between the taxpayer and the Revenue. If it is a big number or big issue it will get escalated. In my experience, some things went all the way up to the board to be agreed at that level, although that would be extremely rare.

Q235 Mr Mudie: But, John, even Dave Hartnett himself has said this is where he goes in, has lunch, looks them in the eye, says, "You’d better settle or I’ll send hundreds of HMRC inspectors in," and they write the cheque there and then. That may have been said a bit tongue in cheek, but that seems to be the shape of it. That sounds like a new departure. Is it a happy one?

John Whiting: Didn’t Cardinal Morton have a version of that? It sounds like a variation on Morton’s fork, back in Henry VIII’s time. However, if it’s to that extent, it strikes me as a bit of a new departure-a one-person agreement. As I said, my experience is that it went all the way up the tree. I don’t know what Frank would say.

Frank Haskew: It’s clearly a difficult area. There clearly need to be transparency and governance arrangements here. You are in bilateral or multilateral negotiations here, and people like Dave Hartnett have been working hard to come up with a good deal for the UK. But, clearly, there need to be governance procedures to make sure that what comes out is reasonable in the long term.

Q236 Mr Mudie: Have you come across them? Do you think there are such things? I always worry about civil servants or councillors going into financial negotiations without a transparent, open and supervised method of working. You’re not aware of such a system being introduced to safeguard officials?

Frank Haskew: I can’t say that I am, but we are still in quite early days on a lot of this.

Q237 Mr Mudie: It’s being going on for a while, hasn’t it?

Frank Haskew: Well, we’re still in the early stages of coming up with a lot of these agreements. I think we will see more transparency in governance over time.

Q238 Chair: Is there anything you wanted to add, Mr Williamson? You’ve looked slightly cut out of all these exchanges.

Robin Williamson: Just something that occurred to me while John and Frank were answering the last point. There is certainly a lot to be said for saying that 7.5% of something is rather better than 23% of nothing. There are business reasons, obviously, for particular settlements at particular high levels. But coming back to the principle of fairness, these things look very odd and unfair, perhaps, to your average market trader, who might be pounced on and charged a 30% penalty for a mistake because, he is told, he has not taken reasonable care. People might even have a shot at charging a 70% penalty, arguing that whatever mistake he had made was in fact deliberate, and the market trader may not have the wherewithal to counter those arguments. Yet, we hear about settlements with much lower levels of penalty for very much higher levels of avoidance, evasion or whatever.

Q239 Chair: John Whiting, I was a little perturbed by one of the answers you gave Michael Fallon. You effectively said you were negotiating with the Chancellor what you’re going to look at. It would be of considerable interest to the Committee if the OTS provides us with details of the areas you think should be looked at, but which have been rejected by the Chancellor. That’s a message we’d like you to take back.

John Whiting: Obviously, bound up with this-Mr Fallon alluded to it-is the question of resources. We are trying to come up with a list of areas, and we’ve come up with some ideas based on our experience over the last six months of what people seem to think would be very helpful and on our own work. We’ve come up with a list, and we haven’t got the resources to do everything on it, so it is quite reasonable that we sit down and ask which appeals to the Chancellor and which doesn’t. I’ve got my own preferences and my own wants, but I don’t want to do something that the Chancellor and his fellow Ministers have no interest in.

Q240 Chair: I think it would be helpful if we had a look at your longer list.

John Whiting: When we do it, I would be more than happy to write to you, Chairman.

Chair: Thank you very much for coming today. I’m sorry it’s been a somewhat abbreviated session and that we started late. If there are major points that follow from of what’s been said or things you didn’t have an opportunity to comment on at all, please come back to us in writing as soon as possible. Thank you very much.