Appendix: Government Response
Introduction
1. The Treasury has again been unable to provide
all the information needed by deadlines agreed with the OBR. The
Government may, as the Chairman of the Office for Budget Responsibility
suggested, have decided that for political reasons this was a
"price worth paying." This would set an undesirable
precedent. The work of the Office for Budget Responsibility depends
on the Treasury meeting the agreed deadlines. (Paragraph 7)
The Government recognises the importance of providing
the OBR with timely information. Unfortunately, as the Chancellor
made clear, the details of the announcements on health were not
finalised until after the OBR's initial deadlines for the economic
forecast.
2. We welcome the OBR's innovation of providing
uncertainty ratings for policy costings. (Paragraph 8)
3. We recommend in future that the OBR publish
a breakdown of the uncertainty rating assessment against the three
criteria for all announced measures at Autumn Statements and Budgets.
(Paragraph 8)
4. The Committee welcomes the Government's continued
publication of the distributional analysis of the Government's
policy changes. The Committee recommends that the next Government
continue with this important aid to transparency. (Paragraph 9)
The government agrees with the committee that the
publication of distributional analysis at fiscal events is an
important contribution to transparency about tax and spending
decisions.
5. The current inflation target set by the Government
is symmetrical, and is 2 per cent at all times. Several witnesses
alluded to the risks of very low inflation and subsequent deflation,
including the Chancellor. The Chancellor has publicly welcomed
the current level of inflation. This is not likely to help anchor
inflationary expectations. The Governor of the Bank of England
is required to write to explain to the Chancellor why inflation
has fallen below 1 per cent. It is important to avoid mixed messages
on inflation targeting. (Paragraph 27)
Annual CPI inflation declined to 0.3 per cent in
January—its lowest rate since modern recording began—down
from 0.5 per cent in December 2014. Inflation has been below target
over the past 13 months which is largely due to declining prices
in food and energy goods—of the -1.7 percentage point decline
in headline inflation between December 2013 and January 2014,
-1.4 percentage point is explained by lower food and energy prices,
as global commodity prices decline and UK retailers face intensified
competition. Annual inflation in Food prices was -2.5 per cent
in January—the fastest decline since modern recording began.
Core inflation (which excluded the more volatile food and energy
components) has increased over the last two months, to 1.4 per
cent in January suggesting that underlying inflationary pressure
is more stable than headline.
The Government's commitment to medium term price
stability remains absolute. The 2 per cent inflation target applies
at all times and remains the primary objective of monetary policy.
As highlighted out in the update of the MPC remit in January 2015,
this target is symmetric: deviations below the target are treated
the same way as deviations above the target. This ensures that
the framework does not have a deflationary bias.
Low inflation recently experienced in the UK has
mostly been driven by global factors, notably the sharp fall in
oil prices and the decline in food prices. Earnings growth has
recently been showing signs of strengthening, with total pay up
2.1% on the year according to the latest data, and now rising
significantly faster than inflation. This is good news for hard-working
families.
On 12 February, the Governor of the Bank of England
wrote an open letter to the Chancellor explaining why inflation
had deviated from target and what the MPC was going to do about
it. This was the first open letter for inflation falling more
than 1 percentage point below target.
In his open letter, the Governor of the Bank of England
highlighted that a few months of very low or even negative inflation,
driven mainly by external factors, does not in and of itself mean
that we run the risk of generalised deflation. Indeed lower energy
and food prices are welcome news for Britain's households, which
is why we are robust in insisting they are passed on in lower
pump prices and utility bills, and we should not confuse this
with the threat of persistent low inflation.
As set out in the inflation open letter, the MPC's
latest forecast shows that while inflation is likely to remain
low for the next year or so, this mostly reflects the recent falls
in commodity and food prices, so that inflation then returns to
target in two years' time. The MPC judges that it is appropriate
to return inflation to target within the next two years.
In his response to the Governor's open letter, the
Chancellor welcomed that the MPC remains vigilant to both upside
and downside risks to its forecast and stands ready to act if
these risks materialise, to ensure inflation remains likely to
return to target within two years.
6. The Bank of England should undertake research
on the effect of net migration, and the potential for future net
migration, on the supply of labour and wage growth as part of
the work on meeting the MPC's remit. The Treasury should ensure
that discussions within Government on immigration policy fully
consider the requirements of the economy. (Paragraph 36)
The UK's monetary policy framework, set out in the
Bank of England Act 1998, gives operational responsibility for
monetary policy to the independent Monetary Policy Committee (MPC).
Determining what research is needed to inform its discussions
and judgements is a matter for the MPC.
The Government believes we should continue to be
an open and diverse society, attracting and welcoming those who
help promote economic growth and competitiveness by working, studying
and investing in the UK. The Government is addressing the factors
which draw people to Britain for the wrong reasons whilst continuing
to attract the most highly skilled workers and students. The Government
is continuing to simplify and improve immigration policy and law
to make sure the UK has an internationally competitive visa system
alongside an efficient and effective enforcement operation.
7. Witnesses have emphasised to the Committee
that productivity growth will be the key to sustainable improvements
in wages, economic growth and the public finances. Yet productivity
growth has once again fallen short when compared against the OBR's
forecast in March 2014. Should this pattern continue, the OBR
may have to consider whether its forecast of productivity growth
returning to its long-term trend rate remains an appropriate one.
(Paragraph 44)
Public Finances
8. For the fifth Economic and Fiscal Outlook in
a row, the OBR forecasts that the Government will meet the rolling
fiscal mandate, but not the supplementary target. The Government
has, as in previous Budgets and Autumn Statements since December
2012, not proposed any action in order to meet the supplementary
target. (Paragraph 49)
In its latest forecast at Autumn Statement 2014,
the independent OBR forecast that the government was on track
to meet its fiscal mandate in 2017-18—2 years early relative
to the target year under the Charter for Budget Responsibility
in force at the time. Going forward, on the basis of the latest
OBR forecast from the December Economic and fiscal outlook, the
deficit will continue to fall year-on-year throughout the forecast
period and the UK will run a small surplus in 2018-19—the
first surplus in 18 years.
Prior to the Autumn Statement 2014 update to the
Charter for Budget Responsibility, the fiscal mandate was complemented
by an aim for public sector net debt to be falling by 2015-16,
as a percentage of GDP. The OBR forecast public sector net debt
as a percentage of GDP to be falling in 2016-17, a year later
than set out in the supplementary debt target. However public
sector net debt peaks at a level of 81.1% of GDP, 0.5 ppts lower
than Budget on an ESA10 basis. While debt is peaking later than
originally planned, this is due to the lasting impact of the euro
area crisis and higher commodity prices in 2011 and 2012. As a
result, economic growth in 2011 and 2012 was not as high as originally
forecast. Due to the credibility earned through its long-term
economic plan and by utilising the flexibility offered by its
fiscal mandate, the Government was able to allow the automatic
stabilisers to complement active monetary policy, supporting the
economy through the headwinds faced in 2011 and 2012. Meanwhile,
the Government has stuck to its long-term economic plan and, as
a result, debt is forecast to be falling from 2016-17 and thereafter
over the forecast period.
In 2010 the Government said that it would revisit
the fiscal rules once the public finances were closer to balance
and a revised Charter for Budget Responsibility was approved by
Parliament on 13 January 2015. This sets out:
· A
revised fiscal mandate, with an aim to achieve cyclically-adjusted
current balance by the end of the third year of the rolling five-year
forecast horizon
· A supplementary
aim for public sector net debt as a percentage of GDP to be falling
in 2016-17.
As a result of the progress the Government has made
to date on reducing the deficit, the revised fiscal mandate shortens
the horizon for the Government to achieve a cyclically adjusted
current balance, creating a tighter fiscal constraint. The record
deficit inherited by this Government means that, on the basis
of the latest OBR forecast, public sector net debt is still forecast
to peak in 2015-16 at its highest level since the late 1960s.
Both parties in the coalition recognise that the UK faces a long-term
debt challenge and, are committed to bringing down debt as a percentage
of GDP once this supplementary target for debt has been met. The
revised Charter focuses on getting debt on a declining path and
reinforces the Government's commitment to addressing the long-term
challenge. The Government will be assessed against the updated
Charter for Budget Responsibility for the first time at Budget
2015.
9. The OBR is required to provide a forecast of
public spending over the next five years. From 2016-17 onwards
it has used the Government's policy assumptions to achieve this.
The implied path of public spending set out by the OBR from 2016-17
indicates that further fiscal consolidation will be achieved primarily
through reductions in departmental spending. It is, though, important
to recognise that these policy assumptions do not reflect the
view of either of the coalition parties on how fiscal consolidation
should be achieved. (Paragraph 70)
10. Institute for Fiscal Studies calculations
show that following the Government's outlined path will lead to
a total cut to DEL in real terms of 22.2 per cent between 2010-11
and 2019-20. However, within DEL, the government has so far chosen
to protect certain departmental budgets from budget cuts. If these
protections are maintained, IFS calculations show that non-ring-fenced
departments will have experienced real-terms budget cuts of 41
per cent between 2010-11 and 2019-20. As we have previously reported,
ring-fencing will require spending reductions to be targeted on
the diminishing budgets of the non-ring-fenced departments; and
we have previously reported on the possible consequences. (Paragraph
71)
The Government has taken tough decisions in order
to bring down the deficit while maintaining the vital public services
that everyone relies on at home, and supporting the poorest overseas—over
this parliament, the Government has successfully delivered spending
reductions while maintaining real terms growth in health spending.
Key to the fairness of the Government's deficit reductions has
been the focus on efficiency and cost-effectiveness across all
areas of public spending, including those that have been protected
from headline reductions.
11. The Government's new Charter for Budget Responsibility
shortens the target date of both the fiscal mandate and the supplementary
target. It also now describes the former 'targets' as 'aims'.
Aims are generally considered to be less binding than targets.
The Chancellor's assertion that they amount to the same thing
was surprising. (Paragraph 77)
This change does not make a substantive difference
to the fiscal framework. The Budget Responsibility and National
Audit Act 2011 requires the OBR, on at least two occasions for
each financial year, to prepare an assessment of the extent to
which the fiscal mandate has been, or is likely to be, achieved.
The OBR will continue to make their assessment of the government's
progress against the fiscal mandate, supplementary aim for debt
and welfare cap in the same way as they have made their assessments
to date.
The OBR was established in 2010 in a major reform
to the fiscal framework, introducing independence, greater transparency
and credibility to the economic and fiscal forecasts on which
fiscal policy is based. As one of a growing number of independent
fiscal authorities around the world, the creation of the OBR places
the UK at the forefront of institutional reform internationally.
The Government has addressed key weaknesses of the
past by providing the independent OBR with executive responsibility
for producing the official forecasts and assessing progress against
the fiscal mandate. All OBR forecasts are produced independently
of Ministers, supporting the credibility of official economic
and fiscal forecasts.
12. The new Charter still relies on the OBR coming
to a nominally authoritative view about the unmeasurable and unobservable
output gap, something of which this Committee has been sceptical
in the past. (Paragraph 78)
13. Furthermore, the current Charter for Budget
Responsibility will become obsolete by 2016-17—the target
date for the supplementary aim. The Charter may therefore be better
regarded as a statement of policy intention until then, rather
than a long term fiscal rule. (Paragraph 79)
The previous fiscal mandate, set in 2010, reflected
the exceptional fiscal challenge the Government faced. In 2010
the Government said that they would revisit the fiscal rules once
the public finances were closer to balance. Since then, the Government
have made significant progress on their fiscal consolidation,
reducing the cyclically adjusted current Budget deficit from its
peak of 4.7% of GDP in 2009-10 to 2.6% of GDP in 2013-14. On the
OBR's central forecast in their December 2014 Economic and Fiscal
Outlook, the cyclically adjusted current Budget will be in surplus
by 0.7% of GDP in 2017-18.
In this context the horizon on the fiscal mandate
can safely be shortened to create a tighter constraint on future
fiscal policy choices. The new Charter sets a three-year rolling
horizon—so at Budget 2015 the target year will be 2017-18—while
retaining flexibility for the automatic stabilisers to operate.
The revised Charter for Budget Responsibility also sets a new
supplementary aim for debt to be falling as a percentage of GDP
in 2016-17. Both parties in the coalition recognise that the UK
faces a long-term debt challenge and, are committed to bringing
down debt as a percentage of GDP once this supplementary target
for debt has been met.
14. The Chancellor has said that the sharp cuts
to departmental spending assumed by the OBR from 2015-16 can be
mitigated by savings to the welfare bill. The experience of the
past five years shows that the achievement of planned welfare
savings depends partly on economic developments, particularly
in the labour and housing markets, that are not within government
control. It also depends on the timely implementation and operational
success of any major reforms to the welfare system. Any decision
to reduce welfare expenditure while protecting other specified
areas will increase the proportion of savings to be found from
other parts of the welfare bill. (Paragraph 97)
15. In its first assessment, the OBR has found
that the Government is on track to meet the welfare cap commitment.
Although there was no disagreement between the Treasury and OBR
on this occasion, the potential for disagreement over whether
a measure is a "discretionary policy change" risks causing
dispute between them in the future. In the event that the Treasury's
own view differs from the OBR's, it should explain the reasons
for this in the Budget or Autumn Statement Command Papers. (Paragraph
103)
The welfare cap is a new mechanism that improves
control and scrutiny of welfare spending. It ensures that unplanned
increases in spending do not go uncorrected. At Autumn Statement
2014, the OBR's assessment was that the Government was meeting
the cap in every year.
The Government agrees that there should be transparency
over definitions of policy measures. The OBR makes the decision
in any given case as to what constitutes a policy measure, in
accordance with the request made to OBR by the Chancellor in his
letter of 3 Dec 2013. In the event of any disagreement, an explanation
would be provided. The precise format of this explanation will
depend on the circumstances.
Taxation
16. Estimating the yield from anti-avoidance measures
is inherently difficult. In response to this Committee's recommendation
from 2013, the OBR in the December 2014 Economic and Fiscal Outlook
published its evaluation of all past avoidance measures since
2010. It found that there was no systematic bias across the costings—some
produced higher returns, some lower. However, in cash terms, owing
to the shortfall in the UK-Swiss tax agreement, significantly
less revenue was raised in total than originally expected. The
underperformance of a single measure with a large expected yield
can more than offset better performance of a number of smaller
measures. (Paragraph 108)
As the committee notes, in their evaluation into
anti-avoidance costings the OBR found that there has not been
systematic bias across the costings; some measures have resulted
in greater yield than expected, while others have lower. Of the
23 measures the OBR evaluated, 15 are expected to generate yield
within 10 per cent of the original costing.
The original forecast for the Swiss deal was based
upon the best available information at the time and was certified
by the independent OBR. Estimating the prospective yield from
such agreements is difficult due to the lack of information on
the assets held in offshore centres and the extent of any behavioural
response to these agreements. HMRC continue to work closely with
the Swiss authorities to find out why what we have received is
less than had been expected. While the UK-Switzerland agreement
has under-performed, two measures taken together - Disguised Remuneration
and Annual Tax on Enveloped Property have overperformed by around
£1 billion.
HMRC is continually improving estimation methods
to take account of the lessons learnt from evaluations such as
the one done by the OBR.
17. The restriction on loss relief for banks is
the largest revenue generating measure in the Autumn Statement,
with an expected yield of £4 billion over the next Parliament.
It has been assigned an uncertainty rating of 'very high'. The
OBR should continue to monitor the performance of all avoidance
measures against their original costings. (Paragraph 109)
18. The assignment by the OBR of uncertainty ratings
to each individual policy provides useful information to outside
observers. The OBR's creation of uncertainty ratings could also
encourage the Treasury to provide more information on their own
judgement of the uncertainty of new policy measures. The OBR should
compare its uncertainty ratings on policy costings of individual
measures against the outturns, and report its findings in its
Forecast Evaluation Report. (Paragraph 110)
The Government welcomes the OBR's greater focus on
the uncertainty associated with costings. Further detail of the
costing methodology is published by the Treasury in the policy
costings document, which also highlights key uncertainties with
the costing, supplementing the information provided by the OBR.
Where the OBR is content with the costing, it will
certify the costing as a central estimate of the impact of the
measure on the public finances. As a result, any uncertainty lies
on both sides: the measure could raise or cost more or less than
expected. The Treasury will continue to work with HMRC and the
OBR to evaluate anti-avoidance measures as they become active.
19. Loss relief is an important element of tax
planning for all firms across all parts of the economy. The Committee
has previously highlighted the importance of certainty in the
tax system in its 2011 Report, Principles of Tax Policy. Apparently
lucrative tax raising measures against unpopular sectors of the
economy, while attractive to governments, carry the risk of undermining
the principle of certainty in the tax system. Uncertainty may
well reduce the yield. (Paragraph 117)
The government set out its approach to tax policy
making in December 2010 and promotes certainty and stability throughout
this process where possible. Loss relief restriction was a specific
response to a particular combination of circumstances: losses
accrued as the result of the financial crisis, misconduct and
mis-selling scandals being used to reduce future corporation tax
payments. To maximise the potential yield from the measure it
was not possible to consult with the sector prior to making the
announcement and an anti-forestalling provision was required to
reduce the scope for banks to circumnavigate the restriction.
Draft legislation was published on the day of the announcement;
we have subsequently consulted on this and incorporated certain
recommendations.
20. Tackling tax avoidance, specifically the problems
associated with base erosion and profit shifting, is an internationally
recognised problem which requires an international response. This
is currently taking place in the form of the OECD's base erosion
and profit shifting project. The Committee notes the Government's
decision to announce a unilateral Diverted Profits Tax ahead of
the conclusion of the OECD's work. This should not be permitted
to destabilise the international effort. (Paragraph 128)
The G20-OECD BEPS project presents the opportunity
for comprehensive reform of the international tax rules and the
UK is fully supportive of this work. However, this does not preclude
action at the national level where we are able to strengthen our
domestic defences to counter aggressive tax planning. The Government
is acting now so that multinationals can no longer avoid UK tax
through contrived arrangements.
The Diverted Profits Tax is consistent with international
tax rules and complements the work going forward in the BEPS project.
The Diverted Profits Tax supports the overall aim of the BEPS
project to better align taxing rights with economic activity.
21. The draft legislation is long and highly complex.
This is undesirable in itself, and is likely to be a source of
uncertainty. (Paragraph 129)
The tax avoidance techniques targeted by the Diverted
Profits Tax involve a wide range of complex arrangements designed
to avoid paying tax in the UK. Tackling this requires comprehensive
legislation.
Draft legislation was published on 10 December 2014
for consultation and the Government is considering where changes
to the final legislation for Finance Bill 2015 are appropriate
to ensure that it is clear and properly targeted. In addition
to this, HMRC will also be issuing further guidance before 1 April
2015 to provide more detail on the operation of the rules.
22. In its Report, Principles of tax policy,
the Treasury Committee recommended as its first principle that
tax policy should be fair. By imposing thousands of pounds of
additional tax liability owing to a penny's difference in a property's
price, the old 'slab' structure of residential stamp duty clearly
breached this principle. The Committee therefore agrees with the
Chancellor and the Institute for Fiscal Studies that the design
of residential stamp duty was significantly flawed, and welcomes
its reform in the Autumn Statement. However, the unfair and distortionary
slab structure continues to apply to stamp duty for non-residential
property transactions. The Government should explain the reasons
for reforming residential stamp duty in this way but not making
a similar reform of non-residential stamp duty. (Paragraph 134)
The Government welcomes the Committee's support for
the Government's reform to Stamp Duty Land Tax (SDLT) on residential
properties, which makes SDLT fairer and more efficient. The reformed
system will provide help to first time buyers and aspirational
homeowners wishing to move up the housing ladder. The Government
believes that the market for non-residential property is very
different from the market for residential property. For example,
non-residential properties have a higher value on average. Furthermore,
non-residential property has been treated differently to residential
property for SDLT purposes since 2003. For these reasons the Government
does not feel it appropriate to make changes to SDLT on non-residential
properties at this time.
23. The Committee notes this example of how fiscal
devolution can lead one government to alter tax policy in response
to the decisions of the other. With further fiscal devolution
to Scotland, this is likely to be more common. (Paragraph 135)
Devolution puts power closer to the citizen so that
local factors can be better recognised in decision-making, whilst
ensuring that the benefits of the union—currency, pensions,
single market, economic stability and security—are retained.
The Committee is right that devolution can lead to
a different policies on devolved areas between Devolved Administrations
and the rest of the United Kingdom. Some of these differences
may arise in response to policy changes by another Government.
This is already a feature of the current devolution settlements
and the Smith Commission will have noted it when determining which
taxes should be devolved to the Scottish Parliament.
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