Select Committee on Treasury Minutes of Evidence

Examination of witnesses (Questions 60 - 80)



Mr Beard

  60. May I ask Kate Barker: do you think the initiatives that the Government has taken to boost productivity are actually working?
  (Ms Barker) If you are talking in terms solely of this Budget, although the Chancellor talked quite a lot about productivity and it was a big thing certainly early on in his speech, he actually did not announce very much just in this Budget to increase productivity in the long term. Of course we have always argued and it has been said many times before that increase in productivity is never going to be a question of one or two big measures. It is going to be as a result of a number of measures that are taken over time, not all of which are purely budgetary. A lot of the focus on skills will of course be the result of decisions that are taken outside the Budget and of course from the CBI's point of view one of the things that could potentially hold back productivity, namely a poor transport system, will be helped by measures taken in the CSR. The good thing from this Budget from a business point of view and to that extent something that should help productivity in the long run was that, unlike in the previous Budgets from this Chancellor, we did not have any unwelcome surprises on the corporation tax side. Indeed, although we did not have very much actually announced which will take effect this year, in a number of cases: the proposed research and development tax credit for larger companies, the recognition of the importance of international competitiveness for multinational taxation, we saw some very helpful pointers to tax measures which we now expect to see come in over the next year or so which will help to improve the investment rate in this country from larger companies and that I think will be good news in the long run. We also saw some measures for SMEs. They were on the whole, I suspect, in the right direction. They were less significant than they have been in the past but as a matter of fact I would agree with the point that Edward Troup made: we have perhaps had too many measures for SMEs, not always with a very clear idea of what each of them individually was supposed to achieve. One of the things I would particularly welcome would be a really good evaluation of just where we are in terms of SME taxation overall, what has been achieved by the measures we have had so far, should any of them be got rid of and be replaced by something better.

  61. What do you see this year as the likely trend in productivity growth? I understand the Chancellor is closing the gap with the USA.
  (Ms Barker) In a sense I could be really dull and go back to the beginning and say that one always wonders exactly how big the gap with the USA is. I personally am of the view that you should look at it in terms of output per person per hour, although the gap is not quite as big as some of the very large gaps that we sometimes have trotted out, which frankly would be unclosable in any feasible period. Beyond that though there are clearly uncertainties about how productivity is measured. Sometimes if you narrow that it can seem a bit less of a mountain to climb. Over the next five years, which is a reasonable length of time to talk about it, I would be optimistic about starting to close the gap with the US and also closing the gap with continental Europe, partly for reasons which are not necessarily something to do with fundamentals but are to do with the rate at which people are adopting the new economy. Of course, seeing the new economy and new technology adopted in the US, they have clearly been first movers. On the back of that we have seen part of the effect in terms of building strong productivity in the US, even though the evidence for it outside the ICT sector is not very great, and we should start to see more of that coming through in the United Kingdom and in particular when we look at Europe over the next few years, and I would think that would be a very positive trend. In addition, and here I agree with the analysis in the Treasury's paper on productivity, we have seen a lot of people moving into the labour force in the United Kingdom over the past few years who have previously been out of the labour force. It would be reasonable to assume that they were not terribly productive when they were first brought in. Their productivity is going to increase. There are again good reasons to think that our greater productivity is going to improve but how much in five years' time will we have closed the gap? It is a little bit less certain because it is possible that some other countries may get smarter too.
  (Mr Coats) What is important about the Budget is the medium term strategy that is beginning to emerge here. The Chancellor has understood that there is only a certain amount you can do through fiscal measures to boost productivity. There are two mentioned in the Red Book. One is the proposed R&D tax credit which the TUC and CBI will be discussing as part of the joint initiative on productivity that the Chancellor has asked us to develop. We are trying to answer jointly some of those design questions about the R&D tax credit: what is eligible and where do you start from? What counts and what is your bench mark for additionality? The second is the suggestion that the Government is willing to look at a tax credit for investment in training for low skilled workers to obtain qualifications up to Level 2. Both of those are very welcome. What is clear is that the Government understands that that is not enough and that ultimately closing the gap with the US and France and Germany depends on what employers and unions are able to do in the work place. I would see the Budget measures as being entirely consistent with the wider initiative the Chancellor has asked us to take as social partners to close that gap, looking at skills, investment, innovation, technology and best practice.

  62. Are there any further steps that you think the Government should have taken to improve the prospects of productivity growth?
  (Mr Coats) Part of the process that we are now engaged in with the CBI is to identify what further steps might be taken next year. The intention is to have a report for the Chancellor by September, all being well—it is quite a tight timetable—so that the recommendations that are made by the TUC and the CBI can be taken into account in next year's Budget.

  63. Could I ask Andrew Dilnot, Edward Troup and Martin Weale whether they think the proposals in the Myners Report, if implemented, are likely to improve productivity?
  (Mr Dilnot) I do not have anything to add on that.
  (Mr Troup) I do not think so. I do not have anything to add.
  (Mr Weale) Could I say that I am not aware that shortage of capital has been the problem for the investing sector. It is something which comes up time and time again. Typically in boom periods we hear how people should be lending more to innovative companies, and then you have recessions, Internet failures and so on. Banks get into difficulties because they were doing what became imprudent lending. My worry on that aspect of the Myners Report might be that a pension fund could start to find themselves in the same sort of position and be encouraged to lend into what really are very uncertain prospects.
  (Ms Barker) I slightly disagree with Martin. Although I do not think there is any particular shortage of capital overall I think there certainly are occasions you can point to, such as the so-called equity financing, the financing gap, when people looking for pockets of money (not very large pockets of money) do find some difficulty in getting themselves invested in by funds. Certainly the Myners Report was addressing that and trying to encourage trustees to as it were take a more flexible view in the circumstances of their scheme. I am sure it would not be consistent with the Myners Report to encourage trustees to take a sort of wildly reckless stance but simply to encourage them to take perhaps a slightly more enlightened view of risk in the schemes where it is appropriate. In that sense I think his motivation was correct. What I think is slightly more difficult is the question you asked as to whether or not the measures he has proposed will make any difference because of course the difficulty for anybody being a trustee, is of being criticised for taking excessive risk or doing things that are different from other people. In a sense, unless the trustees are collectively going to start to move in that direction, it is always going to be very difficult for any individual trustee body. I think he has made some steps in the right direction but it is very uncertain whether or not they will prove to be beneficial.

Mr Plaskitt

  64. May I come back to the measures for small businesses. Kate Barker, you said you did not think there was very much in this one. Can I draw your attention to two things? One is the proposal for the flat rate scheme for paying VAT for the £100,000 and below turnovers, but the other one was the suggestion that small companies could use the same accounting procedures by which they present their annual profits as the basis upon which they can make a return to the Inland Revenue for tax liability. That latter one has had a pretty enthusiastic welcome from the Federation of Small Businesses. Is that quite a significant move for reducing the burden of regulation and administration costs for small companies?
  (Ms Barker) Yes. I would not want to be misunderstood in this. In the sense that I said that the measures were not very significant, I meant not very significant in the sense that Andrew Dilnot was looking at winners and losers; they do not appear as very large negative numbers in terms of the Budget plan, so in terms of cash coming to small businesses it is true that the measures are not as significant as they have been in some earlier years. However, you are quite right to remind me of the fact that one of the things we always complain about is the burden of regulation and these are measures designed to ease regulation on small companies and to that extent they are very welcome. In the case of the second one you mentioned, the review of corporation tax, we will have some way to go. I do not really want to express a view on it today to say just how beneficial I think it would be. Some companies have expressed some concern about whether or not some of the allowances they presently have will be lost under the new system and we will have to wait until we see exactly what is in the Government's mind to have the opportunity to discuss that with a range of companies before we are able to say how far—there is always a tension in this between a tax system that people think encourages them to do the good things such as investing and a tax system that is very simple. It is the difficulty in many tax decisions.

  65. The measure clearly points towards a simplification, does it not, which is something that small businesses have constantly been asking for?
  (Ms Barker) It does clearly point to a simplification and I am making perhaps the unwelcome point that however much businesses ask for simplification it is also the case that sometimes simplification can mean giving up allowances or reliefs that they have found particularly welcome and therefore that turns out not to be welcome.

  66. You cannot have it both ways.
  (Ms Barker) And at the moment I am not sure where this particular consultation will come down in terms of striking that balance. On the whole I think it is a good thing but I would prefer to wait until we can see more of the details before I make a final comment.
  (Mr Troup) I was going to make a point similar to Kate's last point. It is clearly welcome to try and simplify it but it is extraordinarily difficult. I think it is regrettable that in the paper which proposed moving to accounts, effectively leaving businesses to determine their own profit levels for themselves according to their accounts, there is already a reservation saying, "Yes, we want to retain the right to give special allowances for IT expenditure or this and that". It seems to me that the Government have got to decide whether they genuinely believe that businesses can go out there and maximise their profits with a minimum of intervention from the Government or whether Government have got to go on poking around in bits of business and saying, "We want a bit more expenditure on this, a bit more expenditure on that". There is a tension which is not really addressed at all and it is explicit in the paper on small business taxation. The other point is that they are trying to carve out part of the tax system, say small businesses get one regime; everybody else gets another one. That is likely to be as complex as, if not more complex than, what we have at the moment because the small businesses who benefit from the current regime are likely to say, "We want the option to be taxed as a big business", so they then have to worry about whether they should be choosing to be taxed under the small regime or taxed under the large business regime. You have all the boundary and interface problems there. While it is clearly welcome in terms of intention, in detail I have to say my own view is that it is simply not going to work for small business taxation. I also think that it is regrettable that the only measure the Government has put forward in this Budget to help small business with compliance costs is not to try and simplify but simply to offer them grants and payments to meet the cost[1]. That is not reducing the costs of complexity on the economy as a whole. It is simply shifting it from the small businesses back to central government. I do think a rather wider view of the tax system has to be taken and to decide whether the Government wants to go on with micro measures which inevitably create complexity and proportionately more burdens on small businesses, or whether the Government is going to say, "Yes, we genuinely do want to simplify", in which case you have got to row back right across the board and not stopping to look at individual areas.

  67. If you take all the measures together that are in this Budget do you think it has helped or will help to reduce the burden of regulation on small businesses or not?
  (Mr Troup) No.

  68. You do not think it will?
  (Mr Troup) No. It is very difficult to see any individual measure, nothing specific that is proposed, that will.

  69. So the Federation of Small Businesses is wrong?
  (Mr Troup) I am afraid they will be proved wrong. They may benefit small businesses because he has offered to give them money to help with the regulatory burden, but that is not actually reducing the burden. It is simply meeting the cost of it. I have to say that although the flat rate scheme for VAT may offer some relief, I think that the small business corporation tax scheme taken as a whole will not.

  70. The Federation of Small Businesses actually said that it thought this measure would save a lot of companies thousands of pounds a year in administration costs. Do you think it is wrong?
  (Mr Troup) I would be delighted if it does. I am not going to sit here and argue with the Federation of Small Businesses. A flat rate scheme for VAT may well do but I think it will also be quite expensive for the Exchequer. The small business corporation tax scheme, I am afraid if that is what they have said about it, that I do not agree with.

Judy Mallaber

  71. One of the issues that will be raised about small firms is the impact of the reforms of maternity and paternity grants. Maybe Kate Barker and David Coats could comment on what will be the impact of that on small firms but also maybe more broadly on whether there are broader economic and employment implications of the extension of maternity and paternity rights.
  (Ms Barker) The CBI have accepted the introduction of these measures but certainly, on behalf of smaller firms in particular I have to say, rather reluctantly. Of course it is the case that more firms will benefit from the payments given to them to compensate for the administrative costs of dealing with maternity and paternity pay and that is welcome. We are slightly worried that there is a slice of firms that will come just above the cut-off point that will find the extension of the increase in maternity pay and the increase in leave quite costly and quite difficult. Of course it is always true that for the smaller firms, where inevitably every employee is more important, having a long period of maternity leave which they have to cover may prove to be difficult. It may prove to be the case that they have to employ somebody whereas before they might have thought they would get through the period of maternity leave. Certainly it will raise costs. I would not wish to say that we oppose these measures in themselves but they are certainly not helpful to smaller firms. If you take them together with all the other employment measures of course, which are talked about in many other areas although not in here particularly, it does add up to a package of measures which means that costs of employment and of administration for smaller firms, administering working families tax credits for example, have risen under this Government. To go back to the point that was raised earlier, the measures in terms of tax simplification are so much less significant for smaller firms than these employment measures that it is difficult to argue anything other than that the burden of regulation as far as SMEs are concerned has gone up.

  72. And if you look beyond small firms at the broad economic and labour market implications, given that there are starting to be areas of labour shortage?
  (Ms Barker) It is absolutely true in the short term that we have areas of labour shortage and of course this may make it more difficult, but I regard that as a cyclical phenomenon rather than something that would argue against labour market measures that made sense in the longer term.
  (Mr Coats) Two points. First of all, this is obviously a desirable social policy objective which is broadly consistent with the Government strategy elsewhere, enabling people to balance work and family life. The extension of paid maternity leave from 18 to 26 weeks is welcome for that reason. I am not certain that I agree with Kate that you can only see this as a burden. You can interpret these measures as a way of improving the overall performance of the labour market by encouraging women to stay in the labour market and to return to work after they have had children. That is a benefit to employers, not simply a cost, because they are retaining tacit knowledge in the organisation, they are retaining skills, they are reducing their search/recruitment costs as a result, so it is not simply a burden and I think we need to have a rather different discussion about labour market regulation which is focused on how it benefits employers and improves performance and is not simply seen as a burden on business.

Mr Fallon

  73. Edward Troup, the new research and development tax credit is now being extended to large firms. Is there not a danger that the subsidising of research and development that might take place anyway is even greater with large firms than small firms, and what kind of evaluation do you expect to see of whether or not these tax credits actually do boost productivity?
  (Mr Troup) I think evaluation is extremely difficult. I am not an economist but I am happy to take as read that there is a shortfall in the amount of R&D done here because the general benefit of R&D is less than the individual gain to the companies concerned. I am prepared to take on trust that there is a need to subsidise the cost of R&D. The choice between a volume based credit, which effectively has inherent in it a large deadweight cost because everybody who was doing R&D will get the benefit, and the incremental base which attempts only to reward the extra R&D that is done, is very much one of complexity. In terms of evaluation I doubt that you can ever evaluate what R&D was done as a result of the tax credit that was not done otherwise because it requires effectively evidence of subjective decisions made by the managers of businesses as to what they would have done had they not got this tax relief. The one thing about tax is that it is just part of the business decision and no-one will be able to say, "If I did not have that ingredient in the framework I would have taken a different decision". Firm evaluation would be almost impossible. The question of whether you should avoid the deadweight by going for the incremental relief is very much a matter of trying to assess the complexity. The paper does actually make a fair stab at evaluating the complexity, which is very great, and one of the dangers in appearing to have pre-decided that we should go for an incremental system, which is what the paper does, is that it takes as comparisons Japan, France and the US, but the tax and commercial systems are very different in those countries because they effectively do not operate through groups and in the US where they do operate through groups of companies and are taxed on a consolidated basis. We have a tax system which works through individual companies and the complexities (which the paper acknowledges) which that creates are very significant. My preliminary assessment is that a volume base is probably going to be more sensible here simply because the complexities of the incremental base are going to be that much greater, but that has to recognise that that would generate a very considerable amount of deadweight cost.

  74. Andrew Dilnot, if you cannot evaluate it properly how can you ever be sure whether you have boosted productivity?
  (Mr Dilnot) I have to say I think Edward showed a worrying lack of confidence in the competence of statistical economists. I think work is possible which could evaluate this and one of the things which I think it would be reasonable to expect from the Treasury would be a commitment to make the availability of the data and funding such research. It would be well worth asking the Treasury what they have done so far to evaluate their R&D tax credit for small firms. It is striking that if you look at evaluation across the whole run of government policies, a lot of evaluation is being done of many social policies: the New Deal, working families tax credit, and so on. So far not as much evaluation has been contracted out on these kinds of areas where it is crucial. I think something can be done. It would require a great deal of data and extremely sophisticated econometric skills. The balance between complexity and deadweight loss Edward has set out very clearly. There is a trade-off. The particular scheme outlined in the report focuses very tightly, even to the extent of indexing for inflation past spending on R&D. You see the reason for doing that. You do not simply want to give credit for R&D spending that is only large because there has been higher inflation, but it necessarily complicates things.


  75. Thank you all very much. Is there anything you want to say?
  (Mr Dilnot) Yes, there is. There are a couple of things I would like to pick up on from earlier. One is just what has happened to the tax burden.

  76. I thought you might.
  (Mr Dilnot) There was some confusion there. It would have been nice to have seen the numbers in table C23, which go backwards, put against the numbers in table C9 and C5 which go forwards. I think that was what was being struggled for. My copy has had those scribbled in since the evening of the Budget day. On the Chancellor's preferred measure, net taxes and social security contributions, in 1996-97 the figure was 35.2 per cent, in the year about to end the Treasury's forecast is that it will be 37.7 per cent, that is an increase of two and a half percentage points of GDP or roughly £25 billion a year.

Mr Fallon

  77. Does that include the scoring of the tax credit?
  (Mr Dilnot) I am about to come to public sector current receipts. So that is the Chancellor's preferred measure. Public sector current receipts, which is the total of receipts, which leads to the amount we have to borrow or the surplus, the longstanding measure was 37.6 per cent of GDP in 1996-97 and according to table C9 or C5 it would be 40.5 per cent in the year 2000  01, an increase of 2.9 per cent of GDP or about £29 billion. As to whether that is discretionary or not, I think at one level of course it is discretionary because it is up to the Chancellor to decide how much tax she or he will raise in any one year. The component parts of that increase have been some deliberate measures, some announced in advance by the last Conservative Government, some announced and implemented by this Labour Government; growth in the economy, as the economy grows we expect to see tax share of national income rise because the tax system is progressive; then finally forecasting error, tax revenues have been buoyant, buoyant in some unexpected ways and that has contributed to this.


  78. I note you say the Treasury has estimated in the absence of offsetting measures the ratio of taxes to GDP will rise by 0.23 per cent, this is once a year, when the economy is growing at close to a trend rate.
  (Mr Dilnot) Yes.

  79. Over four years that would amount to what?
  (Mr Dilnot) Four years of two and a half per cent growth, roughly ten per cent so you might think about two, two and a half per cent extra on the tax system. There was one other point which I wanted to make which was about fiscal rules. Martin Weale said that many economists would think that the optimum thing was to have constant tax rates going forward. Martin may well be right but I think there is another way of thinking about it. When you ask an economist what the optimum thing is they tend to say "We should balance something against something else", you know a marginal cost and a marginal benefit, and actually the natural thing to think about the activities of Government is you should undertake activities of Government where the marginal social benefit exceeds the marginal social cost, that is it. As the external economy changes, as populations change, that might lead you to borrow more or less, it certainly would not lead you to the fiscal rules that we have at the moment and nor, I think, necessarily would it lead you to the idea that tax rates should be constantly going forwards.

  80. Are we starting a late argument here?
  (Mr Troup) No. You asked if we had any closing comments; I was just going to make comments on a completely different point, really picking up the issue of policy making. This Budget even more than the preceding Budgets gave the impression of being put together in a terrible hurry. There were a number of mistakes in the press releases. The websites were chaotic. I am concerned that the process of policy making is not satisfactory. To pick one example from last year, there was the most tremendous row about—as this Committee is aware—double tax relief. If you look on page 150 of your Red Book, you will see that the first three years of those measures being brought in, it will actually cost the Treasury five million pounds: plus five, plus five, minus 15. So at a cost of five million pounds as a result of what I believe was rushed policy making last year, we have done a great deal of harm to the reputation of the UK as a place to do business. It is one example, I think it is an extremely important example from the point of view of British business but I think you can look at a number of other measures and criticise them for the lack of proper evidence based policy making, proper internal discussion within the Treasury before the announcement and proper discussion out here. I would hope the next Parliament we will do better.
  (Ms Barker) I am slightly obliged to respond to that and defend the Treasury slightly. I absolutely agree what happened with double tax relief last year was confused and highly undesirable. I think I would point out in terms of some of the other measures where consultation has been going on this year, the Treasury has quite rightly decided that they cannot bring them through in a rushed way this year and it has hesitated to bring in changes. This is a bit regrettable in the case of the changes to capital gains on the disposable of substantial shareholdings because I think it is a very desirable measure. Nevertheless I think it is absolutely right that they are taking the time to get it right so perhaps they did well at something.
  (Mr Troup) I agree with that.

  Chairman: I think that is a good time to stop. We cannot start all over again. Thank you very much.

1   Note by Witness: Para 5.13(1) enhanced small employer relief for maternity pay provider for additional payment of `compensation' to recognise increased compliance burden. Back

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