Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 220 - 239)

THURSDAY 6 DECEMBER 2001

MR ANDREW DILNOT, MR EDWARD TROUP AND MR MARTIN WEALE

  220. The Government's policy had two aspects to it. One has been to create stability as a means of enhancing productivity and the other has been various micro-measures in the system. We have had fairly stable conditions for the last four years. Should we not have seen some sort of improvement in productivity over the four years as a result of that?
  (Mr Weale) One might hope that more stable economic conditions would encourage private sector investment, where Britain's position is still somewhat disappointing. Also some of the various micro measures have been designed to encourage investment and there too Britain's position does remain still somewhat disappointing. I must say I would not be expecting the patient to be responding immediately. I would stick with saying we really need a ten-year period to assess these sorts of issues. There is of course the point made in the Pre-Budget Report that in so far as skill levels are concerned, since most of the acquisition of skills happens to people before they enter the labour force or in the early stages, bad policies cast a very long shadow over the economy and conversely it takes a very long time to swing things round.

  221. Do you think there should be a regional dimension to the Government's productivity measures?
  (Mr Weale) The regional analysis the Government has embarked on is very helpful; they do make the point that if one were to level up with the worst performing regions that would do a lot for the economy as a whole. On the other hand there may be an element of Peter gaining at the expense of Paul, the better qualified people moving out of the poorly performing regions into the successful ones and that in itself is a factor explaining the diversities so you cannot simply look at the most successful regions and copy them in order to raise the least successful regions, but the Government is right to focus on the regional aspect, on the factors which do promote local economic success. The analysis of the different performance of various cities in the document which accompanies the Pre-Budget Report is very interesting and it is valuable that the Government is starting to look at these problems. Is it going to work? I remember one of my lecturers 25 years ago saying that a lot of policies had been tried to improve Britain's productivity over the first 75 years of the twentieth century and none of them had really worked. So it is a difficult issue and I think it would be optimistic to say that a government can identify what is wrong and that is bound to lead to a cure. On the other hand, Britain's performance for years has been an anomaly. There is a tendency for backward countries to catch up with the more advanced ones and perhaps in the last 20 years we have started to see that process happening in Britain.

Mr Plaskitt

  222. On the pensioner credit, you said in your introduction that it makes a good deal of sense. That is good to hear. Do you think it is going to achieve its objectives?
  (Mr Dilnot) It will certainly achieve its objectives of increasing the incomes of a group of pensioners who at the moment feel and are perceived to be unjustly treated in that they have small typically private pension incomes which are almost entirely taken away by the operation of the income support system. In redistributional terms for the current generation of pensioners and those about to retire it should achieve its objectives and it is important to note that one of the most significant changes that Mr Brown has delivered has been very significant increases already in the incomes of the poorest amongst the retired population with further significant increases on the way and with this providing a further additional increase for those who are not the very poorest, not the 15 per cent currently entitled to income support or minimum income guarantee but the next slice of pensioners. In redistributional terms the answer is yes. It will also reward their savings in some sense. They will benefit more from their savings. It is not obvious that it will encourage those who have not yet retired to save more because while it guarantees a higher income than you would have had if you got a private pension, it also means that if you reduce the amount of saving you are planning you end up with a larger income than you otherwise would have done. So the incentive effects are not obvious. I also think because of that it will raise the question of compulsion in pension saving. We already of course have some compulsion through SERPS and the second state pension and those contributions. By extending means testing to the bottom half of the pensioner income distribution, the question of whether compulsion needs to be considered will certainly raise its head.

  223. Some costs have been pencilled in to the pensioner credit. Do you think the figures are broadly right?
  (Mr Dilnot) I think they are. They are on the generous end of the estimates we and others had made before the Chancellor made his announcement. The principal reason for that is that the pension credit is going to be introduced in such a way as to try to make sure that housing benefit does not remove much of the game for those who are entitled to housing benefit. A consequence of that is that we are shifting housing benefit entitlement still further up the income distribution for the retired. This points to one area where the Government should feel that it looks very closely. The failure to tackle housing benefit and council tax benefit reform alongside the many other reforms which have been made, particularly to the means-tested social security system, means that we are left with this large and rather complicated system on top of instead of integrated within the rest.

  224. Do you think it would be straightforward enough that it will have a high take-up rate or do you see a take-up problem?
  (Mr Dilnot) I am sure there will be a take-up problem, especially to start with. There are two reasons for that. The first is that we are now going to be extending a means-tested benefit entitlement to a group which typically have not in the past thought of themselves as being entitled to means-tested benefit. It will take a while for them to get on top of it. The second is that some of the entitlements will be quite small. The people on the highest incomes entitled to it will have quite small entitlements. It is worth saying that the proposed administrative mechanism is rather an attractive one. The decision made to have rather infrequent means tests and to calculate entitlement at the point at which people reach retirement, all of that should encourage take-up. I think the Government are doing as much as probably can be done.

Chairman

  225. On capital gains tax, as you know the Government has changed the system to encourage investment and promote enterprise and they have changed the business asset taper for disposals which will mean that the effective rate of tax for a higher rate taxpayer is reduced to 20 per cent after one year of holding an asset and 10 per cent after two years. I happened to be in some social company the other evening when some economists and business people were talking about this. They saw this as manna from heaven. They could not understand the Chancellor's generosity in this area. The opportunities for using it in a number of different ways are manifold. Would you accept that view?
  (Mr Troup) I think so. Ten per cent is a very generous rate. There is a figure buried away on pages 178 and 180 of the Pre-Budget Report which indicates that the forecast yield from CGT for 2002-03 has actually halved since March. If you look on page 180, the project yield from the last column, fifth line, 2002-03 is £1.8 billion for capital gains tax. If you turn back to the previous page, paragraph B48 in the middle, you will see there is a sentence which says that for 2002-03 a larger reduction of £1.75 billion is now forecast. In other words, there has been a £1.75 billion reduction in the CGT forecast for next year to £1.8 billion; that effectively reflects a halving of the projected CGT over the next year. In part that is undoubtedly due to the fall in equity prices during the course of this year. Nevertheless it is a dramatic fall and as B48 indicates, it is attributable, as well as to equity prices, to the introduction of the business taper. There is a very big tax cut coming through here. I am sorry, I do not have the most recent figures, but given that there are only around 200,000[1] capital gains tax payers and only a couple of thousand[2] or so account for something like half of the yield—you would need to check the precise figures but it is that order of magnitude—you can see that there are going to be a few people who are going to get very significant tax reductions indeed, even without any behavioural change. I would not want the Committee to think I am not in favour of a reduction in the general capital gains tax rate from the 40 per cent level which was undoubtedly both high on any sort of judgmental basis, but also very high by international standards, but it does seem to me that the Chancellor has been extremely generous and runs the risk of what I think you are implying, a significant behavioural change, not just to the sort of entrepreneurial investment which he would favour, but to switching of activities or conversion of profits into a form which benefits from the rate. I have to say anecdotally from my practice, this is something which one has seen really from the beginning of the introduction of the taper, but with the reduction of the period to four years and then to two years there is undoubtedly a far greater degree of interest in getting into a position where advantage should be taken of the taper. Whilst I am in favour of a lower rate of capital gains tax, I would prefer, as I have said to this Committee before, that we had a uniform rate applicable to everything after a relatively short period of time, perhaps one year, at a level which strikes the right balance between being over-generous and being excessively high. If you look back to 1965 when the tax was introduced, when it was introduced at a flat rate of 30 per cent, something of the order of half the highest rate of income tax at that time, there was a lot of sense in that and a flat rate tax at around 20 per cent now probably would strike the right balance; I fear ten per cent is going to be seen to be over-generous in future years.

  226. There seems to be a magical political attraction in ten per cent, does there not? The Republic of Ireland held it was responsible for its economic growth but it is much more complex and I think that is what you are saying to us very clearly.
  (Mr Troup) Indeed.

  227. On the proposed volume-based credit for research and development, that will benefit all UK companies carrying out qualifying R&D, whether based in the United Kingdom or not. Do you think that this measure will have any significant effect on the proportion of qualifying R&D currently carried on outside the United Kingdom?
  (Mr Troup) There clearly is a stronger case for doing something about R&D through the tax system than many other measures which we have seen this Government address through taxation, because R&D is something which does have an external benefit which is not captured in the cost to businesses. A Government subsidy of that external benefit can be justified. This measure and the changes which have been proposed to it, effectively to give the credit only to directly incurred R&D, that is not to sub-contracted R&D, will undoubtedly bring in a greater proportion of UK R&D, R&D carried on in the UK, than the previous form of this proposal or one of the suggestions in the paper issued earlier this year. Most of the large UK companies which carry on R&D on a global basis carry on R&D outside the UK through non-UK companies, that is a UK pharmaceutical company with a US operation will typically carry on its US R&D through that company and will not therefore benefit from this credit. So the credit is undoubtedly better designed now than when originally proposed and will disproportionately and quite rightly encourage R&D spending in the UK rather than R&D spending outside the UK, notwithstanding that UK companies carrying on R&D spending outside the UK through overseas branches will be entitled to the credit. There may be some behavioural effect, you may find that UK based companies will switch foreign R&D by not actually moving the location but moving the company they carry it out through to get the benefit of the credit. I think the effect will be relatively small- scale.

Mr Ruffley

  228. May I turn to the Working Tax Credit and Child Tax Credit? Can you explain why we do not have any indication in the PBR of the possible rates? There are no illustrative numbers at all. What do you make of all that?
  (Mr Troup) I am not sure the question about why something is not in the PBR is really for me.

  229. I just wondered what your comments were on the absence of it and what judgements you can make or Parliament can make.
  (Mr Troup) I said at the outset that I was pleased we had more consultation on what one might call the micro, the specific tax and particularly the business tax measures. It clearly makes something of a nonsense to appear to consult on something without any details and it is far more important in something like a personal tax credit that the quantum is there, than the details. In the structure of the business tax system it is the rules you want to know rather than necessarily the rate. When it comes to personal tax credit it is the rates as well as the rules which are really of overriding importance in terms of their effect. If the answer you are looking for is that this is something less of a consultation to put forward proposals without numbers in these areas, I would agree with that.

  230. Have you seen any estimates of what the cost might be?
  (Mr Troup) No, nothing beyond what the IFS have suggested and I do not have those to hand.

  231. Would it be more efficient in achieving the aims the two credits are meant to be satisfying just to raise the minimum wage?
  (Mr Troup) It would clearly have a different distributional effect simply because those who benefit from the minimum wage will be a much smaller proportion of the population notwithstanding that there will be a knock-on effect from any increase in the minimum wage. It is more efficient; it depends on what view you take of how tapers should be organised and whether it is appropriate to introduce a credit which goes so far up the income system. Certainly I have had concerns at the extent to which all of these reforms and tax credits bring together the benefit and the tax systems, which perform very different functions, in a way which makes it difficult to distinguish between those who are tax payers and those who are benefit receivers. There is clearly a high degree of political choice in that and in the choice of the taper level.
  (Mr Weale) Of course the minimum wage is a cost to employers and raising the minimum wage would be likely to have some effect in increasing unemployment; possibly not a large effect but it would be expected to have some effect. The tax credits on the other hand are part of public spending and they affect incentives to go to work, but they do not affect incentives for employers to recruit.

  232. Have you made any assessment or are you aware of any assessment being done on how far this new regime for these two credits will complicate the tax system?
  (Mr Troup) No, I have not seen any assessment and it is quite hard. Rather like the phrase social insurance, complexity in the tax system can mean a great number of different things.

  233. I shall be specific. Is there any notional cost which you think you could ascribe to these new credits so far as administration is concerned?
  (Mr Troup) There clearly is an administrative cost but in a sense that is just a function of the fact that a large number of people are going to have to deal with a number of different aspects of their interaction with government through both tax and benefits and that carries a cost. That flows from the basic point of extending the taper, extending the benefits up the income system, rather than being intrinsic in the structure of these credits. I would hope, if they are fully worked through, they may actually work out simpler in themselves for an individual than some of the past combinations of benefits we have seen. Intrinsically they are not necessarily more complex, although the use of the tax credit system and the involvement of the Inland Revenue is, as has been said here before, not necessarily desirable in terms of reducing complexity and administrative costs, but the multiplication of the number of people who are likely to benefit from them is clearly in aggregate going to increase complexity and administrative costs.

  234. You have seen no work which describes those costs.
  (Mr Troup) No.
  (Mr Weale) No, I am not aware of anything which answers those questions.

Mr Plaskitt

  235. May I start with the savings gateway? I want to know what its behavioural consequences will be and whether they will contribute to what the Chancellor is trying to achieve or work against it.
  (Mr Troup) Andrew has already indicated that the savings gateway is highly attractive for those who are entitled to it because effectively it offers a 100 per cent return on an investment. As someone who has with some regrets seen the way the free market can work in unusual ways, it seems to me that the inevitable response of what is effectively a 100 per cent return to qualifying savers will be to get unscrupulous lenders to offer potential participants the opportunity to borrow money, to fund one of these gateways simply because a 100 per cent return over three years with no risk at all is extremely attractive. Given that what we are trying to do is to encourage those who currently spend to save and these people are by definition at the bottom of the income scale, it seems to me that the level of incentive needed is going to have to be of a level, as is proposed here, which will inevitably encourage that sort of behaviour because money is fungible. Given the choice of spending or saving, if I would rather spend and have the opportunity to borrow; I would borrow to save. It seems to me that that is the single response which will flow from this, which does make this an undesirable policy. I am glad that it is being piloted, but it may be that the only way to make these people save is compulsion and that is probably unacceptable politically. That was the conclusion we came to when this was looked at in the time I was at the Treasury, but obviously not followed up because it is politically unacceptable.
  (Mr Weale) On the savings gateway may I say that there have been several areas, for example giving people energy saving lamps was another one, where the Government seems to feel that people may need incentives and then embarks on incentives which are absolutely vast compared with what you would expect for the sort of intelligent people which it is targeting the policy at. I think that a policy which gives people a 100 per cent return on savings will encourage them to save while they are getting a 100 per cent return, even if in many cases it will be creamed off by unscrupulous lenders. After that they will go back to a situation with the returns which the rest of us face and there seems to me no reason why their savings habits should change. People save because they want to have money to spend in the future and in the light of the rate of return they get. Many of the people or most of the people at whom this policy is targeted find it very difficult to afford to save and at normal rates of return and given the social security system we have, it is not worth their while saving. The short bonus period with very high returns will not change that.

  236. Could you also comment on the reduction in stamp duty for regeneration areas?
  (Mr Troup) Any reduction of tax generally but particularly on property risks just being capitalised into the value of the property rather than making it easier for purchasers to come in. Therefore we have to ask whether this is a real benefit in improving disadvantaged areas, particularly given the difficulties of identifying the areas. There are some quite smart residential properties in the East End of London occupied by City professionals which can take advantage of this relief. More generally, picking up a question and a point about productivity, this measure and the community investment tax credit and one or two other measures are in the Pre-Budget Report under productivity, but by definition what this measure is doing is looking at areas where the return on investment, the productivity, is by definition lower than it is elsewhere in the community otherwise the investments would not be made. It is inevitable that any measures like this, even if they work, will not improve the overall productivity of the country, simply because we are going to be bringing into production low productivity capital and areas. Whilst this may have some effect, it is more likely to be on the capital values and even if it does have an effect, it seems to me inappropriate to describe this as something which meets the productivity challenge rather than addressing the social problems of disadvantaged areas.
  (Mr Weale) May I add to that the broader question which this raises of the function of a stamp tax as opposed to a general property tax. Of course the stamp duty you pay only when the property is bought or sold has the effect of locking people in. A higher rate of general property tax or something in addition to council tax and business rates would not have that blocking in effect. I must say I can see few reasons for maintaining a stamp duty rather than replacing it with a general property tax which could of course have local reliefs in areas where the Chancellor was particularly keen to encourage various activities.
  (Mr Troup) I agree.

Mr Laws

  237. Without giving away all your state secrets which you use to advise your clients, were you suggesting earlier on in relation to your concerns about the new CGT rate of 10 per cent not only that that might be eroding the capital gains tax yield quite significantly, but that there could be quite a leakage out of higher rate income tax by people converting income into capital gains?
  (Mr Troup) Yes.

  238. Do you think that could be quite significant?
  (Mr Troup) It could be significant in small areas. I always lament a diversion of resources into instructing lawyers to try to save tax rather than to achieve business ends in themselves. Whether you could say it has any overall effect on the economy rather than a loss of tax is much more difficult, but it clearly does represent a wasted resource and a loss of revenue.

  239. How big an effect do you think it could have on the yield of upper rate tax?
  (Mr Troup) The fact that the yield is projected to drop from £3.6 billion to £1.8 billion cannot be taken as an indication of how much would be lost, but one is probably talking about £1 billion or £2 billion. We are not talking about £5 or £10 billion, but equally we are not talking about £100 million.

  Chairman: May I thank you for your time this morning. It was very kind of you to come along and we have gained a lot from that.





1   Note by Witness: 154,000 for 1998-99 (Inland Revenue Statistics 2000, Table 14.1). Back

2   Note by Witness: Around 3,000 for 1997-98 (Ibid. Table 14.3) Back


 
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