Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 1 - 19)

MONDAY 22 APRIL 2002

MR CIARA¡N BARR, PROFESSOR TIM CONGDON, MR CARL EMMERSON AND MR MARTIN WEALE

Chairman

  1. Good afternoon, gentlemen. Welcome to this first Budget session where we are examining the Chancellor's Budget from last week. Could I ask you to introduce yourselves for the sake of the shorthand writer, please?
  (Professor Congdon) Professor Tim Congdon. I am Chief Economist at Lombard Street Research.
  (Mr Barr) I am Ciarán Barr, Chief UK Economist at Deutsche Bank.
  (Mr Emmerson) I am Carl Emmerson. I am a Programme Director at the Institute for Fiscal Studies.
  (Mr Weale) I am Martin Weale. I am Director of the National Institute of Economic and Social Research.

  2. Thank you very much. Much has been written about the Budget already. If we looked at the weekend papers in particular we would probably find that there were diametrically opposed views taken on issues such as is it a tax and spend Budget, does it make it easier for us to get into Europe, therefore if we do not achieve our growth targets then the whole house comes down etc? Could I ask you to present your views on it very briefly so we can open it up.
  (Professor Congdon) This very much was a tax and spend budget. It is very difficult to complain about what this Government has done on public finances. The ratio of the net public debt to GDP is only 31 per cent, very low by Britain's post-war standards, and although there is a return to deficits the deficits envisaged are modest by past standards. The increase in spending, particularly on health and education, that this Government has promised is being paid for by higher taxes. Having said that, one might raise some questions about the pattern of the tax increases. I think one could argue that the Government, or the Chancellor, has been boxed in in some ways. The Government does not want to raise direct taxes on households, it does not want to raise taxes on companies, so the remaining options are excise duties and national insurance contributions. I think there are some worries that increases in excise duties, even though in line with inflation, would have affected the inflation target, so the Chancellor has suppressed excise duty increases again. Last year there were these cuts in fuel duties but, again, they have been held back. All that is left is national insurance contributions. I think there are some interesting constitutional questions, questions about the structure of the welfare state, where national insurance in theory is supposed to pay for contributory benefits, such as pension benefits and Jobseeker's Allowance, it is not supposed to pay constitutionally for education and health spending, there are some interesting questions there. One can see why that was the chosen route. Just to finish, I think the Government's economic forecast in the Budget documents is in some ways too complacent. I think the Government believes that there is going to be a slow down in consumption growth at present interest rates on present policies and I do not find that plausible, I think the consumer boom, or boomlet, will continue. I was a bit surprised that the official view seems to be that there will be a slow down in the housing market, consumer spending and so on at these interest rates.

  3. Thank you very much. Ciarán?
  (Mr Barr) My own thoughts are similar to some of Tim's. Obviously as things look the public finances do not look particularly stretched going forward, there is still a buffer there in the finances. Overall it is difficult to take a snapshot and say that the Chancellor has taken many risks going forward, I think certainly the public finances look a lot better than they have done in previous cycles. That said, there are some question marks over his very ambitious growth projections in the next year or two and his assumptions of trend growth. While I would not want to say they look excessive, in fact we are also very optimistic, it is worth bearing in mind that it is very difficult to take back these discretionary spending increases. So if growth were to disappoint in the next few years for any reason you could very quickly see some of the deficits widen very substantially. I think that is worth bearing in mind, particularly with regard to some of the very optimistic growth forecasts for next year. Coming back to the issue of the consumer and so on, before the Budget all the spin was basically we were going to see higher taxes on the household sector that were going to pay for higher NHS spending. That is, if you like, what the Government were telling us the public had told them they wanted. It seems that did not happen at all, as we know corporates have picked up most of the tab for this, certainly the substantial amount. You could argue that in an economic sense, particularly because it is national insurance, that may not matter very much, it all comes out at the end of the day, but I do think it does not put any pressure on to the consumer sector, we are going to see the consumer continue to remain stronger for longer and the Budget has not really changed that, but the expectations certainly in the City were that they would change that, it would take some of the spending power out of households. That has implications for the MPC, it has implications for monetary policy and so on. Also I think it is important to bear in mind that on the EMU issue there has been a lot of white noise coming out, whether it was pro or anti euro or whatever. I think the EMU question is fairly invariant to this year's Budget. I am not somebody who believes that because we are seeing wider deficits going forward that that is going to cause a problem meeting the Maastricht criteria on public finances. If anything, you could turn it around and say that because they ducked the issue of raising household taxes it makes it slightly easier to go for a referendum next year, although that becomes a political judgment. Nonetheless, I am not sure that you can definitely say that the Chancellor has done a Budget that is in any way related to the EMU question. That is all I want to say for the time being.

  4. Thank you. Carl?
  (Mr Emmerson) It certainly was a tax and spend Budget. Measures which we had not previously had any consultation on raised taxes by about £11.5 billion by 2005-06. The Chancellor gave £3.5 billion back in new tax credits and also measures for the companies that we already knew about. The net increase in taxes is going to be used to increase public spending. I think unlike the spring 1993 or the summer 1997 Budgets which increased taxes, this has not been done to reduce borrowing, it has a stated aim, an increase in taxes to increase public spending. In terms of the fiscal rules, the Treasury's forecasts suggest that these will still be met, although it is the case that these current set of forecasts are less cautious than they were in, say, the previous Budget because of the change in trend growth assumption. I would also like to say that the measures used to raise the money means that the Chancellor is also redistributing, he has taken money from the top half of the income distribution and he has given some back to the bottom half with these new tax credits.

  5. Thank you. Mr Weale?
  (Mr Weale) What struck me most about the Budget was, except in the short term, it is actually very expansionary. If you look at what is projected for 2006-07 Government borrowing is increased by one per cent of GDP compared with what would have happened. This does not appear fully as an increase in the borrowing requirement, part of it comes from the adjustment to the trend rate of growth, but of course even the Chancellor cannot vary the actual rate of growth in the economy simply by announcing a different trend. So in the longer term it is undoubtedly expansionary and relative to where we would have been that probably adds about 3p on the basic rate of tax or equivalent taxation in other means. We are a bit pessimistic about the Chancellor achieving the revenue targets shown in the Budget for the period up to 2006-07. I think this is in part because he is making assumptions about revenue buoyancy that may be right, but may not be right, also because he is assuming a stronger cyclical and recovery than I feel comfortable with. Our own analysis suggests that might lead to tax increases on the basic rate of tax of 1.5p or its equivalent. I should stress that forecasts by their nature are uncertain so there is a large margin of uncertainty surrounding these, but it is running rather finer than the Budget document suggests. I suppose also I would make the point that as far as I can see the Budget demonstrates the fiscal rules needs revising. We have had the cumulated surplus of £50 billion over the cycle so far, the rules say that the Chancellor is allowed to spend that—this is on the current account—I am not for one moment saying that he should have but when you have that sort of gap between what a rule allows and what the Budget is actually suggesting then I think one can reasonably ask the question whether the rules should be revised to give a better guide to the Chancellor's actual policies.

  Chairman: Thank you very much. Mr Plaskitt?

Mr Plaskitt

  6. Can I just pursue this trend rate of growth issue for a bit. It has been put to us by another analyst that the £17 billion increase in public spending is 50 per cent financed by tax increases, 25 per cent financed by up rating the growth assumption and 25 per cent by higher borrowing. Does anyone dissent from those figures?
  (Professor Congdon) Can I just ask where they have come from?

  7. Goldman Sachs.
  (Mr Weale) I do not agree with those exact proportions but—

  8. Are they way out?
  (Mr Weale) The key table is table C6 of the Budget Statement on page 215 and there you can see that relative to the PSBR borrowing has increased by £5 billion but the Budget policy decisions are raising the deficit by £13 billion; of those £13 billion, there are rounding errors, £7 billion is accounted for by the changes to the trend rate of growth and other forecasting changes.

  9. So you think that a bigger proportion is financed by increasing the trend rate of growth than 25 per cent?
  (Mr Weale) As with all these things, it depends how you look at it. I have focused on the increase in borrowing, that is a net figure. If you look at increase in spending and then increase in revenue you may get to something closer to the numbers you have quoted.

  10. I am only getting more confused now. I just want to know whether you think it is broadly true to say that about a quarter of the additional spending boom has been created by assuming this higher rate of growth or is that quarter suggestion way out? Is it roughly that?
  (Mr Emmerson) I think it is roughly that.

  11. Right, that is helpful. Does anyone think it really is not that at all? No? Okay, right. The next question is has the Chancellor been prudent, if you like, to make this assumption that the trend rate of growth has now increased or is it incautious to do this?
  (Mr Weale) I have no difficulty with the assumption that the trend rate of growth is faster; my puzzlement was more why the Chancellor ever adopted two and a quarter per cent instead of two and a half per cent. There is an issue with quite wide implications whether faster immigration is going to deliver faster growth in the labour supply but I have no difficulty with the assumption of a trend rate of growth of two and a half per cent. My difficulty, or the lack of caution that I see, is the cyclical recovery that is built in at the earlier stages of the forecast.

  12. Has anybody else got any problems with the increased assumption on trend rate?
  (Professor Congdon) I think the break down of the two and three-quarters is productivity two, a bit of an allowance for a higher employment ratio of a quarter per cent and half per cent immigration. I am a little bit puzzled about the quarter per cent for the employment ratio because I do not think that is going to persist because really in the last few years we have seen employment rising faster than the working age population and that reflects all sorts of Government measures, he changed the tax system, the Jobseeker's Allowance some years ago, all sorts of things. I think it is a bit treacherous to rely on that in the future but I have not got any great quarrels with this. The history of the Treasury raising its views on trend growth is, however, a very bad one. When they did this in the late 1980s all sorts of mistakes were made.

  13. Do you not also agree that in the recent past the Treasury has been under-estimating growth?
  (Professor Congdon) Yes, it said that. It has explained when calculating the fiscal arithmetic it assumes two and a quarter, whereas it really thinks it is two and a half. Just remember that if you were to go back five years, nobody would have forecast the net immigration we have actually had in the last five years. As far as I am aware I do not think anybody forecast that, so the Treasury was fully justified in the view it was taking in my opinion.
  (Mr Emmerson) Could I add that if the Treasury had assumed two and a quarter per cent for this Budget its forecast would still show the golden rule being met and public finances in good shape but not being met with as much cushion as they do because of the change. It is not critical to the forecast needing to meet the golden rule.

  Mr Plaskitt: That is helpful.

Chairman

  14. You mentioned productivity and that is one of the key objectives of the Chancellor, productivity growth. Is there a contradiction there with the way he has gone about the tax increases by putting it on national insurance and thereby maybe inhibiting employers taking on extra workers and productivity targets not being achieved?
  (Professor Congdon) The effect of changes to the national insurance, although important, will be marginal compared with the other determinants of productivity growth. As a matter of fact, on the official figures productivity growth has been slower in the last five years than the previous five years. Having said that, it seems to me two is reasonable.

  Mr Tyrie: Does anybody think that productivity as measured at the moment is sufficiently robust to act as a major influence on policy? Great emphasis has been placed on productivity but it is an amorphous concept at the best of times, very difficult to measure.

  Chairman: Does everybody believe the productivity figures?

Mr Tyrie

  15. Very influenced by the exchange rate.
  (Professor Congdon) There has been an article in a recent issue of Economic Trends about productivity growth in business services and similar sectors, and it basically admits that it is very difficult to measure productivity change in business services, financial services and so on. Since they account for about over 20 per cent of employment this difficulty in measuring productivity change in that sector raises larger questions. I suggest that many of the really big incomes that one finds in this economy are actually in that business services, financial services area. There are lots of interesting questions about whether productivity growth is measured properly but what we do with them I am not sure.
  (Mr Weale) I should say that if we changed our view on how productivity was growing substantially and said the true number should be four per cent rather than two per cent, it would not necessarily make the resources available for the National Health Service any more readily available because then your view of what real growth meant would also have to change.

  16. I am just trying to get some feel for how much emphasis people think should be placed on productivity numbers, productivity growth numbers and productivity as a policy objective in the way that the Chancellor appears to have done. Some countries have had very good histories of productivity but had very poor economic performance and vice versa. A lot depends on how these measures are put together and simple manpower figures are often very difficult although it is easier to make a comparison of trends for productivity within a particular country, is it not?
  (Mr Weale) I do not think it is possible to talk about how much you would like the economy to grow or how fast you would like to make resources available for any particular sector without having some sort of implicit view on what is happening to productivity because, of course, economic growth is productivity growth plus labour input appropriately measured. So if we are going to be concerned about real growth in the economy and have views on what we would like to do, we cannot get away from the need to discuss productivity.
  (Mr Barr) I think what is frustrating for the Government and the Chancellor about the productivity issue is if you look at the United States where there has been a fairly uncontroversial rise in productivity in recent years, although we could argue how much there actually has been, conditioned upon strong investment in the past, in the UK we have actually had very robust business investment in recent years. If you look at business investment as a share of GDP in real terms it is at record level for things like the service sector and so on. There should be productivity improvements flowing from that, one might argue, but that has not really happened. We have had very strong rises in employment growth and the question you have to ask yourself is are we now about to see a productivity spurt come through as a result of previous investment and so on and so forth. The evidence on that is very mixed. I think you can tell that by the way the Chancellor was unable to boost the increased productivity as part of his trend growth business instead of relying on assumptions about population, immigration and so on, which one could argue are convenient at this stage in the cycle when you want higher trend growth levels. I am not really arguing the problem is the trend growth has gone up but it is the way actually it has gone up. I am quite optimistic we will see productivity increases going forward but you would have to be a brave person to say they would be very strong.

  17. Can I move on, or back to what Professor Congdon said right at the beginning. I would like to pick him up on two of the main points he made. First of all, could you just say a little bit more about the contributory principle as far as national insurance contributions are concerned and what implications the allocation of money from the fund to health and education have for the contributory principle and whether we now might argue that national insurance contributions are merely an income tax by another name?
  (Professor Congdon) In the Budget speech Gordon Brown referred to Lord Beveridge's 1942 report on social insurance. That report recommended the contributory principle, essentially that all welfare benefits are to be paid for by contributions, which are to be universal, with the aim of getting away from the idea of means tested benefits. I am not an expert on the constitutional structure of the national insurance fund but I have looked at the national insurance fund, it still exists, very much it is a fund and in that sense the contributory principle remains alive. It shows national insurance contributions as the bulk of receipts of the fund and then the benefits that are paid out are pensions, unemployment benefit as it used to be, now it is called Jobseeker's Allowance, and also Disability Benefits. These are all contributory benefits. The Government Actuary's Department carries out reviews and reviews the solvency of this fund on the basis that these are the benefits for which national insurance contributions are there to pay for them. As far as I am aware there is no basis for this fund being used to pay for health spending or education spending. You might then stand back from this and say in resource terms national insurance contributions are a tax and any tax can pay for any type of Government spending, but I think we should also think about the structure of the welfare state. If this Government wants to suspend the contributory principle perhaps it should say so openly and upfront, and it might also think about how the welfare system is to evolve in the future when so much of it now is means tested benefits and there is a proliferation of tax credits and so on.

  18. Let us just try and encapsulate what you have said in a few sentences. Is the contributory principle dead? Is the national insurance fund now a total fiction and are national insurance contributions to all intents and purposes now a tax? Should we be saying in this Budget that the Chancellor has effectively abolished national insurance contributions as we understand them, or has come very close to that, and created an increase in income tax by ten per cent?
  (Professor Congdon) I think the Budget raises very fundamental questions about the nature of the welfare state. There might be a sophisticated modern view that the national insurance fund is anachronism and simply the state has to find resources to pay for these good things in terms of welfare benefits, education and health that the state provides. I am not sure about the precise constitutional position of the national insurance fund, it may be that if there is more of this, in effect, raiding of the fund there should be a review of the primary legislation associated with national insurance contributions. I think these are really matters though for politicians and parliamentarians. Many people now say the national insurance contribution is just another tax and the contributory principle is basically dead and I think both remarks are perfectly reasonable.

  Mr Tyrie: Does anybody else want to add to that?

Chairman

  19. I do not want to get into a deep debate about this issue, you have said that it is for politicians and we are seeing the Chancellor later on and we have got lots of questions to address to him.
  (Mr Weale) I just want to remind the Committee that we have been somewhere close to this before with the national insurance surcharge which we had in the 1970s and it was abolished, I think, in the early 1980s.
  (Mr Emmerson) Could I add I do not think this Budget killed the national insurance contributory principle, I think it is something that has been going on for a number of years and increasingly implies a reliance on means testing. We have had the abolition of the cap on employers' contributions, the spring 1993 Budget increased the rate of national insurance, additional money for pensions under both the Conservatives and Labour, increasingly so under Labour it has been made available through means tested forms, the Winter Fuel Allowance and the Pension Credit. The Beveridge system was a flat rate contribution for a flat rate benefit, we do not have that now, we have earnings related contributions, most of the benefits are not related to our contributions, with the State Second Pension replacing SERPS there is yet another change, and Disability Benefits are now set to be means tested. This Budget continued that trend, I do not think it started it.


 
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