Select Committee on Treasury Second Report


Health Spending

44. On Budget Day, the Treasury published the review undertaken by Mr Derek Wanless into the long-term trends affecting the health service in the UK, known as the Wanless Report.[124] The review considered a description of the health service in 2022, based on trends in rising patient and public expectations and what a high quality service might mean, and a number of scenarios to account for a range of possible variations in the changing health needs of the population; technological development and medical advance; and use of the workforce and other productivity gains.[125] On consideration of these factors, the report estimated that public health spending would have to increase to between £154 billion and £184 billion by 2022-23 (in 2002-03 prices), from its current level of £68 billion, and recommended that most of the increase in spending should occur in the early years of the plan "to deliver improvements as quickly as sensibly possible".[126]

45. The Chancellor told the House that, in response to the Wanless Report, he proposed raising "UK national health spending by ... on average by 7.4 per cent. in real terms each year ... [on] a five­year settlement" up to and including 2007-08, which would result in spending on the NHS rising to £105.6 billion in 2006-07.[127] This would mean that total health spending (public and private), as a proportion of GDP, would increase from 7.7 per cent in 2002-03 to 8.7 in 2005-06, which would be in accordance with the Prime Minister's stated objective of achieving a level of health spending at 8 per cent of GDP in 2005.[128] This expenditure is projected to increase further to 9.4 per cent in 2007-08.[129]

46. While the Chancellor told the House that the planned increases in NHS spending to 2007-08 represented a 43 per cent increase, after inflation,[130] the King's Fund have estimated that the increase would be 62 per cent in cash terms, but only 35 per cent in volume terms, taking into account NHS-specific inflation. This means, they estimate, that "just over half (56%) of the cash it [the NHS] receives will be available for expanding services".[131]

47. There are concerns that some of the large funding increases in the NHS may be absorbed in higher pay. Mr Appleby told the Committee that, in regard to seeking higher salaries, unions and the British Medical Association, which is a medical doctors' association, "may do, because ... [as they] will see lots more money going into the system, they will perhaps want a share of it".[132] The Chancellor cautioned that "a sustained commitment to better public services demands responsibility in setting public sector pay",[133] although he admitted that the additional National Insurance contributions that the Budget proposed would cost the NHS between £200 and £300 million per year.[134] The Chancellor argued that he considered it "strange that people should argue that somehow the public sector should have been excluded from the National Insurance contribution".[135]

Tax measures

48. The policy decisions contained in the 2002 Budget are expected to result in a net yield to the Exchequer of some £6.1 billion in 2003-04 and £7.6 billion in 2004-05.[136] Some of the most significant decisions in terms of tax yield and spend are considered in the following paragraphs.

Personal Taxes

49. The principal changes to personal taxes were:

·    a freeze in the income tax personal allowance (other than the age-related allowance) and national insurance contribution thresholds in 2003-04 (expected to yield £700 million in 2003-04 and £850 million in 2004-05)[137];

·     a 1 per cent increase in national insurance contributions (NICs) paid by employees and the self-employed on all earnings above the NICs threshold from April 2003 (expected to yield £4,000 million in 2003-04 and £4,150 million in 2004-05). The NICs paid by employers were also increased by 1 per cent from April 2003 - this is considered below; and

·    changes to Tax Credits including a new Child Tax Credit and a new Working Tax Credit from April 2003 (at an estimated cost of some £2,700 million in 2003-04 and £2,600 million in 2004-05).[138]

NATIONAL INSURANCE CONTRIBUTIONS

50. The Red Book notes that the Government's raising of NICs and freezing the personal allowance in 2003-04 is designed to enable it to deliver the growth in spending planned for the NHS. The Red Book also states that the NHS has always been and will continue to be funded in part by NICs. But the Government does not support the hypothecation of revenues to the NHS or other public services on the grounds that it would make public services subject to the ups and downs of the economic cycle and unpredictable changes in revenues.[139]

51. The Chancellor announced the increases in NICs in the following terms: "From April next year, there will be an additional 1 per cent national insurance contribution from employers, employees and the self-employed on all earnings above £4,615. All other national insurance and income tax allowances will be indexed in line with inflation. Save for this 1 per cent contribution, the ceiling of £30,420 remains in place and will be indexed in line with inflation to £30,940. But I believe it is right that when everyone — employees and employers — benefits from the insurance provided by the national health service, everyone who can should make a fair contribution."[140] As a result of these changes, in 2003-04 employees will pay NICs at 11 per cent on earnings between the threshold and the upper earnings limit and 1 per cent on earnings above this limit. Similarly the self-employed will pay NICs at 8 per cent on profits between the threshold and the upper profits limit and 1 per cent on profits above this limit.[141]

52. Mr Dilnot told us that the increase of 1 per cent in NICs for employees and the self-employed and the removal of the upper limits for these rises "delivers a tax increase which is very, very close to being identical to an increase of 1 per cent in the 10 per cent, 22 per cent and 40 per cent rates of income tax. There are only two ways in which it differs. It differs in that the richest third of retired people who do pay income tax will not pay this, and it differs in that those able to live off unearned income will not pay this, but will pay income tax. I think it is a reasonable presumption that for most forms of public spending one might want to give better-off pensioners and those living on unearned income the opportunity to serve through paying tax."[142] The Treasury told us that the distinction between NICs and income tax is that pensioners are not subject to NICs and, as a result, the vast majority of pensioners were not being expected to contribute to the increase in spending on health.[143] The Chancellor said that he had chosen NICs "because it did not seem to me right that pensioners should pay more when they were older towards the National Health Service if we could avoid it, and therefore the National Insurance route seemed the right route to take. ..."[144]

53. We asked the Treasury whether, given the uncapped nature of the 1 per cent rise in NICs, it was still possible to regard the upper earnings and profits limits as a ceiling for NICs. Treasury officials told us that the Chancellor had described exactly the situation. Employees and the self-employed will not be paying the full rate they pay on earnings or profits up to the upper limit, but merely the 1 per cent rate above.[145] They said that the definition of the upper earnings limit on NICs is "the point at which 11 per cent stops and 1 per cent starts with respect to employees."[146] This view seems to be at variance with the previous, widely accepted, definition of the upper earnings limit, which was that it was the maximum amount of weekly earnings in respect of which employee contributions are payable.

54. The proposed increases in NICs for employees and the self-employed will deliver a tax increase to those groups that is very similar to a 1 per cent increase in the rates of income tax. However, unlike increases in income tax, increases in NICs will not affect pensioners and those living off unearned income, who benefit from the insurance provided by the National Health Service, and may be in a position to make a contribution. We think that the Treasury has, as yet, failed to make the case for choosing a method of revenue raising (higher employer and employee national insurance contributions) which excludes well-off pensioners and people living comfortably off unearned income from making a contribution to higher NHS spending.

55. While the upper earnings and profits limits for employees and the self-employed were uprated in the Budget, they will not apply to the 1 per cent increase in NICs. To insist, therefore, that the Upper Earnings ceiling remains intact seems to us mere sophistry. We note this departure from previous practice which could be viewed as a move of the national insurance contribution system towards that of general taxation.

56. The House will shortly be asked to consider legislation to implement the new NIC arrangements. We recommend that it should be framed in such a way that further primary legislation will be required before the rate of charge above the upper earnings limit can be increased.

TAX CREDITS

57. The Budget announced details of the rates and thresholds for two new tax credits:

·    Child Tax Credit which from 2003 will replace the income-related child elements of out of work benefits (Income Support and Jobseeker's Allowance), the Working Families' and Disabled Person's Tax Credits and the Children's Tax Credit; and

·    Working Tax Credit which from 2003 replaces the Working Families' Tax Credit, Disabled Person's Tax Credit and New Deal 50 plus Employment Credit.[147]

58. Following an earlier consultation document on the new tax credits,[148] detailed proposals on how the new system will work and its potential impact on the families most affected by it are contained in a document The Child and Working Tax Credits: The Modernisation of Britain's Tax and Benefit System; Number Ten issued at the same time as the Budget.

59. The Treasury told us that the previous Tax Credits were the best that could have been done within the constraints of the existing tax and benefit system to produce as much help as they could for those people in greatest need.[149] Tax Credits had been developed in "a series of stages towards the steadier state that we will enter from April 2003"[150] with the new Tax Credits that were being planned and designed for a long time.[151]

60. Mr Dilnot told us that, based on past experience following the introduction of new benefits and Tax Credits, the impact of the latest Tax Credits on take-up in the short term is likely to be unwelcome. However "there are some aspects in the way it [Child Tax Credit] will be administered that will be beneficial for take-up, in particular having a fairly wide margin for error on the estimate of income that is used and having a relatively infrequent means test. Those things may be positive. The fact of having a benefit that can be carried from unemployment into work may ease that transition ...so certainly one can see some positives in this."[152] The Treasury accepted that the challenge for them would be to improve on previous rates of take-up and expected, as the Inland Revenue had done in the past, to report on take-up of the new Tax Credits in due course.[153] We expect full details of the take-up of the new Tax Credits to be published when the information is available.

Taper

61. One of the issues of perennial concern is the poverty trap. Many low income families often face very high marginal deduction rates as their incomes increase, as a result of the combination of reductions in benefit and the tax take on the additional income. According to the Government, since 1997, the number of families facing marginal deduction rates of over 70 per cent has fallen by nearly two-thirds - from 740,000 before Budget 1998 to 255,000 in 2002-03.[154] After introduction of the new tax credits, this number is expected to rise slightly, and the number of families suffering marginal deduction rates of over 60 per cent, which has increased slightly since Budget 1998, is expected to rise by over 500.000 to 1,450,000.

62. Mr Dilnot[155] commented that "...the number of people facing a very high marginal tax rate, the multiple withdrawal rate, will rise significantly as a consequence of this very large further extension of means testing. If means testing is the route you are going down, I think that is inevitable". Treasury officials agreed that there would be an increase in the numbers that would "pay marginal votes of withdrawal between 60 and 70 per cent and that is mainly due to the introduction of the Working Tax Credit which extends tax credits to couples or single people with children"[156]. They also pointed out[157] that an employer's basic rate taxpayer on the first taper for Working Tax Credit would suffer a marginal rate withdrawal of 70 per cent. They were pessimistic about the prospects for reducing the very high marginal rates "because essentially we are at the central point of choice in any of these systems between the level at which you start tax credits, the rate at which you withdraw them and the affordability of the system as a whole. ... At this stage it is difficult to see the likelihood of a great diminution in that marginal rate on affordability grounds."

63. We welcome measures that make work pay, and would encourage the Government to keep the issue of high marginal rates under close review in the light of projected substantial increase in the projections for 2003-04.

64. The Institute for Fiscal Studies have calculated that, when all the measures affecting households in the 2002 Budget are fully operative, the effect is redistribution from the top half to the bottom half of the income distribution. "Lower-income individuals gain from the new tax credits and either do not lose, or lose a smaller proportion of their income, from the national insurance changes."[158] We welcome the fact that, within the context of a tax raising Budget, the budget measures are broadly re distributive from those on higher incomes to those on low incomes.

Business Taxes

65. The 1 per cent increase in national insurance contributions paid by employers from April 2003 is expected to yield £3,900 million in 2003-04 and £4,100 million in 2004-05. Other changes affecting business announced in the budget include:

·    new rules on loan relationships, derivative contracts and foreign exchange (expected to yield £230 million in 2003-04 and £350 million in 2004-05);

·    measures to restrict film tax relief to feature films intended for cinema release (expected to yield £225 million in 2003-04 and £295 million in 2004-05);

·    changes to the North sea tax regime (expected to yield £450 million in 2003-04 and £600 million in 2004-05);

·    measures to modernise the taxation of foreign companies operating in the UK through branches (expected to yield £350 million in 2003-04 and £650 million in 2004-05);

·    various VAT anti-avoidance measures and tackling stamp duty avoidance (expected to yield £500 million in 2003-04 and £770 million in 2004-05);

·    an oils fraud strategy (expected to yield £290 million in 2003-04 and £550 million in 2004-05);

·    reducing the starting rate of Corporation tax from 10 per cent to zero and reducing the small companies' rate by 1 per cent to 19 per cent (at an estimated cost of £265 million in 2003-04 and £450 million in 2004-05); and

·    introducing a new research and development tax credit for larger companies (at an estimated cost of £400 million in 2003-04 and 2004-05).[159]

66. A number of witnesses have expressed the view that the bulk of the net tax increases in the Budget fall unfairly on business. For example, Goldman Sachs commented that "the brunt of the tax increases are borne initially by the corporate sector rather than by households. The split in 2003-04 and 2004-05 is roughly 80 per cent on companies and 20 per cent on households.[160] Edward Troup considered that "imposing the majority of tax increases on businesses rather than on employees goes against the Government's stated aims of promoting productivity and employment."[161] The CBI noted that "business has again found itself bearing a disproportionate share of Budget tax increases."[162] The Treasury told us that the additional tax burden on business from the Budget in 2004-05 was about £4.1 billion from the increase in NICs paid by employers. A series of anti-avoidance measures, for example on VAT and stamp duty, amount to some £1.1 billion, but the Treasury do not regard these as adding to the tax burden as the sums represent taxes being paid by non-compliant taxpayers --- they are essentially restoring the revenues to where they should have been had the avoidance not taken place. The remaining measures, the tax increases on the North Sea oil activity, on foreign branches and on foreign exchange reform total some £1.6 billion, which is roughly offset by £1.6 billion in tax reductions for a range of things, in particular, the capital gains reform and the R&D tax credit.[163]

67. The CBI told us that "the increase in employers' national insurance is regarded by many businesses as the worst kind of tax increase. It affects businesses of all sizes and sectors, but crucially takes no account of their profitability. It penalises employment, and in today's fiercely competitive, low profit environment businesses will be forced to take offsetting action...."[164] The CBI also have indicated their disappointment that the Chancellor did not take the opportunity in his Budget to announce measures to reduce the general burden of unnecessary regulation and red tape that is currently being imposed on British businesses. The decision to increase employers' national insurance contributions is justified by the Chancellor in his Budget speech, on the basis that "it is right that when everyone — employees and employers— benefits from the insurance provided by the national health service, everyone who can should make a fair contribution."[165] This is amplified in the Red Book in a section on alternatives for revenue funding, where one of the advantages offered by NICs is considered to be that "NICs are levied on both employers and employees. Higher employers' contributions reflect their interest in a healthy labour supply. The CBI has estimated that workplace absence cost British business over £10 billion in 1999"[166]

68. One of the measures in the 2000 Budget was a 0.3 per cent cut in employers' NICs through recycling revenue raised from the climate change levy.[167] At the time, the Treasury considered that "the lower National Insurance Contributions will act to promote employment opportunities ..."[168]. In the light of this and the evidence we received from the CBI and others, we asked the Chancellor about the impact of the increase in employers' NICs on jobs. The Chancellor told us that, while an impact assessment had not been undertaken, he did not believe it would have a big impact on employment. The system of National Insurance had been reformed cutting the cost of employing someone. He expected that, with growth over the next period, the economy would still be in a position to create jobs. The Chancellor has clearly reneged on his previous view that lower NICs can promote employment.

69. We believe that the Treasury should make an assessment of the employment effects of higher employer national insurance contributions before considering any further increase in this tax.

MEASURES TO MODERNISE THE TAXATION OF FOREIGN COMPANIES OPERATING IN THE UK THROUGH BRANCHES

70. The Budget announced a proposal to modernise the taxation of foreign companies operating in the UK through branches. Capital will be attributed to a UK branch for tax purposes, based on the capital it would need to trade if the branch were an independent, free-standing company. This "will bring the UK closer into line with established international practice, ensuring a level playing field between foreign companies (mainly banks) and their UK based competitors."[169]

71. The London Investment Banking Association noted that the Red Book figures for additional tax from this measure (£350 million in 2003-04 and £650 million thereafter) suggest that it is seen by the Treasury as a substantial fund-raiser. The Association told us that "we have no information on how these figures have been calculated. In particular we do not know what allowance has been made for loss of potential revenue, jobs or business should banks rearrange their structures in the light of any new rules, let alone should they decide to move some or all of their UK operations elsewhere.... The fact that a change of this magnitude is even contemplated without appropriate prior consultation suggests a surprising lack of understanding of the ever more competitive global environment in which the City of London now operates ... This precipitate action ... runs wholly counter to the admirable, sustained and high quality consultations carried out by Inland Revenue and treasury officials on other recent financial sector topics, such as the proposed EU 'Savings' Tax Directive and the review of the taxation of loan relationships , derivatives and foreign exchange."[170]

72. The Chancellor told us that nine out of ten of the top foreign branches were paying no tax. The rules regarding the treatment of capital applied here are different to those applied elsewhere. The aim of this measure is to follow international practice and put us on a level playing-field with America, Germany, France and others. Some of the tax currently paid by foreign companies in their home country will not be paid there, but paid here instead, as in many cases they would be eligible for double taxation relief in their home jurisdiction. The Treasury told us that they did not anticipate these changes affecting the status of the City as a major centre for international financial transactions. On the question of consultation, the Treasury admitted that they had not yet consulted with the banks, but referred to a consultation process at the OECD which they said international banks were well aware of.[171] We regret that the Treasury did not use the Pre-Budget Report 2001 to consult on measures such as the change in the taxation of foreign companies and the changes to the North Sea Oil tax regime. One of the principal reasons for introducing the Pre-Budget Report was to be able to carefully consult on tax matters before bringing proposals forward. We believe that the Treasury has unnecessarily missed an opportunity to consult on these measures in the PBR and we urge the Treasury to use the PBR in the future as part of a full consultative process. We particularly deplore this lack of consultation with foreign banks in London.

FILM TAX RELIEF

73. We are concerned at the abuse of the film tax relief measures which were introduced by the Treasury in 1997 and 2001. We believe that the Treasury should investigate the reasons for this tax avoidance, publish estimates of the revenues lost as a consequence, and consider why loopholes were allowed to be exploited. We are concerned that the recent proliferation of tax reliefs, allowances, and credits will increase the scope for tax avoidance, and we urge the Treasury to carefully consider such issues before bringing forward additional tax reliefs of this kind.

Changes to the North Sea tax regime

74. The Budget introduced changes to the North Sea tax regime. With effect from Budget day companies will pay, in addition to the standard corporation tax rate of 30 per cent, a supplementary charge of 10 per cent on profits from the production of oil and gas in the North Sea. To encourage long term investment, companies will receive a 100 per cent first year allowance for capital expenditure in the North Sea (rather than the 25 per cent currently available). The Government also announced that it intends, subject to consultation on the appropriate timing, to abolish North Sea Royalty.[172]

75. The CBI told us that the new supplementary corporation tax charge of 10 per cent on profits was "both a surprise and a disappointment to CBI members, particularly as they had not been given the opportunity for prior consultation. The perceived financial risk of operating in the North Sea will be increased and it is likely that the profitability of recently completed investment projects will be adversely affected". We agree.

76. We note that the CBI said that "the increase in first year capital allowances to 100 per cent may be a plus, but is not enough to balance the negative effects of the tax rise. The possible abolition of North Sea Royalty should now be speeded up, preferably without the need for a lengthy consultation process."[173]

77. The Treasury told us that the Government started a consultation process on the form of North Sea taxation in 1998, which it had subsequently abandoned because of the collapse in the oil price. The Treasury noted that "since then we have had four further years of clear evidence of very high levels of profit in the North Sea relative to the rest of the economy. In 2001 the net rate of return in the North Sea was over 34 per cent compared with 11 per cent in the non-financial sector of the economy as a whole and over the past five years it has consistently been about twice that level. So the Government has had a declared intention of seeking to get an extra yield for the taxpayer from the North Sea and we now have further evidence on profitability of the North Sea under the current tax regime to back it up."[174]

The new research and development tax credit

78. A research and development tax credit for companies which are small and medium-sized enterprises was introduced in 2000. The 2002 Budget announced a new measure to extend the credit to all other "large" companies. The new relief will be a volume credit based on the total amount of research and development companies undertake. Large companies will be entitled to an additional deduction from their taxable income of 25 per cent of their current spending on qualifying research and development, in addition to the normal 100 per cent deduction.[175] The new research and development tax credit was welcomed by the CBI who told us that they were "particularly pleased with the result of the consultation process - the confirmation of a simple volume based tax credit. We also welcome the headline rate of the tax credit at 25 per cent, which will cut R&D costs by 7.5 per cent."[176]

79. Mr Troup considered that giving a 125 per cent reduction for research and development expenditure would encourage businesses to re-label existing expenditure into the research and development category. While what is measured as research and development expenditure may increase, the question to be asked would be whether this was really additional research and development or simply the re-labelling by companies of expenditure they were already incurring.[177]


124   Derek Wanless, Securing Out Future Health: Taking a Long-Term View, Final Report, April 2002 (hereafter Wanless ReportBack

125   Wanless Report, paragraph 1.31, pp7-8 Back

126   Wanless Report, Letter to the Chancellor of the Exchequer. Back

127   Official Report, col 592, 17 April 2002 Back

128   Official Report, col 327, 5 December 2001 Back

129   HM Treasury, Budget 2002, Table 6.2, p121 Back

130   Official Report, col 592, 17 April 2002 Back

131   Ev 17 Back

132   Q81 Back

133   Q286 Back

134   Q355 Back

135   Q356 Back

136   HM Treasury, Budget 2002, Table 1.2, p14 Back

137   The corresponding alloances for 2002-03 are indexed in the usual manner (ref) Back

138   HM Treasury, Budget 2002, paragraphs 1.14, 1.23, 1.27, and Table 1.2, p14  Back

139   HM Treasury, Budget 2002, paragraphs 6.41, 6.42 Back

140   Official Report, 17 April 2002, col 591 Back

141   National Insurance Rates 2003-04 - Budget 2002 Press Notice from the Inland Revenue, REV 2, dated 17 April 2002  Back

142   Q53 Back

143   Q170 Back

144   Q385 Back

145   Q177 Back

146   Q187 Back

147   New Tax Credits: A £2.7 billion boost for families and the low paid - Budget 2002 Press Notice from the Inland Revenue, REV 3, dated 17 April 2002 Back

148   New Tax Credits: Supporting Families, Making Work Pay and Tackling Poverty, Inland Revenue (2001) Back

149   Q202 Back

150   Q203 Back

151   Q204 Back

152   Q55 Back

153   Qq206, 207 Back

154   HM Treasury, Budget 2002, p78-9 Back

155   Q55 Back

156   Q211 Back

157   Q210 Back

158   Ev 4 Back

159   HM Treasury, Budget 2002, Table 1.2, p14  Back

160   Appendix 1 Back

161   Ev 23 Back

162   Appendix 5 Back

163   Qq 243-246 Back

164   Appendix 5 Back

165   Official Report, 17 April 2002, col 591 Back

166   HM Treasury, Budget 2002, paragraph 6.45 Back

167   HM Treasury, Budget 2000, paragraph 1.27 Back

168   Climate Change Levy - Budget 2000 Press Notice from the Inland Revenue and Customs & Excise, REV/C&E4, dated 21 March 2000 Back

169   A Modern and Competitive Business Tax System - Budget 2002 Press Notice from the Inland Revenue and Customs and Excise, REC/C&E1, dated 17 April 2002 Back

170   Appendix 3 Back

171   Qq235-242, 316-323 Back

172   A Modern and Competitive Business Tax System - Budget 2002 Press Notice from the Inland Revenue and Customs and Excise, REV/C&E1, dated 17 April 2002, p6 Back

173   Ibid, paragraph 11 Back

174   Q220 Back

175   Research and Development(R&D) Tax Credit -Budget 2002-Budget Note from the Inland Revenue, REV BN 16, paragraphs 2,3 and The strength to make long-term decisions: investing in an enterprising, fairer Britain -Budget 2002 Press Notice from HM Treasury, HMT 1, dated 17 April 2002, p9  Back

176   EVXX[BGT17] paragraph 13 Back

177   Q92 Back


 
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