House of Commons - Treasury

Select Committee on Treasury Fifth Report

4 Tax measures

Personal taxation, tax credits and child poverty

SIMPLIFYING THE PERSONAL TAXATION SYSTEM

36. The 2007 Budget contained several reforms of the personal taxation system. The 10% starting tax band was removed, and the basic tax rate lowered from 22% to 20%.[136] However, the 10% tax band will be retained on savings income.[137] The National Insurance system is also being reformed, and from April 2009 the upper earnings limit will be aligned with the higher tax rate threshold.[138] The stated aim of the Government's personal taxation reforms was to "simplify the tax system".[139]

37. In 1999, when introducing the 10% starting rate of tax, the Chancellor of the Exchequer said the tax cuts were "to encourage work and make work pay".[140] Commenting on the removal of the 10% starting tax rate, Mr Chote told us that "it was never very clear that the 10p rate was a particularly effective tool in terms of the distributional implications that were claimed for it at the time, so removing that and the rather curious drop in the combined marginal rate of income tax and [National Insurance] above the top of the upper earnings limit look like sensible changes".[141]

38. On the decision to maintain the 10% starting rate for savings, Mr John Whiting of PricewaterhouseCoopers told us that he thought that this was "entirely to make sure that the pensioner community in particular are protected from the withdrawal of the 10% main band".[142] He felt that the Government could have gone further, questioning "whether it would not have been easier just to give the pensioner community that bit extra by way of personal allowance, combine the 65-plus and 75-plus amounts into one figure and have done, although actually there will be others on low income, apart from pensioners, who will benefit from the retention of that savings band".[143] Dr Weale felt that the maintenance of the 10% starting rate on savings income could be seen in the light of the fact that the capital saved was probably derived from the income of labour.[144] Mr Chote suggested that "in terms of labour income the Chancellor could say that people were compensated from raising the 10p rate to 20p by the cut in the basic rate from 22p to 20p, but for savings the basic rate was already 20p so there was no equivalent cut there. There may have been a presentational concern that you could not tell the same story of taking with one hand and giving back with the other."[145]

39. The other main area of simplification in this year's Budget lay in the changes to the National Insurance system. Despite the modifications to be adopted after the Budget, Mr Whiting was still convinced that there was a meaningful distinction between the National Insurance and taxation systems,[146] although when asked whether he still thought there was a case for National Insurance, he replied "I would say that there is probably a lot to be said for combining the two".[147] Dr Weale concurred with this notion on the grounds of transparency, stating that "It seems to me the main reason for keeping National Insurance separate from income tax is that the Chancellor can say to people, 'There is a standard 20p rate of tax' and forget about the employers' and employees' National Insurance contributions which are in effect also deductions from wages".[148]

WINNERS AND LOSERS AND THE IMPORTANCE OF TAX CREDITS

40. The changes to the personal taxation regime mean that some households will gain, while others lose. When asked about this, Mr Chote outlined how the IFS thought the proportions would work out:

The estimate of the winners and losers if you look just at income tax and national insurance is that you have a group of losers on earnings between around £5,000 and around £18,000 and another around £40,000. If you look at the overall number of households affected by the income tax, national insurance and tax credit changes altogether, you probably have on our estimate about 5.3 million families losing in total. Of those, 2.2 million would be single working people with no children who are not getting the working tax credit. They may not be getting the working tax credit, most of them, because they earn more than £12,500 but less than £18,000. It depends a bit on what you define as low income, but there is clearly a chunk of people in that category. They may also not get the working tax credit because they work fewer than 30 hours or because they are too young. The losers within that group lose about £125 per year on average per family. You then have about 1.2 million losers who will be two earner couples with no children. They may not qualify for the working tax credit or they may fail to take it up. They may also be in the position where the two earners both lose from the income tax and national insurance changes but there is only one gain from the tax credit which is assessed on the household. You can imagine that the biggest loss would be £446, I think, if you had a couple, both of whom were on £7,445, that is where you get the maximum loss from the increase in the lower rate from 10 to 20 and not getting the working tax credit. You have another 0.4 million losing households who are one earner couples without children, most of them because they will be in a range of about £17,000 to £18,500 where they are not compensated. You get 0.7 million two earner couples with children who lose again twice from the income tax and national insurance changes but maybe only gain once from child tax credit/working tax credit. You have 0.3 million losers who would be tax paying women between the ages of 60 and 64 who do not get tax credits and are too young to be compensated by the rise in the pensioner tax allowance and a final 0.5 million non-workers who pay more tax on their taxable benefit or pensions than they gain. Those might be early retirees or incapacity benefit claimants. That is roughly how you get to the 5.3 million total household losers, although most of them do not lose very much. It has to be said that this is an estimate based on much crunching over the last few days and, like shares, it may go up or down. That is our best guess at the moment.[149]

41. When asked about the 5.3 million 'losers', Mr Mark Neale, Managing Director, Budget, Tax and Welfare Directorate in HM Treasury, told us that "the figures that Robert Chote gave you are in the right ball-park", and that they were consistent with the Chancellor of the Exchequer's statement that four out of five households would either gain or remain the same.[150] In response to these figures, the Chancellor of the Exchequer referred to the actions undertaken to help those identified by Mr Chote as "losers". The Chancellor of the Exchequer outlined the support given to low-paid workers through the minimum wage. He argued that the take-up rate of working tax credit would rise in response to a campaign encouraging people to apply, and that some people, who for income tax purposes were dealt with individually, would benefit from being part of a couple for the purposes of children's tax credit and working tax credit.[151] The Chancellor of the Exchequer then went on to reiterate the Government's commitment to encourage the take-up of working tax credit, and stated that an increase in the take-up rate had not been taken into account when the Institute for Fiscal Studies had calculated its figures, which had assumed a static take-up rate across the periods under discussion.[152] An important part of any change to the personal taxation regime must be that both winners and losers can identify, with ease, how they are affected by the changes stated within a Budget package. We recommend that, in future, this information be provided within the Red Book.

TAX CREDIT TAKE-UP

42. The Government has implied that it is important to assess the winners and losers from this year's Budget measures taking into account the whole system of personal taxation and tax credits. The take-up rate of tax credits is therefore important for two reasons. On a personal level, those who are entitled to, but do not claim, tax credits, and are then penalised by the changes in the personal taxation scheme, require assistance. From a fiscal perspective, an increase in the take-up rate of tax credits will require additional spending, which will be part of Annually Managed Expenditure (AME), that part of public expenditure not subject to firm three-year plans.

43. On the personal level, Mr Chote pointed out that "The working tax credit is notably not taken up very highly by people who do not have children. Take-up is about 19% by caseload, 25% by value."[153] Figures produced by HM Revenue & Customs in March 2007 indicate that, for 2004-05, there were, in the central case for those without families, £1,290 million unclaimed amongst 980,000 entitled non-recipients of working tax credits.[154] Treasury officials confirmed that these figures represented the take-up rate for working tax credits in 2004-05, but pointed out that take-up was "showing a steady increase" and that HM Revenue & Customs was "very much looking to boost the take-up of the working tax credit".[155] The Chancellor of the Exchequer was able to provide us with new information on working tax credit take-up rates, informing us that, while the 19% figure was correct for 2004-05, the latest figures showed an increase of almost 100,000 taking up working tax credits since April 2005.[156] The Chancellor of the Exchequer reiterated that the Government was looking to boost the number of working tax credit claimants, telling us "We are both obliged to pay it and want to pay it to those people who are entitled to it".[157]

44. On the fiscal level, Mr Neale told us that when the Treasury forecast public expenditure, it assumed take-up rates in line with the current take-up rate: "the latest figure for 2004-05, as I said, is 25% of entitlement".[158] We questioned the Chancellor of the Exchequer as to what would happen to the fiscal position if take-up rates improved. He pointed out that the take-up rate had improved,[159] and said that the Government provided "a margin in our AME projections to pay for any increase" in the take-up rate.[160] He went on to note that the AME margin was £1 billion for 2007-08.[161]

45. Given that the personal taxation changes announced in this year's Budget will have an impact on the post-tax earnings of those who are childless and earning an income entitling them to claim Working Tax Credit, the need to increase the low take-up rate of Working Tax Credit among that group should be a priority. We therefore welcome the evidence of a recent increase in the take-up of Working Tax Credit provided by the Chancellor of the Exchequer, although we would welcome further details as to the increase in the take-up of Working Tax Credit in percentage terms. We also note the Government's efforts to increase take-up still further. However, we expect the Treasury to carefully monitor the impact of any increase in the take-up rate on the fiscal planning assumptions within Annually Managed Expenditure.

MEETING THE CHILD POVERTY TARGETS

46. The Government has set itself two demanding targets relating to child poverty—to halve the rate of child poverty by 2010-11, and to eliminate child poverty by 2020. The Government defines a child as in poverty if that child lives in a household earning less than 60% of median income, before housing costs. In our Report on the 2006 Pre-Budget Report, we expressed concern that the 2006 Pre-Budget Report had not clearly set out how the Government expected to meet the 2010-11 target.[162] In its response to our Report, the Government pointed to its strategy on child poverty reduction, outlined in Child Poverty Review, a document now nearly three years old.[163]

47. The 2007 Budget contained several measures aimed at helping children. The Government committed itself to increasing the child element of Child Tax Credit by £150 a year above earnings indexation in April 2008.[164] As well as this, the Government announced that the weekly rate of Child Benefit for the eldest child would rise to £20 in April 2010.[165] We asked our expert witnesses how far they thought the measures announced in the 2007 Budget would help the Government reach its 2010-11 target. Mr Chote agreed with the Government's estimate that the 2007 Budget package would lift 200,000 children out of relative poverty.[166] In subsequent written evidence, the IFS provided figures stating that, following the 2007 Budget package, it would cost the Government £3.8 billion a year of extra spending to reach its 2011 target, down from a prior estimate of £4.3 billion a year (in 2006-07 prices).[167] When asked how he would achieve the child poverty targets, Mr Chote considered that "the most targeted way of achieving it is to increase the child element of the child tax credit".[168] In subsequent written evidence, the IFS told us that, for the Government to reach its 2010-11 target on child poverty, "by far the most important policy decision will be that taken by whoever is Chancellor of the Exchequer in 2009 on the generosity of tax credits, income support and child benefit in April 2010" and "the current toolkit of welfare-to-work policies can make only a marginal contribution to hitting the Government's ambitious target for child poverty in 2010-11".[169] However, Mr Chote also acknowledged that increasing benefits meant that work incentives might be harmed.[170] Mr Chote believed that, in order to meet the 2020 target, the Government would have to ensure that lifetime chances, rather than cash transfers, were also aided.[171] Dr Weale agreed that work incentives could be damaged by over-generous benefits, and pointed out that, in order to afford the increases in tax credits, the Government had increased the taper and withdrawal rates on tax credits, to the detriment of work incentives.[172] Regarding the Chancellor of the Exchequer's decision to raise the rate of child benefit for the first child, Mr Chote pointed out that "larger families tend to be poorer ones" and contended that providing support directed to larger families might therefore have a role to play in child poverty reduction.[173]

48. Before we heard oral evidence from Treasury officials, the most recent Households below average income statistics were released. These showed that, on the Government's preferred measure—children living in a household earning less than 60% of median income, before housing costs—child poverty had increased by 100,000 children in 2005-06.[174] In discussing this increase, Treasury officials thought that it would be premature to assume that the Government would now miss its 2010 target, pointing out that the increase of 100,000 children was well within the margin of error on such statistics.[175] Treasury officials refused to give a costing of the expenditure that would be needed to achieve the 2010 target,[176] but did say that the required measures would be re-visited and looked at "in the context of each Pre-Budget Report and Budget".[177] They did accept that efforts would be needed both to provide additional income to poor families, and to ensure that such families were helped into work.[178] The Chancellor of the Exchequer also highlighted the need for a multi-stranded approach to tackling child poverty, including both work and benefits.[179] However, he too refused to be drawn on how much achieving the 2010-11 target of halving of child poverty would cost, reiterating the need for a more comprehensive approach, using incentives to work, child benefit, child tax credits, and the minimum wage.[180] We are concerned by the recently reported rise in child poverty in 2005-06 of 100,000 children, according to the Government's preferred measure. We welcome the extra resources allocated in the Budget, which it is estimated will help around 200,000 children out of relative poverty. We reiterate the recommendation made in our Report on the 2006 Pre-Budget Report that the Government, in reporting on the outcome of the Comprehensive Spending Review, state how it intends to meet the 2010-11 target to halve the number of children in poverty and where the resources will come from to meet that target. We welcome the Government's increased emphasis on improving incentives to work and recommend that, in reporting on the outcome of the Comprehensive Spending Review, the Government publish its analysis of the impact of improving incentives to work on meeting its child poverty targets.

AN ADDITIONAL CHILD POVERTY TARGET?

49. During our inquiry, we heard evidence advocating the value of an additional child poverty target, designed to ensure that the needs of those children who are in families with the lowest incomes are properly addressed. Mr Chote outlined the problem with the current targets focused on the measure of whether or not a child lives in a household earning less than 60% of median income, before housing costs:

It is certainly true that the Government has a headcount measure so it is clearly attractive to them to be able to get people jumping just over the line. The poverty line is at a very highly populated bit of the income distribution, so it can make a lot of difference where exactly you draw the poverty line because a small shift will get a large number of people in or out.[181]

He went on to say that there had not been an improvement in relation to the numbers of children living in severe poverty comparable to that seen in relation to those previously living in households earning less than 60% of median income level before housing costs,[182] although he acknowledged that information at the very lowest levels of income was unreliable.[183] Dr Weale supported the proposition that there ought to be an additional target relating to extreme poverty because he thought that it was important to consider who was in the greatest need of help, and how to target them.[184] Dr Weale, however, shared Mr Chote's acknowledgement of the limitation of statistics relating to extreme poverty, so that a target relating to extreme poverty might be more technical and less satisfactory than existing targets.[185]

50. In explaining why the Government had not hitherto adopted a target specifically relating to children in the most extreme poverty, Mr Neale also warned about the problems with interpreting the data around those on very low incomes, stating that "I think we need to do a bit more work to understand what is going on at the very lowest levels of income".[186] However, he did state that "the Government, looking forward to the 2020 target, has indicated that it will introduce a measure of deprivation which will pick up perhaps what you are seeking to get at here, namely those families who are suffering particular difficulty".[187] He also defended the 60% of median income target as "an internationally recognised threshold and I would not under-estimate the importance of moving families across that line".[188] The Chancellor of the Exchequer confirmed that he was aware of the particular challenge relating to children in households with the lowest incomes, and told us that the Government "do try to look at the different groups and there are some people who are very, very poor and we have got to do more, as we have said, to help them".[189] Targeting those children in families at the very lowest income levels must be a priority for the Government, but is important to ensure that adopting a target to help such children does not detract from meeting the overall 2020 target. We recommend that, in publishing the outcome of the Comprehensive Spending Review, the Government set out its latest understanding of the dynamics of the very poor, perhaps in the context of the Government's work on its new deprivation index. We further recommend that, at the same time, the Government set out its views on the possible value of an additional target specifically focussed on child poverty in the very poorest households (defined as earning less than 40% of median income) within the context of its target of eliminating child poverty by 2020.

THE NEED FOR COMPREHENSIVE ANALYSIS

51. We have noted the Government's reference to many different strands of the personal tax, benefits and tax credits system when describing its efforts to combat child poverty. On top of this, there is also a need to consider the efforts of other departments, such as the Department for Work and Pensions. It is appropriate that the Government use every means at its disposal when tackling such a difficult but important issue. But, this also raises issues of transparency and accountability. We recommend that whenever the Government reports on complicated, multi-faceted responses to policy issues, such as child poverty, it should attempt to draw together all the analysis on all relevant policy instruments in the appropriate Budget or related document, so that it is transparent what the different policies are intended to achieve, at what cost, and how the whole package of policies will interact and achieve their purpose.

Corporate taxation

CHANGES TO THE MAIN RATE AND CAPITAL ALLOWANCES

52. The Chancellor of the Exchequer announced the following changes to corporate taxation in the 2007 Budget:

a reduction in the main rate of corporation tax from 30% to 28%, effective from April 2008;

a reduction in the rate of capital allowances on the general pool of plant and machinery from 25% to 20%, effective from April 2008, bringing it closer into line with economic depreciation;

an increase in the rate of capital allowances on the pool of long-life assets, which applies to assets with expected lives of more than 25 years, from 6% to 10%, effective from April 2008;

fixtures that are integral to a building will be separately classified and will be included in the 10% capital allowances pool, effective from April 2008;

the phased removal of the Industrial Buildings Allowances (IBA) and Agricultural Building Allowance (ABA) with the effective rate of allowance falling to 3% from April 2008, 2% from April 2009, 1% from April 2010 and full abolition taking effect from April 2011.[190]

53. The 2007 Budget stated that the "Government will continue to assess the case for further reductions in the corporation tax rate".[191] Treasury officials told us that the two main factors that would be considered when assessing the case for a further cut in the corporation tax rate were the "the competitiveness of … corporation tax rates" and also the impact of "tax-motivated incorporation".[192] The Chancellor of the Exchequer emphasised that the cut in the corporation tax rate meant that the United Kingdom had the lowest corporation tax rate out of all G7 countries:

Our tax rate was lower than America, it was lower than Germany, lower than France, lower than the other countries, like Italy, in the G7, and lower than Japan. Germany then made a decision that it would move to a 29.8% rate, which is just below our 30% rate. We looked at all of these issues and thought the right thing to do is for us to have a 28 pence rate, so we have now again, and will have when they introduce the German rate, without change, the lowest corporate tax rate in the G7, lower than America, lower than the other European countries and lower than Japan.[193]

However, the IFS Budget analysis pointed out that, even after the recent cut in the corporation tax rate, the United Kingdom had the ninth highest corporation tax rate out of the twenty seven European Union countries.[194] The Chancellor of the Exchequer argued that the corporation tax rate was only one factor amongst many affecting businesses' relocation decisions. He considered the "attractiveness of the location, the skills base of the economy, the openness of the economy, the competitive and entrepreneurial nature of the economy" to be more important factors.[195]

54. The Chancellor of the Exchequer described the corporate tax reform in the 2007 Budget as the "biggest since 1984" because of the reduction in the corporation tax rate and the distinction made between short-term and long-term assets in the capital allowance system.[196] He told us that the change in allowances would reduce anomalies such as warehouses being given more beneficial capital allowances than investment in intellectual property or research and development.[197] Dr Weale thought that the changes to the corporation tax regime were "not very big" and were unlikely to stimulate business growth very much. He told us that on the one hand the change in allowances might place a slight downward pressure on business investment, but on the other hand, the slight reduction in corporation tax could stimulate business activity.[198] Mr Whiting thought that the changes to corporation tax for larger firms would result in manufacturing companies being "hit" and the service sector being "helped".[199] He pointed out that long-term property infrastructure companies would be particularly affected, especially those that had already made commitments on the basis that they would get allowances over some 20 to 25 years.[200] Treasury officials explained that the rationale behind the corporation tax rates was not to produce a different impact on sectors, but to improve incentives for investment.[201]

SMALL BUSINESSES

55. The Chancellor of the Exchequer announced the following changes to corporation taxation for small companies in the 2007 Budget:

a phased increase in the small companies' rate from 19% to 20% from April 2007, 21% from April 2008 and 22% from April 2009 to reduce the differential between incorporated and unincorporated businesses;

the continuation of the 50% first year allowance for small enterprises to April 2008;

an increase in the enhanced deduction element of the SME and mid-sized R&D tax credit from 150% to 175%, effective from April 2008, subject to State aid clearance;

the introduction of an Annual Investment Allowance (AIA) available to all businesses regardless of size and regardless of their legal form.

The new AIA will mean that 100% of expenditure up to £50,000 on general plant and machinery (other than cars) can be offset against taxable profits. The AIA will be effective from April 2008 and will target support on all businesses that are investing for growth. The Government considers that the AIA will be particularly beneficial to small and medium sized businesses.[202]

56. The Chancellor of the Exchequer explained that the corporation tax rate had been increased for small businesses, whilst being lowered for other businesses, in order to prevent tax avoidance:

We have had individuals artificially incorporating as companies for purely taxation purposes, and one of the problems that we have found, faced and had to act upon is that people who are coming to work in this country are being encouraged to form, and work through, managed services companies even before they come into this country. We faced the prospect of schemes that are being marketed right across Eastern Europe, encouraging people to set up companies purely for the purposes of avoiding taxation.[203]

Treasury officials told us that "the Annual Investment Allowance will cover the investments made by 95% of small businesses and in fact will give them a big cash-flow advantage".[204] The Chancellor of the Exchequer argued that "most companies which are investing in the future will not only be as well off, but better off under the proposals we made".[205]

57. Mr Whiting pointed out that "even if a smaller business does invest for a couple of years, at some stage … proprietors need to take some money out to live on".[206] Furthermore, he told us that a PricewaterhouseCoopers survey carried out in 2006 had shown that the R&D tax credit was often given to companies who were already undertaking the R&D, and in many cases the R&D tax credit was not always claimed because it was too difficult to establish that the company qualified.[207] He argued that the changes to the taxation system in the 2007 Budget were unlikely to be behaviour-changing and that businesses tended to prefer a lower tax rate and simpler taxation system to incentives to invest.[208] Dr Weale also stated that he was "in favour of tax simplicity rather than having lots of tax allowances" because "a major disadvantage of a complicated system is that people devote resources trying to exploit the boundaries and to put themselves on the favourable side of the boundary".[209] It is not clear whether measures such as the increase in the R&D tax credit and the introduction of the Annual Investment Allowance will have the desired beneficial impact on investment levels by small companies. We recommend that, prior to the 2009 Budget, the Treasury review the impact of these measures on business investment in order to ensure that the measures are having a positive impact on investment and business growth, including the impact on small businesses that do not qualify for R&D tax credit or the Annual Investment Allowance.

Climate change and environmental measures

BACKGROUND

58. The Stern Review on The Economics of Climate Change was published on 30 October 2006.[210] That Review identified three key elements in an appropriate policy response to mitigate the effects of climate change:

pricing carbon through trading, tax or regulation;
encouraging research, development, demonstration and deployment to bring forward a range of low-carbon technologies; and
measures to encourage long-term behavioural change and overcome barriers, particularly on energy efficiency.[211]

This year's Budget included measures relating to each of these elements.

CARBON PRICING

59. The Government is committed to the use of market mechanisms and incentives to work towards global carbon trading.[212] The EU Emissions Trading Scheme remains "the central component in the Government's domestic policy framework to tackle climate change".[213] In his Budget statement, the Chancellor of the Exchequer said that the Government had "secured support for a strengthened European carbon trading scheme on the road to a global scheme".[214] He also referred to the longer term strategy for the EU set by the 8-9 March 2007 European Council meetings, characterising this as "a new agreement for 2020 on cutting European emissions by at least 20% and potentially 30%".[215]

60. The EU Emissions Trading Scheme covers approximately half of United Kingdom emissions. In sectors not currently covered by that Scheme, the Government considers that national measures can play a part in pricing carbon.[216] In his Budget statement, the Chancellor of the Exchequer announced that the main fuel duty rates for 2007-08 would increase by 2 pence per litre, with the increase deferred until 1 October 2007.[217] The period of deferral is somewhat shorter than that for 2006-07, when the increase did not come into effect until 6 December 2006 following the Pre-Budget Report.[218] The increase in the main fuel duty from 1 October 2007 will provide an Exchequer yield of £480 million in 2007-08 in non-indexed terms.[219] The Chancellor of the Exchequer also announced the level of proposed increases in the main fuel duty rates for 2008-09 and 2009-10 and increases in rebated oil duty rates.[220]

61. These increases in the price of carbon for surface transport follow the doubling of the rates of Air Passenger Duty which was announced in last year's Pre-Budget Report and came into force on 1 February 2007. The Government claimed at the time that these increases would have environmental benefits through reduced emissions.[221] During the present inquiry, Treasury officials went further, telling us that the new rates of Air Passenger Duty had come into force when they did because "there were pressing environmental reasons for bringing that change in quickly".[222]

PROMOTING LOW CARBON TECHNOLOGIES

62. The second element in the Government's approach to mitigating the effects of climate change is the promotion of low carbon technologies. The Budget announced several measures to support research and deployment in this area, including:

the launch of a competition to develop the United Kingdom's first full-scale carbon capture and storage demonstration, the results of which are to be announced in 2008;[223]
increases in the funding of the Low Carbon Buildings Programme to support the development of microgeneration for households;[224]
the establishment of a review to examine the vehicle and fuel technologies which over the next 25 years could help to "de-carbonise" road transport, particularly cars;[225] and
a range of measures to promote biofuels.[226]

ENCOURAGING BEHAVIOURAL CHANGE

63. The third aspect of the Government's approach in this area is to encourage behavioural change. The Government seeks to encourage business energy efficiency through the Climate Change Levy which was introduced in 2001. From 1 April 2007, the Climate Change Levy was uprated in line with current inflation for the first time,[227] and the Budget confirmed that the Levy would also be uprated in the same way from 1 April 2008.[228]

64. The Budget also announced changes to the Vehicle Excise Duty regime to encourage the use of more fuel-efficient vehicles. New rates were announced with effect from 22 March 2007, and further announcements were made about rates in 2008-09 and 2009-10. The highest rate for what the Government characterised as "the most polluting cars" would rise to £300 immediately and to £400 in 2008-09. Further changes were made to encourage more fuel-efficient vehicles.[229] The indexed additional Exchequer yield of these changes is expected to be £125 million in 2007-08, £220 million in 2008-09 and £280 million in 2009-10.[230] The Chancellor of the Exchequer said that, "taken together, those measures will cut vehicle emissions since 1997 by 2 million tonnes".[231] Dr Weale questioned whether the overall environmental effect of increasing Vehicle Excise Duty was as beneficial as that arising from increases in fuel duty.[232] Mr Whiting argued that increasing the cost associated with a less fuel-efficient vehicle might encourage the user to increase the mileage used to recoup the additional cost.[233] The Chancellor of the Exchequer argued that the effect of increases in fuel duty had to be considered together with the impact of incentives, such as a graduated Vehicle Excise Duty regime and those for bio-friendly fuels, as well as scientific advances towards lower carbon vehicles.[234]

THE GOVERNMENT'S OVERALL APPROACH

65. Mr Whiting considered that, while the Government was "going down the route of answering the Stern review", there were not yet signs of a clear strategic approach to environmental taxation.[235] He contended that the Government had not clarified the extent to which environmental measures were designed to raise revenue or to change behaviour, leaving businesses in need of a clear statement about the overall purpose and direction of environmental tax measures.[236] The Government's overall approach to environmental taxation, as well as the impact of particular tax measures and the role of HM Treasury in environmental policy more generally, are matters we will consider when we report on our inquiry into Climate change and the Stern review: implications for HM Treasury policy.

Missing Trader Intra-Community fraud

66. The total amounts of the Government's VAT receipts in recent years have been adversely affected by Missing Trader Intra-Community fraud, characterised by the Government as "an organised criminal attack on the EU VAT system".[237] Such fraud seeks to exploit the fact that exports are zero-rated for VAT, while VAT on imports is subject to deferred payment. The fraud involves company A which sells goods for export reclaiming VAT on those goods because exports are zero-rated while company B importing the goods sells the goods to company C and requires company C to pay to company B the cost of VAT on those goods subject to import. Company B (the "missing trader") then disappears before the VAT which it received from company C is remitted to the revenue authority in the relevant country. The fraudsters involved have regularly changed their methods, but a frequent feature of the fraud is that certain high value goods continue to circulate within the European Union ("carousel fraud"), attracting the rebate when they are exported but with the matching import charge never actually paid by the "missing trader".[238] At the time of last year's Pre-Budget Report, HM Revenue & Customs provided new estimates of the Exchequer losses from Missing Trader Intra-Community fraud, indicating that the United Kingdom's VAT receipts could have been reduced by between £2 billion and £3 billion in 2005-06 alone due to such fraud.[239]

67. The EU VAT system is vulnerable to such fraud in part because the value of VAT on imports is paid by the purchaser to the seller, on whom the VAT liability falls; this opens up the opportunity for the seller who is a "missing trader". One way to combat such fraud is to establish an arrangement whereby the liability to pay VAT does not fall on the seller, but is incurred at the end of the supply chain; this arrangement is referred to as the "reverse charge".[240] The introduction of the "reverse charge" requires a derogation from EU VAT law. In evidence to us on 13 December 2006, the Chancellor of the Exchequer announced:

Securing a derogation from European Union VAT law to enable what is called a 'reverse charge' has been a vital part of the Government's strategy against carousel fraud. The reverse charge would enable VAT to be charged for those particular items where fraud has been more prevalent, mobile phones and computer chips, at the point of sale to the consumer rather than at different points in the supply chain. This now would remove the mechanism by which the fraudster steals VAT in the supply chain. I am, therefore, pleased to tell the Committee that last night an agreement was reached on the derogation we have sought with France and, with the support now of other Member States, I am confident that the derogation will be adopted … The impact of the reverse charge has been cautiously estimated with a yield of an additional £500 million in 2007-08, although the true impact will obviously depend on the levels of fraud in future years. However, the reverse charge will move the mechanism for stealing VAT from around 90% of goods currently traded in carousel fraud.[241]

68. In the event, however, the Chancellor of the Exchequer's announcement was not followed immediately by agreement within the EU on the derogation to permit the introduction of a "reverse charge" on certain types of goods, perhaps in part because certain Member States favoured an approach whereby the "reverse charge" would apply to all goods above a certain value, rather than to particular categories of goods.[242] However, on 19 March 2007, the Government was able to announce that agreement had been reached enabling the "reverse charge" to be introduced on 1 June 2007 for mobile phones and computer chips, the goods most commonly used in Missing Trader Intra-Community fraud.[243] This was followed by a further announcement in the Budget of changes that would enable the Treasury to extend the joint and several liability provisions, which already cover certain goods used by the traders, to a wider range of specified goods.[244] Under the current provisions, HM Revenue & Customs can direct that a business receiving certain goods from another business is jointly and severally liable for VAT if HM Revenue & Customs have reasonable grounds to suspect that VAT would go unpaid elsewhere in the supply chain.[245]

69. The Budget estimated the additional Exchequer yield from the latest measures to counter Missing Trader Intra-Community fraud at £50 million in 2007-08.[246] When asked to explain why the estimated yield in that year was significantly lower than the figure of £500 million cited by the Chancellor of the Exchequer in December 2006 for the gains from the introduction of the "reverse charge", Treasury officials gave two reasons. First, they said that the operational strategy of HM Revenue & Customs to bear down on such fraud had been "very successful, so there is less revenue to save as a result of the derogation".[247] Second, they told us that "the derogation is coming in slightly later than we expected and is only covering the key goods".[248] Overall, the Treasury observed that the deterioration of VAT receipts resulting from the "shock" of Missing Trader fraud "now looks as if it has been contained to a short period".[249] Mr Whiting supported the view that progress was being made in tackling such fraud, both through the "reverse charge" and operational measures taken by HM Revenue & Customs, while noting that there would be a challenge in the future in responding to the possibility that the introduction of a "reverse charge" on certain categories of goods might encourage fraudsters to switch their attention to other types of goods not previously the subject of such fraud.[250] After we concluded taking oral evidence, further information about the derogation became available, indicating that the derogation will initially only be for the period up to 30 April 2009 "because it cannot be ascertained with certainty that the objectives of the measure will be achieved, nor can the impact of the measure on the functioning of the VAT system in the United Kingdom and in other Member States be gauged in advance".[251] We welcome signs of progress by HM Revenue & Customs in combating Missing Trader Intra-Community fraud. We also welcome the agreement secured by the United Kingdom Government to a derogation from EU VAT law to enable the application from 1 June 2007 of a "reverse charge" to certain categories of goods that have proved attractive to fraudsters. We note that estimates of the additional Exchequer receipts from this measure appear to have been revised downwards substantially since the Chancellor of the Exchequer's initial announcement in evidence to us on 13 December 2006 and we recommend that the Government, in its response to this Report, provide a fuller explanation for this downward revision, including an assessment of the likely impact of the time-limited nature of the initial derogation. We expect the Government to remain vigilant for signs that fraudsters are switching their attention to categories of goods that are not covered by the new derogation from EU VAT law. We further recommend that, in its response to this Report, the Government set out the state of discussions within the EU about the possibility of subsequent, further extensions of the VAT derogation to combat Missing Trader Intra-Community fraud, both in terms of the range of goods covered by the derogation and the duration of the derogation.