Examination of Witnesses (Questions 220
THURSDAY 6 DECEMBER 2001
220. The Government's policy had two aspects
to it. One has been to create stability as a means of enhancing
productivity and the other has been various micro-measures in
the system. We have had fairly stable conditions for the last
four years. Should we not have seen some sort of improvement in
productivity over the four years as a result of that?
(Mr Weale) One might hope that more stable economic
conditions would encourage private sector investment, where Britain's
position is still somewhat disappointing. Also some of the various
micro measures have been designed to encourage investment and
there too Britain's position does remain still somewhat disappointing.
I must say I would not be expecting the patient to be responding
immediately. I would stick with saying we really need a ten-year
period to assess these sorts of issues. There is of course the
point made in the Pre-Budget Report that in so far as skill levels
are concerned, since most of the acquisition of skills happens
to people before they enter the labour force or in the early stages,
bad policies cast a very long shadow over the economy and conversely
it takes a very long time to swing things round.
221. Do you think there should be a regional
dimension to the Government's productivity measures?
(Mr Weale) The regional analysis the Government has
embarked on is very helpful; they do make the point that if one
were to level up with the worst performing regions that would
do a lot for the economy as a whole. On the other hand there may
be an element of Peter gaining at the expense of Paul, the better
qualified people moving out of the poorly performing regions into
the successful ones and that in itself is a factor explaining
the diversities so you cannot simply look at the most successful
regions and copy them in order to raise the least successful regions,
but the Government is right to focus on the regional aspect, on
the factors which do promote local economic success. The analysis
of the different performance of various cities in the document
which accompanies the Pre-Budget Report is very interesting and
it is valuable that the Government is starting to look at these
problems. Is it going to work? I remember one of my lecturers
25 years ago saying that a lot of policies had been tried to improve
Britain's productivity over the first 75 years of the twentieth
century and none of them had really worked. So it is a difficult
issue and I think it would be optimistic to say that a government
can identify what is wrong and that is bound to lead to a cure.
On the other hand, Britain's performance for years has been an
anomaly. There is a tendency for backward countries to catch up
with the more advanced ones and perhaps in the last 20 years we
have started to see that process happening in Britain.
222. On the pensioner credit, you said in your
introduction that it makes a good deal of sense. That is good
to hear. Do you think it is going to achieve its objectives?
(Mr Dilnot) It will certainly achieve its objectives
of increasing the incomes of a group of pensioners who at the
moment feel and are perceived to be unjustly treated in that they
have small typically private pension incomes which are almost
entirely taken away by the operation of the income support system.
In redistributional terms for the current generation of pensioners
and those about to retire it should achieve its objectives and
it is important to note that one of the most significant changes
that Mr Brown has delivered has been very significant increases
already in the incomes of the poorest amongst the retired population
with further significant increases on the way and with this providing
a further additional increase for those who are not the very poorest,
not the 15 per cent currently entitled to income support or minimum
income guarantee but the next slice of pensioners. In redistributional
terms the answer is yes. It will also reward their savings in
some sense. They will benefit more from their savings. It is not
obvious that it will encourage those who have not yet retired
to save more because while it guarantees a higher income than
you would have had if you got a private pension, it also means
that if you reduce the amount of saving you are planning you end
up with a larger income than you otherwise would have done. So
the incentive effects are not obvious. I also think because of
that it will raise the question of compulsion in pension saving.
We already of course have some compulsion through SERPS and the
second state pension and those contributions. By extending means
testing to the bottom half of the pensioner income distribution,
the question of whether compulsion needs to be considered will
certainly raise its head.
223. Some costs have been pencilled in to the
pensioner credit. Do you think the figures are broadly right?
(Mr Dilnot) I think they are. They are on the generous
end of the estimates we and others had made before the Chancellor
made his announcement. The principal reason for that is that the
pension credit is going to be introduced in such a way as to try
to make sure that housing benefit does not remove much of the
game for those who are entitled to housing benefit. A consequence
of that is that we are shifting housing benefit entitlement still
further up the income distribution for the retired. This points
to one area where the Government should feel that it looks very
closely. The failure to tackle housing benefit and council tax
benefit reform alongside the many other reforms which have been
made, particularly to the means-tested social security system,
means that we are left with this large and rather complicated
system on top of instead of integrated within the rest.
224. Do you think it would be straightforward
enough that it will have a high take-up rate or do you see a take-up
(Mr Dilnot) I am sure there will be a take-up problem,
especially to start with. There are two reasons for that. The
first is that we are now going to be extending a means-tested
benefit entitlement to a group which typically have not in the
past thought of themselves as being entitled to means-tested benefit.
It will take a while for them to get on top of it. The second
is that some of the entitlements will be quite small. The people
on the highest incomes entitled to it will have quite small entitlements.
It is worth saying that the proposed administrative mechanism
is rather an attractive one. The decision made to have rather
infrequent means tests and to calculate entitlement at the point
at which people reach retirement, all of that should encourage
take-up. I think the Government are doing as much as probably
can be done.
225. On capital gains tax, as you know the Government
has changed the system to encourage investment and promote enterprise
and they have changed the business asset taper for disposals which
will mean that the effective rate of tax for a higher rate taxpayer
is reduced to 20 per cent after one year of holding an asset and
10 per cent after two years. I happened to be in some social company
the other evening when some economists and business people were
talking about this. They saw this as manna from heaven. They could
not understand the Chancellor's generosity in this area. The opportunities
for using it in a number of different ways are manifold. Would
you accept that view?
(Mr Troup) I think so. Ten per cent is a very generous
rate. There is a figure buried away on pages 178 and 180 of the
Pre-Budget Report which indicates that the forecast yield from
CGT for 2002-03 has actually halved since March. If you look on
page 180, the project yield from the last column, fifth line,
2002-03 is £1.8 billion for capital gains tax. If you turn
back to the previous page, paragraph B48 in the middle, you will
see there is a sentence which says that for 2002-03 a larger reduction
of £1.75 billion is now forecast. In other words, there has
been a £1.75 billion reduction in the CGT forecast for next
year to £1.8 billion; that effectively reflects a halving
of the projected CGT over the next year. In part that is undoubtedly
due to the fall in equity prices during the course of this year.
Nevertheless it is a dramatic fall and as B48 indicates, it is
attributable, as well as to equity prices, to the introduction
of the business taper. There is a very big tax cut coming through
here. I am sorry, I do not have the most recent figures, but given
that there are only around 200,000
capital gains tax payers and only a couple of thousand
or so account for something like half of the yieldyou would
need to check the precise figures but it is that order of magnitudeyou
can see that there are going to be a few people who are going
to get very significant tax reductions indeed, even without any
behavioural change. I would not want the Committee to think I
am not in favour of a reduction in the general capital gains tax
rate from the 40 per cent level which was undoubtedly both high
on any sort of judgmental basis, but also very high by international
standards, but it does seem to me that the Chancellor has been
extremely generous and runs the risk of what I think you are implying,
a significant behavioural change, not just to the sort of entrepreneurial
investment which he would favour, but to switching of activities
or conversion of profits into a form which benefits from the rate.
I have to say anecdotally from my practice, this is something
which one has seen really from the beginning of the introduction
of the taper, but with the reduction of the period to four years
and then to two years there is undoubtedly a far greater degree
of interest in getting into a position where advantage should
be taken of the taper. Whilst I am in favour of a lower rate of
capital gains tax, I would prefer, as I have said to this Committee
before, that we had a uniform rate applicable to everything after
a relatively short period of time, perhaps one year, at a level
which strikes the right balance between being over-generous and
being excessively high. If you look back to 1965 when the tax
was introduced, when it was introduced at a flat rate of 30 per
cent, something of the order of half the highest rate of income
tax at that time, there was a lot of sense in that and a flat
rate tax at around 20 per cent now probably would strike the right
balance; I fear ten per cent is going to be seen to be over-generous
in future years.
226. There seems to be a magical political attraction
in ten per cent, does there not? The Republic of Ireland held
it was responsible for its economic growth but it is much more
complex and I think that is what you are saying to us very clearly.
(Mr Troup) Indeed.
227. On the proposed volume-based credit for
research and development, that will benefit all UK companies carrying
out qualifying R&D, whether based in the United Kingdom or
not. Do you think that this measure will have any significant
effect on the proportion of qualifying R&D currently carried
on outside the United Kingdom?
(Mr Troup) There clearly is a stronger case for doing
something about R&D through the tax system than many other
measures which we have seen this Government address through taxation,
because R&D is something which does have an external benefit
which is not captured in the cost to businesses. A Government
subsidy of that external benefit can be justified. This measure
and the changes which have been proposed to it, effectively to
give the credit only to directly incurred R&D, that is not
to sub-contracted R&D, will undoubtedly bring in a greater
proportion of UK R&D, R&D carried on in the UK, than the
previous form of this proposal or one of the suggestions in the
paper issued earlier this year. Most of the large UK companies
which carry on R&D on a global basis carry on R&D outside
the UK through non-UK companies, that is a UK pharmaceutical company
with a US operation will typically carry on its US R&D through
that company and will not therefore benefit from this credit.
So the credit is undoubtedly better designed now than when originally
proposed and will disproportionately and quite rightly encourage
R&D spending in the UK rather than R&D spending outside
the UK, notwithstanding that UK companies carrying on R&D
spending outside the UK through overseas branches will be entitled
to the credit. There may be some behavioural effect, you may find
that UK based companies will switch foreign R&D by not actually
moving the location but moving the company they carry it out through
to get the benefit of the credit. I think the effect will be relatively
228. May I turn to the Working Tax Credit and
Child Tax Credit? Can you explain why we do not have any indication
in the PBR of the possible rates? There are no illustrative numbers
at all. What do you make of all that?
(Mr Troup) I am not sure the question about why something
is not in the PBR is really for me.
229. I just wondered what your comments were
on the absence of it and what judgements you can make or Parliament
(Mr Troup) I said at the outset that I was pleased
we had more consultation on what one might call the micro, the
specific tax and particularly the business tax measures. It clearly
makes something of a nonsense to appear to consult on something
without any details and it is far more important in something
like a personal tax credit that the quantum is there, than the
details. In the structure of the business tax system it is the
rules you want to know rather than necessarily the rate. When
it comes to personal tax credit it is the rates as well as the
rules which are really of overriding importance in terms of their
effect. If the answer you are looking for is that this is something
less of a consultation to put forward proposals without numbers
in these areas, I would agree with that.
230. Have you seen any estimates of what the
cost might be?
(Mr Troup) No, nothing beyond what the IFS have suggested
and I do not have those to hand.
231. Would it be more efficient in achieving
the aims the two credits are meant to be satisfying just to raise
the minimum wage?
(Mr Troup) It would clearly have a different distributional
effect simply because those who benefit from the minimum wage
will be a much smaller proportion of the population notwithstanding
that there will be a knock-on effect from any increase in the
minimum wage. It is more efficient; it depends on what view you
take of how tapers should be organised and whether it is appropriate
to introduce a credit which goes so far up the income system.
Certainly I have had concerns at the extent to which all of these
reforms and tax credits bring together the benefit and the tax
systems, which perform very different functions, in a way which
makes it difficult to distinguish between those who are tax payers
and those who are benefit receivers. There is clearly a high degree
of political choice in that and in the choice of the taper level.
(Mr Weale) Of course the minimum wage is a cost to
employers and raising the minimum wage would be likely to have
some effect in increasing unemployment; possibly not a large effect
but it would be expected to have some effect. The tax credits
on the other hand are part of public spending and they affect
incentives to go to work, but they do not affect incentives for
employers to recruit.
232. Have you made any assessment or are you
aware of any assessment being done on how far this new regime
for these two credits will complicate the tax system?
(Mr Troup) No, I have not seen any assessment and
it is quite hard. Rather like the phrase social insurance, complexity
in the tax system can mean a great number of different things.
233. I shall be specific. Is there any notional
cost which you think you could ascribe to these new credits so
far as administration is concerned?
(Mr Troup) There clearly is an administrative cost
but in a sense that is just a function of the fact that a large
number of people are going to have to deal with a number of different
aspects of their interaction with government through both tax
and benefits and that carries a cost. That flows from the basic
point of extending the taper, extending the benefits up the income
system, rather than being intrinsic in the structure of these
credits. I would hope, if they are fully worked through, they
may actually work out simpler in themselves for an individual
than some of the past combinations of benefits we have seen. Intrinsically
they are not necessarily more complex, although the use of the
tax credit system and the involvement of the Inland Revenue is,
as has been said here before, not necessarily desirable in terms
of reducing complexity and administrative costs, but the multiplication
of the number of people who are likely to benefit from them is
clearly in aggregate going to increase complexity and administrative
234. You have seen no work which describes those
(Mr Troup) No.
(Mr Weale) No, I am not aware of anything which answers
235. May I start with the savings gateway? I
want to know what its behavioural consequences will be and whether
they will contribute to what the Chancellor is trying to achieve
or work against it.
(Mr Troup) Andrew has already indicated that the savings
gateway is highly attractive for those who are entitled to it
because effectively it offers a 100 per cent return on an investment.
As someone who has with some regrets seen the way the free market
can work in unusual ways, it seems to me that the inevitable response
of what is effectively a 100 per cent return to qualifying savers
will be to get unscrupulous lenders to offer potential participants
the opportunity to borrow money, to fund one of these gateways
simply because a 100 per cent return over three years with no
risk at all is extremely attractive. Given that what we are trying
to do is to encourage those who currently spend to save and these
people are by definition at the bottom of the income scale, it
seems to me that the level of incentive needed is going to have
to be of a level, as is proposed here, which will inevitably encourage
that sort of behaviour because money is fungible. Given the choice
of spending or saving, if I would rather spend and have the opportunity
to borrow; I would borrow to save. It seems to me that that is
the single response which will flow from this, which does make
this an undesirable policy. I am glad that it is being piloted,
but it may be that the only way to make these people save is compulsion
and that is probably unacceptable politically. That was the conclusion
we came to when this was looked at in the time I was at the Treasury,
but obviously not followed up because it is politically unacceptable.
(Mr Weale) On the savings gateway may I say that there
have been several areas, for example giving people energy saving
lamps was another one, where the Government seems to feel that
people may need incentives and then embarks on incentives which
are absolutely vast compared with what you would expect for the
sort of intelligent people which it is targeting the policy at.
I think that a policy which gives people a 100 per cent return
on savings will encourage them to save while they are getting
a 100 per cent return, even if in many cases it will be creamed
off by unscrupulous lenders. After that they will go back to a
situation with the returns which the rest of us face and there
seems to me no reason why their savings habits should change.
People save because they want to have money to spend in the future
and in the light of the rate of return they get. Many of the people
or most of the people at whom this policy is targeted find it
very difficult to afford to save and at normal rates of return
and given the social security system we have, it is not worth
their while saving. The short bonus period with very high returns
will not change that.
236. Could you also comment on the reduction
in stamp duty for regeneration areas?
(Mr Troup) Any reduction of tax generally but particularly
on property risks just being capitalised into the value of the
property rather than making it easier for purchasers to come in.
Therefore we have to ask whether this is a real benefit in improving
disadvantaged areas, particularly given the difficulties of identifying
the areas. There are some quite smart residential properties in
the East End of London occupied by City professionals which can
take advantage of this relief. More generally, picking up a question
and a point about productivity, this measure and the community
investment tax credit and one or two other measures are in the
Pre-Budget Report under productivity, but by definition what this
measure is doing is looking at areas where the return on investment,
the productivity, is by definition lower than it is elsewhere
in the community otherwise the investments would not be made.
It is inevitable that any measures like this, even if they work,
will not improve the overall productivity of the country, simply
because we are going to be bringing into production low productivity
capital and areas. Whilst this may have some effect, it is more
likely to be on the capital values and even if it does have an
effect, it seems to me inappropriate to describe this as something
which meets the productivity challenge rather than addressing
the social problems of disadvantaged areas.
(Mr Weale) May I add to that the broader question
which this raises of the function of a stamp tax as opposed to
a general property tax. Of course the stamp duty you pay only
when the property is bought or sold has the effect of locking
people in. A higher rate of general property tax or something
in addition to council tax and business rates would not have that
blocking in effect. I must say I can see few reasons for maintaining
a stamp duty rather than replacing it with a general property
tax which could of course have local reliefs in areas where the
Chancellor was particularly keen to encourage various activities.
(Mr Troup) I agree.
237. Without giving away all your state secrets
which you use to advise your clients, were you suggesting earlier
on in relation to your concerns about the new CGT rate of 10 per
cent not only that that might be eroding the capital gains tax
yield quite significantly, but that there could be quite a leakage
out of higher rate income tax by people converting income into
(Mr Troup) Yes.
238. Do you think that could be quite significant?
(Mr Troup) It could be significant in small areas.
I always lament a diversion of resources into instructing lawyers
to try to save tax rather than to achieve business ends in themselves.
Whether you could say it has any overall effect on the economy
rather than a loss of tax is much more difficult, but it clearly
does represent a wasted resource and a loss of revenue.
239. How big an effect do you think it could
have on the yield of upper rate tax?
(Mr Troup) The fact that the yield is projected to
drop from £3.6 billion to £1.8 billion cannot be taken
as an indication of how much would be lost, but one is probably
talking about £1 billion or £2 billion. We are not talking
about £5 or £10 billion, but equally we are not talking
about £100 million.
Chairman: May I thank you for your time
this morning. It was very kind of you to come along and we have
gained a lot from that.
1 Note by Witness: 154,000 for 1998-99 (Inland
Revenue Statistics 2000, Table 14.1). Back
Note by Witness: Around 3,000 for 1997-98 (Ibid. Table