Examination of Witnesses (Questions 1
MONDAY 22 APRIL 2002
1. Good afternoon, gentlemen. Welcome to this
first Budget session where we are examining the Chancellor's Budget
from last week. Could I ask you to introduce yourselves for the
sake of the shorthand writer, please?
(Professor Congdon) Professor Tim Congdon. I am Chief
Economist at Lombard Street Research.
(Mr Barr) I am Ciarán Barr, Chief UK Economist
at Deutsche Bank.
(Mr Emmerson) I am Carl Emmerson. I am a Programme
Director at the Institute for Fiscal Studies.
(Mr Weale) I am Martin Weale. I am Director of the
National Institute of Economic and Social Research.
2. Thank you very much. Much has been written
about the Budget already. If we looked at the weekend papers in
particular we would probably find that there were diametrically
opposed views taken on issues such as is it a tax and spend Budget,
does it make it easier for us to get into Europe, therefore if
we do not achieve our growth targets then the whole house comes
down etc? Could I ask you to present your views on it very briefly
so we can open it up.
(Professor Congdon) This very much was a tax and spend
budget. It is very difficult to complain about what this Government
has done on public finances. The ratio of the net public debt
to GDP is only 31 per cent, very low by Britain's post-war standards,
and although there is a return to deficits the deficits envisaged
are modest by past standards. The increase in spending, particularly
on health and education, that this Government has promised is
being paid for by higher taxes. Having said that, one might raise
some questions about the pattern of the tax increases. I think
one could argue that the Government, or the Chancellor, has been
boxed in in some ways. The Government does not want to raise direct
taxes on households, it does not want to raise taxes on companies,
so the remaining options are excise duties and national insurance
contributions. I think there are some worries that increases in
excise duties, even though in line with inflation, would have
affected the inflation target, so the Chancellor has suppressed
excise duty increases again. Last year there were these cuts in
fuel duties but, again, they have been held back. All that is
left is national insurance contributions. I think there are some
interesting constitutional questions, questions about the structure
of the welfare state, where national insurance in theory is supposed
to pay for contributory benefits, such as pension benefits and
Jobseeker's Allowance, it is not supposed to pay constitutionally
for education and health spending, there are some interesting
questions there. One can see why that was the chosen route. Just
to finish, I think the Government's economic forecast in the Budget
documents is in some ways too complacent. I think the Government
believes that there is going to be a slow down in consumption
growth at present interest rates on present policies and I do
not find that plausible, I think the consumer boom, or boomlet,
will continue. I was a bit surprised that the official view seems
to be that there will be a slow down in the housing market, consumer
spending and so on at these interest rates.
3. Thank you very much. Ciarán?
(Mr Barr) My own thoughts are similar to some of Tim's.
Obviously as things look the public finances do not look particularly
stretched going forward, there is still a buffer there in the
finances. Overall it is difficult to take a snapshot and say that
the Chancellor has taken many risks going forward, I think certainly
the public finances look a lot better than they have done in previous
cycles. That said, there are some question marks over his very
ambitious growth projections in the next year or two and his assumptions
of trend growth. While I would not want to say they look excessive,
in fact we are also very optimistic, it is worth bearing in mind
that it is very difficult to take back these discretionary spending
increases. So if growth were to disappoint in the next few years
for any reason you could very quickly see some of the deficits
widen very substantially. I think that is worth bearing in mind,
particularly with regard to some of the very optimistic growth
forecasts for next year. Coming back to the issue of the consumer
and so on, before the Budget all the spin was basically we were
going to see higher taxes on the household sector that were going
to pay for higher NHS spending. That is, if you like, what the
Government were telling us the public had told them they wanted.
It seems that did not happen at all, as we know corporates have
picked up most of the tab for this, certainly the substantial
amount. You could argue that in an economic sense, particularly
because it is national insurance, that may not matter very much,
it all comes out at the end of the day, but I do think it does
not put any pressure on to the consumer sector, we are going to
see the consumer continue to remain stronger for longer and the
Budget has not really changed that, but the expectations certainly
in the City were that they would change that, it would take some
of the spending power out of households. That has implications
for the MPC, it has implications for monetary policy and so on.
Also I think it is important to bear in mind that on the EMU issue
there has been a lot of white noise coming out, whether it was
pro or anti euro or whatever. I think the EMU question is fairly
invariant to this year's Budget. I am not somebody who believes
that because we are seeing wider deficits going forward that that
is going to cause a problem meeting the Maastricht criteria on
public finances. If anything, you could turn it around and say
that because they ducked the issue of raising household taxes
it makes it slightly easier to go for a referendum next year,
although that becomes a political judgment. Nonetheless, I am
not sure that you can definitely say that the Chancellor has done
a Budget that is in any way related to the EMU question. That
is all I want to say for the time being.
4. Thank you. Carl?
(Mr Emmerson) It certainly was a tax and spend Budget.
Measures which we had not previously had any consultation on raised
taxes by about £11.5 billion by 2005-06. The Chancellor gave
£3.5 billion back in new tax credits and also measures for
the companies that we already knew about. The net increase in
taxes is going to be used to increase public spending. I think
unlike the spring 1993 or the summer 1997 Budgets which increased
taxes, this has not been done to reduce borrowing, it has a stated
aim, an increase in taxes to increase public spending. In terms
of the fiscal rules, the Treasury's forecasts suggest that these
will still be met, although it is the case that these current
set of forecasts are less cautious than they were in, say, the
previous Budget because of the change in trend growth assumption.
I would also like to say that the measures used to raise the money
means that the Chancellor is also redistributing, he has taken
money from the top half of the income distribution and he has
given some back to the bottom half with these new tax credits.
5. Thank you. Mr Weale?
(Mr Weale) What struck me most about the Budget was,
except in the short term, it is actually very expansionary. If
you look at what is projected for 2006-07 Government borrowing
is increased by one per cent of GDP compared with what would have
happened. This does not appear fully as an increase in the borrowing
requirement, part of it comes from the adjustment to the trend
rate of growth, but of course even the Chancellor cannot vary
the actual rate of growth in the economy simply by announcing
a different trend. So in the longer term it is undoubtedly expansionary
and relative to where we would have been that probably adds about
3p on the basic rate of tax or equivalent taxation in other means.
We are a bit pessimistic about the Chancellor achieving the revenue
targets shown in the Budget for the period up to 2006-07. I think
this is in part because he is making assumptions about revenue
buoyancy that may be right, but may not be right, also because
he is assuming a stronger cyclical and recovery than I feel comfortable
with. Our own analysis suggests that might lead to tax increases
on the basic rate of tax of 1.5p or its equivalent. I should stress
that forecasts by their nature are uncertain so there is a large
margin of uncertainty surrounding these, but it is running rather
finer than the Budget document suggests. I suppose also I would
make the point that as far as I can see the Budget demonstrates
the fiscal rules needs revising. We have had the cumulated surplus
of £50 billion over the cycle so far, the rules say that
the Chancellor is allowed to spend thatthis is on the current
accountI am not for one moment saying that he should have
but when you have that sort of gap between what a rule allows
and what the Budget is actually suggesting then I think one can
reasonably ask the question whether the rules should be revised
to give a better guide to the Chancellor's actual policies.
Chairman: Thank you very much. Mr Plaskitt?
6. Can I just pursue this trend rate of growth
issue for a bit. It has been put to us by another analyst that
the £17 billion increase in public spending is 50 per cent
financed by tax increases, 25 per cent financed by up rating the
growth assumption and 25 per cent by higher borrowing. Does anyone
dissent from those figures?
(Professor Congdon) Can I just ask where they have
7. Goldman Sachs.
(Mr Weale) I do not agree with those exact proportions
8. Are they way out?
(Mr Weale) The key table is table C6 of the Budget
Statement on page 215 and there you can see that relative to the
PSBR borrowing has increased by £5 billion but the Budget
policy decisions are raising the deficit by £13 billion;
of those £13 billion, there are rounding errors, £7
billion is accounted for by the changes to the trend rate of growth
and other forecasting changes.
9. So you think that a bigger proportion is
financed by increasing the trend rate of growth than 25 per cent?
(Mr Weale) As with all these things, it depends how
you look at it. I have focused on the increase in borrowing, that
is a net figure. If you look at increase in spending and then
increase in revenue you may get to something closer to the numbers
you have quoted.
10. I am only getting more confused now. I just
want to know whether you think it is broadly true to say that
about a quarter of the additional spending boom has been created
by assuming this higher rate of growth or is that quarter suggestion
way out? Is it roughly that?
(Mr Emmerson) I think it is roughly that.
11. Right, that is helpful. Does anyone think
it really is not that at all? No? Okay, right. The next question
is has the Chancellor been prudent, if you like, to make this
assumption that the trend rate of growth has now increased or
is it incautious to do this?
(Mr Weale) I have no difficulty with the assumption
that the trend rate of growth is faster; my puzzlement was more
why the Chancellor ever adopted two and a quarter per cent instead
of two and a half per cent. There is an issue with quite wide
implications whether faster immigration is going to deliver faster
growth in the labour supply but I have no difficulty with the
assumption of a trend rate of growth of two and a half per cent.
My difficulty, or the lack of caution that I see, is the cyclical
recovery that is built in at the earlier stages of the forecast.
12. Has anybody else got any problems with the
increased assumption on trend rate?
(Professor Congdon) I think the break down of the
two and three-quarters is productivity two, a bit of an allowance
for a higher employment ratio of a quarter per cent and half per
cent immigration. I am a little bit puzzled about the quarter
per cent for the employment ratio because I do not think that
is going to persist because really in the last few years we have
seen employment rising faster than the working age population
and that reflects all sorts of Government measures, he changed
the tax system, the Jobseeker's Allowance some years ago, all
sorts of things. I think it is a bit treacherous to rely on that
in the future but I have not got any great quarrels with this.
The history of the Treasury raising its views on trend growth
is, however, a very bad one. When they did this in the late 1980s
all sorts of mistakes were made.
13. Do you not also agree that in the recent
past the Treasury has been under-estimating growth?
(Professor Congdon) Yes, it said that. It has explained
when calculating the fiscal arithmetic it assumes two and a quarter,
whereas it really thinks it is two and a half. Just remember that
if you were to go back five years, nobody would have forecast
the net immigration we have actually had in the last five years.
As far as I am aware I do not think anybody forecast that, so
the Treasury was fully justified in the view it was taking in
(Mr Emmerson) Could I add that if the Treasury had
assumed two and a quarter per cent for this Budget its forecast
would still show the golden rule being met and public finances
in good shape but not being met with as much cushion as they do
because of the change. It is not critical to the forecast needing
to meet the golden rule.
Mr Plaskitt: That is helpful.
14. You mentioned productivity and that is one
of the key objectives of the Chancellor, productivity growth.
Is there a contradiction there with the way he has gone about
the tax increases by putting it on national insurance and thereby
maybe inhibiting employers taking on extra workers and productivity
targets not being achieved?
(Professor Congdon) The effect of changes to the national
insurance, although important, will be marginal compared with
the other determinants of productivity growth. As a matter of
fact, on the official figures productivity growth has been slower
in the last five years than the previous five years. Having said
that, it seems to me two is reasonable.
Mr Tyrie: Does anybody think that productivity
as measured at the moment is sufficiently robust to act as a major
influence on policy? Great emphasis has been placed on productivity
but it is an amorphous concept at the best of times, very difficult
Chairman: Does everybody believe the
15. Very influenced by the exchange rate.
(Professor Congdon) There has been an article in a
recent issue of Economic Trends about productivity growth
in business services and similar sectors, and it basically admits
that it is very difficult to measure productivity change in business
services, financial services and so on. Since they account for
about over 20 per cent of employment this difficulty in measuring
productivity change in that sector raises larger questions. I
suggest that many of the really big incomes that one finds in
this economy are actually in that business services, financial
services area. There are lots of interesting questions about whether
productivity growth is measured properly but what we do with them
I am not sure.
(Mr Weale) I should say that if we changed our view
on how productivity was growing substantially and said the true
number should be four per cent rather than two per cent, it would
not necessarily make the resources available for the National
Health Service any more readily available because then your view
of what real growth meant would also have to change.
16. I am just trying to get some feel for how
much emphasis people think should be placed on productivity numbers,
productivity growth numbers and productivity as a policy objective
in the way that the Chancellor appears to have done. Some countries
have had very good histories of productivity but had very poor
economic performance and vice versa. A lot depends on how these
measures are put together and simple manpower figures are often
very difficult although it is easier to make a comparison of trends
for productivity within a particular country, is it not?
(Mr Weale) I do not think it is possible to talk about
how much you would like the economy to grow or how fast you would
like to make resources available for any particular sector without
having some sort of implicit view on what is happening to productivity
because, of course, economic growth is productivity growth plus
labour input appropriately measured. So if we are going to be
concerned about real growth in the economy and have views on what
we would like to do, we cannot get away from the need to discuss
(Mr Barr) I think what is frustrating for the Government
and the Chancellor about the productivity issue is if you look
at the United States where there has been a fairly uncontroversial
rise in productivity in recent years, although we could argue
how much there actually has been, conditioned upon strong investment
in the past, in the UK we have actually had very robust business
investment in recent years. If you look at business investment
as a share of GDP in real terms it is at record level for things
like the service sector and so on. There should be productivity
improvements flowing from that, one might argue, but that has
not really happened. We have had very strong rises in employment
growth and the question you have to ask yourself is are we now
about to see a productivity spurt come through as a result of
previous investment and so on and so forth. The evidence on that
is very mixed. I think you can tell that by the way the Chancellor
was unable to boost the increased productivity as part of his
trend growth business instead of relying on assumptions about
population, immigration and so on, which one could argue are convenient
at this stage in the cycle when you want higher trend growth levels.
I am not really arguing the problem is the trend growth has gone
up but it is the way actually it has gone up. I am quite optimistic
we will see productivity increases going forward but you would
have to be a brave person to say they would be very strong.
17. Can I move on, or back to what Professor
Congdon said right at the beginning. I would like to pick him
up on two of the main points he made. First of all, could you
just say a little bit more about the contributory principle as
far as national insurance contributions are concerned and what
implications the allocation of money from the fund to health and
education have for the contributory principle and whether we now
might argue that national insurance contributions are merely an
income tax by another name?
(Professor Congdon) In the Budget speech Gordon Brown
referred to Lord Beveridge's 1942 report on social insurance.
That report recommended the contributory principle, essentially
that all welfare benefits are to be paid for by contributions,
which are to be universal, with the aim of getting away from the
idea of means tested benefits. I am not an expert on the constitutional
structure of the national insurance fund but I have looked at
the national insurance fund, it still exists, very much it is
a fund and in that sense the contributory principle remains alive.
It shows national insurance contributions as the bulk of receipts
of the fund and then the benefits that are paid out are pensions,
unemployment benefit as it used to be, now it is called Jobseeker's
Allowance, and also Disability Benefits. These are all contributory
benefits. The Government Actuary's Department carries out reviews
and reviews the solvency of this fund on the basis that these
are the benefits for which national insurance contributions are
there to pay for them. As far as I am aware there is no basis
for this fund being used to pay for health spending or education
spending. You might then stand back from this and say in resource
terms national insurance contributions are a tax and any tax can
pay for any type of Government spending, but I think we should
also think about the structure of the welfare state. If this Government
wants to suspend the contributory principle perhaps it should
say so openly and upfront, and it might also think about how the
welfare system is to evolve in the future when so much of it now
is means tested benefits and there is a proliferation of tax credits
and so on.
18. Let us just try and encapsulate what you
have said in a few sentences. Is the contributory principle dead?
Is the national insurance fund now a total fiction and are national
insurance contributions to all intents and purposes now a tax?
Should we be saying in this Budget that the Chancellor has effectively
abolished national insurance contributions as we understand them,
or has come very close to that, and created an increase in income
tax by ten per cent?
(Professor Congdon) I think the Budget raises very
fundamental questions about the nature of the welfare state. There
might be a sophisticated modern view that the national insurance
fund is anachronism and simply the state has to find resources
to pay for these good things in terms of welfare benefits, education
and health that the state provides. I am not sure about the precise
constitutional position of the national insurance fund, it may
be that if there is more of this, in effect, raiding of the fund
there should be a review of the primary legislation associated
with national insurance contributions. I think these are really
matters though for politicians and parliamentarians. Many people
now say the national insurance contribution is just another tax
and the contributory principle is basically dead and I think both
remarks are perfectly reasonable.
Mr Tyrie: Does anybody else want to add
19. I do not want to get into a deep debate
about this issue, you have said that it is for politicians and
we are seeing the Chancellor later on and we have got lots of
questions to address to him.
(Mr Weale) I just want to remind the Committee that
we have been somewhere close to this before with the national
insurance surcharge which we had in the 1970s and it was abolished,
I think, in the early 1980s.
(Mr Emmerson) Could I add I do not think this Budget
killed the national insurance contributory principle, I think
it is something that has been going on for a number of years and
increasingly implies a reliance on means testing. We have had
the abolition of the cap on employers' contributions, the spring
1993 Budget increased the rate of national insurance, additional
money for pensions under both the Conservatives and Labour, increasingly
so under Labour it has been made available through means tested
forms, the Winter Fuel Allowance and the Pension Credit. The Beveridge
system was a flat rate contribution for a flat rate benefit, we
do not have that now, we have earnings related contributions,
most of the benefits are not related to our contributions, with
the State Second Pension replacing SERPS there is yet another
change, and Disability Benefits are now set to be means tested.
This Budget continued that trend, I do not think it started it.