United Kingdom Budget
Right, folks—let us get back in business. The second item is the UK budget, which is expected to be announced on 19 March. I once again give a warm welcome to Paul Johnson, who is director of the Institute for Fiscal Studies, and invite him to make a short opening statement before we move to questions.
Paul Johnson (Institute for Fiscal Studies)
What shall I say by way of introduction? As ever, the key messages with respect to the budget are about the state of the public finances. We finally got some relatively good news in the autumn statement. The Office for Budget Responsibility increased its view of growth last year and this year, so borrowing this year is likely to come in at knocking on for £10 billion less than it was last year, although at more than £110 billion it is still a very large number.
The Chancellor of the Exchequer announced in the autumn statement that he will—assuming that he is still chancellor in 2019—add an additional year to the years of spending restraint, which he will do with the aim of getting a budget balance, or even a very small surplus, by then. That is obviously subject to immense amounts of uncertainty, depending on what happens to tax revenues, growth and so on.
The one bit of good news that the OBR did not come up with was that it has not taken the view that the economy’s potential has increased relative to what it thought it would be a year ago; in its view the scale of the required fiscal adjustment has not changed, despite the additional growth last year. Its view is that that growth was essentially cyclical—it came a bit earlier than it might, but was not additional growth.
However, there is a lot of uncertainty about that. One of the things that we bring out in “The IFS Green Budget: February 2014” is that some macroeconomic forecasters believe that there is a significant output gap and that the potential for the economy to grow is much larger than the OBR believes. If they are right, the suggested scale of consolidation will prove to be more than will be necessary. However, others are less optimistic than the OBR. It is a terribly difficult judgment to make.
I do not expect there to be anything significant in the budget in a couple of weeks that will change the Government’s expected fiscal path, so I do not think that there will be a significant change to expected spending or tax, in toto. If there are changes, and I am sure that there will be, they will be offsetting changes, so there may be some additional spending reductions this year and next—the kind of thing that has been announced in previous budgets—to make space for some tax cuts, or some tax cuts may be paid for by tax increases elsewhere. I would be very surprised if there is a net giveaway or a net takeaway in the budget; indeed, neither has happened since 2010. Each budget and autumn statement since then, for the period of this Parliament at least, has essentially been neutral, but that has not prevented quite a lot of activity within that, with quite a lot of work being put into, for example, funding of substantial increases in the personal allowance, cuts in the rate of corporation tax and so on, which have required changes elsewhere.
We have looked in “The IFS Green Budget” at what is happening to household incomes—I am happy to talk further about that—and we have looked at some specific areas of tax and spending, which I am also happy to talk about in more detail, if members would be interested.
Thank you for that introduction. Your “IFS Green Budget”, which was published on 5 February, covers UK issues, but certain aspects including housing, childcare and education are specific to England, so we will concentrate on the UK and Scottish aspects.
Chapter 1 is entitled, “Public finances: the long road ahead”. It has been a long road already, and will remain so. You say that
“Borrowing this year is forecast ... to be £111 billion, which is still £51 billion higher than it forecast back in 2010.”
You also mention the budget forecast for 2018-19, and say that
“Public sector net debt in 2018–19 is projected to still stand at nearly £1.6 trillion, or 76% of”
anticipated
“national income”,
and you go on to mention
“substantial annual debt interest payments.”
Interest payments can change, of course, but what is the UK’s current level of interest payments on that debt?
We are on a path on which interest payments will move from £20 billion to £40 billion or so over the period. I do not have the number in my head, but it is in the document somewhere.
One of the reasons why spending on certain elements of public services is being squeezed so much is that debt interest payments will rise over the period. If we look at the period between 2010 and 2018, we see that total public spending is not falling by much at all, while debt interest spending is increasing by more than 50 per cent. As one would expect, some other elements of spending are rising, and in order to keep the total level flat, public service spending is being cut substantially.
I am sorry that I do not have the numbers immediately to hand; I can spend a couple of minutes finding them in the document if you like. The role of debt interest is important in constraining other elements of spending.
As you said, that situation is likely to continue for a number of years, and to get worse. In the chapter, “Public finances: risks on tax, bigger risks on spending?”, you mention the remaining
“significant risks to both receipts and spending.”
Can you expand on that a wee bit?
The fiscal numbers depend overwhelmingly on what happens to growth, so if growth does not turn out as expected, tax revenues in particular will turn out very differently. The reason why we have such a big deficit now, in comparison with what the Government was hoping for back in 2010, is that growth has not arrived, and therefore tax revenues are very much lower. There is obviously a growth issue.
If we get the expected growth, the expectations for tax receipts look reasonable to us, but with three concerns. One is that the forecast for tax revenues includes default indexation of things such as petrol duties, council tax, business rates and other such things. The current and previous Governments have not managed to increase petrol duties in line with inflation for a very long time. Council tax has been frozen in England for three years and in Scotland for quite a lot longer, and there are quite a lot of changes going on in business rates and so on. There are policy risks. If it continues to be the case that we cannot increase petrol duties for whatever reason, revenues will need to be made up from elsewhere or there will be a bigger gap.
A second potential risk is the increasing dependence on capital taxes such as stamp duty, capital gains tax and inheritance tax, which are forecast to make up 5 per cent of all revenues by 2018. That will be the highest proportion that they have ever reached. In capital gains tax in particular there is a great deal of uncertainty on how things will move forward.
The third area of risk on the tax side to which we draw attention—I should say that there are upsides as well as downsides to these things—is the extent to which we have become increasingly dependent over quite a long period on a very small number of taxpayers for a very large proportion of total revenue.
For example, the top 1 per cent of income tax payers pay somewhere between 25 and 30 per cent of all income tax, which is itself about 8 per cent of all tax. That is just the income tax that they pay. The top 0.1 per cent are paying more than 10 per cent of all income tax, so 30,000 individuals are paying more than 10 per cent of the entire income tax revenue. That is, of course, because those guys have such an enormous amount of money, but being so dependent on such a small number of individuals means that changes in their behaviour can potentially make tax revenues somewhat volatile. Our view is that the Government estimates are probably the best—and a sensible—central case, but there are some risks around them. Of the three risks that I have mentioned, the policy risk may be the biggest, because it has proved to be difficult to achieve some of the policies that are assumed. That is on the tax side.
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On the spending side, the risk is associated with the scale of the cuts that are anticipated. We have already had some fairly significant cuts in public service spending in police, transport, defence, local government and so on. Those cuts have, in some senses, proved to be easier to deliver than was expected three or four years ago. They have been delivered—in fact, they have been overdelivered, because departments have spent less of their budgets up to now.
However, we are only a third of the way through the cuts in public service spending that are now planned up to 2019. That will mean that, if things continue to move in that direction, and health and other such areas continue to be protected, there will be cuts of more than a third in those budgets between 2010 and 2018. That is a very large cut to achieve, and it will take public service spending to its lowest level since the late 1940s—for which we have comparable data—as a proportion of national income. Whether that is deliverable remains to be seen. As I have said, the cuts have so far proved to be more deliverable than was expected, and that may continue to be the case. On the other hand, however, I presume that the easier cuts have already been made and the harder cuts are still to come.
Finally, there are two particular things that may make the situation even more difficult than it appears. One is that the current Government has already promised significant additional spending increases for the next session of Parliament; those are, in a sense, unfunded. There is £7 billion-worth of promises for additional spending, which will mean £7 billion of cuts from the rest of spending.
Secondly, the population is growing and ageing quite rapidly over the period in question, so spending per head is falling more quickly than total spending. We are going through a period of remarkably rapid demographic change in the current decade, which will make some of those things harder to achieve.
Your comments provide a great deal of food for thought for members of the committee. I will take on a couple of the issues, and then open up the discussion to members, who are all lining up with their questions ready.
You said that freezing fuel duty up to 2018-19 would cost £4.2 billion, but the Government would suggest that one reason why we are not increasing fuel duty is because it is relatively high relative to that of other countries, which undermines competitiveness. In addition, there is an issue with the impact on household budgets. Although £4.2 billion of revenue might be lost on the face of it, there is a counterargument that, if businesses cannot compete because of high fuel duties relative to competition elsewhere, they are not in a position to pay some of the taxes. Surely the £4.2 billion is a two-dimensional figure that does not take into account the impact in the round.
Sure. The actual net costs might be a little bit less than that because of some of the behavioural effects that you are describing.
The point that we were really making is that the official forecasts for revenues assume that fuel duties will rise and that we will get that additional £4 billion of revenue. We are asking whether that will happen. I do not know, but history suggests that it might not. The first-round effect of that will be that revenues will be £4 billion less. That might have a behavioural effect on other economic activity that would increase other revenues, but there is no prospect of it increasing revenues by anything like £4 billion. The real amount to be lost might be £3.5 billion rather than £4 billion, but the point stands: it will require a change of political direction to secure those revenues. It would be perfectly sensible to choose not to increase those revenues and to decide to raise revenues elsewhere, but that is a choice that would have to be made in order to keep to the same total level of revenue.
Your submission says:
“If ‘protection’ for schools, the NHS and aid spending were continued through to 2018–19, other ‘unprotected’ departments would be facing average cuts of 31.2%.”
You go on to say that even if NHS spending—I take it that you mean in England—was
“‘protected’ and frozen in real terms between 2010–11 and 2018–19, real age-adjusted per capita spending on the NHS would be 9.1% lower in 2018–19 than in 2010–11.”
The obvious question is this: what would be the impact on Scotland’s budget?
We have not pushed those numbers through the Barnett spreadsheet. The effect would be whatever the Barnett consequentials would be, so I guess that they would be proportionately similar to the cut in the overall UK budget, but we have not calculated that number.
Okay—but can you give us some kind of ballpark figure? Your submission says:
“Even with the Chancellor’s mooted £12 billion of further cuts to social security benefits, the implied cuts to public services from 2010–11 to 2018–19 would mean departments facing budget cuts of 17.1% on average.”
I have no reason to believe that the numbers would be significantly different in Scotland.
Thank you for that.
Before I open the meeting up to colleagues, I have a final question about spare capacity and productivity. You will recall that we have had quite extensive previous discussions about productivity, and there was some uncertainty, not just from IFS but from the committee’s previous economic adviser. Why has relative productivity not really increased? When one considers what has happened during the past few years, according to what happens in normal recessions, one would expect the economy to shrink, but the number of people in the workforce would shrink further so that there would be productivity gains and so on. That has not really happened in this recession.
Can you talk us through the situation with respect to productivity and, as you mentioned in your paper, the issue of spare capacity in the economy?
I will try, but I am afraid that I am not going to provide any definitive answers.
During the past five years, productivity has dropped remarkably fast against a normal trend, when it would rise. A big gap has therefore opened up in terms of productivity relative to what one might have expected. Why is that? Part of that is the flip-side of what I think is the extremely good news story about what has happened during the past several years: employment levels are higher than they were before the recession. Arithmetically speaking, employment levels are higher, but output is lower and productivity has gone down, so what is causing that drop in productivity?
There appears to be an increasing amount of evidence that that the drop is associated partly with the type of recession that we have had. It was a financial crisis, so the funds that were available to business have been less and the banks have not been lending—especially not to new businesses. It seems that old businesses have been able to continue to access funds, but new business and projects are not being funded. Business investment has been at very low levels, so the capital that workers have to work with has been lower. That has clearly played a role in the issue.
There is also the point about the number of people who are in work. It is hard to know which is driving which. Is low productivity driving high demand for low-skilled labour, or is it the other way around? There appears to have been a change in how the labour market works, which has allowed—or has, perhaps, pushed—more people into work, relative to the 1980s, for example, when a lot of people lost touch with the labour market very quickly. That is partly to do with the type of recession that we have had, and it is probably partly to do with the current structure of the welfare state, which has increased the labour supply of some people.
No doubt we will be arguing for a long time about the causes of what has happened so far. The big uncertainty going forward is about the point at which the productivity story will start to take a turn upwards. It is at that point that we will get to the link between what has been happening to productivity and the question about the scale of the output gap. If a lot of the productivity that we have lost so far is regained—if there is scope for that—that will be equivalent to saying that there is a large output gap remaining. If that productivity is not regained, that is equivalent to saying that there is not much of an output gap remaining.
It is very hard to judge where the output gap lies. Why might we think that there is a very small output gap? We might think that partly because we have very high levels of employment. If we consider that the equilibrium rate of unemployment is somewhere in the 5 per cent or 6 per cent range, we are not very far off that, which means that there is not an awful lot of space left in the labour market. There is also the fact that while business investment may pick up, there is no particular reason to think that it will pick up everything that has been lost over the past five years. That would be a story that says that we have a rather small output gap.
A story that tells us that we have a rather large output gap would be one that says that although a lot of people are in work, many are working part-time and want to work longer hours, and that business investment may well make up a lot of the gap that has been lost over the past few years. The problem is that we will not really know the answer to the question until several years down the road, by which time choices will have been made about the scale of fiscal consolidation, which will be partly irreversible.
Have reduced labour costs had something to do with it? We are also talking about a 6 per cent reduction in real mean household incomes, so it has perhaps been less expensive to retain labour than in previous recessions.
Yes, and again the question is why. It certainly has been less expensive to retain labour. Real wages have fallen by 7 or 8 per cent over the period, which is historically unprecedented. I do not think that we have seen a period like it. There were some times in the 1970s when inflation was very high and wages were not quite keeping up, but during a period of relatively low inflation we have never seen anything like this.
The question is why wages have remained low. It is very difficult to get at the causation. It may be that productivity has been low, which has resulted in low wages. It may be that companies now have more power in the labour market and can pay low wages, therefore the large amount of labour has reduced levels of productivity. Which way round that is working—there is probably a bit of pressure in each direction—is uncertain. However, that very unusual labour market behaviour has been at the root of what has been happening to output, employment and household incomes.
Thank you for that outline, Mr Johnson.
If I understand your UK economic outlook correctly, you are predicting growth at a higher rate than the rate that the OBR predicted. When the OBR predicted its growth rates, a number of commentators said that, given that the trade in the economy is cyclical, the levels at which the OBR was predicting growth could have been predicted anyway. Nothing that the Government is doing is stimulating that increase in growth; it would have happened as a matter of course.
Your predictions are slightly higher than that. Is the Government doing something that you think will increase growth beyond what the OBR predicts? How do you feel about the comment that the growth level that we are told to expect is no more than we could expect in relation to other economic indicators at this point in the economic cycle?
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I should be clear that we are not making growth forecasts—Oxford Economics made the growth forecasts in the document. The point relates to a previous question. The view of Oxford Economics on growth over the next several years is not very different from that of the OBR, but it differs from the OBR in thinking that the output gap will be significantly bigger. Oxford Economics has not forecast the figures, but it thinks that growth will continue at more than 2 per cent for quite a long time after 2018-19, which the OBR does not believe. What differentiates Oxford Economics, rather than the IFS, from the OBR is its view on the output gap rather than on growth in the next three or four years.
I slightly take the view that, over short periods such as the next two or three years, Government policy can make relatively little difference to the position unless it has a big fiscal expansion, which would have trade-offs or costs down the line. What the Government does in the long run can have a big effect on growth and productivity through the education system’s structure, the amount of infrastructure that we have, the design of the tax system and so on. However, changing those things now would impact on growth and productivity over the next decades rather than the next two or three years.
You touched on productivity. As you are well aware, there are different arguments about the value of increasing taxation allowance thresholds in order to reduce in-work benefit levels. You appear to argue that raising the threshold to £12,500 will not be as effective as maintaining or increasing tax credits for people who are in work. That goes against the perception that it is better for people who are working not to be on benefits.
As ever, there is a trade-off and there are pros and cons. Raising the personal allowance is extraordinarily expensive and the Government has already spent more than £10 billion a year on increasing the allowance, which is quite a large investment in the current fiscal circumstances.
Raising the personal allowance further will be less well targeted on the lowest paid, partly because quite a lot of low-paid part-timers have been taken out of income tax already and partly because the allowance is now close to the allowance for pensioners, so they will start to benefit, too. That might be what is wanted but, if the Government wants to help low-paid people, the increase will not be targeted on them. Nevertheless, increasing the personal allowance is the most progressive way of changing the income tax system.
If the aim is to change the direct tax system in a way that helps low-paid individuals, it is clearly better to increase the national insurance contribution floor—the point at which people start to pay NI contributions. National insurance captures more people because it is set at a lower level and focuses only on people who are in work. If the intention is to help low-paid workers through the tax system, it is entirely clear that the Government should raise the point at which people start to pay NI contributions rather than the point at which they start to pay income tax.
The question then arises of what to do about in-work benefits. That involves a genuine trade-off. If a limited amount of money is available, an awful lot more can be done with in-work benefits because they are targeted on people with low household incomes. The downside is that, once people are on in-work benefits, they can face a high withdrawal rate of 70 to 80 per cent, so their incentive to work more is much reduced. The take-up level might also be less than 100 per cent and, for other reasons, the Government might not want people who are in work to be on benefits.
So there is a trade-off. We have not said that one should be done rather than the other, but we have said that, within the direct tax system, NI should be considered rather than income tax and that careful thought needs to be given to the trade-offs between changes to the tax system and changes to the benefits system, depending on exactly who is to be targeted and, in particular, how much worry there is about some of the work incentive effects.
You mentioned the increases in employment levels but, within those statistics, there is increasing underemployment. For individuals who are ostensibly employed but who are on zero-hours contracts or in part-time work, the productivity that they are achieving might be much less than we would expect were they employed on a full-time contract and paid at a level that incentivised them to work more and produce more. We then get into the argument about whether incentivising people to work by increasing their salary would have an impact on the economy, and that brings us to the living wage. We had scare stories about how adversely impacted the economy would be as a result of the introduction of the national minimum wage, and we now hear the same concerns about the introduction of a living wage. Would the living wage increase productivity, and what would be the adverse effect and the complexities of its introduction?
That is another tough question. Inevitably, there is a point at which a higher living wage or minimum wage would have a negative effect. We could not introduce it at the absurd level of £20 an hour. The question is at what point between where it is at the moment and £20 an hour it would start to have a negative effect. Once the minimum wage got up to the living wage level, it would affect a much larger chunk of the population than it does at the moment. At that level, we would be hitting about 20 per cent of the people who are in work, whereas the minimum wage currently affects about 5 per cent. We would get to a much thicker bit of the earnings distribution.
That might have the positive effects that you describe, in the sense that it would force higher productivity, or it might have negative effects because it would impact a lot more people and employers might respond by having fewer jobs. Over the past decade and a half for which the Low Pay Commission has been in place, it has tried to make judgments about the point up to which we can keep moving the minimum wage so that we can be confident that it will not have a significant negative effect on employment and the labour market.
The commission has made that judgment. Initially, it increased the minimum wage significantly, but it has reduced it again. It will probably start to increase a little over the next few years. The level is based on the commission’s best judgment, and I think that the commission’s judgment is that increasing the minimum wage to the level of the living wage would have negative effects on employment. It certainly would if it was done straight away in one big chunk, although moving gradually in that direction might have a less deleterious effect. However, the judgment about where we think that the wage would start to have that impact is a terribly fine one. One thing that we know is that the minimum wage would start to impact on an awful lot more jobs if we increased it significantly above where it is at the moment.
I want to focus on some of the areas that Michael McMahon has touched on. I had wanted to talk about the income tax personal allowance, but that has been usefully explored. In the summary, your green budget states:
“A substantial minority (30%) of those who are low paid have partners who are not low paid. Hence, policies that help all low-paid individuals would also help some relatively high-income families.”
The first question that that begets is: how do you define “not low paid”? The emphasis is interesting because you talk about a substantial minority, but the flip-side is that the overwhelming majority—70 per cent—of those who are low paid do not have partners who are “not low paid”, however you define that.
Indeed. We defined low pay relative to the living wage, so—
Can I just clarify that? Are you saying that anyone who earns the living wage is not low paid?
That is the definition that we used in that chapter. We can put the line wherever we decide to put it, but you are right to say that most of the effect would be on the group that you mention.
I will make two points about the personal allowance. First, if we are to make changes to the income tax system, increasing the personal allowance is the most progressive thing that we can do. Secondly, when we target something on individuals who are low paid—be it wages, income tax or national insurance—we should remember that some of those individuals will have partners who are better off and that an awful lot of people who are on the minimum wage are relatively young people who live at home with their parents and are therefore in households that may not be terribly badly off. It depends on what we are concerned about—the income of the individual, the income of the individual and their partner or the income of the household in which they live—and that is a political rather than an economic judgment.
The natural effect of an increase in the personal allowance is that everyone who is an income tax payer with an income below £100,000 will gain. On a couple of occasions, the Government has ensured that higher rate income tax payers do not gain, and on other occasions it has at least ensured that they do not gain more than basic rate income tax payers, but inevitably people who are not on low incomes do gain as a result of such increases. In a sense, that is a good thing, as people become better off, but it is one reason why such increases are so expensive. An increase in the personal allowance from £7,500 to £10,000 costs £10 billion because it involves giving a bit of money to a lot of people.
Do you accept that, although those who earn the living wage may be defined as not low paid, they are not exactly wealthy?
Of course.
You will be aware that the Scottish Government is committed to paying all its employees the living wage. You talked about the stage at which increasing the minimum wage would have a negative effect and about the vast difference between the minimum wage, which affects 5 per cent of the population, and the living wage, which would affect up to about 20 per cent of the population. On the narrative about a negative effect on the economy, am I right to recall that the same set of arguments were laid out when the minimum wage was introduced?
Yes. The judgment of the Low Pay Commission has been that it will set the minimum wage at a level at which it is not going to cause that kind of damage. At some point it would cause damage, but I do not know where that point is—it may be below the level of the living wage or above it. The Low Pay Commission’s view is that the minimum wage should be roughly where it is at present.
It is difficult to know beforehand what the impact of a change would be. The most compelling thing that we need to take account of is that we would expect a move from something that affects 5, 6 or 7 per cent of the population to something that would affect 20 per cent of the population to have a different effect.
Surely, it could have a positive effect. These individuals are not wealthy, and instead of saving for a rainy day they are spending the money that they earn. Increasing that could have a positive economic impact, could it not?
Of course, but that would depend on the response. If the only effect of the introduction of the living wage was an increase in the incomes of people who were in work, that would be positive, but the money would have to come from somewhere. It would either come from—
Could it come from increased economic growth as a consequence of the change?
Perhaps it could in the very long run, but the change would certainly not have that effect in the short run. It could come from cash piles that some businesses are sitting on, but a lot of people who are affected by low wages work for small employers, who tend to pay an awful lot less than big employers. It is probably not going to come from cash piles in those cases.
It might come from lowering the wages of those who earn a bit more at the moment, it might come from higher prices or it might come from lower profits. If it came from one of those places, it would have some other effect on the economy. It might come from having fewer people in work. I do not know where the effect would be, but there is no cash machine that would create the money that people would get—it would have to come from somewhere else.
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Following that line of inquiry, in chapter 6, which is on the squeeze on incomes, the summary points out:
“the average price level faced by households in the bottom quintile rose by 7.1 percentage points more than that faced by households in the top quintile between 2007-08 and 2013-14.”
In terms of the evidence base, that is intuitively going to have a negative effect on those individuals and households.
Yesterday, the Welfare Reform Committee heard evidence from the Trussell Trust, which told us that 300 per cent more people are using the food banks that it operates in Scotland this year than last year. Presumably, that could have a negative economic impact. Those households are not putting money aside. They are going out and spending it productively, and if their income is being squeezed they can do that less than they could previously, whereas those in the top quintile are more likely to be putting money away and saving for retirement, or having two or three holidays a year. Do you have any assessment of the negative economic impact?
The big impact is the negative social impact. Making people on very low incomes worse off has an immediate impact.
We accept that, and that is obviously readily understood.
What is happening has been driven by an increase in energy and food prices, and that is why inflation has been higher. For better-off people with mortgages, big falls in interest rates have made them relatively better off. That is what is driving it. You are right that, if people with low income are seeing their incomes fall, and they are a group who spend all their income, that will have an effect on the economy, perhaps more immediately and directly than would be the case if money is taken away from people who would otherwise have saved it. Taking money out of the economy and out of people’s pockets has a negative effect on growth in the short run.
I have a final question that relates to a policy divergence between what is happening in Scotland and what is happening south of the border. Chapter 5 of your paper, on housing market trends, refers to the right to buy. It was interesting to read what you say about
“the excess demand for public housing in some localities”.
I would be interested to know the localities that do not face such a demand. There are certainly no localities in the areas that I represent that do not have an excess demand for public housing.
You also say that it is unclear whether the UK Government’s policy of further entrenching the right to buy by increasing the amount of discounts
“will achieve the desired balance between increasing homeownership and minimising reductions in social housing.”
I would have thought that there was plenty of evidence, given the pattern of housing tenure during the period of right to buy’s existence. The UK Government has implemented that policy on the one hand, but on the other hand it has implemented a bedroom tax. It says that there are not enough houses to go round, so we have got to get the right people into the right houses, but at the same time it is selling off the housing stock. Surely the evidence base is there already.
We are trying to say that it depends on how one weights those objectives. If increasing home ownership is weighted extremely highly, that might be the kind of policy to pursue, but it would have to weight very highly relative to the demand for social housing. If any significant weight is put on the demand for social housing as a policy objective, then—
The UK Government says it does so, and that that is why it has introduced the bedroom tax.
Again, as with most such things, there is a trade-off. Increasing the right to buy clearly implies a trade-off where a large part of the objective is to increase owner-occupation relative to being clear that there is enough social housing.
Do you consider that to be an effective use of the public housing stock?
That is a policy trade-off for politicians to decide on, rather than something that I would want to pronounce on.
Fair enough.
Mr Johnson, you said that you see no reason to think that the 17.1 per cent average reduction at UK level would not be replicated in Scotland. However, because of the protection of health and schools, that surely works relatively favourably for Scotland, given that those areas take up about half of the Scottish budget.
Yes, that would be right, for that part, clearly. As I say, we have not run those figures, so I would not like to say what the number would be.
I just wanted to make that point, in case anyone ran out of the room and said that there is going to be a 17.1 per cent reduction in public expenditure in Scotland.
You dealt with policy risks such as dependence on capital taxes and on the small number of taxpayers at the top, but you did not mention two of the things that you addressed in chapter 4, where you say:
“The risks around our forecast are more balanced now than they have been since the financial crisis. Domestically, the main uncertainties surround the housing market and the high level of consumer indebtedness.”
Are you saying that those issues could make the situation a lot worse, or is that not likely to be the case?
Our view is that no great risk is posed to the housing market at the moment. Outside of particular bits of central London, prices are still well below where they were in 2007, and the most likely path is for there to be a continued improvement in the housing market. In 99 per cent of the country, we are nowhere near bubble territory. The prospects are probably relatively positive.
On consumer spending and indebtedness, one of the problems is that the numbers from the Office for National Statistics are changing all the time. Even since we went to the printers with the green budget about six weeks ago, the ONS has changed its view about how much of last year’s growth was down to consumer spending as opposed to business investment, and has moved its estimate in a positive direction. Again, however, the evidence is that we are not yet at a point where one would worry too much about where we are with that. However, if growth this year were to be fuelled by a further increase in consumer spending and indebtedness, and there were to be little in the way of business investment, we would start to worry about that.
So it is all pretty gloomy. You say,
“If the most optimistic assessment of the amount of spare capacity in the economy is right, all spending cuts … could be reversed”,
but you are obviously not totally persuaded of that scenario.
You have touched on this issue to an extent, but are you basically saying that Governments cannot do much about the output gap? You seem to be saying that, but surely the last two things that you mentioned as being relevant—business investment and consumer spending power—can be influenced by Government policy to an extent, as can public investment. Is that not the case?
Yes. Clearly, policies such as patent boxes, rural economic development tax credits, corporation tax and a series of other policies and subsidies impact on business investment. Probably the most important thing that impacts on business investment is the availability of finance, and there are certainly some policies that impact on that. However, it is easier to affect those areas in the long run than it is to make something dramatic happen tomorrow. When you are able to make things happen quickly, you often have to pay a price for that later on—for example, because you have involved yourself in a higher level of borrowing in the short run. That might be a price worth paying, as it gives you a high multiplier on your spending now, relative to what you might get in the future.
That said, I am slightly sceptical about the extent to which the Government can manipulate those issues.
You have already been asked about policies to help the low paid, and what you said was interesting. However, I was slightly puzzled by one bit. One problem with tax credits and so on has been the rate of withdrawal. It seems that raising the amount that people can earn would be a positive work incentive, but you say in the document that
“it would make 200,000 more families eligible for universal credit ... leading to weaker incentives for some people to earn more”.
Surely the higher disregard level is a work incentive rather than a disincentive.
Yes, but, as with all such benefits, there is a trade-off. There will be a benefit for those at the bottom of the system, as they will be able to earn more before having anything withdrawn, but that pushes further up the distribution the point at which people are affected by universal credit, thereby reducing their work incentive. We cannot get away from those trade-offs—
It would push the point up, but one could presumably get round that to some extent just by withdrawing universal credit more gradually.
You could, but the more gradually it is withdrawn, the more people are brought in, so there would be a trade-off. You can pay a citizens’ income to everybody, and everybody would face a tax of 60 per cent or whatever to take it back, or you can just pay income support with a 100 per cent withdrawal rate, which affects a much smaller number of people but has a very negative effect on their work incentives. We just cannot get away from those trade-offs.
The section on childcare in your document is interesting. You are coming across as a bit of a childcare sceptic. I think that we would all agree that childcare is good for child development, and it is right to distinguish between the effects on child development and on employment. However, I was a bit surprised that you imply—I cannot find the exact wording—that there is not much evidence on the effects of childcare on employment. Is that internationally, or just from the way in which childcare operates in England at present?
We were a little surprised at the paucity of evidence on the issue. We were trying to say not that spending on childcare is a bad thing but that there is a degree of conflation in the debate about what childcare is for. One gets the sense that some people think that spending on universal childcare is a good thing for helping children from very deprived backgrounds. It might help a little, but it is not really what is going to help—we need much more targeted and high-cost interventions that involve significant childcare.
Secondly, one likes to hope that childcare will improve labour supply. There is a bit of international evidence to suggest that childcare can be effective in that regard, but there is very little UK evidence. That is not to say that it is not effective, but there really is remarkably little evidence that it is effective in the way that it is delivered.
Thirdly, we wanted to point out that the way in which we spend the £7 billion or so that we spend on childcare policies in the UK is fragmented and complex. Some of it involves direct delivery and some involves subsidy. The way in which the subsidies work is in itself complex, as the amount that people get depends on the exact number of hours that they work and their exact income. Those things will obviously change over the year, so that is likely to be a difficult way of making it all work.
We are certainly sceptical about the current structure of spending on childcare. If we were clear about the objectives, the evidence on where things work and how we are going to deliver childcare, we could almost certainly spend the money more effectively.
It could potentially influence the output gap.
Yes—if one does things that increase labour supply in the short run, or that increase the productive capacity of young people in the long run, one could influence that.
Some European countries have much more extensive support for childcare. I suppose that part of the difficulty of research involves disentangling the effects of that support from the effects of all the other things that are happening in an economy, because intuitively it would seem to have an effect. That is why I was surprised by your statement. I have read quite a lot of information that is presented as evidence that, if one expands childcare provision, not just in nursery education but to cover working hours, that certainly increases, most obviously, female employment rates.
12:30
There are two points to make. First, in the OECD statistics on spending on the early years and childcare, the UK is near the top of the league. The question is not whether we spend too little on those things but whether we are spending effectively. One reason why we rank so highly in the OECD statistics is that the OECD includes the reception class, which we have not included in our figure of £7 billion. Children in most countries do not start school until a year after children in the UK, so the OECD includes reception provision in its numbers. If that is included, we find that we spend considerably more than the average on the early years, so it is not right to start from the presumption that we spend a lot less than most countries.
Some countries, however, have a rather higher provision. The short-run effect might be smaller than the long-run effect, in terms of labour supply, but you are right that it is difficult to disentangle what is going on in, say, the Swedish economy, because all sorts of things are different from what is going on in the British economy. How much of that is to do with the way in which childcare is provided is hard to disentangle. We lack evidence that comes from looking at changes in policy within countries rather than from trying to distinguish the effect of something in one country relative to its effect in another.
Mr Johnson, I have to say that I find your document quite gloomy reading. Because of where we are, I see the differences between the Scottish Government and the Westminster Government. I understand that, currently, we are the fourth most unequal society in the world. Do you think that, given the forecast for the years ahead, we might rapidly become the third or second most unequal society in the world?
I do not know. How high up the inequality scale the UK is depends on what you measure. There is a relatively high degree of inequality in income. It is worth noting, however, that the Scandinavian countries have a much higher degree of inequality of wealth than we do. Even Scandinavia is not super-equal; it is much more equal in terms of income, but it is very unequal in terms of wealth, so the answer to your question depends on what one looks at. That said, we have very unequal wealth as well.
The fact that we have a relatively high degree of inequality is significantly driven by the fact that there are high levels of income at the top of the scale—the top 0.1 per cent that we were talking about earlier. To think about the future, let us think about what has happened over the past 30 years. Inequality in the UK rose dramatically in the 1980s, not because incomes at the bottom of the scale fell but because incomes at the bottom were steady while incomes from the middle to the top continued to rise. There was a big increase in inequality in the 1980s, although that was from a historically low level of inequality in the 1970s.
In the 1990s and 2000s, not much happened across most of the income distribution. Through the 2000s, there was even a bit of a reduction in inequality across most of the distribution but a continued pulling away by the top 1 or 2 per cent. Therefore, depending on how we weight that top 1 or 2 per cent, inequality rose over the 2000s. Since 2007, it looks as though inequality has fallen a bit. Why is that? It is largely because wages have fallen, and wages are earned by people in the higher half of the total income distribution—people at the bottom do not earn.
At least until last year, benefit cuts were not beginning to take effect, but they have now started to take effect and will have an effect over the next couple of years. Our view, therefore, is that the degree of inequality will rise over the next two or three years as wages start to rise, helping the people in the top half of the income distribution, and benefit cuts start to hit people who are towards the bottom. By 2015, the level of inequality will probably not be very different from where it was in 2007. What will happen thereafter? If the top 1 or 2 per cent continue to pull away, the level of inequality will rise further.
If the Government implements the £12 billion of welfare cuts that it suggests it is looking for, that will clearly have a negative effect on the incomes of people who are towards the bottom of the income distribution. We have not done an analysis of that, but my guess is that the thrust of your point is probably right: inequality will probably continue to rise over the next small number of years.
Does the Institute for Fiscal Studies do any calculations on these projections after potential constitutional change in Scotland, so that you are considering a very different set of figures?
In terms of inequality?
No, I mean generally.
Sorry, could you—
Generally, on the budget. It will obviously be a very different budget if Scotland’s system is removed from it. Is that not something that you are concerned with?
You mean what it would look like from the UK point of view if Scotland was removed from the picture.
Scotland is less than 10 per cent of the total UK picture, so the extent to which the overall picture changes will be constrained by that. It will also be constrained by the fact that the fiscal situation in Scotland is not ever so different from the fiscal situation in the UK as a whole. There were a number of years when the fiscal situation in Scotland was a bit better because of North Sea oil. It looks like it is probably a little bit worse at the moment. However, in terms of the scale of the UK budget, we are talking about £2 billion or £3 billion out of a deficit of £110 billion. I would not say that £2 billion or £3 billion is neither here nor there, but it is not a very big number. Over five years, if there were an equilibrium situation and Scotland was outside it, the UK budget would not look terribly different.
Earlier, you spoke about the 0.1 per cent of people, the very, very wealthy, who contribute enormously, paying 10 per cent of all income tax received. This might have been in last night’s presentation, rather than today’s, but you also said that those people mostly live in London. You highlighted the considerable difference that that makes to the tax income. At a stroke, that would make Scotland more equal.
Yes. Scotland is more equal than England.
Given the differential in incomes.
Yes.
Will there be a point at which you will calculate a budget or look at figures without the Scottish economy?
That would fall out relatively straightforwardly from the things that we have done. We could do that, but it would make only a small difference to the UK budget.
Do you accept that a number of the issues raised in “The IFS Green Budget” relate to quite different policies—on housing, for example—which will make a difference to the Scottish budget? In your green budget, they might not be relevant.
Yes. How Scotland spends its budget is very different from how the rest of the UK spends its budget. There is very much higher spending on housing, agriculture, enterprise, transport and so on in Scotland compared with the rest of the UK. The Scottish budget looks very different from that of the rest of the UK.
On the point about small differences, if you net out the additional revenue that you get from North Sea oil and the additional spending, the difference is not very large at the macro level.
I will return to your point about Scotland’s current fiscal position not being as good as the UK’s. you will be aware of the “Government Expenditure and Revenue in Scotland” reports that are produced regularly. My understanding is that the last GERS report that was published demonstrated that Scotland was actually in a stronger fiscal position than the UK, by some £12.6 billion over four years, according to some.
I think that the most recent publication is for 2011-12; we expect the 2012-13 numbers to be out quite soon.
You are absolutely right. For most years in recent history, the Scottish fiscal position, once we take account of North Sea oil revenues, has been noticeably stronger than that of the UK as a whole, but that reverses a little bit if we take into account the Office for Budget Responsibility’s views on oil revenues in 2012-13 and going forward. In that case the Scottish position looks a little bit less good than that of the UK as a whole. That is what I was saying.
The OBR’s oil and gas projections have been pretty conservative compared with other measures. Do you accept that other bodies have suggested that production will be higher?
Some of that is now history, in the sense that we know the numbers for 2012-13, which really were quite small. Our expectation is that that will make a significant difference to the Scottish position relative to the UK position in 2012-13.
I do not know what will happen to oil revenues, but the key point is that they are uncertain and volatile. It may turn out that the OBR has been much too pessimistic, but if we are thinking about an appropriate fiscal policy for an independent Scotland, it will be important to make that policy robust to the uncertainty and volatility of oil revenues. In one sense, there is a limited amount to be gained from saying, “Well, I think the number’s £4 billion,” while someone else thinks that the number is £8 billion. The fact is that we do not know the number and the budget needs to be robust to that uncertainty.
The oil and gas sector invested £14.4 billion of capital in 2013. It did that for a reason, did it not?
Absolutely, and that is one of the reasons why revenue has been lower: that investment can be offset against tax payments.
I do not know, but the key point is that nobody knows. It seems to me that assuming that revenues will be at the optimistic end would be incautious. If they turn out to be at the optimistic end, that will be great, but if we assume that they will be at the optimistic end and they do not turn out as we thought, we will have a bit of a problem. The question is how the volatility is dealt with. That probably means treating oil revenues differently from revenues from elsewhere.
We have covered quite a lot of ground already. I will pick up one or two points from elsewhere.
I was interested in your comments on the help-to-buy scheme, the concept of helping people to buy properties and whether in the longer term that pushes up property prices artificially and squeezes people back out again. There is quite a lot of uncertainty in that area. Is that the reality?
Yes. There are two elements of the Government’s policy, one of which is directly aimed at new properties. The bigger element is aimed at buyers of any properties.
There are a number of reasons why it might be appropriate to have such a policy at the moment. The best economic reason for thinking that help to buy, for example, might make sense is that it is clear that the availability of 90 or 95 per cent mortgages has dropped a lot since the financial crisis began. If one thinks that a well-functioning system would provide those, one might want to intervene in the market to ensure that it does so. That might have three effects. First, it might have an effect on prices in pushing them up a bit. Secondly, it might affect supply by pushing that up a bit, although that would probably be somewhat indirect. The third effect might be on who is able to afford to buy.
Another rationale for such a policy is that, if we are in a world in which we can purchase property only if we have a deposit of 20 or 25 per cent, we might think that there are social equity reasons for helping those who do not have such a deposit, because those who do are likely to be from better-off backgrounds and can go to the bank of mum and dad for help. There is certainly some evidence of that.
The economics of the housing market are quite complex. We need to be very clear about what we are trying to achieve. The Government could be trying to achieve several different things through that policy: it could be trying to achieve some degree of social equity as I have just described; it could be trying to fix what it thinks is a short-term problem with how the finance market is working; it could be trying to increase the amount of supply. You need to be very clear about which of those things you are trying to impact when considering the precise way in which to design such a policy.
12:45
There was some feeling that, in the UK, we have put too much emphasis on property values and prices and owning houses, whereas in other parts of Europe there is less emphasis on owning and people seem to be more comfortable with renting. It seems to me that one of the lessons from before the crisis was that people borrowed too much. I would be wary of saying that it is a good thing that people borrow 90 or 95 per cent of the value of a property.
The question is what a well-functioning market would allow people to do. It may be that we are moving towards a world in which, instead of having to put down only a 5 per cent deposit, people have to put down a 20 per cent deposit. That would be a painful transition because prices will adjust only gradually. We will get a generation—as we have had a generation—of people who are buying much later in their life than they might otherwise have expected.
There has clearly been a gradual reduction in the level of home ownership over the past several years. For the first time in a very long time, there has been quite a sharp reduction in people of particular ages who are home owners. I cannot remember the numbers, but the probability of being a home owner at 30 is now much lower than it was 15 years ago. You may think that that is good or you may think that that is bad, but it is a significant social change—in particular a generational change. The intergenerational effects are potentially substantial.
There has been a significant increase in private renting, but the structure of the tax system continues to favour owner occupation over renting.
Another area that I am interested in is what is driving energy price rises—despite the fact that there has been so much discussion about that issue, perhaps we have not got to the bottom of it. In the chapter on energy prices in your green budget, you specifically say:
“Are prices higher than they should be because markets are not effectively competitive? Are prices being driven up too far, or at too fast a pace, because of the push for secure low-carbon energy?”
Have we really not got to the bottom of that issue?
Another issue that comes to mind is international demand. Is it just that China, for example—or somewhere else—is using loads more oil and gas, which is pushing up the price internationally? Is it because the pound is so weak that it has fallen against the euro? Is that disadvantaging UK prices?
Clearly, the biggest underlying cause of the rise in energy prices—including electricity prices—over the past four or five years has been the increase in the cost of gas and other fuels. The rise has largely been driven by that increase.
The question then is whether there are other things that may be causing problems. Clearly, green policies are increasing the price of energy relative to a world in which we did not have any of those policies. On the other hand, taxes on household energy use are very much below the taxes on energy use by businesses and lower than they are in most European countries. Neither are they very close to what the Government thinks the social cost of carbon is. If you think that a consistent carbon price is an important part of a response to climate change, we are not very close to that. In that sense, taxes are lower than they “ought” to be, but the costs of having higher energy prices are very obvious: we discussed earlier the impact on people on low incomes. As with all these things, there is a trade-off on that side of policy. That is one bit of policy. The other—
So energy prices are too low in one sense?
In one sense. I am not going to sit here and say that they are too low, but if we had a consistent carbon price they would be higher than they are now. However, they will rise over the next several years as the energy market reform effects come in because the price of electricity will be increased in order to create wind power and so on. That is part of the policy that the Government is pursuing and there is a trade-off between the impact on prices and the efficiency with which we reduce carbon emissions.
Can I press you on that? If that was not there, would prices be falling, or would they still have risen over the past few years?
They would still have risen over the past few years, although not quite as much as they have done. Those policies, however, are responsible for a relatively small part of the total rise.
The second part of the question, which the chapter on energy prices was more focused on—we have written quite a lot more about green taxes in the past—but does not come to a very clear conclusion on, is whether, given all that, the energy market is working well. That turns out to be a very difficult question.
We have not had a comprehensive market review by the Office of Fair Trading or the Competition and Markets Authority. There may be a case for such a review, because we remain remarkably ignorant about the extent to which the market genuinely works effectively.
The picture regarding the outcomes—what prices we pay relative to those paid in other countries in Europe—does not look too terrible. The prices that we pay in the UK are not higher than they are in other parts of Europe, but that is not to say by any means that everything is working as well as it could be.
That is extremely interesting.
You seem to suggest that perhaps the tax system and the fact that there is no NIC on pension contributions is distorting the market a bit, and—to go back to points that were raised earlier—may be distorting it in favour of those who can afford to save. On the other hand, we do not want to discourage people from saving, because my gut feeling is that people are not saving enough.
There have been significant reductions in the generosity of the income tax treatment of pensions, particularly for very well-off people, over the past few years. We wanted to look at whether the tax treatment of pensions was appropriate and our view is that the income tax treatment of pensions is not too bad, although it is probably more generous than it ought to be, due to the availability of a tax-free lump sum of more than £300,000, which it seems hard to justify. The income tax treatment otherwise looks pretty sensible. You do not pay tax on pensions when you put money in; you pay tax when you take it out. That is a rather good way of taxing savings.
However, the national insurance treatment looks remarkably generous. If my employer pays me money, they pay national insurance on it and I pay national insurance on it. If the employer puts money into a pension, no NI is paid and, of course, no NI is paid on the way out. It is by far the biggest bit of remuneration that escapes national insurance contributions altogether. If you were to look at significant changes to the way that pension saving is taxed, it would be in the way that employer pension contributions are treated regarding national insurance contributions.
There would be downsides and negative consequences to any tax rise, but it is hard to think of a very good reason why no national insurance contributions should be paid at any point on employer pension contributions. If you are not lucky enough to have an employer putting the money in, you have to pay national insurance contributions.
Is it your gut feeling that the current system favours people at the top end of the scale?
Not necessarily—it favours people whose employers put money into their pensions. Outside of the public sector that probably is people towards the top end of the scale. In the public sector it is much more even across the piece.
Malcolm Chisholm asked about the link between high-quality childcare and parents’ employment. Were you saying that you could not find any work that had been done on that, from a UK point of view, or were you saying that work was being done but that the results are inconclusive?
Not very much work has been done, and that which has been done is inconclusive.
Jamie Hepburn asked about oil revenues. Were you saying that the 2012-13 figures, which will be formally published in GERS next week, are below those of 2011-12?
If my recollection is correct, I think that that is true. I have a chart in my head on which the line comes down sharply between 2011-12 and 2012-13. The numbers are in the public domain.
We will see GERS next week. Your organisation said yesterday—I do not know whether it was a press release; I think it was described as an observation—that
“with the vast majority of payments already having been made for 2013-14,”
the Scottish Government
“forecasts for this year also look to be too optimistic.”
Where did you get the figures for 2013-14? Are they publicly available?
They are publicly available. The figures are published monthly by the ONS and the OBR. They show month by month the revenue that comes in from different revenue streams and you see how much comes in from the North Sea. It may turn out that we have a couple of very good months towards the end of the year, but thus far this year the figures have not been very good.
That concludes the committee’s questions. Do you have any other points that you want to make to the committee?
I do not think so. We have gone through everything fairly comprehensively. Thank you very much.
Thank you very much. We appreciate you coming up and comprehensively answering so many of our questions.
That is the end of today’s meeting and I thank members for their contributions. Before you go, I would like to say that the draft budget will be published before the October recess. The committee pressed for that and it is a very positive development.
Meeting closed at 12:56.