United Kingdom Budget
It has gone time, so good morning and welcome to the seventh meeting in 2012 of the Finance Committee of the Scottish Parliament. I remind everyone to turn off mobile phones, pagers and BlackBerrys. We have received apologies from Michael McMahon, who is unwell and unable to make it to the meeting.
The first item on our agenda relates to the United Kingdom budget, which is due to be published on 21 March. I invite the director of the Institute for Fiscal Studies, Paul Johnson, to make a short opening statement before we move to questions.
Paul Johnson (Institute for Fiscal Studies)
Thank you very much for inviting me to this morning’s meeting. I want to say a few words about “The IFS Green Budget 2012”, which we produced just under a month ago. As you probably know, the IFS is an independent economics research institute and has, for about the past 30 years, been publishing what it calls its green budget—“green” as in “green paper”, rather than in the environmental sense—to set the scene for the Chancellor of the Exchequer’s budget. Unlike most legislation, there is no green paper or consultation before the budget is announced, so our intention is to try to put into the public domain information and analysis to help discussion of it.
The IFS has always worked with a group of macroeconomists on the macroeconomic forecasting in the green budget, because that is something that we do not do ourselves; this year Oxford Economics produced those chapters. I will not say anything about those this morning.
However, I want to speak for a few minutes about the work that we do that relates to the public finances and about some of the specific decisions that we expect the chancellor to make. The background to the budget includes the long-standing fiscal difficulties and, more recently, the Office of Budget Responsibility’s very substantial downgrading of the economic growth outlook—and therefore the public finance outlook—back in November. At that time, the OBR downgraded its view on the long-term trend, growth and capacity of the UK economy by 3.5 per cent of national income into the medium run—in other words, in November, it thought that the UK economy was capable of being 3.5 per cent smaller than it had thought back in March that it would be. Given that 3.5 per cent of national income equates to around £50 billion a year, the OBR’s view of the potential trend output of the UK economy has changed very substantially in a short time. Given that and our position back in March, the current view of the potential long-term trend of the UK economy is that annually it will be 13 per cent smaller than was thought in March 2008—that is, we have lost more than £200 billion a year of output relative to where we were expecting to be just four years ago. That is the backdrop to our current difficult fiscal situation.
As a result of the cut in the view of what long-run trend output will be, which was given in November, it is felt that more needs to be done to get the fiscal books back in balance, and although in November the chancellor did not announce any change in his plans for the next three years, there will now be two further years of tight public spending cuts, in 2015-16 and 2016-17. The total fiscal tightening that the chancellor now plans is of the order of £123 billion. That represents an additional £30 billion of fiscal tightening on what he planned back in March. Even on top of unprecedented times, the difficulty of achieving what he wants to achieve has increased substantially just over that short period. As I said, he did not respond to the bad economic news with further tightening now; he has responded by pencilling in tighter plans after 2015, but has told us nothing about where those spending cuts might take place.
When we put that together with the existing plans, 80 per cent of the £123 billion of tightening is planned to come from spending cuts and 20 per cent of it is planned to come from tax increases. Spending cuts at that level are unprecedented—I will use that word many times. Between 2010 and 2016, we will have seven years of real cuts year on year. We in the UK have never had more than two years of year-on-year real cuts in public service spending. When I talk about public service spending, I mean current spending on health, education and defence and not spending on social security or debt interest, which I treat separately. It is worth being clear that only £1 in every £10 of planned cuts has yet occurred, so 90 per cent of the cuts are still to happen. We are not some significant distance through implementing the spending cuts—we are only in the foothills of implementing them.
As I said, these are extraordinary times and dramatic changes, but it is worth putting them into a little bit of context from the years up to 2008. In the current period, we will have seven years of the biggest cuts that we have had since the second world war. In the period up to 2008, we had seven years of the biggest increases since the second world war. On current plans, public service spending in 2017 will in real terms be about where it was in 2004. As a proportion of national income, it will be about where it was in 2000. In that sense, we will not be taken back to the dark ages; we will be taken back to where we were not terribly long ago.
That is not to say that the changes will be anything other than extremely difficult to achieve. That is much underestimated and underdiscussed as part of the broader fiscal situation. As I said, we looked back at history in the UK, but we also looked at Organisation for Economic Co-operation and Development countries over the past 30 years. We have, until now, not seen changes on the proposed scale in the UK’s history or in any OECD countries in the past 30 years. It is clear that a small number of countries, such as Greece and Ireland, are doing something pretty dramatic at the moment, but these are remarkable times in history.
We look in a little detail at the breakdown of the spending cuts: where will they fall and how does that relate to what happened in the years up to 2008? The direction of travel in the current period is obviously different, but it is striking that the relative prioritisation is extremely similar to the relative prioritisation of spending in the years before the crisis. Of the significant budgets, the biggest winner in the years before the crisis was health. Health is the only major budget to be protected at England level in the current spending review period. Education spending in England went up roughly in line with average increases in the period to 2008, and the same is true of the cuts in the current period.
Spending on defence, law and order, housing and so on went up less quickly than the average up to 2008, but spending in those areas is being cut more quickly than the average over this period. There is a remarkable degree of consistency in terms of relative prioritisation.
On the immediate fiscal forecasts, in the context of these very large numbers and an OBR expectation of a deficit of £124 billion this year, our view is that it looks like the news might be marginally less bad than the OBR thought in November, essentially because it looks as if departments are slightly underspending their budgets this year. Although budgets are tight this year, it looks as if there has been some additional front loading of cuts relative to what is in the budget. Our best guess is that spending and borrowing this year will be something like £3 billion less than the OBR predicted, but that is without taking account of any end-of-year splurge on spending that departments might decide to do.
Over the medium term, in the period to 2016-17, our estimates are that tax revenues might be a little higher than the OBR is expecting, and we might have something like a £9 billion cushion relative to OBR expectations by 2016-17. In ordinary times, we would think that £9 billion was a reasonable amount of money and there might be a case for some medium-term fiscal loosening, but the level of uncertainty at present is much higher than in normal times, and £9 billion out of £120 billion is a relatively small amount.
Oxford Economics produced a range of macroeconomic forecasts, and we considered what their public finance consequences—the risks, essentially—would be. Although the central forecasts are relatively similar to what the OBR expects, and the fiscal consequences are relatively similar, they put a substantial probability—less than 50 per cent, but certainly considerably more than 10 per cent—on things going very wrong in the euro zone. If that happens, the consequences for the UK economy under Oxford Economics’s modelling, and indeed most other people’s, will be pretty grim. Its modelling shows that we would go into recession this year and next, and that the fiscal forecasts would be blown out of the water, essentially. We would not have national debt peaking at about 80 per cent of GDP, but at well over 90 per cent of GDP, and we would inevitably miss the chancellor’s fiscal rules by a long distance. Indeed, I do not think that anyone would expect him to keep to his fiscal rules were something of that magnitude to happen; the previous UK Government ditched its fiscal rules after the financial crisis. There are substantial risks on the downside, which we have examined.
On what needs to happen on the fiscal situation, the most important thing—this sounds like a terribly nerdy and processy point, but it is a desperately important one—is to have another spending review by the end of next year. We say that for three reasons. First, the previous spending review was, of necessity, done swiftly, and some big decisions were taken. There is a strong case for looking back and reviewing and evaluating those decisions and determining whether they remain the correct and most effective and efficient set of priorities.
Secondly, as I said earlier, the chancellor has pencilled in substantial cuts for 2015-16 and 2016-17 without saying what they will be. It would be easier to plan for them if departments knew at least a year before they happen what the cuts are likely to be. It is important to put that knowledge in place.
The third point is something that I have not talked about today, but we say a little more about it in the green budget. There will be continuing long-term pressures on public spending that will go beyond the resolution of the current crisis; those pressures are a result of demographic pressures, particularly on health and pensions, and potential reductions in tax revenues, in particular from petrol. All of that means that pretty major strategic, and substantially bigger, new decisions will need to be made about the shape of the state and public spending.
I could blather on and on, but I will stop at that point. I should say, though, that we have also covered in the document a range of issues—which I am happy to talk about—around tax policy, child benefit policy and other aspects of spending, as well as public sector pay and pensions policy.
10:15
You may say that you could blather on but, unknown to you, I have a button on my desk, and there is a trapdoor under your chair.
Thank you very much for that very interesting and informative statement and for providing us with a summary of the green budget. I am very interested, as I am sure colleagues are, in its content. You have already answered some of my questions, but I have plenty of others—as, I am sure, colleagues do.
You spoke strongly in your opening remarks about the situation to which the chapter 3 summary refers when it states that by the end of the current financial year
“73% of the planned tax increases will have been implemented.”
The summary goes on to state that only 12 per cent of the cuts will have been implemented by the end of the financial year. It also states:
“The impact of the remaining cuts to the services provided is difficult to predict”.
The summary of chapter 3 ends with the statement that
“further tax rises or welfare cuts would be needed to reduce borrowing as currently planned.”
You talked about public spending levels going back to those of 2004-05, but in closing you also talked a wee bit about demographics. Although the spending levels might go back to those of 2004-05, the demographic picture has surely changed quite considerably in the past few years because of the general ageing of the population and there probably being more older and frailer people who are dependent on services. Although the amount that is being spent may be similar to that of 2004-05, there is that demographic factor to be taken into account.
The question that I want to ask is about what we do going forward. Your chapter 4 summary states that
“weaker economic growth than forecast by the OBR is partly offset by a higher oil price and greater North Sea oil and gas production.”
It goes on to say that
“A cut to the main rate of VAT, a reduction in employer National Insurance contributions and a boost to investment spending plans all seem sensible choices for a temporary fiscal stimulus package, were one deemed necessary.”
Given that you talk about national wealth falling by 13 per cent over the piece relative to the pre-recession era, and given that we are in a difficult economic position, do you think that at this stage a fiscal stimulus is justified? Should some of the £3.3 billion departmental underspend that your report mentions be used to do that? Should there be the measures that you described, such as a cut in VAT, to boost construction? What is the IFS’s view on the issue?
There are two important points, the first of which is that there is a very important difference between a medium-term loosening and a short-term stimulus. We are reasonably cautious about suggesting that there should be any kind of medium-term loosening, particularly given the fiscal rules that the chancellor has set himself, because of the scale of the uncertainty. My guess is—this is probably appropriate—that the chancellor will wait to see how those things unwind before deciding what to do in the years from 2015. Essentially, that is what he did in the autumn.
You can certainly argue that what happened in the autumn was a fiscal loosening, because over this year and the next the automatic stabilisers will effectively have been allowed to go ahead and the amount of borrowing has gone up significantly. That represents a degree of fiscal loosening in the short run.
What we say in the document, and what we believe, is that if you compare where we are this year with where we were last year, there seems to be a stronger case for a short-term fiscal loosening. The main reason why is that the economy is significantly weaker than it appeared to be last year and it is certainly weaker than it was predicted to be last year. Indeed, the monetary policy committee minutes from last February show that members voted for interest rate increases, and that there was a fairly clear consensus among macroeconomists that interest rates would rise quite significantly towards the end of last year. It is clear that that did not happen, and that is not now on the agenda. The risk that a short-term fiscal loosening would result in a short-term monetary tightening therefore probably no longer exists.
That must be weighed up against the risk to interest rates on Government debt. The Government needs to issue £750 billion-worth of debt over the next five years, which is a lot of money. In the UK, we have pretty long-term dated debt, but £750 billion is an unprecedented amount to put on to the markets over the next five years.
In a rather unhelpful way, we have set out those arguments and said fairly clearly that we are pretty agnostic on whether there is a case for a short-term loosening of, say, 1 per cent of GDP. The risks can be weighed up, and people argue vehemently on both sides, but doing that or not doing it involves a very close judgment. One can see the arguments for either judgment.
If fiscal loosening is to be done, it seems that three things are needed. First, it needs to be timely, as one would want to impact quickly on the economy, and only a relatively small number of things can be done that would do that quickly. Secondly, it needs to be targeted on things that are likely to impact on economic growth, and thirdly, it needs to be temporary or short term.
Broadly speaking, it seems that there are two or three approaches that would be timely, targeted and temporary. On the spending side, investment spending could be increased, particularly on roads and housing, because investment spending on them can get going relatively quickly. Plans exist and have been shelved, but can be unshelved relatively fast. On the tax side, temporary changes to employer national insurance contributions and the VAT rate might have a positive effect.
I do not have a strong view either way on whether there should be short-term loosening. The arguments in each direction and the risks are relatively clear. In the end, a pretty balanced judgment is involved.
The summary says that chapter 8, “Tax reform and growth”,
“focuses on reforms that could increase national income in the medium term, not on possible short-term stimulus to promote economic recovery.”
A couple of quite intriguing sentences follow that in the same paragraph. They are:
“There are many welfare-enhancing reforms to the tax system which should be pursued even if they don’t promote growth. And there are growth-promoting but welfare-reducing reforms which should not be pursued.”
Will you explain that a wee bit more and give us a couple of examples?
I would love to. Economists are often rather unfairly tarred with the view that all they worry about is money. The truth is that, from one’s first lecture in economics, one is taught to worry about welfare, although economists often forget that. There are things that the tax system does that reduce welfare but do not necessarily impact on growth. I will give members one example. Stamp duty on houses probably has some economic impacts, as it probably reduces labour mobility to some extent, but the big thing it does is make it very expensive for an elderly person with a big house to trade down while a younger person with a growing family wants to trade up. They both have to pay tax in order to do that, which reduces the number of transactions that occur and will make each of those people worse off. That is a welfare cost that does not necessarily have any effect on the economy. Stamp duty could be changed or be got rid of, which would make people better off in respect of their welfare but would not make a difference to the growth of the economy.
Growth-promoting policies that would not necessarily be good for welfare can also be thought of. The complete abolition of the old-age pension would probably promote growth. That would effectively force a lot of older people to work, which would probably be good for growth, but it probably would not be very good for their welfare. Obviously, that is an extreme example.
I was hoping for a more practical suggestion.
The example gives a very good illustration of why it is appropriate that we do not pursue growth at all costs.
Indeed.
Chapter 9 refers to the 50p income tax rate. The summary of the chapter states that
“It is important not to fixate just on whether any revenue is raised”
and adds that
“there might well be better ways of raising a similar amount of revenue from a similar group of people.”
Can you elaborate on what those “better ways” might be?
On the first quotation, it is important to understand the 50p rate. The Treasury forecast is that it will raise about £2.5 billion a year, which we think is probably a little on the optimistic side, although it is certainly well within the bounds of possibility. However, the forecast of £2.5 billion already assumes behaviour change that will lose the Treasury £4 billion a year. Were the 50p rate to be introduced but nobody changed their behaviour, it would raise £6.5 billion. A very substantial cost from avoidance, evasion, moving abroad or whatever is already built into the figures, so it is a relatively costly way of raising tax. If the policy raises £1, that does not make it a good policy relative to the same policy that loses £1. Other things beyond the revenue matter.
A number of aspects of the tax system do not work terribly effectively in terms of raising additional revenue from people of high wealth and people on high incomes. First, despite recent reforms, capital gains tax is still charged at a much lower rate than, in particular, the highest rate of income tax, and it provides a very obvious route to avoidance of the 50p tax. There is a lot of complexity around capital gains tax and, in particular, its potential impact on savings and investment decisions, but our view is that there are ways of aligning the rate of capital gains tax with the rate of income tax while providing allowances against normal returns.
Our inheritance tax system does not work terribly well, for example in trying to get at those who are lifetime wealthy. There are obvious opportunities, for someone who has enough money, to pass on the money before they die when no tax is involved, and it is perfectly legal to avoid inheritance tax through buying farms or unquoted businesses. If you really want to increase revenues from that group, there are routes through the reform of inheritance tax.
It is also the case that, for people who have very expensive houses, housing is undertaxed through the council tax system. A standard neutral system, as it were, on the consumption of housing would be to have a tax that was directly proportional to the value of the house. In fact, the council tax rises much less than proportionately with the value of the house; that situation is, of course, on average much more valuable to people who have expensive houses and high lifetime incomes.
I do not pretend that any of the proposals are politically straightforward, but each of them would improve the efficiency of the tax system and would be a way to increase the amount of tax payments from those who are lifetime wealthy.
The convener highlighted your identification of greater North Sea oil and gas production as offsetting the OBR estimates. Yesterday, a fairly scathing report from Oil & Gas UK indicated that North Sea production dropped by almost 20 per cent last year. Has that been factored into your calculations?
I think that that comes directly from the Oxford Economics forecast of how the economy and world oil prices will move, so I am afraid that I am probably not the right person to ask about that.
If it transpires that there is not greater North Sea oil and gas production, what is the effect?
10:30
There would be a small effect on the overall UK fiscal balance. My understanding is that it would have a much bigger impact at the Scottish level. At the UK level, tax revenues from North Sea oil are close to the level raised from taxes on tobacco. They are important, but they are very small relative to, say, corporation tax, income tax or VAT. Clearly, the reverse is true if we look at Scotland in isolation.
You have highlighted that there are efforts to crack down on tax avoidance. How realistic is it to try to achieve a significant reduction in tax avoidance? What is the best estimate of the amount of tax avoidance that could legitimately be stopped?
That is an extraordinarily hard question. The difficulty is always in looking at the counterfactual. Essentially, my take on what happens is that both sides are continually running to stay still. On the HM Revenue and Customs side, there are continual and genuine efforts to apply legislation and rules to reduce the scope for tax avoidance. The other side of the coin is that there is continued effort by the private sector to find schemes to achieve tax avoidance. We end up with a sort of stalemate in that, in broad terms, against a counterfactual of doing nothing, what the Treasury and HMRC do substantially increases the amount of tax revenue that is brought in, but against a counterfactual of the private sector doing nothing, it probably does not bring anything additional in.
It is impossible to answer the question of how much can be brought in by cracking down on tax avoidance. The answer is that it depends on what set of things the private sector would do to do more of it. I always find it difficult to understand the numbers in budget red books that say, for example, that an extra £5 billion or whatever will be brought in as a result of crackdowns on tax avoidance. We have not done this exercise—we probably should—but if we went back over the past 10 years and added all those numbers up, they would come to an implausibly large number.
In terms of policy, which is more interesting in a sense, there are clearly places where the structure of the tax system encourages tax avoidance of one kind or another, particularly where tax rates are not aligned between different kinds of activity. There is a lot of scope for thinking about the structure of the tax system and how to minimise opportunities for avoidance. I have already mentioned the difference between the tax rates on income and capital gains. There are also differences between the tax rates on earned income, self-employed income and companies.
When the corporate tax rate for small businesses was reduced to 0 per cent for a couple of years, there was an enormous spike in the number of people incorporating. That was not surprising, as it was an obvious opportunity for tax avoidance and of course people took it. There are ways of aligning elements of the tax system to reduce opportunities for avoidance.
I mentioned inheritance tax as well. We have such obvious opportunities for avoidance in the inheritance tax system that it is not surprising that people take advantage of them. Less obvious but complex routes for tax avoidance are available in the corporate tax system, which is an area in which we will have a continual game of cat and mouse.
Although individual taxes make up a small part of the global sum, there has been much talk about the impact that the VAT rise has had on economic growth in terms of activity, particularly in the construction sector. You spoke about the effect that stamp duty has on mobility by preventing people from moving house. It has been argued that the 20 per cent VAT rate has prevented small-scale housing improvements, which although small would take place on such a scale that they would at least keep up employment and keep construction activity going. What evidence do you have of the impact of the VAT rise on economic activity?
The increase in VAT was the most substantial of the tax increases. That increase brings in quite a lot more than the entirety of the revenue from North Sea oil, so it is quite big. There is evidence that the temporary cut in the VAT rate in 2009 had a positive impact on spending and economic activity, partly because it was specifically temporary, so people brought their spending forward. The extent to which it increased the totality of spending over time is much less easy to determine, but there is evidence that it had a temporary effect at least. We would, of course, expect that something that increases prices would reduce consumption, although it might do so by a relatively small amount.
Mark McDonald asked about construction. One of the oddities of the VAT system is that VAT is charged on small-scale improvements to houses but not on the building of new houses. There has been a massive downturn in the building of new houses, which clearly has nothing to do with the VAT system; it is to do with the demand in the economy and the availability of credit. I do not know the numbers relating to whether the impact on small-scale improvements has been bigger or smaller than the impact on the building of new houses. If it has been bigger, that is dramatic, as the rate of construction of new houses has dramatically fallen, but that certainly cannot be laid at the door of the VAT system.
My final question is on the way in which the taxation system is ordered, and I will use the oil and gas industry as an example, as I am familiar with it from the region that I represent and the industry representatives with whom I speak. There is a view that the supplementary charge was increased in order to take in more money and offset a cut in fuel duty. It appears that the impact of that will be that revenues will be decreased as a result of a lack of production. Have you done any calculations on where tipping points occur? Have you considered how far taxes on sectors can be increased before a tipping point is reached at which no more money will be raised because the level of activity will drop and less money will be taken in?
We ask that question about quite a lot of taxes. As I have said, I am certainly no expert on the North Sea example, but the chancellor quite explicitly said that he was trading off the tax on petrol against the additional supplementary charge.
Broadly speaking, we think that there are probably a couple of taxes that are at or close to that tipping point. There is evidence that the taxes on tobacco, whisky and spirits are close to the point at which revenue will be reduced if they are increased further. In each of those cases, a lot of that is to do with the opportunities for smuggling and cross-border shopping, for example, as much as anything else. That is what a lot of the debate about the 50p income tax rate is about, of course. There are examples of tipping points in the tax system that we think we might be close to and, historically, there are examples of tipping points that we know we were above—for example, when we had income tax rates of 83p and 98p. We and other economists look at these things quite a lot, but I have not looked at the example that Mark McDonald raised.
I will deal with two subjects, one being a particular issue and the other being the policy response to it.
In your opening comments, you alluded to the serious risk that the sovereign debt crisis in the euro zone will have negative consequences in terms of austerity in the UK and in Europe. How concerned are you about confidence in the UK economy more generally? How big a drag will lack of consumer demand in the UK be on economic growth in the UK as a whole, although, obviously, we are particularly interested in Scotland? You made more positive comments about the prospects of a modest recovery in the US, but it appears that Europe and the UK will continue to be quite depressed economically, which will pose a major downside risk to the recovery of public sector finances through the budget process. Can you comment a bit more on that?
I will try. It is certainly the view of Oxford Economics and I think that it is the view of macro forecasters more generally that much of the upside for the economy will be driven by what happens in the US and emerging economies. If we are to be pulled out of our current problems, a lot of the pull is probably going to come from well outside the UK and Europe, which obviously leaves us exposed to things over which we have no control. That said, I know that Oxford Economics is relatively confident about what is happening in the US, where things appear to be improving somewhat, and there are at least positive signs in the emerging economies.
It is pretty clear that if things go badly wrong in the euro zone, which is by far our biggest trading partner, that will have substantial effects on the UK economy. The Oxford Economics model suggests that if the euro zone were to collapse—by which it means if five or more members were to leave—UK GDP in 2012-13 would fall by 2 and a bit per cent and fall the following year. However, the model suggests that there would be a strong bounce back, which in some sense looks positive.
If the euro zone collapsed, all fiscal bets would be off. It would clearly be inappropriate to try to maintain a focus on the current set of fiscal rules, because they would be almost impossible to observe. As I said, the previous Government ditched its fiscal rules once the financial crisis hit.
On consumer demand, I am afraid that this is another of those stories in which what has happened over the past few years is unprecedented. Demand is clearly linked to incomes, which have fallen in real terms by something like 7 per cent since 2009. They will probably level off this year and—I hope—begin to increase a little next year.
Demand is driven by a bunch of things. It has been affected partly by increases in taxes and partly by increases in unemployment but mostly by the fact that the rate of inflation has been much higher than the rate of wage increases. Our view is that, by 2015, incomes will be roughly where they were in 2002. We have never had a 13-year period of no growth in incomes. That has obviously had an impact on consumption.
We have looked at what has happened to consumption and what the OBR thinks is going to happen to consumption. The OBR was somewhat taken to task last March for suggesting that increases in consumption from 2012 would help to drive the economy. Even though the OBR’s forecasts were substantially more gloomy than any previous forecasts, they have proved to be slightly too optimistic. Consumption has taken a remarkable hit and it is lower than in 2008. In comparison, consumption in the 1980s recession recovered to its previous level within three years of the bottom of that recession.
A broader point of considerable importance is the interesting breakdown of what has happened this time. There are big differentials in consumption according to demographic group. Our analysis suggests that there has not been very much impact on consumption patterns for people over 40 and certainly not for those over 50. However, as far as the younger generation is concerned, there will be a very dramatic impact on consumption levels, driven partly by unemployment, partly by what is happening to their earnings and partly by the lack of credit in the housing market and the need to save. There is not only a very different level of change in consumption but a pattern that is very different from anything that we have seen before.
10:45
I am intrigued by your last point. The culture among the younger age groups has led to greater exposure to debt while older consumers tend to be more cautious. I wonder whether that, too, might be a factor.
There is an assumption of a modest recovery this year as inflation drops, consumer confidence returns and consumer spending increases. However, might there be a time lag because it will take longer for people’s expectations of earnings to shift? For example, people might not notice that inflation has slowed and, because they are still expecting prices to continue to rise, they might put off spending. In short, recovery might be delayed as expectations catch up with reality.
Such lags as there are will have been built into the forecasts. However, the crucial issue will be what happens to wages over the next nine months. Over the past year, nominal wage increases have been in the range of only 1 to 2 per cent. If increases continue to be made in that range, lower inflation will probably make less of a difference than you might think; people tend to be fairly sensitive to the nominal change and, if they see their wages change in much the same way as they changed last year—even though their real income has not fallen—the difference in their behaviour might well be less than expected. However, as I have said, the crucial issue will be what happens to wages, which is difficult to predict. If earnings start to rise by 3 per cent in a bounce back from the real cuts that we have seen over the past two or three years, that might start to have a more significant effect on behaviour.
I was interested in your earlier comment to the convener about the potential for a short-term fiscal stimulus, particularly the reference to roads and housing as two of the most positive moves in that respect. I feel that one of the challenges that we face is to raise our long-term sustainable growth rates because, by doing so, we might be able to grow the tax base to a point at which we can close the permanent gap in the fiscal position that you have identified and recover some of the spending that we previously enjoyed. Might the financial markets and credit agencies that assess our fiscal position take a more positive view of that kind of investment in roads, housing and even—I would argue—broadband infrastructure and rail? I appreciate that rail might take longer to deliver, but broadband is relatively shovel-ready and other projects—indeed, even some rail projects—in Scotland and elsewhere could be triggered relatively quickly if funding were made available. Would those looking at the UK from outside find raising the long-term economic growth rate through such investment more attractive as a stimulus and response to the current fiscal position than, say, short-term measures such as those involving VAT or other quick hits on consumer demand?
You are right to suggest that long-term growth rates are crucial and anything that can be done to improve them will improve the fiscal situation.
I am probably not the right person to ask about how the markets will respond, but I doubt whether they will respond in a significantly different way to policies that have a slightly different focus on achieving growth—at least, not in the short run. There is a lot of evidence that markets take a surprisingly long time to respond to longer-term issues and little evidence that, when they think about debt, they take much account of accumulated pension liabilities, which are very different across countries but do not seem—or take a very long time—to be reflected in the markets’ response to those countries.
There is a clear difference between things that act as a short-term stimulus and things that create long-term change, but there are links. A short-term stimulus to increase youth employment, for example, would be expected to have some long-term positive effects, because we know that the effects of long-term unemployment can scar young people.
On spending, a lot of road projects appear to have very big benefit cost ratios, probably more so than rail for that type of economic return. In that sense, those projects might be expected to have more of a long-term effect than a straight short-term cut in a tax. You might go for a short-term tax cut because it can be done just like that—you can cut back VAT or national insurance tomorrow, as fast as you want to do it. Road or house building would take a little while to come on stream.
On a point of clarification—
I am keen to let other members in, but I might let you back in if we have time.
I was interested in—and surprised by—some of your statements and suggestions on the issues around tax reform. You suggested in response to Paul Wheelhouse that changes could lead to increased employment among mothers of school-age children—which I presume is what working tax credits and so on were intended to do—and among people aged between 55 and 70. Are you assuming that we will return to full employment? Otherwise, the chances are that the 55 to 70 age group will be economically active at the expense of the 18 to 30 age group.
Again, there is a short-run versus long-run issue. In the long run, there is no evidence that older people are competing much with younger people for jobs. If you look across time and internationally, you will find dramatic differences in the employment rates for older people and younger people, but they tend to be closely correlated. The employment rates for people under 25 and over 55 in France are very low, whereas in the US they are quite high on both sides of the equation. In the 1980s and 1990s, the employment rates for both groups were falling in the UK, but the employment rate for the over-55s has been rising since the mid to late 1990s.
The point that we make in the chapter on tax reform is specifically about the medium term. It is not about what we could do tomorrow to increase growth next year, but about what we could do to the tax and benefits system in the next five years to improve the productive potential of the economy in the next five, 10 or more years. We specifically discuss two groups—those aged over 55 and mothers of school-age children—because there are some groups of people in the population whose working behaviour seems to be almost unaffected by the tax and benefits system.
Across long periods of time and in almost every country, 90-plus per cent of men between the ages of 30 and 50 are working, but different numbers of mothers of school-age children work. That appears to be closely related to the tax and benefits system, the provision of childcare and so on. The same is true of people aged over 55, who are responsive to the pensions system, the tax system and so on. Our modelling suggests that, if we make tax allowances more generous at 55 or reduce the point at which we stop national insurance contributions, we could make quite a big difference to the numbers of people who are in work in the medium term.
I stress that chapter 8 of the green budget is specifically about the medium term. It is not about what we could do tomorrow to make a big difference.
I understand that. If we are looking at reform, many of the proposed models for the future governance of Scotland suggest that we will control our own taxation, so we will have to think about those issues up here when we consider future policies and so on.
The summary of chapter 8 states:
“one of the reasons that consumption taxes may be more growth-friendly than income taxes is that they are generally less progressive.”
That is somewhat counterintuitive. I am not sure that I understand why a less progressive form of taxation, which means that people on lower incomes do less well, necessarily increases economic growth. I presume that, if we tax consumption and property, it is more difficult for people on low incomes to be able to afford to purchase goods and services. I am not sure that I understand the correlation.
The main reason for our making that point is that a number of people—the OECD is a case in point—make such statements with some strength. They say that consumption taxes are better for growth than income taxes. The question is why. What such people often do not go on to say is that consumption taxes are generally less progressive than income taxes.
When we design any tax system, we are always—or mostly—trading things off, including the speed at which we increase marginal rates and the extent to which we charge everything at the same rate. If we have a flat consumption tax, there are probably lower marginal rates across a broader brand of people. If we have income taxes, there is usually a progressive structure, which charges people on higher earnings more.
Most economic models suggest that a higher marginal rate, or a progressive marginal rate structure, has a more negative impact on economic activity than a flat rate. We can trade off, as it were, the greater progressivity of the income tax system and the potential greater efficiency of the consumption tax system. The point that we were trying to make in the chapter that you quoted is that, when some people say that a consumption tax system is more efficient, they forget that it is also less progressive and that there is a trade-off.
It depends on the income structure of the population. I would have thought that, if we have a larger number of people on lower incomes, their spending power will be quite important to economic growth.
Their spending power and behaviour are clearly important. There are many elements. Taxes do three things to behaviour. They reduce people’s income, so they reduce their consumption, but that might result in their working more to maintain their consumption. Taxes also reduce the amount that people earn for every extra hour that they put in, which might reduce their effort and, again, their consumption.
You also mention the setting of corporation tax. In a number of the scenarios that are under discussion, Scotland would be responsible for raising corporation tax. In the green budget, you sound a note of caution about using that power to reduce the rate of corporation tax. It states:
“It is hard to judge whether the benefits from greater levels of activity would be sufficient to outweigh the costs of the public spending cuts that would be needed to finance reductions in the rate of corporation tax”.
It also states:
“separate rates across the four nations could lead to harmful tax competition within the UK, which would reduce tax revenues for all nations.”
You say that, if the power to set corporation tax is devolved to Scotland, we should be cautious about rushing to reduce it, because that could have adverse effects.
You raise two points. Take a world in which the setting of corporation tax is devolved to Scotland and you make a choice about the rate. In the long run, a lower rate of corporation tax will probably have some positive impacts on economic growth. That might also be true of income tax and other taxes. However, as we say in the summary, there is evidence that corporation tax is one of the less efficient taxes. If we choose to reduce it, there will be an immediate fiscal consequence because, to cover the cost, we would need to either increase other taxes or cut spending. Governments make those choices, but how they will turn out over the medium term is difficult to determine.
11:00
In the past 20 years, headline rates of corporation tax in the UK and most other OECD countries have gradually fallen in the face of what is essentially competition between countries. What is interesting, though, is that the amount of revenue that is derived from corporation tax in most countries has not fallen as a proportion of national income, largely because the tax base has become broader over time. People have been forecasting for a long time that corporation tax revenues are bound to fall off a cliff at some point. It has not happened yet, but that is not to say that it will not happen.
In effect, the UK Government is trying to put in place a lower rate of corporation tax for some profits that it deems to be particularly mobile. That is what the thing that they call patent boxes is all about; it is intended to charge a lower rate of tax on revenue that is derived from intellectual property. We can have a discussion about why that is not necessarily being done in the most effective way, but that is how the Government is attempting it.
On the Scottish decision whether to increase or reduce corporation tax if it is devolved to Scotland, there would be a trade-off between the amount of revenue that you would get in the short run, the other tax increases and spending cuts that you would need to make, and the impact that there might be on long-term growth.
I suppose that, in this devolved world, there would then be a spillover effect on what was feasible or sensible in England and the other parts of the United Kingdom. If Scotland reduced its corporation tax rate to, say, 10 per cent, that could have two effects—it could increase the amount of investment in Scotland by Scottish companies, or it could draw in investment that would otherwise have occurred in other parts of the United Kingdom. The latter would be a negative spillover effect on England, which might decide to reduce its corporation tax rate. There would then be competition over rates of corporation tax, which would drive rates and revenues down in all the countries in a way that would not happen if corporation tax was not devolved.
That seems to be the balance of the arguments. One of the key questions is how much new activity would be created by a lower corporation tax rate in Scotland or Northern Ireland and to what extent it would simply take activity from one place and put it in another.
In economic terms, though, Britain is not an island. Even if there was competition within the nations of Britain, it would surely attract investment from overseas as well. I am a graduate of the University of Stirling and I worked in one of the first silicon glen factories or facilities to open, which was Wang Laboratories. When Ireland reduced its corporation tax, that company moved over to Ireland. I also worked for Leo Laboratories, which also moved its facilities from the UK to Ireland because of the reduced corporation tax there.
The issue is not just whether there would be competition between Scotland and England. If there was such competition and England responded by reducing its corporation tax, it would surely be likely to attract investment from other parts of the globe to Scotland, England, Wales or wherever.
You are right. There is the issue of bringing in investment from elsewhere. One of the differences between England and Scotland relative to Wales and Northern Ireland is that England and Scotland are significantly wealthier and have significantly higher corporate tax bases than Wales and Northern Ireland have—or, indeed, than the Republic of Ireland had when it introduced a low rate of corporate tax. As a result, the risk to revenues in the short run is probably bigger in Scotland and England than it is in Northern Ireland and Wales or was in the Republic of Ireland. Nevertheless, you are absolutely right to suggest that one impact would be to bring in more investment from beyond these islands.
I want to explore the point made in chapter 5, which focuses on public sector pensions and pay, that pensions and average hourly wages tend to be higher in the public sector than in the private sector. On the surface, that might be seen as a bad thing, but from another point of view it might be a good thing. After all, if private sector employers are paying only the minimum wage, the public sector has to top up wages with tax credits or whatever. There is still a cost to the public purse. One answer might be to raise the minimum wage and get the private sector’s earnings up and more people paying tax, which would save on tax credits.
Similarly, with regard to the debate over whether public sector pensions are more generous—although, in absolute terms, they are not very generous—are we simply storing up longer term problems for pensioners in the private sector, who will not have any private pension and will be dependent on the state for pension credits and so on? How can we weigh those things up?
Indeed. You have asked a lot of questions. On the relativity between public and private sector wages, I do not have a view on whether it is appropriate for the public sector to pay 5 per cent more, 5 per cent less or whatever. It all depends on the quality of individuals that you want in the different sectors and the way in which labour markets work. Although we have done our best to control for differences between the public and private sector workforces, they might just be different in ways for which we are unable to control.
What is striking about the difference between public and private sector pay is that there appears to have been an unintended relative increase in public sector pay after 2008. Private sector pay responded quickly to the recession, essentially by not increasing much in 2009 and 2010, while public sector pay responded much less quickly, partly because of the number of two and three-year pay deals that were honoured. According to our analysis, it is arithmetically true that, broadly, the two-year public sector pay freeze and the two further years of 1 per cent increases will by 2014-15 have returned the relativities to where they were in 2008-09.
On the role of tax credits in topping up earnings, there is limited evidence on whether tax credits result in employers’ offering lower pay than they would otherwise have done. There might be some impact, but the evidence is by no means convincing. The role of tax credits has certainly grown over time.
I guess that the real issue about the relativity between public and private sector pay is that, if wages get out of line in one direction or the other, either we will not be able to recruit people of adequate quality into the public sector—which one might argue was the world that we were in at the end of the 1990s, when it was extremely difficult in some parts of the country to recruit teachers and nurses—or, if public sector pay is much higher, we will simply crowd out activity in the private sector.
A striking finding of our analysis is that the relativities are different in different parts of the country but that, again, Scotland looks on average very much like England. Indeed, that holds true in much of our analysis of incomes, GDP and so on. Wales and Northern Ireland look out of line with the rest of the UK because in those areas public sector pay and employment are high relative to levels in the private sector. That might well be a cause for concern. On the other hand, public sector pay in London and the south-east looks a bit low, certainly relative to public sector pay in other parts of the country.
On that point, it has been suggested that UK agreements should contain variations to allow higher wages to be paid in London and the south-east than elsewhere. Would paying higher wages for the same job not amount to a kind of subsidy?
London weighting already exists; at one level, someone doing a job in London is already paid more than someone else doing the same job in another part of the country. I cannot remember the numbers, but I believe that a police officer in Wales gets twice the average earnings in Wales, whereas a police officer in London gets just under the city’s average earnings. The lifestyles that a salary can buy in different parts of the country and where people sit in the country’s earnings distribution will be different, and that is reflected in differentials in private sector pay across the country.
I do not know whether you have looked at the minimum wage or feel that it is outwith your remit, but have you considered the impact of raising that to the level of the living wage, which we take to be £7.20 an hour?
We have not carried out our own analysis on the crucial issue of the impact of such a move on employment levels. However, there is clearly a big gender issue. Most people on the minimum wage are women and, going back to your initial question, I should also point out that there is a much bigger gap between the public and private sectors in the wages paid to females. That the public sector premium for women is very much higher than the public sector premium for men might reflect the use of monopsony power in the private sector to keep wages down, particularly for women who work part-time, cannot travel very far and have limited choice, and the fact that in some sense the public sector is a better employer. It is still unclear, but there is a case for arguing that, with the smaller gap between male and female wages, the public sector might actually be paying closer to what might be called a market wage. The difference between the public and private sectors with regard to women is really quite striking.
What I find really striking about what has happened over the past 20 years with regard to pension provision has been private sector companies’ almost complete withdrawal from defined benefit schemes of any kind. The development has been unbelievably dramatic. Twenty-five years ago, we would have thought of the UK as being very dependent on occupational defined benefit schemes, with 40 or 50 per cent of private sector employees in them; now, I think that significantly fewer than 10 per cent of private sector employees have access to an open defined benefit scheme and for young people coming into the labour market the number is smaller and disappearing.
There are two or three reasons for that withdrawal. First, the very big and somewhat unexpected increase in longevity has increased costs, and it is a cost—and a risk—that, for good reasons, the sector finds very hard to bear. The fact that the public sector can bear such costs is one reason why, as you have suggested, people think that pension provision in the public and private sectors might be different. Secondly, there has been a significant increase in regulation and companies have lost control over what they can do with their schemes. Finally, returns from the equity markets have been volatile and, over the period, not very good.
There are differences between the public and private sectors with regard to those issues because, as I have said, the public sector can bear risks that the private sector cannot, and it is not exposed to certain investment problems. What that means is that, although 40 years ago many aspects of employment in the public and private sectors, including pensions, looked similar, things now look very different.
11:15
There is almost complete coverage of defined benefit schemes in the public sector and almost no coverage in the private sector. That raises two issues. Could the state do anything differently in relation to the private sector, and could it shoulder some of the risks that private sector companies, quite sensibly, cannot or do not want to shoulder? That is an interesting question—could there be more risk-sharing between the public and private sector? If not, are problems created by having that different approach in the public sector? Does the increased generosity of the overall remuneration package in the public sector, relative to that in the private sector, create labour market problems? Secondly, what is the long-term cost of public sector pensions?
The cost is clearly affordable; the question is whether we want to pay it. On average, across the public sector schemes and after all the reforms are put in place, you would add about 16 per cent to the pay of an average public sector worker—if they earn £20,000, you would add £3,200—in order to get the value of their package. The average value of any private sector contribution is a lot lower than that 16 per cent—I cannot remember the exact figure—which increases the gap in remuneration between the public and private sectors.
In the long term, however, the state has the problem of having to subsidise people who have no pension.
The state provides basic pensions for all. A bunch of things are going on in pension policy at the moment. One is the introduction of auto-enrolment from this September, and another is the earnings indexation of the basic state pension, which will apply to everybody—it will apply to both the public sector and the private sector—and will be the biggest driver of increased costs. The idea behind the current level of second state pension plus basic state pension is that most people will not retire on means-tested benefits.
The third thing that is being considered by the Government is the speeding up of the introduction of a single-tier basic pension, the idea being that everyone would retire on at least £140 a week. Contributions to their state earnings-related pensions scheme—the second state pension—would be put together with their basic pension scheme, and they would end up with £140 a week, which would keep them off means-tested benefits. We are waiting to see whether that will be implemented.
Many things are, therefore, going on that ought to result, in the medium term, in a smaller number of people being on means-tested benefits, but you are right to say that a large proportion of people over the pension age currently receive a means-tested benefit of one kind or another.
Gordon Brown’s private pension tax grab clearly did not help either.
Mr Johnson, I want to get some further particulars on some of your opening remarks. Your short-term forecast is slightly weaker than the OBR’s most recent forecast, but you have said that, in the medium term, tax revenues will be slightly higher. The figure you gave was about £9 billion, but you stressed that that would be in the medium term. Where will the increased tax revenues come from, and what will underpin them?
I suppose that the question that we have asked ourselves is slightly different. We do not understand why the OBR is being so gloomy about tax revenues. It has also made assumptions about economic growth. Under economic growth, tax revenues are usually expected to rise in real terms, because, as a result of fiscal drag, people are dragged into higher tax brackets and profits increase. In addition, some of the tax increases announced by the Government have yet to come into effect.
The short answer is that we see more tax revenue throughout the income and corporate tax system than the OBR does. We are meeting the OBR this Friday to try to understand why our view is different. We are a little puzzled about why the OBR is so gloomy about tax revenues.
I should stress that, like the OBR, we are not building into that any assumption about the proposals for the personal tax allowance. Although the Government has said that it wants to achieve those policies, it has not enacted them. The OBR does not take account of policies that have not been enacted. I cannot remember how much those proposals would cost, but it is certainly several billion pounds. They are not in any of the fiscal arithmetic at the moment, and if that approach is to be taken, it will need to be paid for somewhere else in the tax or spending system.
Do your assumptions take into account a rise in line with inflation for the personal allowances, or are you assuming no increase?
They take into account a rise in line with inflation.
One of your conclusions was that you wanted a spending review—an accelerated one, I suppose—by the end of next year. Will you expand on that? Also, for how many years ought that spending review to be in place? Should it be three years or four years, for example?
In some senses, the process would not be accelerated, because the previous spending review was at the end of 2010, so it would still be three years after that one. Historically, over the past 10 to 15 years, that has been the frequency.
Our view is that the issue is really quite important. The previous spending review happened very quickly after the Government came into office, and a lot of big decisions were made about the relative priorities for different departments, for example a real freeze in health, something like an overall 10 per cent cut in education—very much focused on capital spending—a 25 per cent cut in spending on justice, the police and so on, a 30 per cent cut in spending on local government, and a 70 per cent cut in spending on social housing. There were some quite dramatic differences between departments and some significant choices taken within departments.
Given the overall budget constraint that the Government has set itself, it had to make some big choices. By the end of 2013, we will be a couple of years into that process and we will know more about what has happened and how effective it has been, and we hope to know a little more about what the impacts have been. It will be surprising if it turns out that those ex ante decisions were exactly the right set of decisions. That is not a criticism—whatever choice we make, it is unlikely that we will get it right. Some review of that seems an important part of good government.
We know that some cuts are going to be more difficult to achieve than others. An example is the big cuts faced by the Home Office and the Ministry of Justice. It is essentially not possible to make policemen redundant, which makes it difficult to achieve the proposed cuts. If they are achieved, it will probably be by making redundant those who are the least expensive to employ and leaving in place those who are the most expensive to employ. The committee might want to revisit that example. That is one part of it.
The second part is that by the end of 2013 we will be only 18 months away from the new set of cuts that have been pencilled in for 2015-16. Given the scale of change that local authorities and education and health systems will have gone through up to that period, if they are not given an adequate period to prepare for more very bad times or for some slightly better times, there is a risk that substantially inefficient decisions will be taken very quickly. From a political point of view, it would probably be more comfortable to leave those decisions until after the 2015 election, but that would mean making in-year cuts immediately. If people do not have a chance to plan, particularly after the difficulties that they will inevitably have had over the period up to that point, there will be a risk of significant inefficiency.
It may be that 2013 is too early, but 2016 is certainly not too early for the Government and the country to be thinking really hard about what we want the shape of the state to be going forward. On OBR projections, by 2060 we will be spending half of everything that the state spends on just health and pensions, purely as a result of demographic change. In our view, those are conservative assumptions and the figure may be higher than that. That leaves us with some very big, long-term strategic decisions to make. We might seek to move from a broad equilibrium of spending 40 per cent of GDP on public spending to spending 45 per cent of GDP on public spending to accommodate those pressures. That is a plausible but big long-term choice. Alternatively, we might want to make substantial reforms to health and pension spending in order not to accommodate those pressures, or we might need to find ways of imposing more substantial cuts on everything else that the state does. Over time, those things change, but they tend to change without any serious discussion. Our view is that we are getting to the point at which we need to think publicly, not just within Government, about what our decisions should be.
Thank you. In your analysis, have you drilled down much into the Scottish economy? If so, are your projections for the Scottish economy different from those for the UK economy more generally?
We have not looked at the Scottish economy. However, I can give you a couple of thoughts that strike me immediately, looking from the outside at how the UK fiscal and economic situation relates to that in Scotland. I have said it a couple of times, but the income and GDP levels and so on look very similar. As you know, Scotland is not like Wales and Northern Ireland, which are very much poorer than England.
The second point that strikes me is how important North Sea oil is to the Scottish economy. The North Sea oil tax revenues are important in the UK budget, but they are small. However, in the context of the Scottish budget, they are really important. That makes the Scottish economy a different kind of economy from the English economy. It also has an impact on volatility in the fiscal situation at a Scottish level.
I do not really have any views on the macroeconomic outlook for Scotland relative to that for England.
I want to raise one other issue that has not been touched on by anyone so far, although it takes up one of the 11 chapters in the green budget. The withdrawal of child benefit from better-off families will impact on 1.5 million families and is significant, given that child benefit can range up to £2,449 a year for families with three or more children. You say:
“The ‘cliff-edge’ feature of this policy ... will create a bizarre and economically damaging set of incentives for people within certain income bands.”
You go on to talk about
“the fairness of effectively rewarding people for working less or arranging a pay cut with their employer.”
A couple who earned £42,000 each would not lose benefit, but one person earning £43,000 would. If someone earning slightly less than that were offered a pay rise or promotion, they might decide to reject it because they would lose their benefit entitlement.
Can you expand a wee bit more on the impact of the change on the Exchequer? You have talked about the significant loss to the Exchequer through people avoiding tax and so on.
11:30
You have summarised the issue very well. I should probably declare a personal interest as the father of four children who currently receives child benefit.
The point that we are making is not about whether taking child benefit from people on higher incomes is the right thing to do. The question is whether the approach in question is an effective way of achieving that. As you say, there seem to be two quite substantial problems associated with it. One problem is that the moment a person becomes a higher-rate taxpayer, they will lose all their child benefit, which means that, as we have said, several hundred thousand people will become worse off if their earnings rise, and several hundred thousand people will become better off if they manage to reduce their pay. That is not as difficult as it may appear: if a person makes pension contributions, their taxable income will not be affected, so a clear incentive will be put into the system for people who are just over the higher-rate threshold to up their pension contributions, which will increase their long-term income—and their short-term income. It will be interesting to see whether people take advantage of that.
The Exchequer saving from the policy is reasonably significant. I cannot remember what it is—I do not have the number in front of me—but I think that it is around £2 billion. Given the problems that you have pointed out, the question is whether there are ways of achieving something similar without creating those problems. The obvious method would be integration into the current tax credit system, which provides a direct mechanism for providing higher child benefit payments to particular groups that one wants to target. We have illustrated ways in which that can be done. That will not give exactly the same outcome as will come from the child benefit policy as described, partly because the child tax credit is also dependent on family income. That is probably an advantage for exactly the reasons that you have described—unless we want to treat two people who are on £40,000 much more generously than one person who is on £44,000.
The downside of that approach is that the take-up of child tax credit is not 100 per cent, whereas the take-up of child benefit is near enough 100 per cent. One would therefore potentially risk not paying support for children to a reasonably substantial number of families that one is not aiming to take it away from. I cannot remember the take-up level for child tax credits for people on £30,000 or so, but it will be well below 100 per cent. If there was a move towards paying child benefit through that route, there would be a risk of reducing the take-up level to well below 100 per cent. As a policy, it seems better, but it is not without risks, and the policy as it is currently constituted looks odd.
Thank you.
I apologise to Paul Wheelhouse and Mark McDonald, who have further questions—unfortunately, the session has already really overrun. I will allow our committee adviser, Professor Bell, to make some comments, if he wants to do so. He is not allowed to ask questions, but he can make comments.
Professor David Bell (Adviser)
I have very much enjoyed the session. I will make three or four points that the committee might like to consider.
In particular, I want to pick up the point about the IFS proposal that there should be a spending review in the very near future. I invite the committee to think about what its role would be in the spending review that would naturally follow for Scotland, particularly in the light of the gloomy public spending outcome that we can see on the horizon over the next few years. Once again, that raises the problems that the committee has had over the years in trying to press for the maximum efficiency out of our public services and getting the data that we need in order to get efficiency to increase. That is particularly relevant in the light of some of the earlier discussion.
I think that Mark McDonald first brought up the issue of tipping points. Some tax rates are so high that we are getting to the stage of having difficulty seriously believing that revenue will expand significantly in the future.
There are further reasons why we should be interested in understanding behaviours in response to tax changes. It is possible that Scotland will have more tax powers, so those behaviours will be as relevant to us as they are to the UK as a whole. If we had control over excise duties, issues such as the importance of smuggling would take on a different aspect. How mothers with young children or older people respond to changes in the income tax system will be relevant in almost any state of the world if the Scotland Bill is passed.
Paul Johnson argued that Scotland and the UK as a whole are pretty much the same in many respects, but our demographic situation is a little trickier. In relation to public spending projections, that raises the problem of intergenerational equity, which I have banged on about. I learned an interesting fact about that this morning, which was to do with the differences in consumption patterns between the over-50s and the under-50s. We had a good session on demography, but we must translate that into understanding what it means for the Scottish budget.
We had an interesting discussion about public sector pay and pensions. As Jeremy Peat is sitting in the public gallery, I highlight the work that the David Hume Institute is doing on public sector pay and pensions, which will result in something being published in the next couple of months or so.
We might want to invite the Low Pay Commission, which has come up once or twice before, to make a presentation on low pay. It is the appropriate body to discuss the response to changes in the minimum wage.
The Barnett formula has not been mentioned at all. The way in which it works in theory is that, as long as spending increases, the Barnett squeeze should occur, so that we move towards equalisation of public spending in what are called the different territories, or nations—I had a big dispute about that yesterday, so I will not commit myself on that.
Go on.
The corollary of the equalisation of public spending per head in England, Scotland, Northern Ireland and Wales when spending increases is that, when spending decreases, we move back towards the original settlement way back in 1979, which would embed Scotland’s public spending advantage going forward. That is a final point to throw in.
Thank you very much, Professor Bell. We are now well over time, so I thank Paul Johnson for his attendance and his answers to our questions. We shall reconvene at 11.45.
11:38
Meeting suspended.
11:45
On resuming—