Treasury Committee
Oral evidence: Autumn 2022 fiscal events, HC 740
Monday 21 November 2022
Ordered by the House of Commons to be published on 21 November 2022.
Watch the meeting
Members present: Harriett Baldwin (Chair); Rushanara Ali; Anthony Browne; Dame Angela Eagle; Emma Hardy; Siobhain McDonagh; Alison Thewliss.
Also present: Anne Marie Morris (Public Accounts Committee)
Questions 232-309
Witnesses
I: Dr Linda Yueh, Fellow, St Edmund Hall at Oxford University, Mike Brewer, Deputy Chief Executive and Chief Economist at Resolution Foundation, Samuel Tombs, Chief UK Economist at Pantheon Economics, and Carl Emmerson, Deputy Director at Institute for Fiscal Studies.
Witnesses: Dr Linda Yueh, Mike Brewer, Samuel Tombs and Carl Emmerson.
Q232 Chair: Welcome to the Treasury Committee evidence session on the autumn statement. We are pleased to welcome a Member who is guesting today, Anne Marie Morris, in her capacity as a member of the Public Accounts Committee. Tomorrow, our Committee will be at full complement. I invite our witnesses to introduce themselves.
Samuel Tombs: I am Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics.
Dr Yueh: I am Linda Yueh, Fellow in Economics at St Edmund Hall, University of Oxford. I also hold an adjunct professorship of economics at London Business School.
Carl Emmerson: I am Carl Emmerson, Deputy Director at the Institute for Fiscal Studies.
Mike Brewer: I am Mike Brewer, Deputy Chief Executive at Resolution Foundation.
Q233 Chair: I welcome you all. I will start with you, Linda. One of the strange things about the current UK economy is that we are arguably already in recession, yet we have very low unemployment and we have had some marked changes to the labour force since the pandemic. Is that unique to the UK, or are you seeing that elsewhere?
Dr Yueh: It is not unique. Lots of major economies are also experiencing either stagnant or contracting economies. For example, the US was in—I was about to say it was in recession, but it has not been judged to be in recession, even though the economy contracted for about six months. The labour market there is also very tight, as in unemployment is low. The great resignation partly picks out the point that over the past couple of years the pandemic lockdown has changed behaviour. A lot of major economies are in a similar position, looking at tightness in the labour market, recessionary conditions and, in our case, record vacancies—1.3 million—which is an unusual combination.
Looking ahead, because the economy has been contracting since about August and the latest OBR forecast is that we will be in recession for about a year, based on that forecast it looks like unemployment is expected to increase to just under 5%. That is not going to happen for about a year or so, and that is because unemployment is a lagging indicator. I suspect that that is very similar for other economies because, especially in tight labour markets, firms will want to hold on to workers. Only when they are sure that they cannot keep them, because of recession, will they lay people off. Unfortunately, we will see unemployment increase later.
Q234 Chair: I hear that other developed economies see some of the same characteristics in their labour force. On Thursday, the Chancellor announced that a piece of work would be done with the Department for Work and Pensions on how to address some of the issues. May I widen the questioning to the rest of the panel? What can be done about this unusual labour market situation?
Carl Emmerson: One of the challenges is that a lot of older people who we think would have been in the labour market had the pandemic not happened are now economically inactive. Some colleagues have done some research looking at that, and they do not think it is the case that people have been in work, got ill and left work; they think what has happened is that two separate things are going on.
A set of older people were already out of the labour market, but seem to be now in worse health—that is one policy problem. The second policy problem is closer to your labour market question, which is that a set of people who were in paid work have chosen—it looks like—to leave the labour market. That might be good for them, or bad for them—time will tell—but if the policy question is how we would get them to go back into work, that is a pretty hard thing to do.
We know that once people have left the labour market at older ages, some re-enter but it is not that common. If they are not unemployed, it might be quite hard for, say, the Department for Work and Pensions to pull a policy lever that makes it happen. Actually, what policy makers might need to think about is this. Is it a one-off shock, a generation of older people who hit the pandemic, perhaps experienced furlough or working from home, and decided, for whatever reason, they wanted to retire, or is it something that will feed through to subsequent generations? Will people who saw their older colleagues and perhaps their older siblings retire earlier also be looking to do that? Will it be something that will continue? That, to me, seems to be the big question, rather than how plausible it is that we can get these people back into work, which I think would be very difficult.
Q235 Chair: The work that you have done suggests that this is predominantly older people. What are we talking about in terms of percentages?
Carl Emmerson: A large part of it is older people. There is also an increase in the number of younger people who are inactive, and there has been an increase in the number of younger people who are in education rather than paid work. But a large part of it is older people: I think about half a million fewer people are in paid work at older ages than would have been had pre-pandemic trends continued.
Q236 Chair: Mike, what is the solution to this problem?
Mike Brewer: Well, we need to know a lot more about the situation of these older people. At the risk of generalising, if it is people who have a large amount of housing wealth and pension wealth and they are just deciding they do not need to work any more—they have reached the end of their working life—there is not a great deal that Government can do, mostly because you don’t have any direct interaction with these people. Of course, the UK does have a relatively high employment rate. We think we are at full employment; we have a relatively high employment rate. I am fairly relaxed about our aggregate labour supply, but I did note the OBR’s warning about the rise in disability benefit claimants, which I think is a separate issue from the older people stepping out of the labour market right now for the reasons that Carl gave. The OBR did say it has increased its forecast for the number of people on disability benefits by 1 million by the end of the forecast period. It looks like that is the main challenge to labour supply in this country.
Q237 Chair: Has there also been a big shift in terms of people who are self-employed, because during the pandemic, people discovered that furlough applied predominantly to people who were on a payroll? Has that changed behaviour? Are you seeing that in your work?
Mike Brewer: There was a big fall in the number of self-employed in the pandemic. I think our work shows that a good chunk of that—maybe the majority of it—is about reclassification: employment went up; people were either simply reclassifying or actually changing from self-employment to employment. I think the headline figures overstate what has actually happened to the labour force when it comes to looking at self-employment.
Q238 Chair: Samuel, is the rise that we are seeing in unemployment and that the OBR has set out in the forecast period due predominantly to the fact that the Bank of England is raising rates to combat inflation? Is that the cause, or does it have something to do with the tax and spend policies announced in the autumn statement?
Samuel Tombs: Monetary tightening certainly is having a big influence on corporates’ hiring plans. We have started to see that emerge in the latest survey data. If you look at things like the Report on Jobs survey for October, for instance, you see very sharp falls in the number of businesses wanting to go out and hire in the wake of the big rise in interest rates that they are starting to experience. It is important to note that corporates borrow a lot on floating-rate terms; about 80% of bank loans to corporates are floating rate, so there is an immediate impact on their financing conditions whenever the MPC increases the bank rate. Already we have seen an increase to 3%, and that has started to impact those CFOs’ hiring decisions and investment decisions in the last couple of months. Evidence is starting to emerge that corporates are pulling back from those hiring decisions.
The OBR’s forecast assumes, as Linda mentioned, around a year’s lag between the first drop in GDP, which we have just seen in Q3, and employment starting to fall. I think we could see a much sooner pass-through into falling employment, based on the fact that some of those survey indicators have started to weaken, but also, historical experience suggests that the lag isn’t quite that long. If we look back to the 2008 recession, GDP started falling in Q2 and employment started falling in Q3 of that year. The same is true of the 1990s recession: they fell almost simultaneously. I think we have less scope just to wait it out and see what happens in the labour market; we should start to see the data deteriorate in the next three or four months. In that sense, I think there is a much more pressing problem with unemployment coming than perhaps is embedded in the latest unemployment projections. Also, looking back to past recessions, there is around a 3:1 relationship between falling GDP and falling employment. In the 2008 recession, for instance, GDP fell by about 6% and employment by about 2%. In the OBR’s forecasts now, it is assuming a much smaller pass-through from falling GDP into employment. It has GDP falling, peak to trough, by 2% but employment only falling by 0.4%. If you were to apply that 3:1 relationship, you would be looking at more like a 0.7% peak-to-trough fall in employment.
The OBR is assuming quite a lot of good news in its forecasts—a much weaker relationship between GDP and employment than we have seen in the past. There is some reason to think that it could be weaker, because we have a very tight labour market right now and businesses may want to hoard a bit more labour than usual, but I would say the risks to that assumption are to the downside, both in terms of the magnitude of the hit to employment and how quickly it might feed through.
Q239 Chair: Samuel, you are on this panel because you have a good track record as a private sector economist—I hope that does not make you blush too much. I just wonder where you would quibble with what the OBR has put out. Where do you see the biggest difference in terms of your own work, and where do you see the biggest risks to the OBR forecast?
Samuel Tombs: The OBR’s forecasts for real disposable income for households look quite dramatic. It has a 3% fall this year and a further 3.4% fall next year. That is unprecedented, at least in the last 70 years, for which we have the data.
The situation probably is not quite as bad as that. I have had a look at its numbers and I think perhaps it is factoring in too big a shock from mortgage refinancing. Its projection for the effective mortgage rate to rise to 5% in two years’ time seems to assume quite a lot of mortgages being rolled over, when we know that only around 7% of the stock of mortgages is refinanced every quarter. To get up to 5% in a couple of years from 2.2% at the moment would require a very large roll-over of mortgages and/or very high interest rates being assumed, and I cannot quite get my numbers to get it up as high as that. I think the income shock could be a bit smaller in the near term than the OBR is expecting when I look at its mortgage rate assumptions.
However, what really drives its forecast of what is quite a swift recovery—we have a 2% fall in GDP in the OBR’s forecast for the next year, and then much stronger growth than most other forecasters are expecting coming through in the subsequent years—is that it expects the saving rate to fall quite significantly. It expects that households will suddenly become a bit more carefree and will run down the savings balances that they amassed during the pandemic, or perhaps borrow a bit more. Therefore, in the OBR’s forecast, you see quite a swift recovery in real expenditure from households in 2024, and that brings the economy out of this slump.
This is where there is a big difference with the Bank of England’s forecasts. The Bank is forecasting a persistently high saving rate going forwards, rather than a falling one, and therefore the squeeze on incomes feeds through much more fully to expenditure in the BOE’s forecasts.
I would probable side more with the Bank of England on this. I think that the saving rate will remain quite high. After all, if you look back to previous occasions when unemployment has been rising, households tend to save more, for precautionary reasons, whenever the chances of being made unemployed are rising. If you look back to every past recession, you see the saving rate rise alongside the unemployment rate, whereas in the OBR’s forecast you have unemployment rising but the saving rate falling. That does seem a little hard to reconcile with past experience.
We already see as well, in some timely data, that households are stepping up their ad hoc repayment of debt. They are choosing to hold on to those big savings balances that they amassed—in aggregate, anyway—in the pandemic, and they are choosing to pay off debts more frequently in the last few months. Finally, the fact that consumer confidence is very low at the moment would usually be associated with a rising saving rate, or it being maintained at a higher rate rather than falling further. So I would say the OBR’s projections for the saving rate to fall to a joint 60-year low next year seem quite optimistic.
Q240 Chair: Turning to the characteristics that we have described in the labour market, let us discuss some of the cliff edges that are becoming quite entrenched in the measures that successive Chancellors have announced. I am thinking in particular about the cost of living payments that were announced for this winter to help people on benefits. I can see that was done to be a quick, robust and straightforward way of paying households the £650. The Chancellor has announced £900 for a similar cohort next year. That seems to start to entrench quite a big cliff edge for people who are on means-tested benefits; people who are on means-tested benefits plus £1, as I understand it, will lose the full £900. That is going to send some behavioural distortions into the labour market, isn’t it? Carl, you have done some work on this, have you not?
Carl Emmerson: It is certainly not desirable. I think you can imagine why, if you are trying to do policy very quickly, this is the kind of thing you come up with and do, but it both gives rather strange incentives at those margins and, arguably, creates unfairness. People who happen to go on universal credit at the right moment in time get their slice of the £900, but those who happen not to be on it at that moment will not. Normally we want something that is tapered away. Universal credit, by design, is supposed to have a smooth taper—that is what we would want. It doesn’t just apply to the £900, but to things such as free school meals and legal aid, which have these cliff edges too.
My other point is that the £900 is a flat rate for people on universal credit. It does not take into account how many adults and children there are in your family. Again, if you have got time you would like to think you could do something that would say, “Well, people with more people in their household should get more money because, for example, they will be spending more on energy.” Given that this is for next April, it is a bit disappointing that they were not able to do something that was a bit better targeted and did not have some of these undesirable distortions in it.
Q241 Chair: In addition, is there any reason why it could not just be added to universal credit and tapered in the same way that universal credit is?
Carl Emmerson: Clearly we can increase universal credit in a more standard way if we want. Maybe the Treasury might be concerned that once you start to do that, people might see it as a part of universal credit and therefore start to argue it should be permanent, whereas clearly the intention is to have a time-limited payment, to help people for a particular period of time. They might think that by having it as a separate energy payment it is easier to allow it to expire.
Chair: Mike?
Mike Brewer: In some of the earlier lump-sum payments we have seen—the ones last year, but also the ones during the pandemic—the Government have used the excuse that they couldn’t increase all the rates of benefits in a way that allowed everyone to benefit fairly. That is not the case now. The Government have only just set the rates of benefits for next April, so they definitely could have increased benefits by £900, or whatever they wanted, from April. I presume that must be because they didn’t want to get back into that £20 row they had through 2021, where people expected and wanted that to be continued.
Q242 Chair: Have you done any work on how people will behave in front of this cliff edge?
Mike Brewer: No, we haven’t. The disincentive effect of this depends on how many payments they are going to make. They made two payments in the current financial year of £325 each, so there were two cut-off points. We don’t yet know how the £900 will be split. The more payments that are made, the less unfairness is generated from each payment, but perhaps the longer the disincentive effect is prolonged. I would hope they make three or four payments, and I would also hope they skew them towards the winter months.
Q243 Chair: Does the increase in the national minimum wage have any way of countering the problem for people who perhaps do not qualify for these payments?
Mike Brewer: It was certainly very welcome and, to some extent, surprising that the Government followed the LPC’s recommendations. This is a significant rise in the national living wage. We know there is not a big overlap at all between people who earn the living wage and people who are on universal credit. To some extent, they are nearly complementary, so that should be some relief for those people who are low paid but not getting universal credit.
Q244 Chair: Does anyone else on the panel want to pick up on the point about cliff edges and refer the Committee to any work that has been done on the impact that might have on work incentives and the challenge that we see in the labour markets?
Samuel Tombs: If you are trying to boost labour supply, freezing tax thresholds—the income tax threshold and the national insurance threshold—as a way of raising money is probably not the best way to go about it. Obviously, there are many reasons why people choose not to work, but freezing those allowances for the best part of this decade is certainly eroding the incentives.
Q245 Chair: What would be a better approach, in your view?
Samuel Tombs: Perhaps there are other taxes that could be increased that would have less of an impact on labour supply, which seems to be biggest issue in our economy at the moment. If we increase VAT, that keeps inflation higher than you might otherwise like, but it does not have these labour supply side impacts. Perhaps there are other taxes, such as capital gains tax, which could be aligned more closely to income tax rates, that would potentially not have an impact on labour supply but are another way of raising money.
The 2010s, when we saw the income tax thresholds increased significantly by the coalition Government, was period when there was an ample labour supply, strong growth in the workforce and participation rising, so it is a little odd to be looking at that as a way of making revenue. Of course it is politically expedient, because people don’t really notice when their thresholds don’t increase in line with inflation, but from the perspective of labour supply, perhaps that is not the best way to do it.
Q246 Dame Angela Eagle: On that point, if tax is taken up by freezing thresholds rather than being more honest about it and putting it on the headline rate, does that not take more money from those in the middle than it does those at the top as a percentage of their earnings? Is it more unfair on those in the middle? Apart from the stealth nature of it—
Carl Emmerson: Others can judge what is fair or unfair, but if you are raising the same amount of money by pushing up the rate, you will hit people who are on higher incomes more than if you raise the same amount of money by increasing the threshold. It would be more progressive to increase rates than it would be to increase thresholds.
Q247 Chair: Conversely, increasing thresholds, as has been happening, has been more progressive.
Carl Emmerson: The most progressive way to cut income tax is to increase the thresholds, so the converse is also true: the least progressive way to increase income tax is to reduce the threshold. Of course, it is still a very progressive tax.
Chair: Thank you. Angela, the floor is yours.
Q248 Dame Angela Eagle: I want to ask about the change in fiscal targets and the reduced headroom in the Chancellor’s plans. Mike Brewer, the Resolution Foundation stated: “The ‘headroom’…against meeting the rules is the lowest for any set of rules at their introduction since 2010.” Of course, we have had six different sets of these fiscal rules since 2010. How likely do you think it is that the Chancellor will not meet what are now even looser fiscal rules?
Mike Brewer: Yes, we said—well, it is the case—that the headroom that the Chancellor has five years ahead is the smallest it has ever been.
Dame Angela Eagle: It is 0.3% of GDP.
Mike Brewer: Yes, it is basically negligible. He set out a series of forecasts, which, if everything comes to pass as the OBR forecasts, he will basically hit. I am not too worried about that lack of headroom because the forecast horizon is five years away, and so much can happen in five years. A good reason to have headroom is if your target is in the short run and an unexpected shock would force you to do something undesirable to the public finances. The target here is five years away, and I think in that situation it is fine not to have much headroom. It is also the case, though, that the target is not a very binding one. It is very loose.
Q249 Dame Angela Eagle: It has been called the mañana rule by some.
Mike Brewer: Yes, absolutely. It basically binds the Chancellor to produce forecasts that achieve a certain objective; it does not actually bind the Chancellor to achieve an outcome that hits a certain objective. We could in practice have debt continuously rising and still be compliant with the Chancellor’s rules.
Q250 Dame Angela Eagle: We are quite close to having debt, at least on an even keel, continuously rising, aren’t we, even on this rule?
Mike Brewer: Yes, an alternative could have been to put in some sort of debt ceiling target, or at least to have debt falling by a particular year and not just a rolling five-year horizon.
Having said all that, I do not think I would have wanted the Chancellor to adopt a much more aggressive fiscal contraction than the one he has set out. I think he has made a good judgment as to how hard to contract right now, so I am not clamouring for the Chancellor to set himself a more exacting set of fiscal targets. But that reflects the state of the economy that we are in now. As we emerge out of this recession into more normal times, it would be good to have targets that set an absolute limit on the level of debt.
Q251 Dame Angela Eagle: Before I ask others about that particular issue with a mañana target, the Resolution Foundation made the point that “the framework treats current and investment spending as broadly equivalent despite clear evidence that investment” spending could “raise the level of long-term economic activity”. Do you think that that is a mistake?
Mike Brewer: Previous versions of the borrowing target have allowed Governments to borrow to invest. The current target still allows the Government to borrow to invest to some extent, but basically puts a cap on that, because you can borrow only 3%, regardless of the form of spending. In principle it would be desirable for the Government to borrow as much as it wants to to invest. Having said that, the current forecasts for how much the Government expects to invest still have investment running at reasonably high levels on an historical basis. In practice, I do not think—
Q252 Dame Angela Eagle: That is the catch-up. We are meant to be in the era of plenty in investment following the era of not very much investment at all, aren’t we?
Mike Brewer: We are, yes. The current forecasts are a little bit lower than set out by Rishi Sunak when he was Chancellor, when Boris Johnson first came into office and pledged an investment drive. They are slightly lower, but really not much lower, so at the moment that rule is not having much impact on investment. However, it would be better if the borrowing rule was just about current spending.
Q253 Dame Angela Eagle: We have now got to the stage where we have a five-year plan—I don’t know who they’ve been copying in the Treasury. To what extent do you think five-year plans, which often go over a general election period, are credible or meaningful at all?
Mike Brewer: I presume you are referring to the fact that in the current set of forecasts there are significant tax rises and spending cuts coming after 2025.
Q254 Dame Angela Eagle: But also that the investment rules have been extended to five years from the current three, so it is going further and further out, and more and more beyond the political cycle into five-year plans moving forwards. As you were saying earlier, it is constraining the Chancellor in his fiscal plans, rather than his outcomes, which seems to me to be quite a crucial difference.
Mike Brewer: I do not think I would want the Government or the OBR to take a shorter time horizon. Five years is a good period to look through temporary economic fluctuations; it is also a good period on which to set people’s expectations about where, say, Government investment is going. But, yes, there is definitely an issue with the current plan: it has back-loaded many of the tax rises and spending cuts after the next election, which must then raise some doubts as to how credible those are.
Q255 Dame Angela Eagle: Are there any other thoughts on the use of the new fiscal targets and the very narrow headroom?
Carl Emmerson: It certainly is the loosest set of fiscal targets we have had. I agree with Mike: I do not necessarily think that we should be doing more fiscal consolidation over the next few years than what the Chancellor is planning. But given that we know that we cannot have debt rising in every year, and I think we know that we want debt to rise when bad shocks happen, we do at some point need to aim to get debt on a falling path.
Now, you can argue that five years is arbitrary and it would be fine to do it in six or seven years, but at some point we do have to get debt on a path where it is coming down decisively, not by the £9 billion margin that the Chancellor has for five years hence, which is basically zero. I would not criticise him for not striving to do enough over these five years, but collectively as a country, we do need to get into a position where over the medium term we are planning to get debt decisively down, because when that next shock comes along and it is a bad one, we will want to push it up again. I think that is the key here.
On the investment plans, it is true that they have cut back what they planned to spend on investment, but in 2027-28 they are still planning to spend 2.2% of GDP on investment, which is still higher than what we managed in every single year between 1984 and 2008. At least by UK standards, I would not describe it as a low level of investment.
Dr Yueh: I agree. Because it is important to have a long enough time horizon to get through the current cost of living shock, it is also important to have an incentive for investment to occur now, because it takes years for investment to have returns. Too short a horizon arguably reduces the ability to see the payoff that is coming, so in current circumstances, I think a five-year path—not a plan, but a path—is an appropriate horizon. I think the rolling five-year basis is more arguable, as you have already heard; I agree with what has been said.
Having the budget deficit below 3% of GDP is consistent with the Maastricht treaty of the European Union. I think that does give a little bit of space to borrow to invest, but I also agree that when it comes to separating out current and capital spending, if you are intent on growing the economy and investing, borrowing to invest clearly tells our creditors, “This is why borrowing has gone up, and these are the things we are spending it on.” Then, they can take a judgment as to whether or not you will have a return in three, four or five years’ time. Having that clarity would be helpful. As we all know, a lot of this is predicated on credibility and confidence in financial markets, so I think separating out the two would be helpful. Otherwise, I agree with what has been said about the fiscal rules.
Infrastructure investment, which will come in over several years, is crucially important because one of the reasons we are not growing as quickly as we were before the banking crash a decade ago is that we invest less as a share of GDP than comparable economies. We invest 19% of GDP on average, which is lower than other G7 countries. Our business investment is 10% of GDP, which is also lower than comparable countries—the United States, for instance, is about 13%.
To grow, we need to invest in infrastructure and digital, and also in people. Part of the infrastructure plan involves investing in NHS hospitals. All these things are important so that, when we come out of the recession, we have invested in order to grow the economy, especially if there is going to be fiscal tightening in the back half of this five-year period. Investing to grow the denominator—because it is always the debt to GDP ratio—becomes even more important if there are public spending cutbacks and tax increases.
Q256 Dame Angela Eagle: That raises a philosophical question. The previous fiscal targets were put in place only last November, and now they have been superseded. I think this is the sixth or seventh version of the fiscal rules since 2010. Are they any use any more?
Samuel Tombs: I do not think many investors in the gilt market really believe them or would place much weight on them any more. They are five-year rolling targets for the debt to GDP ratio to be falling and the deficit to be below 3%, and we never get to the fifth year: it rolls forward every time.
I think the markets did view this is a credible fiscal plan, because it takes immediate action to bring down the cost of borrowing, rather than the amount that the Government is borrowing. The cyclically adjusted primary deficit—this is looking at the discretionary impact of fiscal policy on the economy, so you remove interest payments from Government borrowing when looking at the primary deficit—is set to fall by 2.5% of GDP next year, which is the biggest contraction since the early 1980s. That is because the pull-back of energy price support is very sudden and severe.
Although the tax increases and spending cuts are quite long term—they come into effect in the middle of the 2020s, and hopefully, if we get stronger growth or lower interest rates, they may not need to occur—the fact is that we have an up-front, big fiscal consolidation now. That is really what the markets demanded a couple of months ago, when the energy price support was going to be very expensive for the Government to run. That is really what the markets wanted to see in this statement. Even though much looser fiscal rules were adopted this time around, there was no adverse reaction in the gilt market and that risk premium has disappeared.
Q257 Anthony Browne: The growth plan in September prioritised growth over balancing the books, whereas this autumn statement prioritises balancing the books over growth. We do need growth, so how growth friendly is this autumn statement?
Samuel Tombs: Because there is this big up-front consolidation with the energy price support being pulled back very quickly, which will really dampen households’ disposable income, it is not very growth friendly in the near term. It is accepting that we have to adjust to a world of much higher energy prices. We are getting on with the adjustment now, and households will feel the pain. In the short term, it is obviously not very growth friendly.
In the medium term, the consolidation to get the debt to GDP ratio falling is substantial. In terms of how it has been structured, it is good. As the other panellists highlighted, public sector investment has largely been spared from cuts, particularly in the near term. Obviously, there is a relatively high fiscal multiplier associated with public sector investment; it tends to pay dividends for the economy, whereas raising taxes—obviously, it depends which taxes you raise—generally has a lower multiplier effect on the economy. People may save a bit less or consume fewer imports than they otherwise would have done, and therefore there is a smaller GDP impact. Compared with the 2010s, the policy mix here is perhaps more growth friendly. If you have to do fiscal consolidation, balancing it a bit more evenly between tax rises and spending cuts is a better way to go than the 2010s, when there was a lot of emphasis on spending cuts.
Q258 Anthony Browne: Dr Yueh, do you think this will promote growth? I am particularly interested in the different measures in there, like reducing the thresholds on capital gains tax and dividends, frozen thresholds, and employers’ national insurance.
Dr Yueh: I think the investment piece is supportive of growth, as we have already discussed. With the piece around R&D—cutting back some of that for SMEs, but increasing the generosity for larger firms—as I understand it the Government plan to do a consultation around it. I suggest doing it for the entire set of tax measures, because every fiscal decision around taxes has an impact on how firms will invest and how they think about things, whether it is dividends or capital gains. I think it is worth looking at the entire set and seeing if there are ways of putting together the fiscal side with the investment side, in a way that can show which measures are pro-growth, which are more redistributive, and which are purely trying to balance the books. I think that kind of clarity would help.
However, the most important thing that economists have come to focus on in the UK is growth, and the investment piece is key to that. The other piece, which we have touched on, is labour productivity and the inactivity rate, and investing in human capital. Again, that could be done through fiscal incentives, for instance R&D tax credits, which is what some of the states in the United States have done. If you are going to look at things in the round, those are also things that could make sure that the investment is not just physical and/or digital but is also in people. I think we need that. The spring is not that far away, but it would be helpful by the spring Budget to have a growth strategy that ties all these bits together and shows that we are going to generate growth in a sustainable way.
Anthony Browne: Carl?
Carl Emmerson: For me, we clearly need sustainable, long-run growth. We need policies that will promote that. I think that there the tax changes were disappointing, in the sense that the Government has gone for an approach where it is pushing up taxes—it is going for a higher tax burden—yet it is not reforming those taxes. Pushing up unreformed taxes is more damaging to the economy than reforming the taxes to make them smarter and then pushing them up.
To give some examples, we are pushing up council tax, yet in England it is still based on what your home was worth in 1991 and put into eight bands. If we want to put up capital gains tax, why don’t we get rid of the exemption at death, introduce indexation and then shove the rates up? So, put up the rates on a reformed tax to get rid of some of the unpleasant distortions.
Even where the Chancellor is cutting tax—take business rates, for example—I am not quite sure what the strategy is. We think that retail needs a 50% discount this year but a 75% discount next year—and then no discount the following year? I don’t really follow what kind of strategy there is there. I understand the Chancellor has not been in office for very long, but there is a genuine need for proper tax reform, which means that if we then have to accept a higher tax burden it won’t be so damaging.
Anthony Browne: Mike?
Mike Brewer: I agree with your characterisation: this was not a fiscal event where the Chancellor was really trying to do much to the underlying growth rates. It was an event—it was an autumn statement, not a Budget—where he was trying to restore the public finances and calm down the markets.
The statement reminds us, of course, that a lot of the UK’s current problems are due to our fundamental lack of growth, so I think the onus is very much on the Government, albeit recognising they are fairly new, to tell us what their strategy is to improve long-run growth. I don’t think the statement was anti-growth; I think the Government have just deferred the issue to a future event. But we do need to hear that soon, yes.
Q259 Anthony Browne: The main fiscal consolidation comes after 2024, obviously, and we expect the recession to sort of be ending by then. Isn’t there a risk that the fiscal consolidation will prolong the recession at the end? Is it really credible to have that fiscal consolidation when we will still have a big output gap?
Carl Emmerson: You have to remember that, ultimately, what the Chancellor is trying to deal with is the fact that a big part of this is because the price of energy has gone up right across Europe. That makes us poorer as a country. It means households and businesses and indeed the Government finances just have to make those adjustments. Part of this is a structural adjustment that needs to happen in the economy, not a temporary downturn.
On credibility, it seems the case that markets are okay with what the Chancellor is planning, so it seems to be okay. If markets are really worried about what is going to be happening to, say, borrowing in three, four, five years’ time, I would suggest, yes, they want to look at a credible plan from the Government; they may look at the opinion polls and look at what alternative plans might be in place at that point. But for now at least it seems that they are okay with having a back-loaded consolidation.
Dr Yueh: I think the timing of it, roughly speaking, is to have the bulk of the consolidation happening when the economy is expected to recover. There is a lot of uncertainty. As we know, the Bank of England, for instance, has changed its forecast of recession from five quarters to about two years—we will see what happens now with the new fiscal plan. The OBR has said that this autumn statement has reduced the depth of the recession by 1 percentage point of GDP, which is considerable. There is a lot of uncertainty around that. With a five-year rolling target, as we have discussed, if the economy has not recovered as expected, fiscal policy should continue to support those who are most affected by the downturn. Of course, this is a cost of living crisis, so a lot also depends on global factors and what will happen with inflation and whether there will be more shocks coming from the global system. A degree of flexibility is also why we have all roughly said that the five-year horizon is probably right, given how uncertain it is right now with these forecasts.
Q260 Anthony Browne: In the Chair’s opening questions, we touched on the fact that the OBR forecast is a lot more optimistic, or at least less pessimistic, than the Bank of England. Sam, you cast some doubt that—you said you were more on the Bank of England side than the OBR side. When the Chancellor made his announcement of the measures he was taking, the OBR said it would lead to a more shallow and shorter recession than would otherwise be the case. Do you think that’s unlikely, then?
Samuel Tombs: The fiscal statement has helped to bring down market expectations for interest rates from a peak of almost 6% a couple of months ago to now 4.5%. The fiscal turnaround and change in leadership have helped to calm markets, which is obviously leading to a smaller monetary financing shock for the economy going forwards. The consolidation has been announced because those tax rises and spending cuts are back loaded, which is helping to mitigate the downturn in the near term. Of course, because the Government’s finances are so sensitive to dead interest costs, if the Bank of England were to raise rates to only 4%, that could lead to around half the tax rises not having to go ahead. It is certainly a good idea at the moment to see where the Bank of England goes in the next few quarters with interest rates and then reassess whether the full package of measures that has been announced today has to go ahead.
In terms of the differences between the OBR’s and MPC’s forecasts, as I ran through earlier, there is a big difference on saving. The other big difference is on productivity growth. The OBR’s assumption is that there is a big burst of relatively strong growth and productivity in the mid-2020s—about double the rate that we saw in the 2010s—which is another key reason why its forecasts are relatively different. I would cast some doubt over whether we really will see growth in output per hour of 1.3% in the medium term, as the OBR forecasts, which is double the rate we saw in the 2010s, given that over the next few years business investment is set to be quite a small share of GDP and, unfortunately, things like Brexit have impacted the economy’s supply potential.
In short, I think there is not a good reason to be as upbeat as the OBR on the medium-term outlook. Were that to materialise and growth come in weaker, there would be a need for a larger consolidation than what has been pencilled in here, but there are lots of moving parts. Interest payments as well could be coming in lower and therefore reducing some need for consolidation. It depends on the balance of those two factors over the next year or so.
Q261 Anthony Browne: Carl, do you agree with the Chancellor that these measures will make the recession shorter and shallower than it would otherwise be? Quickly, please, as I have run out of time.
Carl Emmerson: The big measure we heard about in the autumn statement that will clearly help households, and therefore the debt for the recession, is the extent of what is replacing the energy price guarantee from April. A lot depends on whether that is more or less generous than what you thought was going to be in place. When the OBR is making that statement, it is saying that is relative to a baseline of having nothing in place beyond April. This makes the outlook for the economy better, which is not surprising.
Emma Hardy: Afternoon, everybody. The OBR said that real household disposable income is going to fall by 4.3% in 2022-23, which will be the largest fall since ONS records began in 1956-57, followed by the second largest fall in 2023-24. Could and should the Chancellor have done more to protect households?
Mike Brewer: We have been acknowledging this afternoon that the Chancellor faced a difficult set of circumstances leading up to this autumn statement, with a desperate need to restore the public finances in the face of an imminent recession plus the structural adjustment that is making us all poorer. We were pleased to see that the Chancellor did commit to uprating benefits in line with inflation, which is quite a significant step, as well as increasing the benefit cap. In replacing the energy price guarantee he is being less generous than Liz Truss wanted to be when she was Prime Minister, but he has done so in a targeted way—taking the target aspect of the previous year’s approach. Overall, there is a lot to be welcomed in the autumn statement for low-income households. The fact that RHDI is falling by that amount reflects, as Carl has said and we were all acknowledging, that energy prices are making the country poorer. There is no getting round that.
Q262 Emma Hardy: So you do not think that the Chancellor could have done anything else to support households during the cost of living crisis?
Mike Brewer: I was surprised—pleasantly surprised—by some of what the Chancellor said. That is a way of saying that I feared that it could have been worse. It was good of him to commit to the measures that he did commit to. Of course, next year will not be easy for low-income households; I am particularly worried about next winter. Energy prices will be significantly higher next winter than they are this winter, so I am worried about that, particularly for prepayment meter households that will bear the entire burden next year. Next year is a long way off and we need to see what will happen to global energy prices between now and then.
Q263 Emma Hardy: Carl? Could and should the Chancellor have done more?
Carl Emmerson: Fundamentally, as Mike says, it is difficult in a world where a key good that we import is becoming much more expensive. That makes us poorer. The Government cannot make all that pain go away for everybody—that is just not possible. They do have choices about how that pain is allocated, and they can change the timing over time by borrowing more money and pushing it into the future. We are doing a lot of that this winter with the energy price guarantee that is in place.
If we had time to design something, we probably would not give as much money to better-off households to help them with their energy bills this winter. I understand that it had to be set in place very quickly though, so I am sympathetic as to why we have that in place. Having the more targeted approach next year of saying, “Actually, there are key groups that we want to protect—pensioners, people on disability benefits and low-income families with children” is a sensible approach to take. The challenge now is to ensure that, as much as possible, people are not falling through the cracks of that targeting.
I would now be worried about those people that are eligible for universal credit but are not taking it up. How do we get the design right, in terms of the payments that we are making each month? What about people who are flowing on and off universal credit each month? Those kinds of things need to be gotten right. Borrowing more money is obviously always an option, but you must be careful when markets were clearly concerned about what had happened just a few weeks earlier. I am sympathetic that the Chancellor has done quite a lot. Doing more may have been possible, but others can judge whether he should have done more.
Q264 Emma Hardy: Earlier, you mentioned reforming taxes and making that a fairer system. Is that something that you think the Chancellor could and should have done?
Carl Emmerson: Virtually all the UK’s taxes could be made to work better. Successive Governments have failed to implement reforms that would make them work better. I guess I have to be a bit sympathetic, because he has not been Chancellor for very long, but if we have a crisis and we need to shove up taxes I would rather he took the opportunity—if we are going to make unpleasant decisions on the tax side—to reform the taxes and then put them up. You can do it in a way that causes fewer distortions. That is not to say that tax rises are ever going to be easy to do or not have any unwanted consequences, but they would be fewer if we designed those taxes well rather than just pushing up unreformed taxes.
Q265 Emma Hardy: Further to the point made by the Chair in the opening questions, I will ask about a fairer way of doing it—you talked about raising or upping the threshold to make it fairer. Do you want to elaborate on that point a little?
Carl Emmerson: I cannot tell you that freezing the threshold is less fair than, for example, just putting up the rate. There is a distributional consequence. Different households will be winning and losing. Others can judge which is a fairer outcome. It is more the point that our taxes are a long way from perfect and if we are just pushing up our taxes, why don’t we take the opportunity to reform them?
I gave the example of capital gains tax. We have pushed up capital gains tax by cutting the allowance. Capital gains tax is badly designed. It taxes gains that could just be because of inflation. It encourages people to hold on to their assets right through to death, rather than realising gains earlier. I would much rather have a system that allows some indexation, which gets rid of that tax-free death element, and then, having reformed it, increase the rate or cut the threshold so it is a better tax. You can do that to lots of other taxes, too.
Q266 Emma Hardy: I have a slightly different question for you, Dr Yueh, but you are welcome to comment on whether the Chancellor could, or should, have done more. Is there a danger that consumer confidence will drop off rapidly in the face of such a drop in living standards and that that will weaken consumption more than is expected?
Dr Yueh: Yes, I think that is a significant risk. Consumer confidence has already dropped quite a lot. The closest analogy to this recession is from the 1970s. When it is a supply-side shock like this, people become extremely worried, especially when they hear that 80% of inflation is due to global factors, so it is out of the control of Government. For those stresses around growth, it is about showing that the spending today is targeted to help those who need it most and also to generate growth, because that helps us look forward. Economies always have ups and downs. The question is whether fiscal policy is cushioning the recession, and then it is about spending strategically so that we come out of it in a position where people can feel a bit more confident.
Another example is that, during the pandemic lockdowns, if you looked at Germany and France and their fiscal stimuli, a good proportion of their investment was targeted towards green energy. Germany wanted every petrol station to have an electric charging point. All of that allows consumers to look ahead. It says to them, “These are tough times, but we are spending the money so we get better-quality growth in the future and can see a longer-term horizon”. That is why I think, in this—thankfully—unusual type of recession, it is even more important to show how strategic the spending and support is as an investment for when the recession ends.
Q267 Emma Hardy: On the point about the Chancellor, do you think he could have done more in that particular area—looking forward and giving people that confidence?
Dr Yueh: I was just reflecting on the short period he has had to do this. Ideally, yes. This was an autumn statement. It does have investment measures around growth but, as we have all said, he had a very short period of time to put it together, and a lot of that was around stability. In his next go at this, it would be helpful to see a focus on how we can invest to grow, what kind of growth we are looking at, and the way in which taxes, in particular, are geared towards supporting that. Not everything will be pro-growth, as I said. Some fiscal policy is geared towards redistribution—things that are absolutely needed—but having a clear vision about how we will look in three to five years’ time will help boost consumer confidence and be very helpful.
Q268 Emma Hardy: Samuel, thinking about wealthier households or those who have managed to accumulate savings, and we know that quite a few people have, how willing do you think they will be to support consumption in the country by using those accumulated savings?
Samuel Tombs: The excess savings held by households are colossal. If you look at them on paper, they are equal to about 14% of annual disposable incomes for all households—about £180 billion. If they were to tap that, that would provide tremendous support to the economy over the next couple of years. The trouble is that many economists have had the theory for the past 18 months that as soon as we got out of lockdown, we would start to spend down those savings that we accumulated in aggregate, and that has simply not happened. Most forecasters—the OBR—have been surprised by how slow the saving rate has fallen. Most households have remained very cautious for the last year or so.
There is also data to suggest that the distribution of those savings is not very even—not in a demanding-enhancing way. The vast bulk must be held by high-income households, because we can see in ONS survey data that over the course of this year a rising proportion of households have said that they cannot afford an unexpected expense of £850. It has risen to about 36% from 28% at the end of last year. That suggests that the total stock that households haven’t drawn down has become even more unequally distributed over the last year, and many more households are living hand to mouth.
We are also starting to see signs in the data that households are picking up their repayments of mortgages—ad hoc repayments. Most households are locked into fixed rate mortgages where they are committed to monthly payments for two or five years. However, most of those mortgages do allow them to overpay if they want to—up to 10% of the outstanding balance of the loan—without incurring a fee. In that data, we have started to see a clear pick-up again in the last few months. Higher-income households that do have those savings are using them not to support the economy or to spend more, but to pay down debt. Households that have mortgages face a very big refinancing shock coming down the tracks in the next year or two. I don’t think those savings will filter back into the economy; they will be used to pay down debt where possible.
Emma Hardy: That is really interesting. Thank you.
Q269 Chair: That is absolutely great, but may I ask the panel to make sure that they get the pithy points across, given that we are all hoping to speak in this evening’s debate after the urgent questions?
I really want a quick yes or no answer: the Chancellor said in his statement that our actions today will help inflation to fall sharply from the middle of next year. Is that a yes, Mike?
Mike Brewer: The EPG does that, yes.
Carl Emmerson: I agree, yes.
Dr Yueh: Yes.
Samuel Tombs: Yes.
Chair: Okay, good. Now we have Anne Marie Morris making her Treasury Committee debut.
Q270 Anne Marie Morris: We turn now to spending. Dr Yueh, there is a backdrop of expected significant cuts across Government Departments. Many people were pleased to see the NHS and social care and education do much better than expected. Do you think that was the right thing to do, in the context of where we are in the economy? Do you think the numbers that were allocated were the right numbers? Will they deliver in the next two years, which is what was promised?
Dr Yueh: The answer is yes. For the NHS, there is a real urgent need. There is also an urgent need over the longer term because of the demography and because of people with long covid—things that will be very familiar. Similarly, education has been very disrupted; as we speak about growth, investing in education is hugely important. Whether they will deliver is much more of an execution point.
Q271 Anne Marie Morris: That is more of a challenge, in which case let me drill down further with Mr Brewer. If I can take you into the vexed question of funding for the NHS and social care, too often it is described as throwing money into a bottomless pit. I think this links to the point that Dr Yueh was making. You have to give money, because clearly the money is necessary, but it has to be spent efficiently and effectively. The Chancellor talks about Scandinavian quality and Singaporean efficiency; is that really going to be delivered? Did you get any sense from anything he said that the figures he has come up with—£8 billion overall for the NHS and social care—are actually going to deliver that without more fundamental change and more fundamental work on efficiency? Without those efficiency savings, is £8 billion really going to be enough?
Mike Brewer: I do not think that the health service is going to be transformed by this small amount of money, but, as a consumer of healthcare, I am grateful that the Chancellor did it. I don’t think I know the answer to your original question, but I welcome the fact that our current Chancellor is much more of an expert than I am, being previously the Secretary of State for Health.
Q272 Anne Marie Morris: Do you think that this is going to work in the time he has given himself? He talks now about the workforce plan, which I think we all agree is the right thing to do. You and I are long enough in the tooth to realise that if you come up with a plan, it takes a while to implement it. Given the time that will inevitably take, is the £8 billion going to give us what we need—this Scandinavian quality and Singaporean efficiency?
Mike Brewer: No, I don’t think it is. I see the £8 billion extra spending in the next couple of years as just a response to the increased waiting lists and the sense of crisis in all parts of the health service—trying to address the crisis. I did not really hear anything last week that is going to deal with efficiency at all, but that could come with subsequent announcements. I am not saying that is a flaw in what the Chancellor said, but I saw last week’s announcement of extra cash as being a case of, “Goodness me, there is a real chance the health service or A&E departments could start to fall apart this winter or next year.”
Q273 Anne Marie Morris: Do you have any sense of how he got to that figure? Did he get to it because he added up his numbers and that is what he needed, or was it simply what he thought he could afford?
Mike Brewer: I don’t know. Obviously, he will be thinking about the fact that the NHS is coming under extra pressure because prices are higher than they anticipated when they previously set them, so that may have played some role in a decision, but I’m afraid I don’t know any more than that.
Q274 Anne Marie Morris: Okay. Mr Emmerson, I am very happy to have your further comments on health, but I was then going to take you on to schools, because I know that is something the IFS has commented on.
Carl Emmerson: With the NHS, I think the extra money alone is not quite enough to make up for the fact that we now think economy-wide inflation is going to run a lot faster than what was expected when the settlements were made a year ago. My understanding is NHS England is claiming it can make up the rest with a bit more efficiency, so it is not about making the NHS be any better than what we were intending a year ago. It is really just making up for the fact that inflation is much higher.
Some colleagues have looked at what is happening to waiting lists and I think the most remarkable thing there is that the NHS is managing to treat fewer people than it was pre-pandemic. That is causing waiting lists to continue to rise, so the story is not all about people returning post-pandemic but about what the NHS is doing. On NHS calculations, it seems that waiting lists might not start to fall for another year and could be rising for quite some time.
One of the biggest pressures the NHS faces, and indeed the rest of the public sector, is going to be public sector pay, so if you add another 1% to the pay of NHS employees, that’s roughly £1 billion gone. You can see that while the pay deals currently being made are much higher than what the Government intended a year ago, they are clearly running well below inflation. In fact, they are well below what the private sector is getting. Over the long run, you cannot pay public sector workers less than they could get in the private sector, so there will be a huge challenge, not just with this year’s pay round but next year’s too, about what settlement to come to, the extent to which they are funded out of existing settlements that the Treasury has made, and whether additional cash is needed.
Q275 Anne Marie Morris: In the same way as you would like to reform the tax system before we start fiddling with it and increasing or decreasing taxes, do you think it is mission critical for the Chancellor to insist on efficiencies and innovation within the NHS to enable the extra funding to deliver?
Carl Emmerson: It is going to be crucial to make sure the money is used as well as it can be across all public services. The NHS is particularly important for two reasons: first, because we know it has been particularly hard to get efficiency savings there in the past; and secondly, because it matters so much for overall productivity in the UK, not just that of the public sector.
Q276 Anne Marie Morris: Social care is challenging because effectively it is means tested at the point of delivery. The connection between health and social care is always going to be very challenging; none the less, the Chancellor has put in a substantial sum of money that he hopes will deal with hospital discharges, and he has given some of the money to local government to try to improve services. Given the disconnect between the two, how are the extra billions going into social care to try to deal with discharges going to work? Will it work?
Carl Emmerson: I am not sure, but it is worth noting that local government was a winner from last week’s statement, and it is pretty rare to be able to sit here and say that.
Q277 Siobhain McDonagh: You mean social care providers—
Carl Emmerson: The social care providers to local government were winners and that is not usual. There is a chance it can help in some ways, but it was also disappointing that the Government pushed back the Dilnot reforms. Individuals cannot really save privately for their own social care needs and the private insurance market does not work, so we need to do something along those lines. I think it is wrong to have legislated for it and keep just pushing it back and back.
Q278 Anne Marie Morris: Another area for future rethinking, I suspect, is schools. I think we were all surprised that they got their £2.3 billion. The IFS has written quite a bit about this, and it seems that you perceive that to be good news, but it seems to be principally for primary and secondary, not early years, where much of the problem is post pandemic, or post 16, which seems odd given the job market and the fact that we are trying to train our own rather than rely on immigration. What do you think?
Carl Emmerson: On schools spending, when the Government set out their spending review a year ago, they said that they wanted per-pupil spending in real terms in 2025 to return to 2010 levels. The money they found last week means that they are still on course to do that. Again, it is making up for inflation, and it is meeting the Government’s stated intent from a year ago, so in that sense it is a good thing. Of course, it is remarkable that in 2025 we will only be spending the same per pupil in real terms as we were spending in 2010. That is an astonishing period.
On your wider point, I certainly agree that post-16 education needs to be a big priority, in particular for the half of young people who do not go through higher education. That is one of the things that the Government need to get on top of and tackle as part of our long-run growth agenda.
Q279 Anne Marie Morris: Mr Tombs, were you surprised that defence did not get any more, given what is going on in Ukraine?
Samuel Tombs: The allocation of Government spending between Departments is not really my area of expertise, so I do not have anything of value to add there.
Q280 Anne Marie Morris: All right. Dr Yueh, do you have a view? Were you surprised?
Dr Yueh: Like Samuel, I think that is a political judgment around defence spending.
Q281 Anne Marie Morris: What about the economic view? Mr Emmerson, you seem to be very happy, so maybe you can comment on this, too. Given the obvious—that we spend an awful lot of money on an awful lot of munitions, training and so on—the coffers must be low. Given that defence of the realm is the first responsibility of Government, did you therefore feel it was economically appropriate that we are reverting to the 2% target?
Carl Emmerson: The UK is continuing to comply with the target of spending 2% of GDP on defence. Not many countries in NATO do that; the US and Greece might be the only other ones. Obviously, the situation in Ukraine might make you think we need to spend more, but my understanding is that countries such as France and Germany are also now spending a lot more on defence. You might think that that reduces the extent to which we need to spend more. I do not know which way that goes.
Anne Marie Morris: That’s an interesting comment. Thank you.
Q282 Rushanara Ali: I have some questions about fiscal consolidation, but first let me take a step back. We just talked about health and education. In health, we know that there are 7 million people on the waiting lists, and 117,000 people are reported to have died waiting for treatment. We also know about the long-term sickness issue, and the way it is interacting with the economy. Can each of you talk us through whether intervening with a slight increase in health spending, which was rather belated, after considerable challenge for the NHS, is adequate to deal with both the problem in itself and the interaction between health and economics? I’m afraid you will have to be brief, because I have quite a few questions.
Mike Brewer: We did not hear that in the autumn statement, for sure. As I said earlier in my evidence, it was notable that the OBR pointed to the rise in the number of people on disability benefits. The rise in people with health conditions is probably the most important drag on our aggregate labour supply.
Q283 Rushanara Ali: How much is the drag, in terms of a percentage of GDP, of not getting a grip on the 7 million waiting lists and on those who could come back to work if they were treated, rather than dying waiting for treatment?
Mike Brewer: I do not have those figures, but those are exactly the kind of figures you would expect the Treasury, DWP and the Department of Health to be working out together.
Q284 Rushanara Ali: Does anyone else have a sense of what the drag would be?
Samuel Tombs: Since February 2020, we have seen a rise of roughly 400,000 in the number of people who are of working age but economically inactive, and who say that they are so because of long-term sickness. That is a 1.2% hit to the size of the workforce. That is a sense of the order of magnitude. Others have looked at whether the Government’s plans for waiting lists are adequate, and have suggested that, unfortunately, waiting lists are likely to rise a lot further. Looking at some of the projections from the IFS, it looks like those waiting lists will not top out until the end of next year. Looking at the relationships between those waiting lists, which obviously apply to all adults, many of whom will be pensioners and out of the workforce, you could be looking at a 0.7% hit to the workforce.
Q285 Rushanara Ali: A 0.7% hit to the workforce—in terms of output, what would that be?
Samuel Tombs: You could be looking at a similar sized decline, depending on how productive those workers were.
Q286 Rushanara Ali: Thank you, that is really helpful. Did anyone else want to come in on that? If not, I will move on. My next question is linked to what you said earlier about growth, and the connection between education, investment and some of the points that have been discussed. From what we have heard from the Chancellor and from today’s evidence, it seems that the autumn statement has helped to allay some immediate issues, but when it comes to a growth plan, there is not much of a growth strategy and there is not enough in place to create a path out of this doom loop. What do you think should have happened and needs to happen; and, building on what you have already said, what order of investment should we have had versus what we have had? Perhaps Dr Yueh could kick off?
Dr Yueh: Firm surveys consistently show that the two biggest factors in boosting private sector investment, which is what you want to encourage, are certainty—less uncertainty both in the regulatory and tax regimes—and skills. Skills are increasingly becoming the most important factor. A skilled workforce takes time to develop, but you can have a very clear framework for a medium-term growth strategy that is consistent. Firms want to know that if they place an investment today, the framework is set in legislation, so that if they invest in the green energy sector, for example, it will give them certainty over a medium-term horizon. That would help. The IMF has suggested that in times of high uncertainty, such as now, public sector investment can crowd in more private sector investment, especially in new areas such as green technology and digital. It creates more jobs than traditional infrastructure and gives a bigger boost to GDP. Those are the kinds of growth measures that would help. Again, that is centred on investment, but not to forget that it is people ultimately who—
Q287 Rushanara Ali: We have had 12 years of these sorts of demands being made, and there has been a lot of chopping and changing. How quickly do these things need to be put in place in order to start to see the dividends in growth? When can we expect that to happen if we put these measures in?
Dr Yueh: The IMF estimates suggest that you should be able to see the impact on GDP and employment in about two years. Obviously, there is a longer term tail in terms of returns, so it is important to try to incentivise that.
Q288 Rushanara Ali: If you were to put it in percentage terms, what sort of mark as a percentage would you give the Chancellor for what he has put in place to generate growth? What percentage do you need him to do to see that happening within the two-to-five-year framework?
Dr Yueh: I was going to say something about grade inflation.
Rushanara Ali: Okay, what grade would you give him, or what percentage? It is useful for us to understand whether we have enough in place to see growth happening. Otherwise, we are going to be stuck in this position.
Dr Yueh: I think there is probably another component to generating investment and growth, which is maintaining the confidence of the financial markets that determine the cost of borrowing. I think the autumn statement did do that.
Rushanara Ali: Yes, we have established that.
Dr Yueh: But the strategy part needs a lot more fleshing out in all the ways we were talking about before. There are bits of it that point to maintaining the national infrastructure plan—for instance, the R&D tax credit, which we have discussed—but a lot more needs to be there.
Q289 Rushanara Ali: If you were to put a percentage on it, what has been done? Is it 20% on the way and 80% to go, or is it 50:50? Do you have a sense of what that looks like?
Dr Yueh: I guess if we did a traffic light system, the cost of borrowing bit of it is green. The growth plan is probably a mixture of red and yellow—orange, or kind of yellowish. We are not at green because, as we have discussed, the Chancellor had a very short period to put this autumn statement together. He has only been Chancellor for a short period, but I hope that by the Budget next year all the things we have discussed will have been brought together. Fiscal policy can incentivise growth. There are bits of it there, but we are not quite at the green light.
Q290 Rushanara Ali: This is for our colleague from the IFS in particular, but also for the others. The head of the IFS said that he is expecting a huge amount of poverty because of the slowdown in income growth. The poor income growth since 2008 is set to continue. Real household disposable income per capita is expected to be 32% lower in 2027-28 than we might have expected in 2008, and then of course we have talked about the impact on different groups. Can you talk us through what that means for our economy overall?
Carl Emmerson: It has been an absolutely remarkable period. Paul was saying that if you take a counterfactual world that we might have thought was quite reasonable in 2007, in which the kind of growth rates we had been used to for many decades just continued, and compare that to what has actually happened, we are on average much, much poorer than we would have been—something like 30% poorer. Clearly, the overhang from the financial crisis is a big part of that. There have been various shocks hitting the UK economy. The pandemic has not helped, and nor has the big increase in European gas prices. There have been some policy mistakes in there too, which also haven’t helped.
Q291 Rushanara Ali: Yes, he talks about own goals. What were they? We know about the external ones—last week we heard evidence about the external shocks—but could you talk us through what the own goals are?
Carl Emmerson: We have cut investment spending, and now increased it back up again. What matters for growth is how much capital you have in your economy. If we had a deficit problem, cutting investment spending and increasing it again isn’t going to help that. If you are worried about the deficit, you need sustained spending cuts or tax rises, so that is clearly an error.
We have still failed to give the roughly half of young people who do not go on to university a really clear route and very high-quality education and skills experience post 16. As a country, we have chosen to go down a very hard form of Brexit, leaving the single market, which makes trade with our nearest and richest trading partner more difficult. That may have some benefits, but in terms of the economics it makes us poorer.
We have had lots of policy instability. To give a recent example, the Government said it was going to increase the corporation tax rate from 19% to 25%, then it said it wasn’t going to do it, and now it says it is going to do it. You might have different views about what the corporation tax rate should be, but that kind of instability is not helpful for growth. There have been various policy mistakes made.
Q292 Rushanara Ali: What was the cost of the mini-Budget, in terms of fiscal consolidation? Is it £30 billion?
Carl Emmerson: I do not have a number for the cost of the mini-Budget. The legacy is the fact that the Chancellor had to focus very much on ensuring the markets were content with the autumn statement. So the cost is potentially one where, in the current environment, a Chancellor who is seen as credible might want to be very, very flexible and nimble and take a very long-run approach, versus to what extent he felt he had to do stuff in the near term in order to reassure markets. I think that is the cost; it’s pretty hard to put a number on it, though.
Q293 Rushanara Ali: Obviously, we have had to have consolidation of £55 billion. What amount of that do you think he had to do in order to bring confidence to the market post mini-Budget?
Carl Emmerson: I do not know.
Q294 Rushanara Ali: As a percentage or proportion?
Samuel Tombs: I think it is really a very small proportion that you can directly attribute to the mini-Budget and the blowout in gilt yields that we saw.
Rushanara Ali: Sorry, say that again.
Samuel Tombs: A very small proportion can be attributed to the gilt market disturbance that we saw in the wake of the mini-Budget, because of course yields have already come down quite a lot—considerably—since then. If you look at the year-to-date increase for UK Government bond yields relative to other countries, it is all now back in line. There does not seem to be much scarring in the gilt market, but of course we had to do this fiscal U-turn to get there. But I would say the vast majority of that £55-billion long-term consolidation reflects the fact that we have much higher energy prices, reducing disposable incomes and creating this fiscal gap—
Q295 Rushanara Ali: But you are saying quite different things from what Carl Emmerson was saying about the own goals. Are you saying it’s both these things? I just want to be clear. You are focusing on one set of things, which are external; we know about the external shocks. Are you saying there are no internal own goals, as described by Paul Johnson and Carl Emmerson?
Samuel Tombs: No, I think there have been, but I think most of the damage from the mini-Budget has been reversed by the subsequent actions; they have calmed markets—
Q296 Rushanara Ali: Except market confidence—
Samuel Tombs: Yes, although that has been—
Rushanara Ali: Which is quite a big thing.
Samuel Tombs: But I think it has been largely restored. If you look at gilt yields, at sterling—
Q297 Rushanara Ali: After the autumn statement and the Chancellor having to introduce austerity 2.0. Isn’t that right?
Samuel Tombs: But most of those measures would have been required regardless.
Q298 Rushanara Ali: No, they wouldn’t have been; they weren’t required in September.
Samuel Tombs: That is because we didn’t have any OBR forecast at that point on which to ground policy. But once we had seen the deterioration in the economic outlook that has been largely caused by higher energy prices and the fact that—
Q299 Rushanara Ali: We had that before September as well. The Ukrainian war started in February. Deterioration of oil prices has been happening for some months, not since September—with respect.
Samuel Tombs: Yes, but the biggest rise in energy prices occurred in August. That is when we saw the biggest deterioration. And because of that, the OBR would have had to revise its forecast for GDP down considerably in September, just as it has this time round. The vast bulk of the need for long-term fiscal consolidation comes from the fact that we have an assumption of higher energy prices. Also, the level of economic activity that is sustainable with keeping inflation under control is much lower than we thought. There are other ways in which the Government, I think, has not helped in that regard. There has been a lot of scarring to the economy—
Rushanara Ali: So we would have still needed this statement, then.
Chair: We could discuss this much longer, but unfortunately time is not on our side. I just want to say this very quickly. There is an element of the Budget that obviously has soared—even doubled—and that is debt interest. Quite a lot of that is down to the fact that such a high proportion of gilts are linked to inflation. To help the Committee’s memory, was there ever a point where it was made clear that the Treasury had made a decision to issue more that were index linked—in other words, to make a sort of bet on inflation remaining low, which is now coming back to bite it? Was that something that was ever announced by any Chancellor in the past? I ask because the proportion has gone up a lot since 2000. In 2000, only 6% of gilts issued were linked to inflation; now, it is 22%. Can anyone help us out on that? Or if you can in the future drop us a note, that would be really helpful.
We are going to cover various points to do with energy now.
Q300 Alison Thewliss: We are going to go quite broadly and discuss various energy measures in the statement. Can I ask first about your thoughts on the Government’s £6 billion of additional spending on energy-efficiency measures, which will not necessarily start until 2025? Are these sufficient? Do you have any views on their effectiveness?
Mike Brewer: It is very difficult to understand why those energy-efficiency measures are not happening right now, because right now is when the Treasury itself would save money if we all saved energy, and it would also help households through what could be a very expensive year. It is very surprising to hear that they are going to be delayed. We don’t know much about what that £6 billion will buy, so I will not comment on their efficiency. But you would have thought that now is the perfect time to encourage energy efficiency.
Q301 Alison Thewliss: I suppose I was asking because the Chair of the Environmental Audit Committee has said that the scheme is confusing for consumers, quite stop-start and people do not necessarily know what is available to them. Do the Government need to do more to get the money out the door?
Mike Brewer: Yes. Carl was describing instability in corporation tax policy; it is also good to have stability in energy policy. That is all part of ensuring consumer confidence, as Linda was talking about earlier.
It does now seem that energy policy is settled until April 2024. Perhaps households should have some reassurance about what the price will be until April ’24. I know the Government has said that it will be consulting widely on what to do after that.
I think that is broadly sensible. Most people expect the energy price will have fallen substantially by 2024, so we do not need to settle things for the long term right now. But yes—it is good to have the policy settled for the next year. That is a good thing.
Q302 Alison Thewliss: Thank you. Carl, have you anything to add to that?
Carl Emmerson: No, nothing to add on that.
Q303 Alison Thewliss: On the Government’s decision to go ahead with Sizewell C nuclear power station, is that something that you would welcome? The Chancellor also said this is about energy independence. Given the source of nuclear fuel and the companies involved in producing that power station, is that accurate?
Carl Emmerson: I’m afraid I have not done anything on that. Sorry.
Q304 Alison Thewliss: Okay. Moving on to the energy profits levy within the statement, that increases the oil and gas energy profits levy to 35%, taking the total headline tax rate to 75% of profits. Will this put off energy companies from investing in the UK?
Mike Brewer: I do not think it should, no. I think that the new tax on electricity generators is very clearly defined. It is clearly earmarked as the profits you make by selling electricity above a particular price, which is clearly an extraordinary price. No, I think if anything that has been reasonably well crafted to indicate that it is a temporary measure.
Carl Emmerson: I agree. In fact, if you are doing investment now, you are getting a deduction at a higher rate than what you will expect to pay in tax when you generate revenues from that investment in future years once the tax rate falls back down again. So, I do not think there’s a problem there.
Dr Yueh: I would only say that I think that electricity generators are wondering about whether they can write off their investments. I think that a bit of clarity is required there.
Again, it comes back to this point: if you want to incentivise investment and you do not want to deter it, having absolute clarity on these things would help.
Q305 Alison Thewliss: The oil and gas sector, I understand, has an investment allowance it can offset, but that doesn’t seem to apply to renewables. Is that a problem if we are trying to move towards renewables and away from fossil fuels?
Dr Yueh: I think that is what the electricity generators have begun to say. I think that the Treasury has said that they will be able to write off their investments. However, I think it is not—
Alison Thewliss: It is not clear yet.
Dr Yueh: It is not clear—exactly.
Q306 Alison Thewliss: Are there any other industry sectors that have seen windfall profits that have come through in the past year or so that could be reasonably asked to pay a bit more tax?
Mike Brewer: That is a good question. I don’t know of any. We must of course remember that an awful lot of the excess profits being made right now are going overseas, and so we have got no hope of taxing them. It is the Saudi Arabian Government, for example, that is benefiting, or the Norwegian Government, and there’s not much we can do about that.
It was very welcome that the Chancellor extended the windfall tax from oil and gas producers to electricity generators. I don’t have a wish list of any more people to target at the moment.
Samuel Tombs: The only thing that struck me was that the electricity generator levy is being introduced from January 2023, so those companies have had a year or so of unusually high returns, whereas the energy profits levy on the oil and gas sector was introduced immediately in May. There has been a bit of a windfall that hasn’t been captured by the Government by introducing that slightly later.
Q307 Alison Thewliss: There seem to be some additional complexities in the sector, given the contracts for difference and the other ways in which the industry is structured. When the Prime Minister—the former Chancellor—came to the Committee after some suggestion of that was made earlier in the year, he couldn’t really explain how it would work. Do you think we are any closer to the Government being able to explain how we can go after these profits? The renewables generators did not really recognise the figures that the Government were talking about at that point.
Samuel Tombs: I am afraid that looking at energy companies in that much detail goes beyond my area of expertise, but the timing of the levy is one thing that struck me as being different.
Q308 Alison Thewliss: That’s fine. To go to the more domestic end of energy costs, Mike and Carl, you talked earlier about how the cost of living payments work. Are there particular people who have been missed out from the payments? Is there anyone the Chancellor hasn’t included within the scheme with his targeting? Are there implications of that?
Mike Brewer: There are two sorts of criticisms that you can make of the Government’s strategy next year. One is that the policy doesn’t take much account of your energy need. It takes account of your income—your ability to pay—but not your need. The payments don’t vary by household size, as Carl said, they are not higher for people for disabilities, and they are not higher if you have to live in a draughty, leaky house because your landlord has not insulated it, so there is a mismatch with energy need.
The second criticism is that being on means-tested benefits or being a pensioner is not a perfect guide to who is on low income. There are people who are not claiming benefits that they are entitled to, and there are people who are not entitled to benefits. Our calculation was that if you are single person living alone on £20,000 a year, the price you will be paying for your energy next year, compared with two years ago, is like an 11% cut in your income, which is very sizeable. There is an issue about how slightly broad-brush—"crude” is the wrong word—the benefit system is as a way of identifying people who are really in need.
By way of alternative, we thought the Chancellor might have waited a bit longer. He said that he will talk to the industry and other people about options, including a social tariff, from April 2024. We thought he was going to be doing that with the Treasury from April 2023, but in the end it looks like he has decided to announce something quickly that he knows is deliverable. That means he is limited to these fairly crude and broad-brush ways of targeting households.
Q309 Alison Thewliss: In terms of the impact on businesses, they have a temporary reprieve in their energy costs just now, but many of them have had to sign up to eye-wateringly expensive contracts because that is all that is on offer at the moment, and they don’t know how they will be supported come the spring. Are there particular things that you think would be effective to support businesses, or is it too much and too difficult for the Government to try to reach them? Is there an economic consequence as a result?
Mike Brewer: It is definitely a more difficult problem. There is much more variation in the non-household sector’s energy needs, and there is much more variation in the kind of contracts they sign. In this case, I am pleased that the Treasury is still thinking about it. That is the right thing to do. It is a very hard task to identify needy businesses; we do not have a straightforward test for that.
Alison Thewliss: Has anybody else got anything to add to that? No.
Chair: Siobhain, if you want, you have two minutes.
Siobhain McDonagh: That was a very interesting answer, and I have lots of questions, but I feel that people are under pressure to bring the meeting to an end because they want to participate in today’s debate. Thank you all very much.
Chair: Does anyone else on the Committee have any further last questions? We could have listened to the panel all day, but unfortunately we have to compete with the debate in the Chamber. There are a couple of things you were going to follow up with, in terms of further information. Obviously, a lot of you have already published some very good research in this area, and we really appreciate you sparing the time to go through your insights with us this afternoon. If there are no other questions from members of the Committee, I declare the meeting closed.