Treasury Committee
Oral evidence: Comprehensive Spending Review and Autumn Statement 2015, HC 638
Tuesday 8 December 2015
Ordered by the House of Commons to be published on 8 December 2015
Members present: Andrew Tyrie (Chair); Mr Steve Baker, Mark Garnier, Helen Goodman, George Kerevan, Mr Jacob Rees-Mogg, Wes Streeting
Witnesses: Robert Chote, Chairman, Office for Budget Responsibility, Sir Stephen Nickell CBE, Member, Budget Responsibility Committee, and Graham Parker CBE, Member, Budget Responsibility Committee, gave evidence.
Q105 Chair: Thank you very much for coming in to see us this morning. I normally begin these sessions by asking whether you have been subject to any undue influence by the Treasury, or indeed anybody else or any other institution, and you always give me that assurance. In this case, an allegation has been made. It is now being investigated and, in due course, we will be publishing a report on the basis of the information that we have collected and that investigation. Unless you have other areas of undue influence beyond the one in the public domain to report, we do not need to have that exchange today.
Robert Chote: We have given you the information or are in the process of giving you the information that you need to make the judgment on autumn 2014 but, for the record, I can report that there has been no undue influence at this fiscal event.
Q106 Chair: Good. Mr Chote, are Conservative manifesto pledges aspirations or are they commitments to policy?
Robert Chote: We confine the forecast to what is formally expressed as a policy that is announced at a fiscal event. If there is an aspiration expressed in a manifesto, or indeed an aspiration expressed by a Minister, that is not incorporated in the report, we identify that as a fiscal risk or a policy risk, rather than incorporating it in the policy directly. We took the same approach under the coalition as under this one, so there were aspirations to raise the personal allowance expressed by Ministers in the coalition that we did not incorporate, because they were not formally policy.
Q107 Chair: That is a very helpful amplification about the aspirations of Ministers, but my question was not about those. My question was about manifesto pledges. I would just like clarity again: are manifesto pledges therefore not considered by the OBR to be a commitment to policy?
Robert Chote: They are not in our forecast. The forecast includes policies announced at fiscal events.
Q108 Chair: You do not consider them to amount to a firm commitment to policy action. You do not think they commit the Government to act.
Robert Chote: Well, the degree of commitment is for the person making the commitment. Until it becomes a concrete policy that we can cost in terms of its impact, the certainty that it will happen, the certainty of exactly how it will happen and the certainty of when it will happen, we do not incorporate it.
Q109 Chair: You treat manifesto pledges as aspirations, do you not, just like statements of Ministers?
Robert Chote: Indeed. We will treat them as policy when they are expressed formally as policy at fiscal events, if and when they are expressed at fiscal events.
Q110 Chair: In your view, there is no difference in status between a manifesto pledge and a statement by a Minister.
Robert Chote: No.
Q111 Chair: Do you not think that that has quite significant implications for the way we conduct general elections in this country?
Robert Chote: Yes. We have had the debate before about whether independent scrutiny of manifestos would be helpful, and that caravan has passed.
Q112 Chair: You may be expressing that view, but it is not necessarily the case that Parliament will always hold that view. Let us try a few more specifics in this field. The legislation underpinning the OBR requires its forecast to reflect Government policy. In your latest forecast, you have chosen to exclude some specific intentions, like for example the intention to raise the higher rate tax threshold to £50,000 and to increase the personal allowance to £12,500. Do you do any preliminary work internally to try to assess what the effect would be on the forecast, were these manifesto pledges, after all, to be implemented?
Robert Chote: No, we would not. Particularly for a measure like that, while the costing will always end up being uncertain, for all the reasons that these costings are uncertain, if that were to be an announced change in the personal allowance, you could change that round. There might be events where you wanted to think about a particularly methodologically complicated policy change that had been flagged as a possibility in advance, but those sorts of changes in personal allowances would be relatively straightforward, as and when they were incorporated and dated formally as a policy measure.
Q113 Chair: It might be helpful if at least the numbers that attach to these core pledges were available in the public domain. After all, for those we are talking about here, many of them can be readily put together by the IFS and others.
Robert Chote: Indeed, and there are published ready reckoners for simple measures like that. There are other measures that are more complicated and where we seek clarification from the Government, at the fiscal event, as to whether this is a formal Government policy yet or not. The case here would be the business rates measure.
Chair: I was going to get on to that, so just say a word about that, Robert.
Robert Chote: Again, we explicitly said, “Is this a firm policy yet?” and it was not.
Q114 Chair: You were beginning a sentence that you then perhaps wisely did not finish. You were going to say you approach the Government to find out whether they wish you to include these in your forecast. That might have been the last part of that sentence.
Robert Chote: No, the question is: is this a formal policy or is it an aspiration? You have instructed us to produce the forecast on the basis of current Government policy, which raises the question.
Q115 Chair: Who decides? Is a formal policy just whatever, on the day that you start this work, the Government tell you is a formal policy?
Robert Chote: It evolves over time because, as we begin the forecasting process, the Government will have a list of things that they are thinking of including on the score card, the menu with prices that appears in the Red Book. To start off with, they will give us a list of those measures, some of which will not make it to the finishing line. Some of the ones that are there at the finishing line will not have been in there to begin with. What constitutes policy on the day the Chancellor stands up and makes the statement is evolving and refining, as the Government get close to making final decisions.
Q116 Chair: It might be helpful if you produce a note for us on what constitutes what you described in your very first reply as a fiscal event. The second thing that might be of use is a list of those things that other people out there, the wider public, might consider to be firm policy commitments.
Robert Chote: We identify those routinely in each EFO as policy risks, where somebody has made a statement of that sort. We identify them for precisely that reason.
Q117 Chair: It is for those you are saying are not formal policy and therefore are not included in the forecast. It might be helpful if, in addition, wherever possible, we try to attach a number to those risks.
Robert Chote: It gets us into the awkward business that we have been told not to analyse items that are not Government policy. We have to be slightly careful.
Q118 Chair: When you say you have been told, you mean in the legislation.
Robert Chote: In the legislation, yes. That brings us back to the whole debate about alternative policies as well.
Chair: The costings, yes, which I decided to leave for the time being. I am going to move off this subject for now, because I think we have decided to take this further forward in correspondence, unless there is a very burning point you want to make.
Q119 George Kerevan: Mr Chote, could you explain gently to the Committee how maintaining the level of the asset purchases at £375 billion for longer reduces the debt interest charges to the Treasury?
Robert Chote: Very roughly speaking, it is because, when the Government are undertaking QE, they are effectively financing some of their borrowing at bank rate, rather than at gilt rate. Gilt rate is low and has fallen, obviously. It has fallen again in this forecast, but bank rate is lower. If you are essentially saying that you are not going to reverse QE, or the implication is that you do not start to reverse QE until later, you continue to be able to finance for longer more of the debt at the lower bank rate, rather than at the higher gilt rate.
Now, the change that has taken place here is that the Bank of England has essentially said that it is not going to start to reverse QE until you have got to a position at which there is the material ability to loosen monetary policy again, should you wish to do so. It has quantified that as being base rates back to 2%. Base rates do not get back to 2% in market expectations in the course of our forecast horizon. Previously we had interpreted, and there was no complaint from the Bank on this, its previous statement about when it would start to reverse QE as when base rates get to 0.75%, i.e. the first material quarter‑point increase. It is a combination of the fact that the Bank is setting that threshold at a higher level, that base rate expectations have moved further out to the right and that QE implies being able to borrow at a lower interest rate than gilts. I hope that was gentle enough.
Q120 George Kerevan: I look around the Committee; it seems to be. When did the OBR come to the conclusion that it was wrong in where it had envisaged the unwinding of quantitative easing to begin and thus we would have a longer period of the lower charges to the Treasury? At what point did you make that decision?
Robert Chote: The decision based on when interest rates would start to rise again comes directly out of market interest rate expectations, and we base that on a 10‑day average leading up to October the something. That feeds through automatically. The basis of when we decided to use a 2% threshold rather than a 0.75% threshold was in the wake of the Bank of England having made that announcement, which I think it made when it released the November inflation report.
Q121 George Kerevan: Let us divide that into two. Let us stick with the point of when the Bank of England made known that it would not unwind QE until it reached circa 2%. If you look at the May 2014 inflation report from the Bank, it is not explicit, but you could read into it. It says, “The MPC is likely to defer sales of assets at least until bank rate has reached a level from which it could be cut materially.” That would suggest to my mind that the Bank was considering a significant rise in the rate, rather than just the odd basis point, but it seems to me that you have premised your forecast on an unwinding of the asset purchase rather quickly after these few basis point changes. That seems odd from what was starting to be hinted in the May 2014 report. Did the May 2014 indication not give you some warning light? Was there not some discussion with the Treasury and the Bank of England about when things might start to unwind to give you more clarity about your forecast?
Robert Chote: Obviously the Bank of England would have seen that that was the assumption we were making. I cannot remember whether we formally asked them, but we had a brief discussion with them in advance of our forecast, which is a useful exchange of information anyway, on whether that was a sensible interpretation of the policy at the time. They did not have any problem with it then. They obviously thought that the new announcement in November was sufficiently significantly different from what they had said in the past that it merited that change of wording and the emphasis that they placed on it.
Q122 George Kerevan: I remember in this Committee, earlier in the summer, talking to the Bank of England and asking them precisely at what point the rate would have to rise before they began a significant unwinding of the asset purchase facility. People then were talking much higher than the odd basis point, so I am not convinced that it has been that opaque until very recently.
What worries me is that we are now in quite a vicious circle, whereby, if you rely on the Bank blowing the whistle as to when exactly it will unwind the asset purchase facility significantly, if you wait for the Bank rather than doing your own independent assessment, the Bank knows that the moment it starts to unwind the asset purchase facility, all your forecasts go to pot as to the Chancellor’s surplus. The Chancellor might discover he has a smaller surplus. We are now in a situation where the Bank, you and the Treasury are all kind of parti pris as to what happens. Does that not cause you some worry? Do you not feel that you should be making independent forecasts, rather than getting involved in this semi‑political fire fight between the different agents?
Robert Chote: From our point of view, the objective is transparency. We need to be clear. The Bank has now been clear that it thinks 2% is the threshold. Of course, it may decide not to do it. It might do it before; it might do it afterwards. Making an independent assessment of whether it is likely to change its mind before we get to that point is probably less helpful than taking it at its word and saying what the implications of that would be and what transparently are the implications of the change from what is implied by what they have said previously. If it changes its mind, it will have effects on the forecast. Our job is to be transparent about what that change of mind reveals, rather than clouding it by making our own guess before and after.
Q123 George Kerevan: We are all clear here that, if the Bank of England was to move to unwind the asset purchase facility more quickly, at a lower rate, then that would materially affect your forecast of the surplus that is available to the Chancellor.
Robert Chote: It would do. It depends quantitatively on how big the difference is, but yes.
Q124 George Kerevan: Let us add the other bit then, which is the market perception of when rates might change. Is it your view that the current market perception of when interest rates might change is a meaningful forecast of what might happen?
Robert Chote: Market expectations are the best that we have to go on, as to people putting their money where their mouths are, in terms of that view. There are two issues: whether a particular instrument or a particular comparison actually tells you what the market’s expectations are, and then there is the alternative version of whether the market’s expectations are sensible expectations. The Bank may think that the market’s expectations are not the expectations it wishes the market had, but that is a slightly different question. From our point of view, the most transparent thing we can do at this stage is to take the market’s expectations and to say that that is the best we have to go on.
Q125 George Kerevan: Even Mr Haldane does not think that there is a particular correlation between the market expectations of what interest rates would be and what actually happens.
Robert Chote: You have picked one person at one end of the spectrum.
George Kerevan: He is the Chief Economist.
Robert Chote: Indeed, but he is at one end of the spectrum of views about interest rates on the MPC. Different ones will have different views. It is a committee.
Q126 George Kerevan: I appreciate that. I realise that, in the absence of information, you pick the best number there is. It is quite clear, statistically, that there is no great correlation between the current market forecast of what future interest rates might be, given that it is dependent on what the Bank of England does, and what actually happens.
Robert Chote: If you go back three years ago, the expectations for market interest rates would not be the same as they are now.
Q127 George Kerevan: Indeed, so what I am trying to probe is, given that we now have this asset purchase facility, which now plays a unique and significant role in determining the Treasury’s surplus as we move on out, you as the independent forecaster have a problem in deciding how accurate your forecasts are, given that the asset purchase facility could change at a moment’s notice. This is fundamentally political, with a small “p”, choice. I am just asking really what faith you expect us to have in a forecast that factors in a market forecast for future interest rates that is more than likely not to be accurate.
Robert Chote: The question is whether you place more faith in the market or, if we were to come up with our own profile for interest rates over this period, whether you would place more faith in that. That would be for you to make your mind up about. This is a market where you can identify fairly clearly what the market’s expectations are. The contrast here is that there is not, in the same way, an easy way of knowing what the market’s expectations are about the timing and the pace with which QE will be reversed. There, we have to fall back more on interpretations of what the statement of policy is. We could produce our own set of interest rate curves to do that, instead of the market.
Sir Stephen Nickell: It would be extremely unlikely that we could produce forecasts of future base rates that were systemically superior to the market forecast. Were we able to do so, we could resign and make billions.
Chair: But would you let us know?
Q128 George Kerevan: I shall stage a delicate retreat, therefore. My point is not that you could produce a superior forecast, but that any forecast in this area is likely to be wrong. Therefore, whether they are good guidance to anything is a point.
Robert Chote: Absolutely, and the other point to note, as you see from forecast to forecast, is that when market interest rate expectations change that has quite a lot of impact on the forecast. You have had a modest move in the pre‑measures forecast, a 0.4 percentage point change in the average gilt yield over the forecast, and what the market giveth the market can taketh away in a subsequent fiscal event. Everybody needs to be conscious of that.
Q129 George Kerevan: I will move on to quite a different subject. I felt that we had not been asking enough questions on the issue of the housing market. One of the elements of the autumn statement is the surcharge on domestic buy to let. Are you in any position to give us an estimate of how you think that might affect the state of the housing market?
Robert Chote: We have assumed that it results in a reduction in housing transactions of 2% to 3%.
Q130 George Kerevan: I think it was 34,000. How did you arrive at that? It seems to me such an uncertain area.
Robert Chote: “We assume that this will reduce the incentive to purchase second homes and reduce the volume of annual property transactions by around 3% in 2016-17 and around 2% in each subsequent year”. Now, one point to bear in mind is that we identified the costing of this measure as being one of relatively high uncertainty, partly because, to date, it has not been necessary for people to flag to HMRC whether a particular transaction relates to a second home, a buy‑to‑let property or not. Therefore, you do not have a robust estimate of the pre‑measures tax base on which to take that off. The other issue is that obviously you are not quite sure what the behavioural response is going to be. Are people going to declare that this is their principal residence, etc?
Q131 George Kerevan: We can all agree we do not know but, in terms of your subsequent analysis, I just wondered whether you can firm up anything, tell us how you did the calculations and give us some sense of how robust they are.
Graham Parker: On the effect on the housing market of the 2% or 3%, as usual, we just looked at the extra transaction cost. Did we do that? The model does that, does it not? Our housing model has a term in it that reflects transaction costs, so we plugged that into the model and came up with the 3%.
Q132 George Kerevan: Is there a possibility that some of the slack could be taken up by commercial companies involved in buy to let, if there is a need that is not being supplied by the more domestic investors, because of the impact on their tax? Could some of the impact not be taken up by commercial companies, which are exempt from the surcharge? Have we modelled that?
Graham Parker: Yes, that is one of the factors involved in giving it a very high uncertainty ratio, because that would depress the yields on this measure. It is possible, but it depends. It is very uncertain. I am not sure that I can add anything. There are very many factors and we have reduced them. The costing that appears is certainly not the full amount. We think that there will be some behavioural effects that will reduce it considerably.
Q133 George Kerevan: Why do you think it would be more in year 1?
Graham Parker: Do we?
Robert Chote: Yes, we have a 3% effect.
Graham Parker: That is because it may take people time. With your example, it may be a while before companies gear up to step in, so there will be more attrition on the costing in year 2 than year 1, because it will take time for the various ways round this to materialise.
Robert Chote: That is a familiar pattern with a lot of the costing we do. For example on avoidance measures, you assume that effects later are less, because there has been more time for people’s behaviour to adapt. They know they are going to want to change their behaviour, but getting around to doing it and having the mechanisms in place to do it takes a bit longer.
Q134 George Kerevan: My final question is: given the levels of uncertainty available, can you put any kind of figure on how robust you think your forecast is for the housing market, in this respect?
Graham Parker: We think it is a central forecast and we think it is a reasonable forecast, otherwise we would not have certified it, but the actual error range around it is considerable. I would not like to put a number on the standard deviation.
Robert Chote: There is particular difficulty with stamp duty measures. For example, we and the Scottish Government produce forecasts for the LBTT. You can have lots of interesting views about exactly how you do that, but which one turns out to be closer to the truth will depend, to a considerable degree, on just what the transactions turned out to have been and actually knowing how much it is the measure that has affected that or just that transactions are very hard to predict. Sometimes, as we have had here, transactions are moving differently for relatively highly paid houses than for less highly paid houses.
It is one of those measures where, even after the event, going back and saying, “Did you get that right or not?” is very hard to do, because you do not know what it was that determined the transaction in the first place.
Q135 Mark Garnier: Stephen Nickell, can I turn to a subject that I know you enjoy talking about a great deal, and that is the one of immigration? As part of the negotiations of EU membership, the Government are seeking to restrict access to in‑work benefit for EU migrants. Do you think at any practical level that is going to make a change to EU immigration?
Sir Stephen Nickell: Just to get this clear, you are asking me what impact changing the benefit rules for EU migration, so that it becomes more difficult to obtain, is likely to have.
Mark Garnier: In your opinion, yes.
Sir Stephen Nickell: In my opinion, not much.
Q136 Mark Garnier: Do you want to expand on that?
Sir Stephen Nickell: Do you mean make a precise quantification? The answer is I have no idea, because I have not investigated it.
Q137 Mark Garnier: You are an economist. You understand this type of stuff, the movement of people and what goes on in the world. It is quite key to the Government’s policy on renegotiating our membership to the EU and, as you know, there is a particularly political sensitivity around this area in the UK. It is a very big issue. It is very useful to have thoughts from the OBR, as to whether some of this policy will actually work, because it then does go on to have implications to the economy, which I want to develop a bit later. It would just be very useful, to start off with, to get a sense of whether you think this is a sensible policy.
Sir Stephen Nickell: I am not sure it is our job to express views on the consequences of things that are not as yet policy. As you have heard, I am prepared to say that any changes to benefit rules are unlikely to have a huge impact on migration flows, but to go further and start trying to analyse the actual consequences of these things is not basically within our remit.
Q138 Mark Garnier: Is that on the basis that it is an aspiration and not a policy, as yet?
Sir Stephen Nickell: It is on the basis that it is not a policy.
Q139 Mark Garnier: Fair enough. We are probably not going to get very far with my line of questioning then, but I will press on nonetheless. You must have cast an eye over this. Do you think there is any evidence at all, not your own opinion, not the opinion of the OBR, but just as a general commentary on the evidence that is available, that people would be less enthusiastic to come to the UK if their income was dropped as a result of tax credits being removed for four years? Is there any evidence to support that?
Sir Stephen Nickell: The answer is, in general, there is evidence that suggests that migration flows are influenced by the difference between what you are able to get in the country of origin and what you are able to get in the country you migrate to. Yes, there is quite a lot of evidence that the differential in job opportunities, the differential in pay, is a significant factor in determining migration flows. That is the general point about the determinants of migration around the world.
Q140 Mark Garnier: For sure, but the minimum wage in Romania I guess is significantly lower than the minimum wage in the UK. Does it necessarily need to have extra in‑work benefits on top of that, in order to make it attractive, or would it still be just as attractive a relative difference if you did not have that?
Sir Stephen Nickell: The fact is that, if the differential gets bigger, the incentive gets bigger. There is not just a cut‑off point. Do you see what I mean? If the differential gets bigger, the attraction gets bigger. That is the general point. That has been found to be the case on migration flows around the world.
Q141 Mark Garnier: The OBR is forecasting that employment is going to grow by 1.1 million by 2020. What proportion of that is from immigration and what proportion of that is from population growth? You must be able to answer that one.
Robert Chote: It is all population growth. Essentially speaking, if you look at the rates, the unemployment rate, the employment rate and the inactivity rate, they are essentially the same at the end of the forecast as they are at the beginning. It is a consequence of population growth and, roughly speaking, about three quarters of that would arise from migration, rather than domestically. The population growth over that period is probably about half and half but, because of the net migration tends to be more of working age, then the employment effect will be bigger.
Mark Garnier: There are 775,000 more immigrants coming in by 2020 is what you are saying.
Robert Chote: Roughly speaking, yes.
Q142 Mark Garnier: That is very interesting. You do not necessarily work all those numbers out yourself. Where did you get that 1.1 million from?
Robert Chote: That is our forecast of the increase in employment.
Q143 Mark Garnier: That is quite interesting, is it not? Do you want to expand on what the economic effects are of these migrations? Were we not to have these immigrants coming in, what would be your forecast? To reduce the population growth from 1.1 million to 325,000, that would have significantly less impact on the economy and economic growth, would it not?
Robert Chote: The fact that we have assumed higher rates of net inward migration in this forecast than we have assumed in previous ones is a reflection of the fact that the Office for National Statistics has updated the population projections. and that we have to make a choice amongst the various variants that the ONS produces of what we are going to base the forecast on. One consequence of that is that potential GDP is higher at the end of the forecast than it would otherwise be. That means that the economy would be bigger on that basis, but you also have more people. Now, you would also expect there to be a change in GDP per head, as well as GDP, again because net inward migrants tend to be more of working age, but it is not going to be as big as the overall change. It is one reason why there is an effect on potential GDP at the end of it, because we have more legroom.
Q144 Mark Garnier: GDP is bigger. Is GDP per capita bigger or smaller?
Robert Chote: It is bigger, but by nowhere near as much, because of the age composition.
Q145 Mark Garnier: The overall size of the economy will be bigger as a result of migration, but GDP per capita will not be as big as it would have been.
Robert Chote: It will not be bigger by the same proportion.
Q146 Mark Garnier: If you did not have any migration, the overall economy would be slightly smaller than it would otherwise have been. Have I got that right?
Robert Chote: The less employment growth you have, the less the population is, the smaller the economy is going to be.
Q147 Mark Garnier: Can I ask you another question about the quality of migrants coming in? One interesting thing that has come up in this debate is that, in trying to reduce the number of migrants coming to this country, we can do that by putting a lid, if you like, on the non‑EU migration coming in. Of course, we have to allow those EU migrants to come in through the free movement of peoples laws. However, there is an argument that says that we are turning down engineers from America, brain surgeons from India and very highly qualified people, in order to allow in lower‑skilled workers from Eastern Europe. Is that a fair comment, first of all, and, secondly, does that have an effect on the economy?
Robert Chote: Stephen may want to say something on the substantive point. As far as the forecast is concerned, we are assuming that the migrants have the same productivity, on average, as the native population of the same age. The effect shows up through the age structure and gender, rather than through compositions, so we do not look at a detailed analysis of what sort of people might be coming in or might by deterred by particular sets of policies.
Sir Stephen Nickell: That is right. We basically do not investigate, in any great depth, migration from different parts of the world. We do not go into that, essentially because forecasting these things is too difficult and it would be too much of a focus on something that, in overall terms, would not be very significant. We really are not in a position to say the extent to which non‑EU migration substitutes for EU migration, and so on and so forth.
Robert Chote: We did a review of the productivity issue and the 2013 fiscal sustainability report pointed out that there are differences, but the averages are not very different.
Q148 Mr Baker: It was a fascinating discussion about monetary policy, but I do just want to drill into some additional bits. Charles Bean and others produced a Geneva Report, in which they argued that “a return to a world with a higher neutral real interest rate” would be “rather desirable”. Would you agree that we should we have higher interest rates?
Sir Stephen Nickell: Higher real interest rates is what they said.
Mr Baker: Indeed.
Sir Stephen Nickell: Let me start by going back in history. The neutral real interest rate appears to have fallen steadily over the last 25 years, and many reasons have been put forward for this. One such is that there has been an excess of savings relative to investment opportunities, so that leads us to the view that it might be desirable if the world had higher neutral real interest rates, because that would mean that the world had better investment opportunities than apparently are currently the case. In that sense, a world of higher real interest rates would be a world in which investment opportunities were better than they are today and that might be a good thing.
To say, of course, that a world of higher real interest rates being a good thing means that we should aim monetary policy to get higher real interests does not follow at all. In other words, the fundamental factor behind the lower real interest rates is the lack of investment opportunities around the world, relative to savings. In some sense, if you want higher real interest rates around the world then, somehow or other, you have to improve investment opportunities, and then they would naturally lead to higher interest rates, because the demand for the savings would then increase.
Q149 Mr Baker: That is an absolutely fascinating answer. We could spend another half an hour just talking through all the implications of what you said. Earlier on, we had an exchange as the panel, where you talked at some length about the interplay between the Bank of England and the height of interest rates and, in particular, things like what market interest rates were. I think Mr Chote said something about whether or not market expectations were the expectations the Bank of England wanted them to have and so forth. Do you not think that this apparent fall in interest rates, over the course of 25 years, might be because central banks around the world have chosen to drive interest rates lower?
Sir Stephen Nickell: To some extent, central banks are the prisoners of their overall environment. Of course, they can choose whatever short‑term rate they see fit in order to hit their inflation target but, under the assumption that they are choosing interest rates to hit an inflation target, then, if inflationary pressures around the world are lower for whatever reason, they will find themselves setting lower interest rates. In a sense, what I am saying is that central banks are not just free to choose whatever interest rate they like irrespective of what is going on in the world, because they are trying to set interest rates to hit some inflation target or whatever other target they might have—exchange rate targets, and so on and so forth. They are, in that sense, limited by the environment in which they operate.
Q150 Mr Baker: On the way in, I picked up a City A.M., which covered a report that says we should now be expecting a credit boom leading to a further housing bubble. Do you think there is any danger of that? In particular, you are talking about chasing CPI as a target. Is it not the case that house prices are once again accelerating, but of course the Bank of England does not target the rate of house price increases when it sets monetary policy? Do you not think there is a danger, with the central bank acting as it is, that you will end up basing your forecasts on a further credit bubble, a further housing boom and, inevitably, since it is underpinned by state guarantees, a restarting of the cycle that has got us into this?
Sir Stephen Nickell: These dangers have been around for a long time, in the sense that a recognition that there may be credit bubbles, which pure interest‑rate‑setting monetary policy is not well equipped to deal with, has led to the whole paraphernalia of other committees of the Bank of England, whose job it is to focus on these matters. They have other policy tools, such as restricting ratios of mortgages to value, and so on and so forth. It is now the Financial Policy Committee’s job to, in some sense, deal with these matters.
Q151 Mr Baker: Something else you said in the course of your answer was that there is an excess of savings in relation to investment opportunities, but is the world not still awash with human needs for which investment could take place? To what do you attribute the lack of investment to meet those human needs?
Sir Stephen Nickell: As you say, the world is awash with human needs, but investment opportunities require one to get returns on the investment. If satisfying these human needs does not yield much of a return, as, for example, investing in new antibiotics may not lead to much of a return because the demand for these antibiotics is rather limited, there is a sort of unmet need.
Q152 Mr Baker: I am trying to get to the heart of the question I originally asked you, which was: do you agree that it would be rather desirable to get to a world with a higher neutral interest rate? I am trying to tease out some of the damage that I think is being done by having sustained low interest rates. In the end, where does this boil down to? Do you think damage is being done to society and the economy by having sustained low interest rates? Could you answer that very simply? It is not for you to judge is an acceptable answer.
Sir Stephen Nickell: No, my answer would be that the world would be a better place if interest rates were higher, because then there would be better investment opportunities.
Chair: You see how hard we try to help our witnesses out.
Q153 Mr Baker: I popped back to the financing arithmetic while we were sitting here. Although the central Government net cash requirement is £75.5 billion in this statement, the net financing requirement for the Debt Management Office is £128.4 billion. Just bearing in mind some of your earlier remarks about interest rates and the role of the Bank of England in helping to finance all of this, how do you expect the gilt market to react as the bank rate starts to come back up to 2%, so they can unwind QE? What is your expectation for how that dynamic will evolve, as we continue to be reliant on the gilt market to raise these enormous sums to refinance the outstanding debt?
Robert Chote: The forecast is basically taking the curve as it is and assuming that is embodying the market’s expectations of policy evolution and the response accordingly. There is a world in which we could make an alternative set of assumptions of our own but, in terms of the way in which we do the debt interest forecast, we assume that the market expectations are the best we have to go on.
Q154 Mr Baker: Could you characterise, please, your level of uncertainty around this area?
Robert Chote: My level of uncertainty around almost every area is considerable, and this is at least one of them. An obvious question, in terms of the outlook or the potential movements in the yield curve, is what the market’s reaction is going to be if and when the Federal Reserve starts tightening in the US. How much is that in the price already? How much of it will come as a surprise? Will people get excited about that? Will they conclude that we have been waiting and all this has done has ratified our expectations? What effect will that have on the UK? Clearly that is one potential near‑term sort of uncertainty.
Q155 Mr Baker: I do not expect the Chancellor will thank me, but it seems to me that you have given the Chancellor a windfall by adjusting your forecast, which has been spent in advance. We know that there is a great degree of uncertainty around the Government’s ability to continue financing through the gilt markets, and interest rates are lower for longer. We have reached the point where we have accepted that you do not judge the consequences of those interest rates being lower for longer. Is there any advice you would like to offer the Chancellor on the fiscal responsibility side about what he should be doing, in the context of all this uncertainty?
Robert Chote: I am sure that what he will have done, or one would hope that he would have done, would be to recognise the uncertainties and not merely the path of the central forecast in making the spending and other policy decisions that he did at the autumn statement. There is a contrast between your everyday budget or autumn statement, which will be followed a few months later by another one—the forecast can move around and the policy changes can move around as well—versus an autumn statement where you are setting out spending plans over the rest of the Parliament and, in some cases, a bit further than that. Those are harder, although not impossible, to modify, if you decide that you want things to look somewhat different. I am sure that will have been weighing on his mind, in terms of the amount of caution that he felt it was appropriate to have.
In terms of focusing on his particular preference to have a surplus of £10 billion in 2019‑20 for the fiscal mandate, past forecasting errors would suggest that that corresponds to a 55/45 chance of the budget actually being in surplus in that year. It is for him, rather than for us, to decide whether 55% is a high enough number.
I should just make the other point that, as you say, there has been “a windfall” that he has spent. You only have to look at every previous autumn statement that we have done to see that sometimes those forecasts go in your favour; sometimes they go against. They normally move by larger amounts than this one has. I am sure he will, and those who advise him will wish him to, weigh that consideration in mind.
Q156 Mr Baker: In your judgment, to what extent has the Chancellor satisfactorily taken into account the uncertainties in the forecast?
Robert Chote: As I say, he has done it to a degree that, on the single measure of the fiscal mandate, would give him a 55/45 chance of doing that. We can be transparent about that, but it is not part of our job to say whether that is an adequate level of caution to put in. That is your and his responsibility.
Q157 Mr Baker: Pursuing this issue of caution, you have said, “To meet the Government’s aspiration the UK’s export market share now would need to rise by around 50% over the next five years, compared to a 3.3% fall in our latest forecast.” The exporting sector of the economy is not going to make it in accordance with the Government’s ambition, is it?
Robert Chote: Not in our central forecast, no.
Q158 Mr Baker: How confident are you that your forecast is correct and the Government’s ambition will be vastly wrong?
Robert Chote: It is a central forecast and there is thus a 50% probability that it falls either side. My gut instinct is that it is more likely that exports will be in line with our forecast than in line with the Government’s original aspiration.
Q159 Wes Streeting: How much and what proportion of public spending is being moved from central Government to local government by the Chancellor?
Graham Parker: We do not know yet, do we?
Robert Chote: That depends on the full local government settlement.
Graham Parker: It comes back to the business rates question we touched on earlier. In this forecast, we have not incorporated the full effects of the devolution of business rates to local authorities, because that will come together with other moves, which will move spending.
Robert Chote: It will come with policy decisions about what spending responsibilities then go to local government.
Graham Parker: They have not yet been settled.
Q160 Wes Streeting: I will come back to business rates for a related question. I have a whole series of questions about how on earth you are going to work through the implications of the decisions that the Government are making and how you can produce effective models, but the first thing I wanted to answer about was the way in which the Chancellor has allowed local authorities to effectively charge an increase in council tax to fund social care and policing. How did you model the effects of that change?
Robert Chote: We had to basically make a judgment about the degree to which local authorities in aggregate, and police authorities on the police side, were going to take advantage of that and, if they did, to what extent it would be spent. In the assumptions that we have made on the social care side, we have assumed that there is about 95% take‑up of that opportunity, which might be everybody doing 95% of the new room for manoeuvre or 95% doing all of it. We have not been explicit about that. We have assumed that some relatively small proportion of the additional money that is raised from that goes into reserves and that the rest is spent. We have made those judgments on the basis of what we can interpret from the behaviour of local authorities, but it is a judgment, rather than a precise science.
Graham Parker: Not every local authority is up to the 2% current referendum limit. I would not expect them all to go up to the full 4% or to take up the extra 2% in total, but it is a judgment. For the purpose of our forecast, it does not matter that much. The only thing that matters for our forecast is how much of it we assume is spent in the same year, because we are balancing the extra council tax with extra local authority spending. In terms of the effect on the deficit, it has practically no effect at all.
Q161 Wes Streeting: I probably should have said initially that I am still a councillor in the London Borough of Redbridge, albeit an unpaid one.
Graham Parker: You could help us on the behavioural side.
Q162 Wes Streeting: That is a really interesting question. I have looked at the LGA forecast as well. They are making assumptions that virtually everyone is going to go up the full whack, so your 95% assessment would chime with them. The difference between the OBR and the LGA is that the LGA, for small “p” political reasons, has every reason to suggest that local authorities would charge the maximum amount, because they do not want to sound too alarmist about the shortfalls in funding of social care. The OBR has a different remit and a different focus, but you are saying that effectively a certain amount of this has to be guesswork and is very difficult to predict. Is that a fair assessment?
Robert Chote: Absolutely, it has to be a judgment. As Graham said, you are basing it partly on the fact that it is unlikely to be a central assumption that everybody takes it up to the full extent, given their current behaviour. Therefore, aiming off that slightly in what is not a hugely scientific way, but hopefully one that is reasonably robust in judgment, seems a sensible thing to do.
Q163 Wes Streeting: What interactions have you had with local authorities, in terms of reaching your own judgment?
Robert Chote: We have a discussion with local authority finance experts in the run‑up to most of the forecasts that we do, but of course we cannot do talk to them about the likely impact of policy measures that have not been announced yet. We typically sit around and try to ponder the eternal mystery of how much money local authorities are going to put into reserves in the coming year and talk in general terms about the additional uncertainties of the business rate situation. We cannot talk to them about: “The Government is going to announce this in three weeks; what effect do you think that would have?”
Wes Streeting: It would be great if you did. It would be interesting for us.
Robert Chote: It would be open government in practice, but that is not our choice to make.
Q164 Wes Streeting: In terms of the behavioural side of things, I would not anticipate local authorities ploughing much into their reserves at all, for two reasons. One is that they are being encouraged by the Government not to and have been encouraged to spend their reserves. Secondly, when you look at how much revenue would be raised from the 2% surcharge to fund social care, and you run that alongside the increase in the national minimum wage to the Government’s so‑called national living wage level, most of that is going to be eaten up by wage increases before you even begin to address the rising costs and burdens of social care. You can safely assume that tax revenues will be spent.
Robert Chote: Just to make the point, this is an area where we have been caught out in the opposite direction for much of our time in existence. We have said, “Look at the squeeze that is going on with local authority funding; surely they are going to start eating into their reserves.” In fact, they have ended up putting more in. This year, that is not so much the case, but one of the conclusions we have generally drawn from the discussions with LGA, CIPFA and other experts in this area is that the behaviour is as much motivated by uncertainty about their financial position in future years as it is by the knowledge that it is going to get more difficult. It is the uncertainty that brings out what Tony Travers describes as the “squirrel” DNA in local authority finance directors.
Q165 Wes Streeting: Turning back to business rates, given that planned changes to business rates have not been incorporated into the OBR’s forecast, how are you going to go about estimating the effects of those changes?
Robert Chote: It will depend on the precise definition of the policy, when it is firmed up sufficiently for us to be able to take it on board. A key issue there is going to be what additional responsibilities local authorities are given in terms of their expenditure, and the judgments that will lead us to make on how this affects the reserves policy, which is what is making the difference. It kicks it through to the deficit forecast in a way that other changes, which are neutral across spending and revenue, do not.
Graham Parker: We will have to wait and see the details of what the Government are proposing, what it will actually delegate to local authorities in the business rates regime on that side and also, as Robert said, what other spending they will transfer to local authorities.
Q166 Wes Streeting: Thinking about the outlook for the whole Parliament, not just the decisions of this spending review, it is pretty clear that a number of fiscal powers will be transferred, not just to English local authorities, but also to Scotland and Wales. What challenges will this pose to you in producing fiscal forecasts for the whole of the UK?
Robert Chote: It is going to be a key issue for us in this Parliament. At the high level, there will be more decisions that have potential implications for the UK public finances—some at the level of the deficit, but some more compositional—which are not being taken in the course of the fiscal events that we focus on regularly. From our point of view, we have to interact more with the devolved Administrations.
We now have our new colleagues in the Scottish Fiscal Commission, with whom we have a very good relationship, talking about the impacts of the tax decisions that are already being devolved to Scotland. I would expect, as Smith comes through, that we will be talking to them about a wider range of issues. We will have to go through a significant practical increase in workload and engagement, devoting time to elements of the forecast that, at the moment, are not necessarily material to the UK picture as a whole, so it is a challenge.
Q167 Wes Streeting: Therefore, how will you and we go about scrutinising taxation that central Government devolves to local authorities?
Robert Chote: Presumably, each forecast we do will be incorporating current policy, as it is decided by all the relevant devolved Administrations, and then any new decisions that are announced in the course of a budget or an autumn statement. Presumably you can quiz us on those. I also appear regularly before the Finance Committee in the Scottish Parliament. There is a particular focus there generally across the piece, but also on the particular forecast changes.
Now, one very interesting issue in terms of how complicated this is going to be is whether, to take Scotland, the Scottish Government decide to use the power they have to come up with different rates of taxation for roughly the same thing that applies in the rest of the UK. Clearly, there is a challenge for forecasting what Scottish income tax receipts are with the UK, as there is for the rest of the UK, if we end up with a different tax rate applying in Scotland and the UK. We then have to take into account the whole series of issues on the behavioural response to that, which are not going to be straightforward to answer, but which we will try to answer as transparently as we can, but where it will also be very useful for us to be talking to people like the Scottish Fiscal Commission, which will be very focused on those issues as well. They will not have to forecast the same things, but they will have to scrutinise the Scottish Government’s forecast of some of those same things.
Graham Parker: There are also going to be some issues about data and making sure we have the right access. It is easier now: when it is all central Government, we can go to people in central Government. The more things are devolved to other bodies, the more difficult it is for us to be able to get access to the data and the advice we need.
Q168 Wes Streeting: Given some of the difficulties you have described in relation to English local authorities, and you mentioned the relationship with the devolved Governments, are you concerned that you lack the necessary information‑sharing arrangements with not just the devolved Governments, Scotland and Wales in particular, but hundreds of decision‑making bodies across England?
Robert Chote: At the local government level, clearly you are having to make judgments in aggregate. We could not have a bilateral relationship with every local authority and draw information on that basis. Talking to people like CIPFA, LGA and experts in this area is a helpful thing. With the devolved Administrations, there is a more formal process involved, and one thing we will be looking at is whether we end up with a memorandum of understanding that applies between us and the Scottish institutions, in the same way that we currently have between us, HMRC, DWP and bodies like that.
Q169 Wes Streeting: This is really short; I am sorry to press. There is £6.2 billion estimated in your forecast from council tax revenue. I am not convinced from the answers you have given—and they are reasonable challenges you have outlined; this is not a criticism of the OBR—that that can be a robust figure. Can it?
Robert Chote: It is our central forecast, around which there is considerable uncertainty.
Chair: That is known as a neutral question, by the way.
Graham Parker: It should not be that bad. Obviously it is subject to uncertainty, but we have a base and we make assumptions about the level of the increase in council tax.
Q170 Chair: These are important uncertainties and it is very important that it should be raised.
Wes Streeting: Thanks for your indulgence.
Graham Parker: It is better than some.
Robert Chote: I was going to say that there are bits of the forecast that are a lot more uncertain than others, as regular viewers of our North Sea receipts forecast will know very well.
Q171 Helen Goodman: On page 54, you have a real GDP growth fan chart, which I love. I just want to check that I have understood it. You have the central expectation, which is the black line, then you have the dark grey bands. I am working on the assumption that it is 40% probable that things fall within the dark grey bands.
Robert Chote: It is 20/40/60/80 as you go up.
Q172 Helen Goodman: That is good, so there is quite a bit of uncertainty. Mr Baker ended up by asking a question about exports and the unlikelihood of the Government’s export target being met. I want to ask you about the export forecast and what you believe are the major uncertainties about the export forecasts. You have set out, on page 77 in box 3.4, how you have come to your view. One key aspect of this is to whom we export. Another key aspect is what the growth is in those markets. Another key aspect is import intensity and another key aspect is the exchange rate, so could we just discuss each of those four in turn?
Robert Chote: On one level, you can start off with a forecast for the world economy, for world GDP growth. For the international forecast, given our size and capacity, basically we take the IMF’s global forecast and adjust it where we think it is necessary or helpful to do so. You can start off with a view of the world economy. Then there is the relationship between world GDP growth and trade growth. One thing that we have taken on board in this forecast, which has been noticeable recently, is that, for a given amount of world GDP growth, you have been getting less trade growth than had been previously anticipated. The IMF has made adjustments in that form and so we have reflected some of that.
Then, as you say, you have an issue about, if there is a slowdown, whether it is a slowdown in the bits that the UK exports less to or more to. We are more exposed to what is going on in the eurozone than we are to what is going on in emerging markets. That can go both ways. It may be that world trade growth slows but, if it is slowing because emerging markets are not trading as much with each other, then that is not something that has a great deal of consequences for the UK. On the export market share, you can see on the top chart of page 77, there has been a trend decline, which we are assuming will continue in coming years.
Helen Goodman: That is what one would expect.
Robert Chote: The responsiveness of that market share to particular shifts in the exchange rate is not a straightforward thing to judge. Sometimes there is more of a response and sometimes there is less. The experience of the 1990s with exchange rate shifts was different, both in terms of its impact on trade and its impact on inflation, than it has been more recently.
In terms of the exchange rate itself, we are plugging in an assumption based on the levels of interest rates in respective countries, uncovered interest parity, so again we are taking a relatively mechanistic view of the exchange rate. There would be those who say, looking in particular at the overall balance of lending in different sectors, looking at all of this and the size of the current account deficit, that there may be a risk of a larger exchange rate adjustment than that, which is a perfectly reasonable view. We highlight that as one of the risks but, for our purposes, we take up what is implied by interest rate differentials.
Q173 Helen Goodman: You take the current market rates, as you were discussing previously. If we were exporting to different countries, is that the shift that we could make in our behaviour that would give us the greatest chance for doing better on our exporting?
Robert Chote: Yes. Whether you are explicitly targeting that or you are producing a set of products and services that are particularly attractive in countries that have rapidly expanding demand, so choosing a set of products and services versus, given a set of products and services, where you try to market that, which of those would be more effective? I do not know.
Sir Stephen Nickell: In some senses, if you want your exports to grow, it would be a good idea to export a lot to fast‑growing countries.
Helen Goodman: You cannot immediately switch because of what you make.
Sir Stephen Nickell: It is easy to say, but you then have to produce products that are especially attractive to the people in fast‑growing countries. It is not something that you can just do and, by and large, it is hard to think of a policy that could produce that outcome.
Q174 Helen Goodman: Ministers can lead trade delegations to faraway countries.
Sir Stephen Nickell: They can, yes.
Robert Chote: One argument that links to the productivity puzzle is, looking back over the past few years, whether the gumming up of the financial system has made the ability to allocate capital to potentially rapidly innovating and productive firms more difficult. That could similarly be the sort of thing that makes it difficult to reallocate your activity and take advantage of particular markets. There might be improvements in the general financial system that help in this area indirectly.
Q175 Helen Goodman: Could you just say a little bit more about those exchange rate risks and how great they are, if your approach turns out not to be the most accurate, and how significant they would be for export volumes?
Robert Chote: In terms of the risks, we have basically made the assumption that the exchange rate moves in line with interest rate differentials. Clearly, there are risks to that. As I say, some people in particular would look at the size of the current account deficit and say, at the moment, we have a situation in which we are relying on a pickup in investment and a continued deficit in the household sector to offset the fiscal retrenchment, in terms of an overall balanced view. Some people would say, “Is that really plausible? Surely a more likely thing is that we have a more rapid adjustment in the exchange rate, which produces a bigger improvement on the external balance, and you could change the composition.” It is not something that we have put a particular probability on.
In terms of the changes in the exchange rate, its impact on exports, on inflation and on activity more generally, the difficulty is that historical episodes have shown that, on some occasions, changes in the exchange rate have much less or greater effect on inflation or on the trade position than you would have anticipated. If you look at the export market share line, that has not been moved as much by the exchange rate depreciation a few years back as some people would have been anticipating at the time.
Sir Stephen Nickell: If that line went back to the mid‑1990s, there was a distinct flattening off of that line during the period in the mid‑1990s when the exchange rate was rather low, having fallen in the early 1990s. In that period, the lower exchange rate seemed to have had quite a big effect but, more recently, it seems to have had much less of an effect. Indeed, people expected it to have more of an effect, but were disappointed when the effect was not large.
Q176 Helen Goodman: All this is on current policy assumptions, so we are staying in Europe, on your assumptions. We are not achieving any significant changes in the international trading rules of the game, on your assumptions. Indeed, there is a footnote somewhere about trade liberalisation. I do not know whether I can find it anymore.
Robert Chote: That is talking about the structural shift.
Sir Stephen Nickell: It is on page 49. That footnote is talking about trying to understand why growth of international trade relative to the growth in world GDP has been much lower recently than it used to be.
Robert Chote: It is an IMF conclusion.
Q177 Helen Goodman: That is helpful. One of the questions I have about this is: everyone says, “We are going to liberalise. It is going to be great. We are going to get loads more exports”, but we might get more imports as well, presumably. The import intensity might go up too.
Robert Chote: Yes. In the adjustments we have made, we have pulled down exports, in part as a reflection of the trade intensity argument, but we have pulled down imports as well. Actually, net trade is slightly less of a drag over the forecast than it was in the previous one, because we have pulled imports down by more than we have pulled exports down.
Sir Stephen Nickell: You are right in the sense that, with trade liberalisation, you get more exports and more imports. You get more trade, in some sense. Everyone gets more open and it is a good thing.
Q178 Helen Goodman: Can I just ask you one question about tax? You have forecast higher corporation tax receipts. Let me turn it into a question: did you do that before you knew there were going to be big cuts at HMRC, the digitisation process, as they call it? I am using the shorthand “big cuts”. They are saying they will move over to this digitisation model for collecting money.
Robert Chote: The change in the forecast is primarily a reflection of recent data on how things have been coming so far. There is the policy measure. Are you referring to Making Tax Digital?
Helen Goodman: Yes.
Robert Chote: We reflect that in the post‑measures forecast, not in pre‑measures one.
Graham Parker: It is not corporation tax, really. It is smaller companies’ corporation tax, but it is also income tax and VAT. In the July budget, there were lots of compliance‑type measures, which will affect the corporation tax yield and, before we certified those, we had assurances from the Treasury that there would be sufficient funding provided to HMRC to not only justify their baseline compliance work, but also to do the extra compliance work for these measures. We had assurances that there would be enough resource in HMRC to achieve the existing baseline for compliance yield and for the new anti‑avoidance and other operational measures.
Robert Chote: We did more than that. We got concrete figures out of them, which we published in the July report, on what HMRC would have available to spend on its compliance activity.
Graham Parker: The actual cuts announced by HMRC, I assume—we do not get involved in the detail of the spending review settlement—are outside the compliance area.
Q179 Helen Goodman: What assessment have you made of the impact of those? Is that in that big chart at the end?
Graham Parker: Those are just this time’s measures.
Helen Goodman: Yes, but I am asking about this time’s measures, modernising the tax and benefits system.
Graham Parker: Whenever there is a measure like that, which involves HMRC resource, we ask the question, “Will the extra resource be funded?” We will not certify it unless we get a satisfactory assurance on that.
Q180 Helen Goodman: Okay, fine. This corporation tax special rate on restitution payments is based on an estimate of HMRC’s liabilities. Did you discuss that with them? Can you remember?
Graham Parker: We discussed it with them. Whether I can remember much of the discussion is another matter. We looked at rather a lot of measures this time. We have in the forecast something in respect of what HMRC will have to pay out for this type of case. We make an allowance for it in the forecast. It is quite complicated, because some of it we saw as spending eventually, rather than linked to tax. We do have an assumption about that, so what is in the costing is consistent with that.
Q181 Helen Goodman: It is quite a lot, is it not, £700 million over the period?
Graham Parker: They did pay out quite a lot.
Q182 Helen Goodman: At the end, you have an assessment of how risky these various forecasts are. If it is high‑risk, highly uncertain, which is the Making Tax Digital point, what level of uncertainty does that involve? If you had a fan chart for it, where would you be on the fan chart?
Robert Chote: We have not tried to plot it, tempting as it would be to quantify.
Helen Goodman: “High” and “medium” are terms of art, not scientific.
Robert Chote: Exactly, that is correct.
Graham Parker: I am afraid it is beyond us. It is difficult enough. The overall fan charts are based on past errors. There is nothing you can do on costings.
Robert Chote: Some of the uncertainties are in areas where the data is not very good, as to the number of stages you have to go through in the forecast or if it is something that is likely to change behaviour. It is not one source of uncertainty that you could calibrate; it is often a combination of very different sorts.
Q183 Mr Rees-Mogg: I wonder if I can move on to the levy for apprentices and whether you, Mr Chote, think that is basically the same as an increase in employers’ national insurance contributions or if it is fundamentally different.
Robert Chote: Steve can probably give you a more informed answer. We have certainly treated it as something that will be incident on wages eventually, which is what you would expect of that sort of treatment. To begin with, there is a split between some effect on profits, but still a majority of it on wages. Towards the end, it is more on the wages side.
Sir Stephen Nickell: Basically, we think of it as a form of payroll tax.
Q184 Mr Rees-Mogg: If it is a payroll tax, is it going to be broadly good for economic growth or broadly negative for economic growth?
Sir Stephen Nickell: It is broadly pretty neutral. Basically, it is a payroll tax. In the end, the incidence of a payroll tax tends to fall on workers. In some sense, it ends up being a pay cut and it does not have that much impact on profits. The implications for growth in the longer term are minimal.
Q185 Mr Rees-Mogg: For people on the national minimum wage or the living wage, because it is an employer contribution, it will be a straight cost to business.
Sir Stephen Nickell: That is true. By and large, most people are not on the minimum wage.
Mr Rees-Mogg: Indeed, but basically it might just as well be national insurance. It has just been repackaged and hypothecated, but actually it is Labour Party policy, is it not, to increase? This is for Ms Goodman’s benefit. You are not making any great distinction.
Sir Stephen Nickell: No.
Q186 Mr Rees-Mogg: To move on to some timing changed that are being made in taxation, under the banner of simplifying the payment of taxes, which is a lovely euphemism for squeezing more out of the hard‑pressed taxpayer, do you think this is really about cash flow for the Exchequer or is it genuinely about tax simplification?
Robert Chote: You can identify a number of measures, not just in this statement but previously, which, as you say, are essentially bringing forward the time that this stuff has to be paid. That gets you a revenue gain that is neither reversed nor repeated. It is one reason to be quite careful about the profile of the changes in receipts coming in over the forecast for exactly that sort of reason. I have heard it said that some firms would find a more timely approach paradoxically helpful to them, as you are doing this while all the details are fresh, etc, and it is more straightforward.
Mr Rees-Mogg: You have not spent the money.
Robert Chote: Indeed. It is probably easier to apply that argument to smaller firms than to larger ones.
Mr Rees-Mogg: The larger ones are the bigger payers, by and large.
Robert Chote: Yes, so the corporation tax measure in the July budget was a substantial revenue raiser when you are dealing with much larger firms.
Q187 Mr Rees-Mogg: There is a forecast here for £610 million in 2020‑21. Is this really that people make errors paying tax or is it purely the timing?
Graham Parker: We made some assumption about the timing effect in this measure, but not much. This has not been a change of payment dates. There is no compulsory change of payment dates. This is just people reducing the errors. A large part of it is reducing errors.
Q188 Mr Rees-Mogg: Why does it reduce errors so much?
Graham Parker: That is a good question. We asked HMRC a very similar question in some detail. They have a finely detailed analysis of the type of errors people make. You can forget to record and invoice, etc, but the idea with this is that you are less able to forget to record things, so you will not make that error.
Q189 Mr Rees-Mogg: Are you also less able to forget the expenses that you might charge against it?
Graham Parker: Again, you are treading on ground that we asked, but the analysis that they have done does show that. If people do add value, the value of the missing expenses is less than the value of the missing invoice, even if people were completely unbiased in what they have.
Robert Chote: You would still expect a revenue gain, but clearly they do not and that makes it bigger.
Mr Rees-Mogg: The only thing I would question on that is that the companies that are likely to be forgetful are the ones that are probably not very well run, and therefore they may not be the most profitable companies.
Graham Parker: The analysis that HMRC bases this on is the detail based on a survey of when they have actually looked and done their random audits of people. They have looked at the accounts in detail and have a very detailed analysis of what types of errors there were.
Q190 Mr Rees-Mogg: You think this is reasonably robust.
Graham Parker: It is reasonable.
Mr Rees-Mogg: It is reasonable, rather than robust.
Graham Parker: We gave it a high uncertainty rating, so it is not that robust. There is still scope for behaviour, as you say. The people who forget to record things may find some other way of achieving the same thing.
Q191 Mr Rees-Mogg: Okay, so this may be a little bit more than absent‑mindedness.
Graham Parker: It is quite difficult. HMRC would possibly not call things avoidance if there is some kind of doubt, so they call it an error.
Mr Rees-Mogg: It is error heading towards avoidance heading towards evasion.
Graham Parker: There is a grey area between error and avoidance, and this may cover some of that.
Q192 Mr Rees-Mogg: The Treasury has also claimed that digital transacting with HMRC will save businesses £400 million by the end of 2019‑20.
Graham Parker: We did not have to audit that.
Robert Chote: I presume that is an impact assessment.
Q193 Mr Rees-Mogg: You have not had to look at that, so you do not have a view on whether doing things digitally and paying tax earlier will actually save businesses lots of money.
Graham Parker: As I say, paying tax earlier is not in this.
Mr Rees-Mogg: It is a one‑off benefit.
Graham Parker: Yes, it is not in this costing at the moment. Again, it is hard to see how that could actually save companies money, if they lose the cash flow and Government gain it. I can see why this could save. Once you have the system in place, it could save businesses money, I would have thought.
Q194 Chair: I just want to return very briefly to this VAT forecasting error. This is the correction of the error to the VAT forecasting model, which created an £11.5 billion windfall. Why did it take so long to spot this?
Robert Chote: It only really emerged as, over time, we saw the central Government public expenditure cuts mounting, and then the error picked up. Previously the assumption had been that you were modelling the deductions as an extrapolation of past history. As part history becomes less representative, it shows up.
Q195 Chair: I understand, but you say it emerged, which is a rather interesting word. Who emerged it? Was it emerged by HMRC, for example? Who spotted this?
Graham Parker: We did, our staff.
Q196 Chair: You do not own these models, do you, Mr Parker? These models are owned by HMRC and others.
Graham Parker: No, this was when we were preparing this year’s forecast evaluation report.
Q197 Chair: This is a defect in the way that you put this forecast together and not necessarily your fault. You spotted it, but you are very dependent on what you get, are you not?
Graham Parker: Yes.
Q198 Chair: Are you concerned about other models that you use, Mr Parker?
Graham Parker: Yes, I am always concerned.
Chair: Does this experience lead you to be concerned about other models? After all, we are talking about £11.5 billion here.
Graham Parker: We have a programme of trying to look at individual models. We suggest improvements during the process. There are restricted resources in HMRC, as well as in the OBR, about how much we can do at one time.
Q199 Chair: We had better have a note to the Committee on progress in trying to scrutinise these models and any suggestions you may have for trying to sharpen them up a bit. When it is the odd £100 million here or there, it is one thing. I know that you deal in large sums of money but, when we are talking about £11.5 billion, this is having a very big impact and we have to make sure we get this right.
Robert Chote: As you will recall, this was a key conclusion of Dave Ramsden’s review, which you questioned him about. It would be good to have the resources to be able to do more scrutiny of the models outside the harvest period.
Q200 Chair: There is one other point I wanted to raise with respect to this. The economic and fiscal outlook states that the error persisted, because the model was not sufficiently transparent. Is one of the key issues that you are going to need to look at, before drafting that note that we have now commissioned, what scope there is for increasing the transparency of the other models, in the hope it can improve their performance?
Graham Parker: As I say, we have this box in here setting out the criteria we want to work to.
Chair: The status quo is clearly not a very happy place to be and so we want some suggestions on how to improve on it, please.
Robert Chote: It is the nature of this business that, when you are going through the forecasting process, things emerge as you are doing it. Going out to seek them specifically is great, particularly if you have the resources to do that, but you are never going to avoid the situation where something odd comes up in the numbers.
Q201 Chair: All these roads come back to the recommendation of the independent report about whether we can carry on with a system where you basically do not own a huge proportion of the tools by which you do this work and you are dependent on others for them. We run a very lean operation, which we are being assured guarantees independence, while at the same time working closely with staff in the Treasury and other institutions. In the long run, this might not be the right model for doing this. I am not suggesting that we need to change it, but I am saying that the work I have just asked you to do in this area on behalf of the Committee is crucial for forming a view about whether we should carry on with the existing method of forecasting. Do you agree?
Robert Chote: Yes, I do. Like you, I would have reservations about saying you shift the thing out, but the ability to scrutinise this and having the resources to do it, not just for us, but for HMRC and whoever runs them more regularly, is key.
Chair: Thank you very much for coming to give evidence today. It has been interesting and we are going to have a further exchange about this undue influence issue in writing initially, and that will probably result in a report from this Committee and possibly further evidence from you on it. Thank you very much indeed.
Oral evidence: Comprehensive Spending Review and Autumn Statement 2015, HC 638 2