Treasury Committee
Oral evidence: Comprehensive Spending Review and Autumn Statement 2015, HC 638
Wednesday 9 December 2015
Ordered by the House of Commons to be published on 9 December 2015
Members present: Andrew Tyrie (Chair); Helen Goodman, Stephen Hammond, George Kerevan, Chris Philp, Wes Streeting
Questions 202-295
Witnesses: James Sproule, Chief Economist and Director of Policy, Institute of Directors, Robert Wood, Chief UK Economist, Bank of America Merrill Lynch, and Simon Kirby, Head of Macroeconomic Modelling and Forecasting, National Institute of Economic and Social Research, gave evidence.
Q202 Chair: We will get under way as quickly as possible. We have quite a lot to get through before four o’clock. We apologise if things are somewhat compressed. If you feel you are cut off and you have not said what you really want to say or it occurs to you afterwards, please do write it down and send it in. We are just as happy with written evidence in the conduct of this Inquiry.
Can I begin with a question about the countercyclical capital buffer? Are financial markets and analysts focusing too much on the MPC and interest rates and too little on the FPC and the tools they have at their disposal, such as the buffer, which can have many of the effects that monetary policy might—perhaps because of the legacy of decades of concentrating largely, if not only, on interest rate policy?
Robert Wood: I would not say that markets are focusing too much on the MPC. Ahead of the Financial Policy Committee meeting recently, certainly a number of questions we were getting were about the interaction of macroprudential policy and monetary policy, the extent to which they could substitute for each other, and what would happen if the bank had, for instance, tightened conditions on consumer credit, which may have been important for the recovery, given the importance of consumption.
It is a pretty active area of discussion. In terms of conclusions, that is a little bit more difficult. There is relatively little evidence so far on how these work.
Q203 Chair: I agree. What caught my eye, Mr Wood, was the FPC’s own conclusion, where they said, “Increasing the countercyclical capital buffer may restrain credit growth somewhat and mitigate the build-up of risks to banks, but the effect is unlikely to be substantial.” It is almost as if they are prejudging, for the purposes of monetary policy, the effectiveness of their own tool.
Robert Wood: It does sound like they have made a judgment about that. Certainly, the way this has been written about in the past by the bank—since Charlie Bean’s speech a while ago—was that the FPC were deliberately trying to choose tools that would have a relatively large effect on credit but a relatively small effect on GDP. In a way, if they are following that advice, which it seems they are, given that statement, they are choosing the tools deliberately to achieve that aim. We will see in practice, of course, whether that turns out to be true. As I say, the evidence on the effect of these sorts of tools is much harder to come by than the evidence on interest rates.
Q204 Chair: Therefore, the level of uncertainty is much higher. We just do really know what is going to happen if and when these tools are deployed, nor their relationship with monetary policy.
Robert Wood: Yes, absolutely. At least from the perspective of the Financial Policy Committee, we can see what they think it means for monetary policy from the statement—but, indeed, the degree of uncertainty must be high around these tools, given the lack of experience of them.
Chair: I am not going to ask you now, but, if any of you wanted to write down answers, we would be very interested to know how the fact we have two policy committees that might end up pointing in different directions might play out. Many countries have both sets of people sitting around the same table. We have two policy committees with overlapping memberships and the same chairmanship. It is a very unusual relationship, largely created on ad hoc basis, on the hoof, in the middle of the crisis or just afterwards. That is why I have asked those questions.
It is unusual for me to give a long explanation as to why I have posed questions, but I will leave it there on this occasion.
Q205 Helen Goodman: Good afternoon. I want to ask you questions about the housing market. I do not know which one of you is most interested in the housing market, but the first question is: what impact will the measures in the Spending Review and the Autumn Statement have on the housing market? Shall I remind you what the measures are? You probably do not have this in your head. 200,000 starter homes will be sold at a 20% discount. Will it go up or down?
Simon Kirby: The impact of overall package with regard to the housing market that was in the Autumn Statement is going to be relatively modest on house prices. The general trajectory is going to continue, which is reasonably rapid rates of growth, especially compared with the earnings of the average member of the population. In terms of housing market transactions, the OBR’s own forecast and detailed analysis does highlight that they expect some modest slowdown in housing transactions relative to where they otherwise would have been, but that is relatively modest. Overall, there will be a relatively muted impact on our housing market over the next five years.
Q206 Helen Goodman: Would you say that all measures were pulling in the same direction or that some measures were pulling in one direction and others were pulling in another direction?
Simon Kirby: There are measures moving in different directions, but one of the fundamental problems with the UK housing market is the lack of supply. While there are some measures that will have a relatively modest impact on that, there are also clearly measures designed to stoke demand as well, which is a follow‑on from previous fiscal statements over the last few years.
Helen Goodman: In stoking demand, you would include shared ownership, for example, maybe inheritance—
Simon Kirby: Yes, and London Help to Buy.
Q207 Helen Goodman: Thank you; that is helpful. We heard yesterday from the OBR about the level of migration into this country. They were suggesting that there will be 750,000 people migrating into this country. That does not necessarily mean 750,000 households, obviously, but that is on top of the natural increase in population. Is an aspiration to have 400,000 affordable new homes built up to 2020 going to be sufficient?
Simon Kirby: On this sort of question, I would defer to a greater expert than I, Dame Kate Barker, who was talking about a figure of around 300,000 homes per annum over the next five years or so.
Q208 Helen Goodman: UBS did a report recently, saying that London was in bubble territory. Do you agree with that? Mr Sproule, do you have anything to say about that?
James Sproule: Yes, I do. There are certainly parts of London that are clearly showing signs of that. It is one of the reasons we have been pointing this out and calling for some time for the interest rates to start a slow gradual point of increasing. There is capital misallocation, and that is most obvious in certain parts of the housing market, particularly prime London. That has been a problem.
It has slowed down considerably in the last few months as a result of changes to the stamp duty, but in general I would agree with you that there are still some stretched valuations at that top end.
Q209 Helen Goodman: Might interest rates be a rather blunt instrument to deal with the London housing market, given that it will have ripples right across the entire country?
James Sproule: With interest rates, you are looking at one of a variety of reasons we are calling for it. Clearly, I would agree with you entirely if we were calling for interest rate rises solely to counter that, but there is a variety of reasons why we are thinking that interest rates could start on a gradual path upwards.
Q210 Helen Goodman: There have been some quite alarming stories in the press about not just the amount of hot money coming in to London but the amount of money coming in as foreign criminals seek to launder money through the London housing market. Do you have any sense of how much that might be?
James Sproule: I am afraid I do not have anything to say on that side.
Helen Goodman: Does anybody else on the panel have anything to say?
Simon Kirby: I am afraid I also have no information on that.
Q211 Helen Goodman: Donald Toon, Director of the Economic Crime Command at the National Crime Agency, has said that he thinks this is having a significant impact, because they buy things at the top and it affects the whole of the Central London market. With an issue like that, a broad measure like interest rates would not really be very effective, would it?
James Sproule: No, but, as I said, I am not calling for a rise in interest rates solely for this reason. What you are looking at is the housing market showing some of the stretched valuations that come from capital misallocation. This is one of a variety of places. You can also see it in some of the stock valuations as well, which again would be indicative of that type of problem.
Q212 Helen Goodman: What do you mean by “misallocation”? Could you spell that out a little bit?
James Sproule: Sure. Any time you have—most obviously we saw this in 2004, 2005 and 2006—too much money entering the market, investors are keen to put that money to work. As they are keen to put that money to work, they discount risk too severely. We are seeing some evidence of that coming through now with companies themselves. I am speaking to companies and I am saying, “What are you looking at in terms of your investment hurdles?” They are saying, “We are looking at higher than the interest rate and higher than our cost of capital, because we are concerned that interest rates may rise and we want to make sure that the investments we make are sensible ones.” If you were to not look at that higher rate investment hurdle, however, you would potentially make investments that would not pay out, I suspect, in the long term—if interest rates were to start to rise.
There is a caution within some companies, which I am very pleased about, but I am sure there are other companies that I have not spoken to that have not shown that caution. Therefore, they will be making investments based on assumptions that are not necessarily safe in the longer term. It is not prudent.
Q213 Helen Goodman: When you say “investments”, do you mean investment in new build or investment in transactions?
James Sproule: I mean investment as in “expanding the business in particular ways”.
Q214 Helen Goodman: What other measures have you called for? You said you had called for other things.
James Sproule: Do you mean in terms of why we are calling for interest rate rises?
Helen Goodman: Yes.
James Sproule: Because I would like to see two other things in particular. I would like to see interest rates rising on a nice, slow, gradual path. The sooner you start off on that path, the more you can make it nice and slow—maybe at a quarter point every half year. The other one is to give ourselves some sort of flexibility so we have monetary policy that works. Right now, of course, the Bank of England does not have monetary policy that works, because if there were a euro crisis or something that blew up, what could we do other than more QE? I would prefer if we had a steady state of, say, 3.5%. Then the Bank of England would have some ability to have some countercyclical policy.
Q215 Stephen Hammond: Good afternoon, gentlemen. Could I ask a couple of questions about productivity? It has been notable that the UK has been a persistent laggard for a while, but there has been a recent small pickup. That was to the second quarter of this year, effectively. In your own forecasting, what is your outlook for productivity? Does it remain the most uncertain element of your forecasting?
Simon Kirby: Underpinning our latest forecast, which we published at the start of November, crucially, when you look over the next few years and into the longer term as well, it is productivity growth that underpins the forecast. To answer your question now, it is the key domestic risk, in my mind, with regards to our outlook. However, it is the key domestic risk in a number of countries, not just the UK.
Productivity is the crucial driver of our economic performance. It is the reason why we have sustained increases in real consumer wages and a rising standard of living in our forecast. Underpinning that is an assumption that we resume our process of catch‑up with the technological frontier, which in our model is the United States.
That goes back to an earlier point: this is clearly the key risk. The last couple of quarters could simply be a blip and the period we have been going through over the last few years could well continue. That is of major concern to the outlook.
Q216 Stephen Hammond: Can I pick you up on that? You said it is the key underlying determinant of sustained wage growth, which indeed it should be, but one of the Deputy Governors in the summer made the point that he still saw some scope for wage growth, even real wage growth, without productivity pickup. Is that a view you share?
Simon Kirby: There is certainly some of that in our forecast, but the fundamental driver is productivity growth. You may see a modest amount of pickup in real consumer wages. Certainly, part of the reason we have seen the pickup in real consumer wages over the last six months or so is because of the collapse in the headline rate of inflation. However, it is always going to come back to productivity growth as the driver of the standard of living.
Q217 Stephen Hammond: Given that we have been a relative laggard in international terms, what has been driving the last two quarters? Is it that there has been some investment in skills that is showing through or some physical investment? What has been the determinant of the small pickup?
Simon Kirby: At the moment it is too early to tell exactly what is going on there, unfortunately. One thing I would additionally highlight, however, is that a number of academics have been looking at the productivity puzzle in other countries. While we are talking about the period from 2007 onwards as particularly problematic, there are academics now looking at the United States and continental Europe who are looking at the early 2000s as the starting point for a slowdown in productivity performance.
In all cases it is a puzzle, so as yet we do not have the answers as to why this has been happening. However, this is a global phenomenon. It has perhaps been going on a little bit longer in other countries than it has been in the United Kingdom.
Q218 Stephen Hammond: The period around the early 2000s was marked by a redefinition of productivity to hide the fact ours was falling dramatically in that period as well.
Simon Kirby: That is also regarded as a period of sustained catch‑up, because, as you say, we had been the laggards compared with many of our advanced‑economy peers. Over that period of time, we were catching up on the United States, France and Germany in particular.
Q219 Stephen Hammond: In your forecasting in terms of productivity growth over the next two years, do you see unwinding of labour hoarding as a big factor in that?
Simon Kirby: Not especially, no. Part of what is underpinning our forecast is a continuation of what we have begun to see, which is the transition of people from self‑employed jobs into employee jobs. On average, those in full‑time permanent employment are in higher productivity jobs than those in self-employment. Part of it might be simply related to the fact they have access to more capital to work with as well as access to more training and so on and so forth—those intangible investments as well. However, that is part of the reason we see a pickup in productivity over the next few years, rather than a reversal of labour hoarding.
James Sproule: I would like to add a couple of things on that. One is that we have surveyed our members recently on this whole issue. Whilst most companies do not measure productivity in that, we did ask them, “Are you planning on giving pay rises?” This was at the end of 2014; we asked the same question again more recently. The answer at the end of 2014 was, “Yes.” We asked, “How are you planning on giving those pay rises? Will you be matching inflation or giving a fixed‑term percentage?” In almost every case, the answer was, “We are planning on giving them in line with corporate performance,” which we interpreted to mean “in line with some broad measure of productivity in those firms”.
That was a good sign, insomuch as we had had a period of stagnant real wages, but we were now seeing better times, allowing companies to pay more. That is partly what you are seeing in the most recent quarter. It has been that. It is a pickup in wages based upon a sustainable path, which is very good.
At the IOD, of course, we particularly represent SMEs, which typically do not have quite as good productivity as large caps, but they also typically do have slightly better agility. There is a balance to be struck between the productivity that, clearly, all of you are focused on and the agility that, in large, is going to be an indicator of how prosperous the UK economy is going to be in the coming years.
Q220 Stephen Hammond: I have one final question. Given the structure of the labour market in the UK—where you see more flexibility in working, more SMEs and, indeed, more self‑employment—are any of you concerned that there is an under‑capture of productivity against large‑scale firms that we need to think about?
James Sproule: As I say, we have recently written a report on the whole idea of agility. That is key. Looking at some of the continental European markets, it is extremely noticeable. It is not just about entrepreneurship and the numbers of people joining firms. In Italy, more than 50% of employees have been with their firm for more than a decade.
Clearly, longevity with a firm can be very valuable; however, at the same time, you also want people joining a firm at a variety of levels, because that is the way you introduce new ideas and concepts more rapidly. In the UK it is about a third, which is much more in line with the OECD average. There is probably a degree of agility in the market there, which is probably quite good news.
Chair: I am going to bring in George Kerevan and then come back to productivity with Chris Philp.
Q221 George Kerevan: I was intrigued by Mr Sproule’s recommendation that we should start to raise interest rates. If you get your wish and Mrs Yellen raises interest rates in America next week, then continental Europe, the UK and the US would be on divergent paths regarding interest rates, which clearly would have an impact on the exchange rate. How would you evaluate the impact on the UK economy and UK growth forecasts, which underpin the Autumn Statement, if that happens?
James Sproule: There are two things to keep in mind. First of all, we are talking about relatively slight, minor divergence. I grant you that divergence is certainly there. People will interpret this, as all domestic interest rates should be, largely as for domestic purposes—as opposed to trying to target your exchange rate. From the 1980s onwards, we have decided that is not such a brilliant idea in most cases, and that is probably the correct choice on all of that.
As far as the eurozone as a whole, they have some special, and particularly difficult, circumstances there in getting their economies to grow. As much as Mr Draghi is doing a very good job, it is going to take a lot more effort from him to get the eurozone economies growing as rapidly as we would all like to see, and the eurozone countries are responding to their domestic situations.
Although the Bank of England would say they are independent—and, clearly, they are—the reason the UK has not raised interest rates is because they have been waiting for the Fed. If the Fed does raise rates, as most people expect, it will give the Bank of England room to manoeuvre without affecting the rate of sterling quite as badly as it would if they had been the first mover.
Q222 George Kerevan: Nevertheless, Mr Draghi continues to pursue a loose monetary policy—and he has claimed he is going to for the foreseeable future.
James Sproule: We would still have loose, too.
George Kerevan: The odds are that, for the next few years, we are going to have a higher exchange rate here versus Europe. I am intrigued as to how comfortable you are with that.
James Sproule: I am reasonably comfortable, because the advantages of getting business to look more carefully at their investment plans would be a good thing. Yes, it might hurt some exports to Europe—and IOD members are disproportionately likely to export to Europe. At the same time, though, most of them are expecting this sort of thing to be coming over the next year. We are talking about relatively small movements and, on the whole, it would be a positive for the UK economy.
Q223 George Kerevan: I will pursue that with Mr Kirby. The yield curves are quite flat some way out, which would suggest that the markets would not particularly react in any positive way to the disincentive effect of a rise in interest rates. The disincentive effect might not be that great. How would you evaluate a shift in interest rates and its impact on growth and growth forecasts?
Simon Kirby: First off, markets have priced in an increase by the Federal Reserve in the December meeting. The surprise there will be if they do not—and the Federal Reserve does not like to surprise markets.
In terms of the UK, following on from the Federal Reserve increasing, I expect the MPC to begin to lay the ground with markets for an earlier interest rate rise than they are currently pricing in. Certainly, I would not expect the first rate rise to be at the end of 2016 or the start of 2017, given the outlook for the UK and the global economy at the moment.
It is up to the MPC’s communications to bring the markets gradually back to a more plausible starting point for interest rate rises. They have the time to do that over the next couple of months or so. If communication is clear, markets will react in a relatively stable fashion and the impact on the real economy will be relatively modest. The one major risk in all of this, though, is the indebtedness of UK households and the impact in terms of income gearing that will come as a consequence of even a modest increase in interest rates in the UK—given that we still have a large number of variable mortgages and fixed mortgages are, at most, five years.
Down the line, even modest increases in interest rates will undoubtedly have a downward effect on the disposable income available to households and thus a depressing effect on consumption. That kind of process, however, is built into our forecast—and our forecast is for a relatively stable rate of growth in the UK economy at around about 2.5% per annum over the next few years or so.
George Kerevan: You mean even with rate rises.
Simon Kirby: Even with rate rises, yes.
Q224 George Kerevan: Mr Wood, what is your take on rate rises?
Robert Wood: I am in a similar boat, in that I do not expect the Bank of England to wait until 2017. Inflation is obviously very low; that points towards waiting. Equally, we know that a whole chunk of that low inflation is due to temporary things like oil prices, which are probably not going to continue dragging on inflation for two to three years, which is why the bank and almost everyone expects inflation to pick up certainly away from zero and closer to target.
Of course, the other thing I would look at is unemployment. At 5.2%, we are back to pre‑crisis levels of unemployment. They have dropped dramatically over the past three years or so. Wage growth has picked up. It is not extremely strong. You would probably not even describe it as strong, but it is certainly stronger than it was a couple of years ago. We need to set interest rates looking a couple of years ahead. On that basis, I am looking for the middle of next year. Exactly when is very tricky, but my call is the second quarter with risks to delay.
On the exchange rate, I would not mind adding that, certainly, there are two key areas of divergence: the US and the ECB. It would not come as a surprise to the market that these two regions are going to diverge. You have seen through this year a lot of that effect already being priced in to the exchange rate. The degree of further movement in those exchange rates in sterling from here is a bit harder to answer. I think it moves in the direction you suggest, but I would caution about exactly how much is priced in. For instance, if you look at the reaction to the ECB underwhelming the market on its announcement, you see the euro rising.
What is far more important for the UK economy is how fast demand abroad is growing. Would we rather have stronger sterling and a well performing eurozone or weaker sterling and a poorly performing eurozone? It is the former. The more policymakers are able to do to stimulate growth abroad, the better. Of course, it probably affects sterling—but ultimately I would rather have faster demand growth in bigger markets to which to sell our exports than the alternative.
Q225 George Kerevan: I have a final question, if I may.
Chair: Be quick.
George Kerevan: It was to follow up on exports. Three years ago, in the 2012 budget, the Chancellor set himself what was a rather ambitious aspiration—he did not call it a target—to raise exports to £1 trillion, which he has clearly missed by a long measure. Given that we are weakest in emerging markets in terms of exports—and given that any shift in the pattern of interest rates would go in the direction of destabilising emerging markets even more—where are we going to sell our exports?
Robert Wood: You are right: we have underperformed relative to the target. We are not strong in exporting to emerging markets relative to some other countries. You would often talk about Chinese and German exports relative to our own. However, I would not turn that into a counsel of despair. We still export a third of our GDP, which is quite a lot internationally. The fact that our shares of exports are relatively low, of course, gives you much more room for improvement. You obviously have to take hold of that.
The final point I would make is that it is important to remember the mix of our exports and our comparative advantage relative to other countries. We are much more heavily service‑based than Germany, say. The things that China and other emerging markets have wanted recently are much more goods than services. As these countries develop, with any luck they will want more of the high-value-added services the UK produces and relatively less of the manufactured goods. That is not to say we have done terrifically overall at selling to these countries, but it certainly means the outlook is not, as I say, a counsel of despair.
Q226 Chris Philp: Good afternoon and thank you for joining us today. Can I start by returning to the question of productivity, which Stephen Hammond was asking about? Could I ask each member of the panel to suggest, briefly, one action you believe the UK Government could take that would sort out, or at least help sort out, this productivity issue?
James Sproule: The trite answer is usually education and skills. That probably is absolutely key; it is not going to be a quick fix, however. That is one of the frustrations. These things are cyclical. We have gone into a cyclical downtrend since 2007. I expect us to come back but not for reasons we are necessarily going to be particularly happy about, because we are likely to see a slight falling away in employment over the next couple of years.
Various costs of employment have risen, most notably the apprenticeship levy but, also, the living wage. That may well bear down on some of the low‑paid work, which will mean that companies do not have as many of those people on their staff and productivity will rise as a result. I am not particularly happy about that, but never mind.
If we want to fix productivity in the long term in a positive way, it is going to be about getting education and skills right.
Simon Kirby: First off, I would highlight that, as a trade, economists have not yet got to the bottom of what is behind the productivity puzzle. We need to understand that in order to be able to shape appropriate policies. I would build on the point around education and skills, because that will always be an answer, no matter what is going on in an economy. I would also highlight the UK’s continued problem of intermediate skills, i.e. the middle of the distribution. This is where government policy around apprenticeships may well begin to help. Continuing in that direction is appropriate.
Chris Philp: We are on the verge of getting consensus. Do you have a different idea, Mr Wood?
Robert Wood: I will answer the question, but let me start by challenging it. One fallacy when thinking about productivity is to think there is one thing that can be done to answer this. Ultimately, we do not really understand why productivity has been weak. Economists do not have great explanations, in fact, for why productivity moves in the way it does. It is probably to do with a vast array of factors in the economy. It is not a matter of pulling one lever and suddenly the UK will catch up to the US. It really is not.
There are so many, whether that is skills, infrastructure, incentives for business investment, the organisation of corporations to encourage innovation, research grants for innovation, the whole environment for setting up a business, or whether credit is available for these fast‑growing businesses. I could go on and on.
If I were forced to pick one—I will answer the question—I would pick infrastructure. That is something the Government can do and others cannot. It is vastly important for how efficient the economy is. Of course, we can name any number of infrastructure projects. You would obviously want to pick the ones that pay off the most. I would pick that.
Q227 Chris Philp: There are three economists and two answers; it is usually the other way around.
Coming to the question of the housing market, which Helen Goodman was asking about, would the panel agree with the Governor, who has expressed concerns about the extent to which buy‑to‑let landlords both domestic and overseas have grown as a proportion of the market? They are now about 20% or even 25% of new mortgage issuance. Do you share his view that this is too high? Is it crowding out home ownership? Is it beginning to pose a potentially systemic risk?
James Sproule: No, I am not particularly concerned about it. It is people’s response to two things: first of all, the Government a couple of years ago was encouraging people to put buy‑to‑let homes within their portfolio. It is a lifecycle effect with a lot of people looking at how they are going to thrive in their retirements, and they have moved towards this. The bottom line is that there has not been sufficient addressing of the supply problem, rather than who is buying them. Those homes are still lived in, quite clearly.
Simon Kirby: I do not know what the appropriate level of buy‑to‑let as a share of the overall housing market is, because, number one, we need to have a well-functioning rental market as well as home ownership. The one thing that does surprise me, compared with many other countries, is that we do not seem to have many corporates investing heavily in buy‑to‑let. Germany is one of the prime examples with regard to that. James is correct: these sorts of discussions manifest as a consequence of the lack of supply in the market.
Robert Wood: To change from giving a different answer, I will give the same one. I tend to think about the housing market from that macro‑perspective. It seems to me that house prices are going up faster than incomes because we are not building as many of them—or at least as fast as the population is increasing. Moreover, across the world, real interest rates have fallen very dramatically and all sorts of asset prices have risen as a result; houses are one of them.
I do not know what the appropriate level of buy‑to‑let investment is or whether we have breached it or not, but the fundamental issue is one of supply and demand and the level of real interest rates, which is not something we, as a country, control.
Q228 Chris Philp: Everyone agrees that supply is the fundamental issue. Given a fixed supply, there is a concern that the superior financial firepower of buy‑to‑let landlords is crowding out potential first‑time buyers, which is a social as well as an economic issue.
Moving on to my final area of questioning, the current account deficit is pretty high. It is around 5% of GDP, which is one of the highest in the developed world. Could I ask, firstly, whether this higher level of current account deficit concerns you—or should it concern us as a country?
Simon Kirby: First, we need to decompose it. If you look at the trade balance, it is pretty much where it was pre‑crisis; it is flat at just over 2% of GDP.
Chris Philp: You mean 2% negative.
Simon Kirby: Yes, negative. Then the story is about, “Why has the income account moved from surplus to deficit in a relatively short period of time?” It is mainly the income account with respect to the European Union. That reversal in fortunes is yet another puzzle for the UK economy.
We have been looking at that, and we do not have a firm explanation as to why. There is a recent paper published by Philip Lane, who has just been appointed as Governor of the Central Bank of Ireland, who has started to talk about how, perhaps, the reason behind this is financial engineering—corporates effectively re‑domiciling themselves for tax reasons or whatever.
The situation is that the way we then measure our balance of payments distorts the picture. The crucial reason why we would not be concerned if this were happening is because, fundamentally, economic activity has not shifted.
Q229 Chris Philp: To be clear, what the future Governor of the Central Bank of Ireland is suggesting is that UK corporates are effectively borrowing money from offshore jurisdictions as a tax circumvention technique and then paying interest from the UK into these offshore jurisdictions, which then appears as a negative entry in our current account.
Simon Kirby: Yes, their income flows flow through other jurisdictions. The reason why it is an important—
Q230 Chris Philp: I am sorry to interrupt. Although that would suggest economic activity is still occurring here, nonetheless there is this untaxed cash outflow going on.
Simon Kirby: Quite possibly, yes.
Q231 Chris Philp: From a fiscal point of view, there is potentially a lot of lost revenue to the Exchequer, which is of concern, is it not?
Simon Kirby: It is possible; I do not have a magnitude for the sorts of numbers.
Q232 Chris Philp: It is moving our current account deficit to the tune of 3% of GDP; that is quite a big number.
Simon Kirby: Yes, exactly: it is a big number. It is an important point that is worth highlighting, because while it is up to the Office for National Statistics to investigate what is going on—they have access to the confidential data that none of us ever will—as yet there has been no response as to what is driving this, as opposed to when you talk to economists and statisticians in other countries.
Ireland is one example. There was a recent paper from 2013 by John Fitzgerald, who highlighted that, once you take into account these sorts of operations going on, the 6% of GDP current account surplus Ireland had in 2012 is entirely eliminated. They were suggesting that, in large part, it is British firms that have been doing this.
Chair: That is very interesting.
Q233 Wes Streeting: So many of the rabbits the Chancellor pulled out of his hat during the Autumn Statement were made possible thanks to the cumulative £27 billion fiscal windfall provided by the OBR’s lower interest rate assumptions and higher revenue forecast. How likely is it that this £27 billion is going to materialise? I am interested in the views of the panel collectively.
James Sproule: It would be lovely if it were to come out, wouldn’t it? I have a chart I regularly show in presentations I give that shows GDP, which bounces all over the place, and the forecasts from economists over the last 20‑odd years, which are invariably a horizontal line stretching off into the future. Yet again we have seen the same sort of thing. It is very rare to see economies grow at steady states of 2.4% to 2.5% for prolonged periods of time. Maybe it will happen.
Wes Streeting: You sound sceptical, though.
James Sproule: I do.
Robert Wood: I would split this into two questions. One is, “Will the OBR’s central forecast for the next five years turn out to be right, exactly on the button?” No, almost certainly not. The errors around these things even two years out, let alone five, tend to be very large—particularly for a deficit, the difference between two very uncertain and very large numbers, taxes and revenues. Is that likely to happen? No, probably not.
I will perhaps split it into three. The second part is, “Is it a fair forecast, given what we know today?” Of course, the OBR were in here yesterday. I do not have any particular insight into how they have done their forecast, but the economic side of it is pretty similar to my own. That is one in which the UK continues to expand at roughly around its trend rate, 2% to 2.5%—absent a big negative shock, which we are not anticipating. I am not anticipating one just now. It seems reasonably fair.
In terms of the tax change, £27 billion over five years is a relatively small number compared with the total tax take over that period. The judgment there is, “Was it a fair estimate of the change in the actual outlook?” At least as the document is concerned, it is pretty transparent about what they have done.
Almost certainly, the forecast will not happen—because forecasts never happen. However, am I sure it is going to be wrong in one direction or the other? No.
Q234 Wes Streeting: Given that, is the risk to public finances weighted on the upside or the downside? Accepting what you have said about the reasonable estimates, in terms of the judgments the Chancellor has then made about how to behave in terms of his spending decisions, is he managing the risks well?
Robert Wood: In terms of the OBR’s projection, certainly, are the risks balanced one way or the other? No. They have taken the Chancellor’s spending plans and their best view of taxes—and they have a lot more resources and time to spend on forecasting than I am able to. No, I do not have a reason to think it is slanted one way or the other.
If pressed, I would say that continuing to restrain spending, which is the Chancellor’s plan for five more years, is widely seen as a difficult thing to do. That is not a controversial point. If one were to spend more and not tax more, that would obviously mean a higher deficit—but of course in future years there are always ways to correct any misstep.
Wes Streeting: That is probably why the Chancellor is spending more and taxing more. Simon, do you have a different view?
Simon Kirby: The one thing I would like to pick up on is your point about the interest rate assumptions. That has obviously improved the position of the public finances over the next five years. On one hand, the OBR is in a difficult position there: it does not want to comment on monetary policy. On the other hand, as the OBR themselves said to you yesterday, they do not have a way of beating the market with regard to interest rates.
It is a reasonable assumption for them to make. The consequence of that, though, is to provide the Chancellor with an additional £12 billion over a four‑year period. This is the outcome of building in transparent forecasting assumptions.
Q235 Wes Streeting: I accept what you have all said, but there are, effectively, risks in two directions, aren’t there, in terms of variations from the forecast either way? If the economy picks up sooner than expected, we will have an interest rate rise and then the fiscal position could deteriorate. If the economy underperforms, tax revenues fall short. There is still a challenge there.
James Sproule: There is also another challenge there as far as tax goes, which is that, so far as I can tell, looking into the numbers, there are two approaches you can take right now. You can think that what we had as a given level of economic activity yielded a given level of tax revenue historically and that, right now, it has underperformed as far as tax revenues are concerned.
Either that will recover—in which case the Chancellor or the OBR’s forecasts have a reasonable chance of coming to pass—or people have in some way altered their behaviour as a result of the last few years and we are now looking at a lower yield of tax, given the present tax structure that we have, out of a given level of economic activity—in which case the Chancellor is likely to find he has to raise taxes or delay his deficit reduction or cut spending or something more in the next few years.
It is still an open question. Have people learned to avoid tax or will taxes rebound to their previous levels? Time will tell.
Wes Streeting: How are we doing for time?
Chair: We are okay.
Wes Streeting: In 2011, the Chancellor told this Committee, “When it comes to the fiscal mandate, I think it is important to recognise that there is an economic cycle and that there is a structural element to your deficit and that there is a cyclical element.” Asked in July 2015 about his latest fiscal rule, which does not adjust for the economic cycle, he cited measurement difficulties and excessive flexibility as the reasons for abandoning cyclical adjustment. Who do you agree with, the Chancellor of 2011 or the Chancellor of 2015?
As a supplementary to that, as a Committee we have been trying to find anyone with actual expertise in economics to defend or suggest that the Charter for Budget Responsibility we passed is good economics. Would any of you like to rise to that challenge and leap to the Chancellor’s defence? We have been unable to find anyone.
James Sproule: I am not going to leap either way—to the defence of the Chancellor or not.
Wes Streeting: That is very wise. You should be a politician.
James Sproule: I am afraid I am not familiar enough with the detail to give an opinion.
Wes Streeting: That is fair enough.
Simon Kirby: The current rule is dramatically inflexible. The major issue I have with it is the fact that the capital budget is included within the overall measurement. In terms of the output gap, we all know that, at any particular point in time, we do not know what the sign of the great unobservable is; however, that is not a reason not to at least take into account some form of economic cycle when trying to set policy.
Robert Wood: I have nothing else to add; I would just repeat that.
Wes Streeting: Given how fast and loose we have played with fiscal rules in the past, we should not lose any sleep—but it was interesting to hear your thoughts anyway.
Chair: Thank you very much indeed for coming to give evidence. I am sorry it has been much briefer than all of us would like, but we have another session starting right away—and we have a lot to get through today. If you have anything more you want to add, please do send it to us in writing. Thank you very much indeed.
We will go straight on to the next session.
Examination of Witnesses
Witnesses: Paul Johnson, Director, Institute for Fiscal Studies, James Browne, Senior Research Economist, Institute for Fiscal Studies, and Gemma Tetlow, Programme Director, Institute for Fiscal Studies, gave evidence.
Q236 Chair: Good afternoon. Thank you very much for coming to give evidence. If I start with you, Mr Johnson, the Chancellor’s little bit of extra spending, the fiscal room he had, has been described as a windfall. Is that fair?
Paul Johnson: There was a small windfall in the sense that, given his fiscal rule, the key point was what the change in 2019-20 was. That was of the order of £4 billion a year.
Q237 Chair: Is it a good idea to spend this every year? After all, it might go into reverse and there might need to be a somewhat disorderly tightening.
Paul Johnson: As your previous panel were saying, the fiscal rule he set himself is extremely inflexible. He has left himself with much the same kind of wiggle room against that, four years out. Given the level of uncertainty about things, that gives—as the OBR still says—a more than 40% chance that, if he changes nothing from now, he will miss that rule. He has not banked that additional money. What he has done is, as you say, decided to spend a bit more.
The more important thing he has done, though, certainly if you put the July budget and the Autumn Statement together, is raise taxes, which has also allowed him to spend a bit more.
Q238 Chair: For a while, we did have fiscal rules that incorporated some attempt to smooth the cycle, but we were not very good at spotting the cycle, were we? Rather, the “cycle cliff” would have been a better description. Indeed, that is largely the history of post‑war recessions, although this one was particularly bad. Groupthink prevents people spotting things and, therefore, cycles get incorrectly defined. Nonetheless, would there have been merit in having a form of adjustment built into the fiscal target?
Paul Johnson: There is certainly a case for having more flexibility built into it. If the Chancellor wants to achieve balance at a reasonable point into the future, the issue is about how he can say that is what he wants to achieve with an adequate degree of certainty but without the complete inflexibility you have in the current system. You could work with a cyclically adjusted rule or you could work with a rule that is more flexible about exactly when he reaches that point.
Chair: What would you do?
Paul Johnson: I would work with a more flexible rule, which says, supposing I want to get to budget surplus, “Look, world: what I want to do is get to budget surplus at some point within the next five to 10 years, according to how the economy pans out, without being anything like as precise.” The difficulty he clearly has is that the world wants more precision than that, but I am not sure the precision is worth very much—given the difficulties it might create.
Q239 Chair: Far from making it more precise, in a sense, by trying to build an element of the cycle into the fiscal target, you would go the other way, in a sense, and make it much more flexible by removing the timeframe.
Paul Johnson: I would make it more flexible, and I would also ask the OBR to say, given my broadly stated fiscal rule, whether I am on course to meet that. That is the advantage that the OBR gives you.
Q240 Chair: The Government does not carry general reserves. It used to, even when it was running a deficit, in the old days. When one does not have any adjustment for the cycle built into the fiscal target, is there a case for resurrecting reserves?
Paul Johnson: I suspect the Chancellor is seeing his £10 billion surplus in 2019 in the same way. The reserves were never real; they were just an adjustment you could make each year. He is still able to make an adjustment in any year, and he has got a £10 billion adjustment that he can make in 2019.
Q241 Chair: Well, they were scored in—
Paul Johnson: I know they were scored.
Chair: They were scored in on the annual PESC round—the annual public expenditure round—so they were real. They were not being spent at the time they were identified, but they were real and they did often end up being spent—and sometimes overrun. Can I just ask the same question again? We do not have reserves these days. If you do not have a cyclical adjustment to your fiscal target, should we resurrect reserves?
Paul Johnson: I will repeat the answer. Yes, those reserves were in the forecasts. You could change next year; you could decide to spend a bit more next year or tax a bit less, and have a different deficit. I really do think this is semantic.
Q242 Chair: Is the answer “no”?
Paul Johnson: I do not see a great deal of value in it.
Q243 Wes Streeting: I will talk about a couple of my hobby‑horses this afternoon, first student finance. The Autumn Statement announced the threshold at which student loans begin to be paid back would be frozen at £21,000. This will not only be applied to new applicants but to existing students and graduates who are still paying off their loans; that particular cohort will be affected. Can you describe the impact that this will have in social justice terms—in terms of which particular groups of graduates might be affected—but, also, give a view about whether you think it is fair that these changes should be applied retrospectively?
Paul Johnson: It certainly reduces the long‑run cost to the Government of providing the loans. Now, my understanding of the process through which this £21,000 point was decided upon was on the presumption, in a sense, that real earnings or nominal earnings would have grown by more than they have. If you are taking the Government’s point of view and defending this, you might say “Actually, what we intended to do was something a bit different. It was to have a real level that is closer to where £21,000 now ends up if you freeze it for a few years.” Now, that is not what they said they were going to do, but that is what they said they would intend to do. The impact will be largely to affect middle‑earning graduates. This is still not going to affect the lowest‑earning graduates, because they are still going to earn over that, and it is not going to have much effect on the highest‑earning graduates, because they will be paying back quite quickly. The low‑middle to upper‑middle group will be paying back significantly more as a result of this.
Q244 Wes Streeting: Have you done any work looking at the changes the Chancellor has announced in relation to nursing and midwifery students, in terms of the types of people that would be affected by replacing the NHS bursary with a student loan?
Paul Johnson: We have not, no.
Q245 Wes Streeting: It would be interesting if you did. I will not go as far as the Chairman in mandating this work, but it would be very interesting nonetheless.
I want to turn to local government now; I will give my usual declaration that I am still a serving councillor in the London Borough of Redbridge, albeit an unpaid one. I want to ask, in particular, about the funding of social care. Now, the Autumn Statement announced that councillors would be able to impose a social care levy of up to 2%—effectively, a 2% council tax increase, but allocated to social care. Do you expect that all local authorities will levy that 2% precept?
Paul Johnson: I do not know. My understanding of how this will work is that, essentially, this will allow councils to raise their overall council tax by 4% before they have to go to a referendum on it. Certainly, by no means all were raising it by the maximum of 2%; in fact, I think a minority were even going to the 2%. Gemma may know that.
Gemma Tetlow: That is true, although we were still in a period where there was an incentive not to increase your rates, so it is difficult to know how they were responding to that.
Q246 Wes Streeting: There is a clash in local government between the culture that has been established of trying to keep council tax down, which I welcome, and the enormous pressure, particularly around social care. The precept is expected to raise around £2 billion, assuming that pretty much all local authorities do charge the precept, but £1.4 billion of that is expected to be needed because of the national minimum wage increase, up to the so‑called “national living wage” levels. Based on what we know about the increasing social care costs and pressures on local authorities, do you think the precept will be enough to plug that hole in social care budgets?
Gemma Tetlow: One thing we pointed out in our post‑Autumn Statement analysis was that, clearly, the implications are very different across different local authorities. Those that raise relatively more from council tax will gain a relatively large amount of money by increasing by 2%. For some authorities, it may represent a very big share of what they might be trying to spend on social care, and might make a big difference to their ability to meet some of those increasing demands. For other areas, that will be much less the case. In terms of whether all will do it, there will be different trade‑offs in different local areas. For some areas, doing the increase will deliver them a large amount of money to spend on social care; for other areas, for the political pain of doing that council tax increase, there will be less monetary gain to them, so there will be different decisions facing different areas. We have not looked in any more detail at whether it is enough to meet the growing costs.
Q247 Wes Streeting: You talk about the varying benefits to different sizes of authorities, based on their council tax base. We then throw on top of that the freedom around business rates and the devolution of business rates that is taking place, and what we are increasingly seeing is volatility across the sector as a whole, because different authorities will benefit to different degrees. The detail around business rates has not even yet been spelled out. Given all of this, and given the uncertainty about the pressures, do you think it is wise for the Chancellor to be advising local authorities to spend down their reserves when they may well need them for the turbulent times ahead?
Paul Johnson: There was quite a lot in your statement. Certainly, we have seen a significant reduction in the degree of equalisation across councils, up until now. I do not think we have yet got the local government settlement for next year, unless it has come out in the last 24 hours, but we are expecting that very soon. That will tell us quite a lot about whether that movement away from equalisation is stopping; it may be doing so.
You are right: there are a number of uncertainties on the business rate. One is how much the fact that they can keep any additional rates is going to mean to any individual authority. For some, this may be a significant windfall; for many, this will not be. We also do not know how the new keeping of the whole of business rates within the council sector is going to be offset by additional responsibilities, nor, in the long run, how both the top‑ups and tariffs are going to work, nor the extent to which any additional business rates they may get in may get taxed back at some point in the future as they try to re‑achieve equalisation. So, you are right: there is a huge amount of uncertainty there, which will lead to very significant change. Whether, in that circumstance, it is appropriate for councils to spend down their reserves is very much for them, but they are living in a more uncertain world.
Q248 Wes Streeting: Absolutely. If you take somewhere like Redcar, for example, the steelworks collapses; not only are loads of jobs lost but there are potentially other costs that will be incurred by the local authority as a result, in terms of accessing different council services. That is a huge blow to the business rate base, and the Government says there will be some mitigation there, but again the detail is not spelled out. Do you think there is a risk that further down the line local authorities will be accused of not fixing the roof while the sun was shining for spending down their reserves?
Paul Johnson: You make the point, and I agree with it, that there is a significant amount of uncertainty in local authority budgets. They are going through a period of really significant chance. It is going to be for them to judge how they are going to manage that significant risk.
Wes Streeting: One final question, Chairman; sorry.
Chair: That is what people normally say as they are warming up in the middle of their cross‑examination.
Q249 Wes Streeting: No, brevity is a new skill. You, in your analysis of the Autumn Statement, say that the overall impact of the decisions will be cash‑neutral for local government overall. Did that take into account the increasing pressures, or is that simply talking in terms of a steady state? You have not thought about the increasing cost pressures on local government in great detail, have you?
Gemma Tetlow: No, we have not. All our analysis was simply looking at the real‑terms change in budgets. We were not thinking about the demand side.
Wes Streeting: All right. We can hold that for another day.
Q250 Chris Philp: I would like to turn to the housing market, and in particular concerns the Governor has expressed about the explosive growth in the buy‑to‑let market over the last few years. Do you share the Governor’s concern in that area?
Paul Johnson: We do not tend to look at the housing market in that sense. Clearly, there have been big changes. Renting has become much more significant than owner‑occupation, but I do not think we would take a particularly strong view on the right balance between renting and owner‑occupation. The big issue, which your previous panel was alluding to, is that to some extent this is probably driven by some intergenerational differences, in that it is quite difficult for younger people to get into the housing market. There is quite a lot of asset‑richness among an older generation, and so this is creating a rather different distribution of wealth than might otherwise have been the case, but again whether that is appropriate or not is a judgment.
Q251 Chris Philp: What sort of fiscal and behavioural effect do you think the introduction of the 3% premium on stamp duty, which I support, will have in terms of the property market?
Paul Johnson: First, this is not going to have much effect on those who are already in the buy‑to‑let market, or have second homes. In the sense of undoing something that already exists, it is not going to have any effect. Secondly, it will clearly increase the cost of buying into that market; how big the effect will be, I do not know, but it must reduce the chances of people buying into it. But, thirdly, it must create incentives for attempts at avoidance, whether that is through incorporation—because this does not appear to affect incorporated organisations, or ones that are getting bigger—or pretending that it is not a buy‑to‑let, or something. There are going to be problems around that.
Q252 Chris Philp: I thought the only exceptions were for caravans and boats, properties under £40,000, and corporates, if they hold more than 15 properties. Corporates less than 15 properties will be caught.
Paul Johnson: It is not going to affect people who incorporate who have lots of properties, which is an interesting boundary.
Q253 Chair: Sorry to interrupt, but what do you mean by an “interesting boundary”?
Paul Johnson: I suppose the question is, if you think this is the right thing to do, why do you think it is the right thing to do for someone with 14 properties and not 16? I do not know. Clearly, that is a boundary that will be gamed, one way or another.
Chris Philp: Well, the answer to that question is—
Q254 Chair: Hang on; you are not answering the questions here. It is what Paul Johnson has got to say that we are interested in here. What is your answer to the question?
Paul Johnson: To “Why is that an interesting boundary”?
Q255 Chair: Well, you half-answered that, but what do you think should be the reason for putting in a boundary?
Paul Johnson: I do not know. Personally, I would not do it like this to start with.
Q256 Chris Philp: How would you do it, then?
Paul Johnson: First of all, you need to decide whether the problem is that buy‑to‑let or renting is more tax‑favoured than owner‑occupation. It is pretty hard to make that case, because it is not. Is there a different set of problems associated with intergenerational equity or, as you were talking about before, more money coming in from abroad, or what have you? If you think that is the problem, it is probably better to do something like have a recurrent tax on ownership, rather than a tax on transactions, so increasing the council tax on the owner or something like that—if you think there is a tax problem in the first place.
Q257 Chris Philp: Wouldn’t you agree, though, that to the extent that future buy‑to‑let landlords are, to some extent, deterred by this, it will effectively free up units that they would have otherwise have purchased for, for example, first‑time buyers?
Paul Johnson: Because it becomes more expensive to purchase these properties, as you say, as a buy‑to‑let landlord, either they will be bought by people looking for owner‑occupation, or perhaps by corporates with more than 15 properties.
Q258 Chris Philp: Yes, but hopefully by first‑time buyers.
Paul Johnson: I assume that was the hope.
Q259 Chris Philp: Yes, I think that is the hope, and the expectation. You mentioned in a speech you gave on 26 November that this reintroduces, albeit on a small scale, a cliff edge into the stamp duty schedule. Is that a reference to the £40,000?
Paul Johnson: Yes.
Q260 Chris Philp: Alright. That is not really too significant, is it? Do you agree with the OBR’s or the Autumn Statement’s assessment that this will raise slightly under £1 billion per year, roughly—£800 million or £900 million per year?
Paul Johnson: We have not modelled that separately. We do not have any reason to think that is the wrong number.
Chris Philp: Okay. Thank you very much.
Chair: Chris, that was very swift. I should have let you answer a few questions.
Q261 George Kerevan: Mr Johnson, how would you assess the net fiscal impact on business from the Autumn Statement?
Paul Johnson: What was in there for business? I cannot remember that there was very much. Oh, the apprenticeship levy; that was quite big. Essentially, there was £3 billion on a payroll tax, some of which will be recouped through spending on training. That is clearly fairly substantial.
Q262 George Kerevan: Do we have evidence from other countries about what the impact would be?
Paul Johnson: I do not know what the evidence is from other countries. There are clearly pros and cons to the policy. This will effectively, for those affected, make a significant amount of apprenticeship training costless to them, because they can claim that back off reduced spending on the levy. That may have a positive effect if they are currently underinvesting in apprentices. There may well be other kinds of behavioural effects, such as relabelling things as apprenticeships—introducing new things, calling them apprenticeships, and them not being terribly valuable. This will inevitably involve additional regulation and oversight, which itself may create costs and may be a different kind of burden on business. But £3 billion is a very substantial sum of money.
Q263 George Kerevan: We asked the OBR the same question. They were quite willing to call it the equivalent of a payroll tax.
Paul Johnson: It is a payroll tax, yes.
Q264 George Kerevan: What are the negative consequences of that?
Paul Johnson: Payroll taxes have two potential effects. One is to reduce wages, and the other is to reduce employment. It does not look so different from an increase in the employer national insurance contribution. Clearly, it only affects those employers with payrolls of more than £3 million, so it is affecting a very small number of employers relative to doing that, but beyond that it will look very similar, except that, as I say, you will be able to get the money back if you spend the money on apprenticeships. But, yes, it is a payroll tax.
Q265 George Kerevan: Do you detect any pattern, looking across the Chancellor’s last few budgets—the summer budget and the Autumn Statement—towards more hypothecation or ring-fencing, in terms of spending decisions?
Paul Johnson: Well, there is that. Was there a road fund—VED or something? I cannot remember.
Gemma Tetlow: There was spending on women’s charities.
James Browne: There was notional hypothecation of VED, but I do not think it amounted to anything, because we already spend more on roads than is raised in VED.
Paul Johnson: So, a little bit of one—not yet a big trend, I do not think.
Q266 George Kerevan: I am just adding the various forms of departmental ring‑fencing, the hypothecation—which, clearly, the apprenticeship levy is—plus all the various rules that we have enacted now in the Commons on tax caps. The fiscal framework seems to be becoming increasingly inflexible. Is it particularly more inflexible than in other countries or jurisdictions?
Paul Johnson: Yes. Obviously, eurozone countries have, in principle, a very inflexible set of rules about what they are and are not allowed to do, and in that sense the fact that we have control creates more flexibility. But we have inflexibility, at least in principle, in a number of places. One is the welfare cap; one is the fact that we are supposed to get to balance in 2019, and no other year; one is, as you say, that there is legislation to avoid increases in VAT, national insurance and income tax. That is quite a significant set of constraints around decisions, for sure.
Gemma Tetlow: The one area where we have seen a big increase in flexibility is in local spending, compared with where we were before 2010. Prior to 2010, a huge amount of budgets that got sent to local government were ring‑fenced for particular purposes, and a lot of that has now gone. One area where we perhaps have more flexibility is that local authorities have more control over how they spend their budgets, albeit their budgets are shrinking at the same time.
Q267 George Kerevan: As we appear to be moving away from the majority of fiscal decisions being taken at Treasury level, and devolving more and more fiscal decisions to local authorities in England—the devolved jurisdictions—do we have numbers about the scale with which that is progressing through the budget cycle, and will it reach a scale where it becomes more difficult to predict fiscal outcomes because we have so devolved the degree of decision‑making over the spending round?
Paul Johnson: There is some difficulty in predicting, for example, what local authorities will do with their reserves, and that has an effect on total spending. To the extent that there are still constraints on the amount that they can borrow, that clearly restricts the degree of uncertainty there. There remain some significant decisions, as we were saying earlier, to be made about what it is that local authorities will actually be responsible for in a world in which the whole of business rates revenue is devolved to them, so there are big changes there; as we were saying before, there are significant uncertainties. The more that you devolve, the more—in some sense—the Treasury is losing control over some of the levers, but that need not in any sense be a bad thing.
Q268 Helen Goodman: Mr Johnson, when you began you did not explain the responsibilities of your colleagues. Could you just say what Ms Tetlow and Mr Browne do, so that I can ask my questions of the right person?
Paul Johnson: James is here, essentially, to answer questions about welfare and universal credit, and that kind of thing. James is your man for that. Gemma can speak on the public spending and public finances side.
Q269 Helen Goodman: I see. I want to start off by asking some questions about housing benefit that follow on from our earlier discussion. The IFS said, in its presentation on benefits changes announced in the Autumn Statement, that the housing benefit caps are increasingly arbitrary. Why did you say that? What did you mean by that?
James Browne: At the moment, the maximum amount you can claim if you are a private tenant is based on the 30th percentile of rents in the area in 2012. Since 2012, those caps have been increased in line with CPI inflation, and if that policy is continued over the very long term—
Helen Goodman: Oh, not in line with grants.
James Browne: —what is going to happen is that in places that had relatively high rents in 2012, you will be able to get more, but if somewhere had a lower level of rents in 2012 that then subsequently increased, somebody in that sort of local authority would be able to purchase a much lower quality of housing.
Q270 Chair: Given the degree of accuracy that we now have about house price movements—through, for example, nethouseprices.com and the fact there is a public register, albeit about a year in arrears, for private transactions—isn’t there a case for localisation of the indexation?
James Browne: There is, to the extent to which you are prepared to allow variation in the minimum amount of income people receive from local authorities.
Q271 Chair: That will address your problem.
James Browne: Indeed, yes. You could go back to the old system where it was centrally set at the 30th percentile or—
Q272 Chair: Sorry to interrupt. I just want to clarify whether that, in your view, is a plausible, practical solution. “Solution” is too strong, but is it a considerable mitigation to the problem that you have outlined?
James Browne: Indeed, yes.
Paul Johnson: It does depend on what you want to achieve, of course. If the Government is trying to move the amount that people get paid away from anything that is directly associated with housing costs, what they are doing will achieve that—again, in a rather arbitrary way, but it will do that.
Q273 Helen Goodman: Speaking as a former Minister with responsibility for housing benefit, could I just say that if we were to localise the indexation, we might find ourselves going back to the situation that we had when I was the Minister, most unfortunately, in 2009, when some people in some places were getting very high rates of housing benefit?
James Browne: Indeed. Since then, we have got the national caps as well, so there is an argument here about how much localisation you want.
Paul Johnson: It is a different degree of local.
Q274 Helen Goodman: I think you will agree that controlling the housing benefit bill is an exceptionally difficult thing to do in an era of rising housing costs.
Paul Johnson: Indeed.
James Browne: Of course.
Q275 Helen Goodman: So, given that is the case, do you think it is an unachievable aspiration to control the housing benefit bill without changing market conditions by changing the rules? Is that possible or impossible? Are there some further tweaks that you can see that the Government could adopt or not?
James Browne: It is always possible to just reduce the amount that you give to people. At the moment, they are based on the 30th percentile of rents in a particular area; you could move that to a lower percentile, or you could look across a larger area when you are calculating how much support you are going to give to people. But, almost inevitably, if you are trying to reduce housing benefit spending while housing costs are going up, that will lead to people having to pay more towards their rent themselves.
Q276 Helen Goodman: What steps, beyond changing the rules on housing benefit, do you think the Government could take to bring down the housing benefit bill while continuing to ensure that people are decently housed?
James Browne: Fundamentally, if you want to reduce housing costs, you have to increase the amount of housing that is available. There are various ways in which you can go about achieving that: by changing the planning system or releasing land that is owned by the Government for housing.
Q277 Helen Goodman: What about the system that is used in other countries of introducing rent controls in some places?
James Browne: That would, if anything, reduce the amount of housing that is released on to the rental market. On the whole, you would think that would be beneficial for the people who were still able to find a property, but there would be an excess of demand over supply.
Q278 Helen Goodman: Just following up on that, do you have any quantification of that?
James Browne: No. That is just what you would expect.
Q279 Helen Goodman: It is what you would expect. What would you expect, Mr Johnson?
Paul Johnson: It is worth saying that there are other aspects of government housing policy that have an effect here. The fact that council tax rates are higher on low‑value properties and lower on high‑value properties gives people who are in high‑value properties an incentive to stay there. The same is true of very high levels of stamp duty on some kinds of transactions. If you combine that with the planning rules that James was talking about, there are lots of things here that are driving down mobility within the sector and the incentive on owner‑occupiers to trade down, and driving up underlying prices and underlying rental prices. Indeed, on the stamp duty changes that we just heard about, for those who end up in the rental sector, it can only push the rent one way, and that is up. There are all sorts of things that are driving the housing market in an unhelpful way.
Q280 Helen Goodman: Yes, indeed. John Hills has observed that we are putting more support into the demand side than the supply side than was the case, say, 30 or 40 years ago. Do you think it is possible to make a shift, or do you think that is very difficult because of the short‑term blip in spending that would mean?
Paul Johnson: Clearly, you could—and there would be a strong case for doing so—think that spending more on the supply of housing should be a priority. The supply of housing is one of the biggest economic and social issues that we face.
Helen Goodman: Thank you. Could I turn now to your distributional analysis?
Q281 Chair: Before we come on to that, briefly, have you made any effort to draw up a balance sheet of the supply and demand balance, and how it has been affected over the last few years by housing policy, overall? It is not easy.
Paul Johnson: No. I am not quite sure I can see what that would look like.
Q282 Chair: No. That is why we have the IFS, isn’t it—to help us along? Would you have a think about it?
Paul Johnson: I will think about that one.
Chair: There are various stages in this: first of all, identifying the list of measures, and then there is a much trickier problem of putting numbers on some of these things. Could we just think about stage 1, initially, which should be a good deal less work than stage 2? Thanks very much.
Q283 Helen Goodman: Let me go back to your distributional analysis. Does it show that the poorest have been hit hardest by the things that the Chancellor of the Exchequer has done since the General Election?
James Browne: If you look at the very long‑run impact of the measures, once they are all fully in place—which is what our distributional analysis is focusing on—you definitely do see that the lowest income groups are losing the most, both in cash terms and as a percentage of their income.
Q284 Helen Goodman: I have only got here your percentage graph. Did you produce a cash graph?
James Browne: There is a cash one, either on a separate presentation or at the back of that one.
Q285 Helen Goodman: We have had some difficulty in getting these numbers out of the Treasury, so it is extremely useful that you are still producing this particular analysis. The Chancellor, by his own admission, has now made changes that will breach his welfare cap—not the cap on households but for the budget as a whole. Do you think that breach undermines the Government’s credibility in this area of policy?
James Browne: The Government has simply changed its mind about the amount of welfare spending it considers desirable in the next few years. I do not think it necessarily means the welfare cap is a bad idea; the rationale behind it was that, if unforeseen events increase spending in a particular area and increase welfare spending overall, it would at least force you to consider whether you were prepared to spend that additional money or look at ways of reducing overall welfare spending.
Q286 Helen Goodman: Did he change the cap, or did he abandon the cap?
James Browne: I am not entirely sure. He has breached the cap that he set in July.
Q287 Helen Goodman: But not set a new one?
Gemma Tetlow: He breached the cap in the next three years, and essentially took the stance that he was happy to do that and not attempt to get back down below the cap.
Q288 Helen Goodman: The new forecast is the new cap, as it were?
Gemma Tetlow: No, the cap has not been moved, officially; he is just above the cap, and I believe he needs a vote from Parliament.
Helen Goodman: Oh, I see. Okay.
Gemma Tetlow: Possibly more concerning is what happened in the last two years of the forecast period, where he did not formally breach the cap, but the way he managed to do that was by reallocating an item of spending out of welfare and moving it to local government spending, instead.
Q289 Helen Goodman: Which item was that?
Gemma Tetlow: That was support for temporary housing in a local area. It used to be paid from the—
Q290 Helen Goodman: Oh, did he not make an adjustment in the cap when he made that transfer?
Gemma Tetlow: No.
Helen Goodman: That is very interesting.
Gemma Tetlow: He and the Treasury made the case that was a policy change and therefore would influence behaviour.
Q291 Helen Goodman: Can you remember how much it is?
Gemma Tetlow: It amounted to £300 million.
Helen Goodman: Oh, that is quite a lot.
Gemma Tetlow: It had the effect of bringing him about £100 million below the cap. It just raises an issue that there are three ways of getting yourself within the cap. One is active policy change; one is forecasting changes that work in your favour; and the third is reclassification of items of spending. It raises the issue of the transparency of the distinctions between those things, and how they get used.
Q292 Helen Goodman: That is a very good point indeed. For example, forecast savings from disability benefits are within the cap, aren’t they?
James Browne: Yes.
Q293 Helen Goodman: They have not come out as well as the Government was anticipating with the shift from DLA to PIP, have they? Do you think that we are going to see significant savings in this area?
James Browne: It does not look as though the anticipated savings are going to materialise from the evidence that we have so far. This is, perhaps, the sort of thing that, if that caused the breach of the welfare cap, would lead you to want to reconsider what the system should look like, and whether you should be reducing spending to keep the overall spending on benefits below a particular level.
Q294 Helen Goodman: Another major benefit that is inside the cap is universal credit. The switch from tax credits to universal credit, in a way, is what saved the Chancellor’s bacon, because he gets his savings in 2020 but does not have big reductions in people’s incomes next year. This transition is achieved by the move to universal credit, but the OBR is showing that transition being pushed back and back and back. Do you think that we are going to see that pushed back again?
James Browne: You certainly would not rule it out, and that has consequences, as you say, for how quickly the savings are going to be delivered. Now we are expecting universal credit to be, overall, quite a big reduction in generosity to the amount of support we give to working‑age people.
Q295 Helen Goodman: There is more incentive for Ministers to hit the timetable, then, one might say.
James Browne: Indeed. Previously, it has been an increase in the generosity, and delays have been a policy change that has reduced welfare spending.
Helen Goodman: Thank you very much.
Chair: We are slightly ahead of time, which is extremely rare for our cross‑examination of the IFS, but we did give you a small task in the housing field, and so you have got a few extra minutes in which to get it done. Thank you very much indeed for coming and giving evidence, and we look forward to receiving that bit of written material.
Oral evidence: Comprehensive Spending Review and Autumn Statement 2015, HC 638 30