Oral evidence: Budget 2014, HC 1189Tuesday 25 March 2014

Oral evidence, 25 March 2014.

Chair

Thank you very much for coming in. You have provided a great deal of very interesting information, as the IFS has historically over many years, prior to and since the budget. In your presentation on the budget you noted that the long-term fiscal position of the UK has been weakened by what you described as permanent tax giveaways funded by what you called “unspecified spending cuts and temporary increases in tax revenues”. What did you mean by that? It does not sound very good news for your view of the robustness of the Chancellor’s arithmetic.

Paul Johnson

I think it is important to put it in context in the sense that the changes in the budget were pretty small in the total scale of the planned consolidation, but there were some tax reductions, particularly the increase in the personal allowance, which are permanent, and a restatement of some increases in spending, for example on child care. In the scorecard you see increasing revenue from, for example, the pension changes that you were just discussing and one or two other tax changes, including the short-run voluntary NICs payments. These things balance out in the scorecard but the increased revenue runs out pretty soon after the end of the scorecard, and indeed goes negative, while the reduced taxes or increased spending are permanent. Obviously they can be changed but it is more difficult to change these things once they are there. But as I said, these are a few billions out of the still £100 billion-odd of borrowing we are doing.

Chair

They are not serious enough concerns for you to want to challenge the Chancellor’s statement in his budget that he had not been tempted to squander the gains from a recovering economy and improve borrowing forecasts. Is the Chancellor being as prudent as he claims?

Paul Johnson

Again, I think the differences are small but I think he is not being quite as prudent as that might suggest. I do not think this is an entirely neutral budget. One reason for stressing that a little more than we might otherwise is that rather similar things have been done over the last budget and autumn statement where we have seen, for example, one of the biggest, contracting out for employer national insurance contributions, will cost the public sector around £3 billion a year. That was scored as additional revenue and the assumption is that they will just be additional spending cuts. It is something that has happened two or three times. You begin to add those up and it begins to make a noticeable difference.

Chair

A crucial way of looking at the extent to which the Chancellor is being prudent is to assess his performance against his own fiscal mandate. The fiscal mandate in turn is derived from an OBR estimate of, among other things, a rather arbitrary judgment—certainly it is a very difficult one—about the size of the current deficit or surplus. Given how difficult that is and that the Government is now reviewing the fiscal mandate, do you think the cyclically-adjusted current budget target should remain part of the mandate?

Paul Johnson

It is a difficult one. I think it is appropriate to think about your fiscal position in the context of where you think you are relative to the cycle or relative to the output gap. Clearly, if you are simply outbalanced, if you think you have a massive negative output gap, you are well above trend, then that is not a long-term sustainable position. So you do need to take a view on that. In one sense you need to do it, in another you need to be very aware of the considerable uncertainty that exists around it. I think it is quite interesting that while the fiscal mandate still exists, and the Chancellor refers to it, he is referring more and more to his aim of getting to actual simple budget surplus by 2018-19, which is not directly related to the level of the output gap. We will be doing some additional work and thinking about what the fiscal rules might be going forward, but there are balances between uncertainty on the one hand and the need to have an output gap measure on the other.

Gemma Tetlow

The only thing I would add to that is, as Paul said, there are good reasons for not worrying about the bits of borrowing that are purely cyclical and temporary. In more normal times, this distinction becomes less important. If you are in a small recession or you are in a small boom, then well within the five-year forecasting horizon you would expect the economy to be back at its trend level again and, therefore, the cyclically-adjusted measure is exactly the same as the headline measure. The reason that the cyclically-adjusted measure was an important part of the fiscal mandate four years ago now is that we were forecasting a very long period of below potential economic activity. Therefore, there was a difference for all five years of the forecast horizon between a cyclically-adjusted measure and a headline measure. As we get back to a more normal operating position, I think the distinction between the two becomes a lot less important and it is a lot easier simply to think about the headline measure.

Chair

There is going to be a lot of focus on this over the next few years, not to mention in the general election, given that the two parties have a different view about what they want to achieve, a point that you also flagged up in your pre-budget presentations. The OBR, from what I can tell—and I am looking now at page 156 of the Fiscal Outlook, table 4.39—seems to be suggesting that the surplus of the current budget, on the basis of their own forecasting, is going to be £30 billion. The Shadow Chancellor’s stated position, as you put it in your presentations at any rate, is that he does not want a surplus. He wants a balance over the same period. Is that correct?

Paul Johnson

My understanding of what the Shadow Chancellor said back in January, that he was looking for a balance or surplus on the current budget at some point through the next Parliament, does, on these numbers, suggest that he has left himself with £30 billion of additional room for manoeuvre relative to where the current Chancellor is. The Shadow Chancellor has made it clear that he has not set out a specific target and he may want to over-achieve on that, but that is the constraint that he has publicly announced.

Chair

You said a moment ago, on the relevance and importance of this current measure, that you are doing some extra work on what the Government has put out in this field anyway.

Paul Johnson

Given that the Chancellor has said that he is looking at the fiscal framework, we will do some work over the next two or three months to look at some of the options that might be open to him.

Chair

One more question, which goes back to the point about how credible the forecast is over the longer term. In your own Green Budget publication on page 40, table 2.4—you might know all this so well that you do not need to look it up—you have a set of numbers showing how difficult it is to maintain strict discipline on public expenditure while at the same time ringfencing nearly half resource DELs or departmental expenditure limits. A key question has to be: is it realistic to believe that a Government can deliver these numbers, given that the denominator is shrinking every year from which you have to take further cuts?

Paul Johnson

That is a difficult question. What we have done there is take the numbers from the autumn statement. We have assumed that all of the tightening that needs to occur will happen through departmental spending. For example, we have not factored in the £12 billion of additional welfare cuts the Chancellor has suggested and we have not factored in potential tax increases. There are options open to Governments that want to meet that same target. In terms of the scale of the cuts, if you make those assumptions then the cuts are more than a third between 2010 and 2018 in non-ringfenced departments. The difficulty, of course, is that the biggest ringfence is around the Department of Health and our other calculations suggest that, once you look at health spending on an age-adjusted per capita basis, that is falling by around 9% over this period. The two bits of unringfenced spending that are genuinely more significantly protected are obviously the overseas development spending and school spending, which is not constrained in quite the same way that health spending is because we do not have quite the same demographic change that schools are having to deal with at the moment that the health service is having to deal with at the moment.

Jesse Norman

Obviously you will have heard the discussion we had on the outward cap earlier. Do you share the view that the volatility of policy is somewhat increased because we are at the zero band on the monetary side? We are in more of a toggle where there is a tremendous incentive to keep everything slow and gentle economically, because of the worry that a shock would cause people to suddenly change expectations, and that the reason why you might get a sudden change is because we have burnt the furniture and we are at the zero band of monetary policy.

Paul Johnson

That is clearly a constraint on the kinds of policy that people can pursue. There are clearly concerns about what would happen if interest rates were suddenly raised, given the condition of the economy, and it clearly puts a lot of additional pressure on the fiscal side. I am not sure whether it makes the policy any more volatile.

Jesse Norman

Very quickly on the same related issue, do you also share Michael Saunders’ analysis that the delay in the fiscal tightening until later in the next Parliament creates political risk?

Paul Johnson

Gemma might say something about exactly what that delay is. It is clear that there is a large amount of consolidation still required in the next Parliament. Beyond 2015-16 we have not heard from this Government what exact spending cuts they would introduce. We do not know what the Opposition would do. That is kind of the position we were at in 2009-10 before the election, but clearly that there are three years of very big spending cuts pencilled in and we know next to nothing about what they will look like.

Gemma Tetlow

The only thing I would rephrase slightly about how Michael Saunders described that pace of the tightening is he was talking about the changes in the structural primary balance, which is one way of looking at it. If you think instead about what active policies have been introduced and are planned, the current Coalition Government has stuck to its plan for the tax increases and the spending cuts it was going to do in this Parliament but, in a sense, the size of the problem that they have been faced with has been revised over time. They have tacked on to the end of it additional cuts to come in the next Parliament. The pace of policy change has been as planned over this Parliament. It is just that there is more needed and further to go in the next Parliament and perhaps that makes sense if you think there was a trade-off between the amount of policy action you can do versus the effect on the macro-economy in the shorter term. It makes sense if the problem is bigger to take longer to deal with it, but it does mean that there is more left somewhat unspecified in the next Parliament.

Jesse Norman

Also, just to pick up the Chairman’s point, it puts a further squeeze given the amount of ringfencing already apparently being planned.

Gemma Tetlow

Certainly the default currently in the plans is that that further spending cut that is planned in the next Parliament comes from departmental spending because we have not yet heard any explicit further welfare cuts or tax increases but, as Paul said, a new Government after the next election could choose to shift that mix a bit and take some of the pressure off departmental spending.

Mr McFadden

Can I pick up on where we left off with our previous witnesses, which was on the budget and pension changes? I will start with you, Paul. First of all, what are the fiscal implications of what the Chancellor announced?

Paul Johnson

I think relatively small. The scorecard suggests an extra £1 billion or £1.5 billion of revenues in the short run. The OBR document makes it very clear there is a huge amount of uncertainty about that and that depends on fairly unknown assumptions about how pensioners will behave: how much they will draw down early or the extent to which they will, nevertheless, buy annuities or not. If you take those forecasts, in the long run—and I think this is after about 2030-something—you get a reduction in revenues as the income is used up a bit quicker. I think the answer is the fiscal implications are probably small; probably positive in the short run and negative in the long run.

Mr McFadden

Let me just get this straight. You are saying in the short term, as people probably draw down more than they would have and spend more than they would have, there is a short-term boost to Government revenues, but in the longer term there may be less for exactly the same reason, namely that the money is no longer there in the future?

Paul Johnson

Yes, that is what the OBR numbers suggest. As I said, they are very clear there is a lot of uncertainty around that. Something of that kind one would expect. How big it is, that is uncertain.

Mr McFadden

Can I then ask about the tax implications, as distinct from the fiscal implications? Our previous set of witnesses raised a question, which I think you did in the immediate post-budget presentation that you did, of whether these changes raise the question of how the taxation of pensions should be treated. I will start with you Gemma. Could you expand a little bit on that and explain to us why you think this raises this question of how pensions should be treated tax-wise?

Gemma Tetlow

Pensions are, in a number of ways, more tax-favoured than many other types of saving. One of the justifications for that might be that people are giving up some freedom by saving into a pension because they were required to take an annuity. Clearly, the set of changes reduces the restrictions on people’s behaviour, although it will still be the case that they cannot access this money until they get to 55 at least. The thing to be clear about is exactly what we mean by the more tax-favoured bit of pension saving. You do not pay any tax on your contributions to a pension. You do not pay any tax on the investment returns in your fund, but then you pay tax on the way out. Most of that we would not think of as over-generous tax-favouring of pension saving. There are strong reasons, as outlined in the Mirrlees Review, for not taxing the normal return on savings and ISAs have a similar feature, although they are taxed and then exempt in the two other places. It is not that bit of tax treatment of pensions that we were focusing on as being more generous than other forms of saving. It is other elements, such as the fact that employer contributions to pension schemes avoid all national insurance contributions as well, which obviously never get charged on the way out either, and the fact that you can take 25% of your pension fund completely tax free. That is 25% that never gets taxed at any point. It is those elements that seem much more generous relative to any other form of savings vehicle that you could think of.

Mr McFadden

Is a simple way to put this that these changes will make the savings that you get in a defined contribution scheme much more similar to other types of saving and therefore they should be treated, tax-wise, like other types of saving? Is that a reasonably way to sum that up?

Paul Johnson

Sort of. Not in the sense that we think they should be treated like money I stick in a bank account or if I just go out and buy shares, because they are taxed very heavily. We would not suggest that—

Mr McFadden

What about the money I stick in an ISA?

Paul Johnson

—pensions should be taxed very heavily. They should not be taxed twice. It is just that they should be taxed once and, as Gemma said, the case for taking a quarter of it up to £300,000 or something, completely tax free—never been taxed on the way in, not taxed when it is there, not taxed on the way out—has always looked a little difficult but, given that you can now take this as a lump sum anyway and pay normal tax, the case for that is probably reduced. I think it is important to be terribly clear that we are not suggesting with any of this that we want to move away from or that the Government should want to move away from exempting from tax contributions on the way in because that is just part of a—

Mr McFadden

Exempting pensions from tax contributions.

Paul Johnson

Exactly, because I think that is just part of sensible system for taxing savings; you are only taxed once and you are taxed on the way out. That seems like an appropriate way of taxing savings.

Mr McFadden

In your submissions and evidence you said there are two good public policy reasons to incentivise pension saving, which is to prevent people unintentionally under-saving or to prevent people from falling back on to means-tested benefits because they have not made sufficient provision during their working lives. Do the new reforms to the state pension make a difference to those reasons? Do they reduce the worry about means testing in the future and, if so, in what way?

Gemma Tetlow

The reforms to the state pension are intended that, once it is fully in place, virtually everyone will qualify for a single-tier pension that will be slightly above the level of pension credit. That does mean it slightly reduces the number of people who would be expected to end up on means-tested benefits in retirement relative to the current system. However, it does not mean that no one is likely to end up on means-tested benefits. Importantly, pension credit is not the only means-tested benefit that many pensioners qualify for. A lot also qualify for housing benefit and council tax benefit, which continue much further up the income distribution than pension credit does. The Department for Work and Pensions, for example, in their impact assessment for the single tier reforms, estimated that by 2060 under the single tier system about 15% of pensioners would still be eligible for some form of means-tested benefit and that excludes council tax support.

Mr McFadden

So there is still a taxpayer interest in the behavioural consequences of this change?

Gemma Tetlow

Certainly, yes.

Mr McFadden

The Government has been cautious about the switch from defined benefit schemes into defined contribution schemes as a result of this. If the argument here is “trust people with their own pot of money”, which is how the Government has advanced this in the last week, why does the same logic not apply to the money that has been saved in defined benefit schemes?

Paul Johnson

I think part of the issue there is that, from the beginning of the defined benefit system, you have risk sharing. For example, if I hit 60 and I am pretty ill and I think I am not going to live terribly long, I have a very big incentive to take my money out of the DB scheme and make use of this ability not to have to buy an annuity. If I do that and my DB scheme is funded on the assumption that a proportion of people will die early, which they are, then that requires additional contributions from everyone else or reduced benefits; probably additional contributions. There is a danger of undermining the funding structure of DB schemes if you allow those who will benefit most from not having an annuity or a pension to move out early. I can understand the caution here because I think you do risk the schemes being selected against by those who do less well from the schemes. I think that is a fundamental part of the risk sharing that defined benefit schemes provide.

Mr McFadden

That is an interesting reply. The final question is, if the argument is to trust people with their own money, what is the logic of auto-enrolling people in a pension scheme in the first place, which is almost a form of enforced saving?

Paul Johnson

I think it is an interesting question. There is a move towards a little bit more paternalism on putting the money inside and a little bit less paternalism on taking the money outside. It is not compulsory. As you say, it is soft compulsion.

Mr McFadden

It is not compulsory, but it is a pretty heavy nudge.

Paul Johnson

There is clearly a judgment to be made there. I think the judgment that the Government is making is that you need that automaticity of saving—and you can pull yourself out if you want—just to ensure that people do what is easiest and then they are forced to make a choice at the point of retirement.

Mr McFadden

I do not understand why there should be a different approach. If you are trusted with your money, why are you not trusted with your money when you are young?

Gemma Tetlow

There are perhaps two potential reasons for auto-enrolment. One would be that people are very short-sighted. Therefore, even if it is quite easy for them to make the choice to opt into a pension, they do not see the benefit of it because they discount the future.

Mr McFadden

Exactly the argument why it was brought in.

Gemma Tetlow

The second perhaps would be that it is quite a lot of hassle to get yourself organised with a pension. If the default is that you are making those contributions, it removes that hassle factor from you. To get rid of the requirement to by an annuity later on, I think you would have to believe that people are somewhat less short-sighted at the age of 55 or certainly less short-sighted about the end of their lives at that point.

Chair

Which they may well be.

Gemma Tetlow

Which they might be.

Mr Love

We said earlier on in our previous witness session that having done away with the requirement to have an annuity would call into question the tax advantage. If that happens in the longer term will we have a complete review of tax-preferred savings? In other words, will pensions and ISAs and other vehicles for tax-efficient savings merge? Will we move away from having pensions as a favoured treatment and move towards something much more comprehensive in terms of choices that you may have and ways that you can save that are not particularly related to retirement but hopefully will provide an income in retirement?

Paul Johnson

I do not know whether we will. I think it is an interesting question, though. We saw quite a big overhaul of savings taxation in the budget. We have been talking about the pension changes. We also saw an increase in the ISA limits and an increase in the amount of cash you can save through that. You can think of those systems being brought a little bit closer together because you can put more into the ISAs. You no longer have to annuitize the defined contribution pension. There is still a significant difference, which is that one, the ISA, is taxed upfront and not taxed on the way out and the other is not taxed on the way in but is taxed on the way out. To unravel those would be a big change and not one I think you would want to achieve. If you wanted to do what you are suggesting then the obvious thing to do would be to bring down the point, from 55 down to 50 or below, at which you can access your pension. I think what the Government has said is they are going to consult on increasing that in line with the state pension age. That would suggest to me that that is not what you have suggested, which is, as I say, very interesting. It is not what they have in mind because they have said very clearly they are going to consult on increasing the age at which you can do it rather than reduce the age at which you can do it.

Mr Love

Let me just follow this for a second, because one of the other things that was said in the previous witness session that I found interesting is the innovative nature of drawdown vehicles. In other words, people in the City would invent a vehicle, on the basis that you had this pot for your pension, that allowed you to drawdown even earlier than 55, perhaps 50 or 45. Will the innovation in the marketplace force Governments to consider how they tax advantage savings and move them into line in a way that you are saying is not conducive at the present time but may well work out as being a pressure on them to equalise the different savings products?

Paul Johnson

I do not know the extent to which that is likely to happen, to be honest. I am not expert enough on how these products are designed. I was not clear about what I heard from the previous witnesses. I presume the sort of thing they have in mind is using that asset as collateral against some kind of borrowing or as collateral against a mortgage or something. That happens to some extent anyway. I guess that may become more common, but I do not know.

Chair

That was a very interesting set of exchanges there.

Mr Newmark

There seems to be some sort of consensus developing, if I can use that word, between the various political parties on the need for a welfare cap or somehow getting welfare under control and the Government has now provided more detail on what they view as the overall envelope of a welfare cap. Do you think that will improve policymaking in the future?

Paul Johnson

There are a number of points here. One is that it is interesting looking at the cap and the amount of forecasting room around it, which does not grow as you go out. It is about 2% or 2%-and-a-bit each year into the future. You would expect the uncertainty to grow over time. Potentially at least, the tightness of this cap will be bigger over time or it may turn out to be very loose, because there is quite a lot of uncertainty about where we will be in 2018, for example. I suspect setting it five years ahead with a fixed 2% to 2%-and-a-bit forecasting margin around it will not last. For example, in 2016, if it turns out that the forecasts are much lower than they are now, I would expect a future Government to tighten the caps. There is a set of uncertainties about exactly how it will work in practice. I think the positive aspect of it is that in times past we have seen unplanned, very substantial growth in some bits of social security. Think about housing benefits at some points or you think about disability benefits at other points.

Mr Newmark

All right. Do you think there is a lack of flexibility in the system in itself? Do you think there should be caps on individual areas within welfare?

Paul Johnson

This is the question that the cap raises. You can imagine a world in which one benefit, say personal independence payments, starts rising much quicker than expected but that is offset, for some reason, by some reduction in housing benefit or tax credit. If that happened, the cap would not bite and that would not force any policy change, but you might think that you want to be thinking about each individual benefit and what the appropriate structure and spending on those is. Having the cap here will force more active decision-making than perhaps the current structure has force, but within this slightly strange systems where caps are—

Mr Newmark

Just to understand, are you saying that the welfare cap itself is not structured in a granular enough way to give it flexibility, or do you think it is too broad and, therefore, it does not matter if you get a little rise in one particular benefit as long as there is an adjustment on the other, or would you like to see a cap in housing or a cap in some sort of child benefits or whatever it might be?

Paul Johnson

As ever, there is a trade-off here. The current cap is potentially very flexible if different things are going on with different bits of the system, but very inflexible if everything is moving in the same direction or if the forecasting error turns out to be significantly more than 2% four years out. There is clearly just a trade-off between where you put that flexibility.

Mr Newmark

The welfare cap excludes the state pension. Do you agree with this exclusion?

Paul Johnson

It is not clear what the benefit of putting the state pension in would be. The state pension is completely uncontrollable unless you think you are going to renege on previous promises or you are going to adjust, year by year, the rate at which you increase the state pension. If you put the state pension in you are, I think, suggesting that you would consider adjusting the state pension and that is just a policy decision for Government, whether they think that is an appropriate thing to do.

Mr Newmark

In the Green Budget you note, “A mechanism forcing the Government to assess its policy on state pension spending might be beneficial”. Can you explain your rationale for that?

Paul Johnson

For example, if you are thinking about the way in which you are indexing the state pension, clearly the triple lock is a more generous indexation structure than one that is not a triple lock. You certainly will want to think about what the cost of that is going forward.

Mr Newmark

I would ask how much more time I have, Chairman, before I ask—

Chair

One more, Brooks.

Mr Newmark

Is that it? Okay, fine, because I have three. Thank you, Chairman; generous, as always.

Chair

Have a couple, Brooks. Have a couple.

Mr McFadden

Keep going, Brooks.

Mr Newmark

Let us deal with this thing. In the US when they had their debt ceiling and they broke it and everything else, we saw the way the market reacted and so on. The consequences of breaking the welfare cap: there does not seem to be a deterrent unless you look at political stigma. Does the Government have a credible plan on how to reduce welfare spending should it reach a cap, for example if a disaster happens, we have another crisis in Europe, Russia invades Ukraine and moves on to the Baltic States and the gas dries up and everything? What happens then?

Paul Johnson

I think there are two questions in what you were saying.

Mr Newmark

The second bit was facetious, by the way.

Paul Johnson

Well, not entirely. In normal times all you do have, I think, is political stigma and sometimes that works and sometimes it does not. We have a child poverty target that nobody is taking terribly seriously, quite honestly.

Mr Newmark

That is an example of an aspiration as opposed to real cap.

Paul Johnson

It is supposedly to be legislated. Similarly, there was a debt target, which is going to be missed. These things do not appear to have had an enormous amount of bite. This may have more bit but I think there are two issues. One is it would be nice to know what sort of response a Government might have if you are moving in that direction. The second one is, if we did fall into some significant additional recession—and we know that, while the Job Seeker’s Allowance and particular bits of housing benefit are clearly driven by the cycle, other bits of the benefit system are not invariable to the cycle and might rise in the circumstances that you are describing. The question is—and I do not know the answer to this question—suppose that were to happen, would this cap bite or is this a cap only for normal times? I presume that the Chancellor will say this is a cap for whatever times, but it would clearly bite much harder if we were to move into a substantial recession than under normal circumstances.

Mr Newmark

Gemma, you are nodding. Do you have any thoughts? It is not a vote. It is just prayers. Your time is up. My time is up. Sorry, Gemma, you were just saying.

Chair

Carry on, Gemma.

Gemma Tetlow

We did try to look a little bit at how binding this 2% forecasting margin is and the one time that it would have been breached in the last few years is, between the 2011 budget and the 2012 budget, there was a reasonably significant downgrade in the economic forecast from the OBR. That led to the forecast for welfare in scope spending in 2015 being more than 2% higher in budget 2012 than it was in budget 2011. That was a reasonably significant revision to the economic forecast, but not a large recession. That sort of scale of change could cause a breach in this.

Mr Newmark

Thank you, Chairman. I will call it a day.

Teresa Pearce

On the welfare cap, to just have a cap on welfare without other corresponding policies that would pick up consequences—what I am thinking of is within the welfare cap there are things that cannot be controlled without other policies coming in. For instance, there is housing benefit. Unless you can control rents, how can you control the housing benefit budget? The other thing that concerns me is that within the welfare cap there are things that it might be very sensible to spend on such as carer’s allowance. It would be much more sensible to spend the welfare budget on carer’s allowance than for people to go into care homes, which would cost the taxpayer so much more. Do you have concerns about the cap alone being quite damaging to people’s welfare rather than it being part of a holistic group of policies?

Paul Johnson

You are right that, as there are boundaries between the health and social care budgets, I think there are boundaries between things like the carer’s allowance and social care budgets and, as ever, considering these things entirely in isolation can result in unintended consequences. It will be important within that cap to think very carefully about the consequences. In terms of things like the housing benefit budget, I am not suggesting it will be the appropriate thing to do but it clearly is possible within that, as this current Government has done, to change the rules to reduce the amount that you are spending. Whether you would want to change the rules just because higher levels of low income had resulted in more people coming on to housing benefit; you might want to respond to that differently to where something was going up because rents were rising much more quickly than you expected. This is a very top-level cap. It would be very nice to see more detail underneath that about some of the ways in which you might respond. There is a lot of flexibility within the budget. Some of that, as you say, could have unintended consequences elsewhere. The choices over all of the other benefits could range from, as the Government is doing at the moment, just not increasing things in line with inflation—that saves you a lot of money over a few years but hits absolutely everybody on those benefits—through to changing the structure of the housing benefit system, which this Government has done, through to responding differently to the way that rents rise. This is a huge budget and so there are huge numbers of choices that could be made and I do not think we learn very much about what those choices would be from the simple fact of a cap.

Teresa Pearce

Do you think a cap is just a blunt instrument?

Gemma Tetlow

I will add to what Paul was saying. To the extent that this causes you, on an ongoing basis, to assess where welfare spending is going, and the OBR is, in fact, going to publish a report each autumn assessing changes to the welfare forecast and what is going on. To the extent that it causes you to have an ongoing review of benefit spending and to think about, “What is the level of this and how is it distributed and why has it changed since we last looked at it”, I think that is a positive thing. Hopefully, it might cause you to make better policies because you look at this every year rather than suddenly realising that your budget has exploded in a way you did not intend and then trying to address the issue.

Teresa Pearce

I agree with what you are saying, that it makes you look at what is being spent and why and the reasons why and, therefore, you adjust the causes of the reasons. That is good. You are talking about forecasts, but there are so many things in the welfare cap that you cannot forecast. There are bereavement allowances, for instance. You can’t forecast how many people are going to die. You can’t forecast how many people are going to need carer’s allowance. Pensions are exempted and that is the one thing you can forecast. It just seems to me that it is the start of a conversation. It is not the end of a conversation and it is attracting a lot of attention without any of the detail underneath being properly understood.

Paul Johnson

I would entirely agree with you. It is the start of the conversation and it gives, as Gemma was saying, the push to that conversation. I think there are lots of actuaries who would disagree with you about the ability to forecast bereavement allowance, but anyway.

Teresa Pearce

Well, yes, maybe. Thank you.

Mr Love

I wanted to ask you whether there are obvious ways in which we can improve the debate that is likely to occur when they breach the limits, whether the forecast margin is set at an appropriate level. You mentioned 2012 as being a year where we would have breached that. Is that an appropriate margin at 2% and are there other changes that could make it a more effective weapon than having the debate about welfare?

Paul Johnson

As Gemma said, 2% is clearly a margin that will bite in not terribly dramatic times. I presume there is no point having a margin that is so big that is not usually going to bite and not have one so small that it bites every year. It is like the question about what is the right level of debt; I do not know what the right level of margin is. In terms of the discussion we had earlier, I think what might make this more effective would probably be thinking about what sort of response you would have to what sort of change in the budget. I would like to get a sense from the Government of whether the intention is or is not that if one benefit is rising very fast it is the whole budget that will be looked at or whether it will be the single element that will first be part of that cap. As I say, it is the start of that conversation and a conversation that at least has the potential to be helped by doing this. It has the potential to be hindered if then the whole debate comes back, “We have to get within that 2% margin even if something dramatic has happened that is going to make that incredibly difficult”. Hopefully, with the OBR publications and so on we will have more openness about some of that.

Mr Love

It seems to me that the traditional view has been that when there is a recession the financials will change completely in terms of welfare. You indicated that if there was a recession it would almost certainly breach the 2%. Normally they allow the automatic stabilisers to work in those circumstances. This would probably suggest that they are not going to allow that to continue. As well as gaining a debate about what we should do about welfare in those circumstances, do we lose something in terms of the economic impact of automatic stabilisers?

Paul Johnson

Possibly and maybe it is worth reflecting on the fact that fiscal rules tend to go straight out the window as soon as there is a recession. I would not be surprised if this kind of thing did, too.

Gemma Tetlow

Without the welfare cap you are supposing that the current structure of the benefit system is the appropriate automatic stabiliser to operate. It might well be that, depending on the type of recession you are experiencing, you might want to do more or less than that. The current benefit system may not provide enough of an automatic stabiliser or it might provide a bit too much. I do not think our benefit system is designed in such a way as to provide the optimal stimulus during a recession.

Mark Garnier

The zero rate personal allowance level has gone up to £10,500. Is this progressive or regressive?

Paul Johnson

It is the most progressive thing you can do with the income tax system.

Mark Garnier

The most progressive?

Paul Johnson

The most progressive thing you can do with the income tax system. It is clearly not the most progressive thing you can do with the tax system. As we have said, doing something with the national insurance floor would be more progressive from that point of view. You could do more progressive things overall with the benefit system, In terms of the overall effect, I think it probably regressive over the first half of it and then progressive over the second half of it. It helps people in the middle more than it helps people at the bottom or the top.

Mark Garnier

This is the problem, isn’t it, with the people at the bottom end? If you are paid below £10,000 a year, it is going to make absolutely no difference to you whatsoever. Why do you think the Government is not tackling the national insurance contribution conundrum?

Paul Johnson

I am inclined to say you should ask them.

Mark Garnier

We did a few years ago because, of course, there was a review set up of some sort to look at doing exactly this and trying to work out if we could get rid of national insurance contributions altogether. I think the eventual conclusion was—and I think over many Governments, not just this one—that it is just too difficult to get rid of it. It is too complicated. Is this a genuine reason or do you think it is just people are not bothering over many years of talking about it?

Paul Johnson

There are two issues there. Under the last Government the point at which you started paying income tax and the point at which you started paying national insurance came very close together and so it was an active decision of this Government to pull them apart again. Obviously part of the reason for that is to move both national insurance floor and the tax allowance up is even more expensive than just moving the tax allowance up. There are clearly some people who gain from the increase in the income tax allowance who would not gain from the national insurance floor, those with unearned income who are not paying national insurance, and that would be true for pensioners after it passes through £10,500 where the pensioner allowance is at the moment. You are affecting slightly different groups and you may have a slightly different distributional focus, but I suspect it also has something to do with the salience of the income tax system relative to the national insurance system.

Mark Garnier

There are a lot of political parties talking about increasing this tax free allowance to £12,500 and some talking about it introducing a 10p tax rate, presumably as a starting rate as opposed to whatever. What would be far more progressive would be to raise that starting point of national insurance and forget, for the time being, doing anything with the base allowance. Would you agree?

Paul Johnson

That is right. Yes, I agree.

Mark Garnier

Could I turn to the higher-rate tax threshold, which is now £42,285 by 2015-16. That is going up, isn’t it? It has gone up by 1%, but more people are being dragged into it. I think you estimate that 400,000 are being dragged into it but that is because these people are getting paid more and are catching up with it, rather than it coming down, isn’t it?

Paul Johnson

It has come down significantly since 2010, but not in a way that has made anybody worse off, no. It has made people worse off if they are earning more than £120,000, and significantly worse off, but for other higher-rate taxpayers essentially what the Government has done is to ensure that they are either not gaining or not gaining more than basic rate taxpayers when the personal allowance has gone up. I think it is important to be clear. A lot more people are paying higher-rate tax. The point at which you start to pay higher-rate tax has come down, but that has not resulted in most higher-rate taxpayers being any worse off. It has just prevented them from gaining from the increase in the personal allowance.

Mark Garnier

The corner we are all in together is absolutely the case up to £120,000 and if you earn £120,000 to £150,000 you are more into it together than anybody else and after that you are less in it together.

Paul Johnson

Well, it depends what your baseline is. Certainly those earning over £120,000 have lost something like £1,100 a year, if my recollection is correct, from the tax and national insurance changes. Those between about £40,000 and £120,000 are essentially unaffected from the main income tax changes and those who are base rate taxpayers have gained about £500 a year from just the income tax changes. There is a series of other things going on as well, of course, but from just the things we are talking about that is the pattern.

Mark Garnier

Do you think this is going to cause any problems? Do you think it is going to stifle ambitious or stifle people’s enthusiasm to work harder, put more hours in and to go across the tax threshold or do you think it will make no difference?

Paul Johnson

It is important to be clear that you are moving essentially from 32% tax and national insurance to 42% tax and national insurance. I don’t think there is a huge amount of evidence that that change will make a great deal of difference, but these are pretty uncertain estimates.

John Thurso

Can I ask you about tax avoidance and HMRC and the changes that the Government are planning there? First of all, is the announcement of a new requirement for taxpayers to pay upfront in big disputes, which presumably only affects people who have quite a lot of tax to pay and who are engaged in spending a lot of money in trying to avoid it, but the critical point is that the new policy is estimated to bring in about £4 billion over the next five years. Do you think that is a realistic estimate?

Paul Johnson

We have no data on which to assess that. The only information we have is the published information that is in front of you. That scheme is a bit different from some of the other avoidance schemes because it is about bringing in money upfront, which, in a sense—

John Thurso

It is cash flow rather than end result.

Paul Johnson

Yes. On the positive side, I think HMRC is much more certain about that number than it would be for a lot of tax avoidance numbers because these are things happening at the moment. On the minus side, again you can see—and Treasury and OBR have been quite open about this and in all of these things—they have been quite open about the fact there is extra money upfront but there is less money later on.

John Thurso

In a way, one could take that £4 billion figure as a proxy for HMRC’s estimate of what they think they can contest and possibly win back.

Paul Johnson

Possibly. We have not gone through the numbers. Given the numbers going forward, and the numbers going forward look negative, you can probably back out of that, I think, how much of this they would expect to take upfront and then have to pay back. It might be worth asking them because they must have that number.

John Thurso

It seems to me there is not a lot of data and neither the OBR or the Government seem to put a lot of data out. It might be worth pushing for a little more clarity.

Paul Johnson

Given the numbers you have there, there are some very specific question I think you could ask of HMRC to provide you with information about their expectations.

John Thurso

A spinoff from that is, if all that money got taken in advance and HMRC had its judgment slightly wrong and the HMRC then lost those cases and it had then to pay all the money back with interest, that would be quite a large contingent liability, would it not, to be placing on the Government’s accounts going forward?

Paul Johnson

There is some assumption with these numbers about how much will have to be paid back and I do not know what that assumption is. It would be very good to get that.

John Thurso

So there is some work to be done there. The last one to ask you is the question around the idea that HMRC should be given the powers to seize money directly from people’s bank accounts. Do you agree with that?

Paul Johnson

That is a little outside my expertise to be able to comment on it, to be honest.

John Thurso

That is an interesting answer because one might say that this is more a matter of justice and civil liberties than it is to do with the Treasury. It is quite a big step to say, “We are going to allow the Government tax-takers to raid your personal account directly”. That is quite a big step, isn’t it?

Paul Johnson

Yes, I think it is a significant step but, as I say, it is not necessarily one that we are in the best position to comment on.

John Thurso

The Government has said that a minimum aggregate allowance of £5,000 will be left in place across all accounts. I remember, when tax credits first came in, regularly winning cases against HMRC where they were claiming sums of £12,000, £10,000, £7,000 and them then writing off those debts. Under this policy they would have snaffled the cash first and you would be fighting to try to get it back. Given their record of competence in that area, this does not fill me with any great confidence.

Paul Johnson

I think it is certainly worthy of pursuing further.

John Thurso

Well, we will pursue that further. Thank you.

Chair

Thank you very much indeed for coming in to give evidence this morning. You have produced a wealth of very interesting information in the run-up to this budget, as you so often do, and this evidence was also useful. There may be some further things we would like to follow up with you afterwards, not least the point that we were just having an exchange on there on what should be extracted from HMRC. Oral evidence:Budget 2014, HC 1189 29