The Commercial Secretary to the Treasury (Lord Sassoon)
My Lords, I beg to move that the Bill be now read a second time.
This Bill follows the emergency Budget and puts in place many of the measures necessary to gain control of the public finances and strengthen the economy. Despite its brevity, this Bill makes significant and necessary changes to our tax system—changes that will secure fiscal credibility, changes that will promote free enterprise and changes that will promote fairness, especially for the most vulnerable in society.
Our Budget was necessarily a tough Budget, but it was also a fair Budget. It set out the decisive and credible plan that is necessary to deal with the record deficit that this Government inherited. We currently have the largest budget deficit in Europe, with the single exception of Ireland, and we are borrowing one pound for every four we spend. Our deficit reduction plan will pave the way for sustainable, private-sector led growth, keep interest rates lower for longer and help to support jobs in the private sector. I cannot put it better than the noble Lord, Lord Myners, put it in this House on 8 June, when he said:
“There is nothing progressive about a Government who consistently spend more than they can raise in taxation, and certainly nothing progressive that endows generations to come with the liabilities incurred by the current generation. There will need to be significant cuts in public expenditure”.
The noble Lord went on to say:
“The Government cannot create jobs. The Government can create an environment that is conducive to the creation of jobs, but they cannot create jobs and we mislead ourselves if we believe they can”.—[Official Report, 8/6/10; col. 625.]
Earlier this month, in its report on the UK, the OECD said:
“The comprehensive budget announced by the government on 22 June was courageous and appropriate. It was an essential starting point. It signals the commitment to provide the necessary degree of fiscal consolidation over the coming years to bring public finances to a sustainable path, while still supporting the recovery”.
Despite containing only nine substantive clauses, the Bill represents a clear change from the past and a new direction of travel. As my honourable friend the Exchequer Secretary said to the other place, it is underpinned by the three principles of responsibility, freedom and fairness. First, the Bill is based on the principle of responsibility. We are taking responsible action to restore our nation’s finances because failure to address the deficit is the greatest economic threat that we face. We have been honest about the scale of the challenge and we have been honest about the actions needed to address it. If we are to bring down the deficit without cutting vital public services, raising valued added tax is an unavoidable choice.
For the first time, we have published within the Budget an analysis of the distributional impacts its measures will have. This shows that fairness underpins the tough choices that the Government have taken to tackle the deficit. It shows that this is a progressive Budget that deals with the deficit fairly: all sections of society will contribute, but the richest pay more than the poorest. We cannot, as some have done, look at the VAT increase in isolation. It is part of a wider package that ensures that the most vulnerable in society are protected. Without tough action on the deficit we risk losing the freedom to protect the services that the most vulnerable rely on.
Our long-term objective remains to increase the income tax personal allowance to £10,000, as set out in the coalition agreement, and we will take steps towards achieving that objective through the rest of this Parliament. Additionally, we have taken steps to increase child tax credit by £150 next year and £60 the following year. As a result of that, the level of child poverty will not increase.
Secondly, the Bill is based on the principle of freedom of enterprise in Britain, the freedom that our private sector so urgently needs in order to thrive and to spearhead a strong and stable recovery. A genuine and long-lasting economic recovery must have its foundations in the private sector. By cutting the corporation tax rate to 27 per cent, the Bill takes the first step towards reversing the decline in the UK’s competitiveness that we have seen over the past decade. As the Budget announced, we will continue to cut the rate of corporation tax by one percentage point every year until it reaches 24 per cent—the lowest rate of any major western economy and the lowest rate that this country has ever known.
The concern has been raised that cutting the main rate of corporation tax would mean that banks do not pay their fair share of taxes. However, I would point to the wider reforms outlined in the Budget, in particular the announcement of a banking levy, which will, in fact, ensure that the banking sector makes a greater contribution, one that outweighs the benefit that it receives from lower corporation tax rates. Banks will pay at least £2 billion more in tax as a consequence of these proposals.
Concerns were also raised in another place that the banks will not be deterred from pursuing risky behaviour. This is not the case: we have taken a targeted approach that preserves competitiveness, while ensuring that those who indulge in risky behaviour pay an appropriate premium for it. Tax competitiveness is good for employment and society as a whole and the bank levy allows us to be competitive while ensuring appropriate tax treatment for those activities that pose the greatest threat.
The reduction in the main rate of corporation tax is just one part of a wider package to build a private sector led recovery. Instead of increasing the small profits rate by 1 per cent, as planned by the previous Government, in next year’s Bill we will cut it to 20 per cent, benefiting some 850,000 companies from April 2011. We are also increasing the threshold at which employers start to pay national insurance contributions, and the Budget included a wider package of support for small businesses.
As we cut the rate of corporation tax we will also reduce allowances. The Budget announced a reduction in the writing-down value of plant and machinery allowances to 18 per cent and a reduction in the annual investment allowance to £25,000. However, allowances will remain broadly in line with depreciation and the annual investment allowance will still cover the annual qualifying expenditure of 95 per cent of businesses. Furthermore, by reducing the main rate of corporation tax in 2011 and changing allowances only in 2012, we are giving companies a timing benefit, which will form part of the £13 billion additional investment that we expect as a result of these changes.
Thirdly, I come to the principle of fairness in the Bill. Clause 2 increases the rate of capital gains tax for higher-rate taxpayers to 28 per cent. This progressive change will substantially reduce the incentive for individuals to disguise their income as a return on capital and will ensure that the appropriate rate of taxation is paid. This is fair in itself, but we have also ensured protection for those on more modest incomes. Consequently, those who pay only the basic rate of income tax will carry on paying capital gains tax at 18 per cent. In addition, this increase in the rate will help to fund the increases in income tax personal allowances that I mentioned. Those who have the most will help to lift more of those who earn the least out of income tax altogether. The optimum rate of capital gains tax has been debated at length in another place. Treasury analysis has shown that 28 per cent is the revenue-maximising level and is therefore the appropriate rate. A different value would reduce revenues, either by increasing the incentive to shift from income to capital or by reducing the incentive to invest in the economy.
Tax avoidance has also been a significant issue during the passage of the Bill. It was raised in reference to corporation tax and capital gains tax and is the target of Clauses 8 and 9, which together protect around £200 million of revenue per annum. The Government are absolutely committed to tackling robustly avoidance and evasion. We must continue to take the necessary steps to protect the Exchequer and to maintain fairness in the tax system. In the future, we want to take a more strategic approach to tax avoidance by protecting against such opportunities when reforming policy and by seeking to reduce complexity within the tax system. Against this background, we are considering whether a general anti-avoidance rule should form one element of those defences and we will seek the views of interested parties on whether there is a case for this approach.
The Government have inherited plans to limit tax relief on pension saving for the wealthiest. Under the approach of the Finance Act 2010, individuals on the highest incomes who are able to make very large pension contributions could have continued to receive pensions tax relief worth up to £51,000 every year. We have concerns about both the complexity and the fairness of the previous Government’s approach but, given the state of the public finances, we cannot ignore the £4 billion of revenue that this policy was set to raise. We are committed to protecting the public finances and we will put forward an alternative measure that will raise no less revenue than the existing plans. We are looking at an approach where annual tax relief available will be restricted to less than half that available under the previous Government’s plan, which will significantly curtail the ability of the super-rich to benefit from pensions tax relief. We want to ensure that this is a fair and effective approach and will be talking to employers, pension schemes and other interested parties to determine the design of an alternative scheme. It was requested in another place that the Government publish an analysis of the impacts of the alternative measure that we establish. I can confirm that the Government, as a part of our commitment to transparency, will publish a range of assessments alongside the legislation, including the impact on the economy and the impacts of the policy, as suggested.
This is a progressive Budget. It ensures that every part of society makes a contribution to deficit reduction, while protecting the most vulnerable, including pensioners. In fact, the Budget included a number of measures to support pensioners, not least our triple lock guaranteeing an annual increase in the state pension in line with earnings, prices or a 2.5 per cent increase, whichever is highest, to the benefit of 11 million pensioners across the country.
Lord Lea of Crondall
Is the noble Lord suggesting that inequality in Britain will be reduced by this Budget?
Lord Sassoon
My Lords, as I have already said, the Budget document sets out transparently for the first time tables which have never been published before and indicate the effect on different decile income bands of the population. These show that the Budget is progressive in its effect.
Continuing on the theme of pensions, the Government will enable people in retirement to make more flexible use of their pension savings. We intend to end from April 2011 the obligation to annuitise by the age of 75. Last week we launched a consultation on the detail of this change. The Bill therefore provides interim measures which delay this requirement until an individual has reached the age of 77, so that people turning 75 on or after the day of the Budget will not be required to annuitise before the new system is introduced in next year’s Finance Bill.
To conclude, the Finance Bill is founded on the principles of responsibility, freedom of enterprise and fairness, and is a vital part of implementing the changes to the tax system set out in the Budget. I look forward to hearing this afternoon’s speeches. In particular, I will listen intently to the maiden speeches of my noble friends Lady Browning and Lord Spicer, who bring many years’ experience of scrutinising Finance Bills in the other place. I commend the Bill to the House.
Lord Tunnicliffe
My Lords, I thank the Minister for setting out in such detail the Bill and what it will do. I was tempted for a few moments to think that it would be exciting to go through all this detail and slog it out, clause by clause, in Committee, but I was reminded that it is a money Bill. As such, this afternoon is a formality. Nevertheless, it is an occasion when this House can debate the generality of the Budget. I will stick to that generality, rather than go into much detail.
The objective of the Budget should be to set a fiscal framework for the enhancement of the material well-being of the British people. That is how it should be judged. Does the Budget contribute to the expansion of the production of goods and services that define national well-being? Mr Geoffrey Dicks of the Office for Budget Responsibility told the Treasury Committee in another place that, “logically the chances of” a double-dip recession “have increased” as a result of the Budget. I think Mr Dicks is right, which raises another important question: why is the coalition proposing measures that most objective observers believe will harm the well-being of the British people? To answer that question we need to examine the coalition’s analysis of the crisis and its own justification for its destructive policies. Consider, for example, Mr Cameron’s statement:
“Nothing illustrates better the total irresponsibility of the last Government’s approach than the fact that they kept on ratcheting up unaffordable … spending even when the economy was shrinking”.
Thank goodness the Labour Government did ratchet up spending in the face of the worst financial crisis in 80 years. That is what saved us from entering the terrible recession that would have been our fate if the coalition had been in charge. Indeed, the coalition may take us there. Even now, government expenditure is vital to the maintenance of the fragile recovery.
In the face of the fact that government expenditure is necessary, Mr Cameron still argues that spending is unaffordable. The Budget and the Finance Bill herald massive cuts in the public sector. In his Budget speech, Mr Osborne said:
“What we have not inherited from our predecessors is a credible plan to reduce their record deficit”.—[Official Report, Commons, 22/6/10; col. 166.]
Contrast that with the report by the Office for Budget Responsibility, which demonstrates that the Budget put forward by Alistair Darling would have halved the deficit in four years, exactly the timeframe recommended by the G20 at its meeting in Toronto last month.
Consider also Mr Osborne’s statement that the crisis in the eurozone shows that unless we deal with our debts, there will be no growth. Contrast that with the fact that the UK has the lowest debt to GDP ratio of any major EU economy, that the average maturity of British government debts at 14 years is significantly more than double that of any eurozone economy and that the cost of government borrowing in Britain has been falling all this year. There is no comparison. Mr Osborne said:
“Because the structural deficit is worse than we were told, my Budget today implies further reductions in departmental spending of £17 billion by 2014-15”.—[Official Report, Commons, 22/6/2010; col. 171.]
Note that the Chancellor refers to the structural deficit, not the actual deficit. The structural deficit is a theoretical construct that relies heavily on contentious assumptions. The OBR clearly states that the actual deficit is less than Alistair Darling estimated in March, and the rate of growth of the economy is slightly higher—a fact borne out by second-quarter figures. In other words, the overall economic position is better than my right honourable friend estimated, not worse.
To sum up, it is not true that the overall fiscal position is worse than that presented by Alistair Darling in March. It is not true that the overall economic standing of the UK is comparable with that of major eurozone countries, let alone Greece and Spain. It is not true that the Labour Government had no plan to deal with the deficit. Of course, we have serious economic problems in this country; how could we not when we have just gone through the worst world recession for 80 years and when we have suffered massive convulsions in the financial sector? However, it is our contention that the massive cuts in public expenditure trailed in the Budget will make the situation worse.
There is one crucial question that the Government must face: with the withdrawal of public sector demand planned by the Government, where is the demand in the economy going to come from? The OBR seeks to answer this in the Red Book. It sees only 1.1 per cent coming from private consumption, compared with 1.9 per cent in the boom years. Even 1.1 per cent is likely to be generous as unemployment increases and real pay is cut. Instead, the OBR forecasts that growing business investment will make a positive contribution of 1.1 per cent to the growth of GDP—three times greater than in the boom years—investment in housing will contribute twice as much as in the boom years and the contribution of net trade will be 1.1 per cent, when it was negative in the boom years.
These heroic assumptions are difficult to believe. Of course, the Liberal Democrats will believe them—they have to to keep the coalition together—but do the Tories really think that they are credible, or are they just a cover for the old-fashioned slash-and-burn politics with which they are so comfortable? Their goal is not simply to cut the deficit—Alistair Darling’s proposals did that—but to shrink the public sector, whether it be education, transport or, of course, support for the poor. The Tories want less public sector to make way for tax cuts to come.
One specific measure in this Bill on which I wish to comment is the broken promise on VAT. The Budget announced that VAT would rise from 17.5 per cent to 20 per cent in January 2011. This will cost each household in the country more than £500. Labour rejected a VAT increase as part of our deficit reduction plan and chose to increase national insurance contributions instead.
Lord Bates
My Lords, I am grateful to the noble Lord for giving way, but on that point is he familiar with the comments made by Alistair Darling on the “Andrew Marr Show” on Sunday, when he said that he favoured increasing VAT and not increasing national insurance contributions? Does the noble Lord agree with him?
Lord Tunnicliffe
My Lords, regrettably, I did not watch the “Andrew Marr Show” and did not hear Alistair Darling’s precise words. Therefore, I will not comment on them.
Before the election, the Liberal Democrats warned that the Conservatives would raise VAT. Nick Clegg said, “Our plans do not require a rise in VAT, the Tory plans do. Their tax promises on marriage and jobs may sound appealing, but they come with a secret VAT bombshell”. In fact, their election campaign was based on it. During the campaign, the Conservatives repeatedly denied they had plans to raise VAT.
“We have no plans to increase VAT”,
said George Osborne in the Times on 10 April 2010. VAT rises are unfair and regressive, as both David Cameron and Nick Clegg know. David Cameron has made an absolute promise that VAT is regressive and hits the poorest hardest. Nick Clegg shares this view that raising VAT would be regressive and penalise the poor.
I touch upon an area that is difficult given our Budget and expenditure structure. I commend the Government and the OBR for the comprehensive analysis in both the Red Book and subsequent documents that have been released, although some of it is based on assumptions I do not find particularly credible. However, this Budget will change the shape of our society, and we will not see that change until the spending review in the autumn, although we can be sure that it will be significant. The Budget anticipates £83 billion less public expenditure in 2014-15, which is more than £1,000 for every man, woman and child. Some of this will come from efficiency, as Alistair Darling’s Budget assumed. Some will be payments by cash transfer, and they are analysed in the Budget documentation. Yet a most important part will come from the non-cash value that we as citizens get out of society. That is what is so weak about the Budget process; the value that is withdrawn by these non-cash items is undoubtedly regressive.
The non-cash items pay for education—everything from Home-Start to universities and research. Cuts in these areas will hit poor people who have to go through state education and use things such as Home-Start. They will come from policing and justice. Yes, some efficiency will be available, but there will also be less policing and fewer justice facilities. They will come from social services such as home helps and respite care—the things that support lonely older and poorer people. They will come from programmes to protect the environment and from the arts, culture and sport. They will come from transport, which needs revenue support to maintain services to all our citizens and specialist support for the bus pass scheme so valued by our older citizens.
This Budget and its consequences in spending cuts will make our nation less secure. It will hit the poor and weakest most. It will leave society as a whole poorer and more fractured. It will leave it a less happy society, attacking those things that cause society to be at peace with itself. History tells us that, once the Tories start cutting, they will not stop. Sadly, these damaging measures may not achieve the Tories’ ultimate goal of tax cuts for the better-off because that depends on an economic recovery. This Budget and Finance Bill make recovery less likely. Without sustained recovery, no significant group of citizens in the country can achieve significant improvement in their material well-being. That is how this Finance Bill should be judged.
Lord Razzall
My Lords, I rise in support of the coalition’s Budget proposals although, as the noble Lord, Lord Tunnicliffe, has indicated, it is immaterial whether or not I do as this is a money Bill and we can only talk to it, not vote on it. I rise to support it as the relevant Liberal Democrat spokesman; I am not part of the Government but am in the coalition. This is probably the first Budget to emerge from a coalition since the 1930s. Apart from trying to provide stability for our government, one reason why the Liberal Democrats went into the coalition was to see which of our measures could be implemented by the coalition agreement and what our track record would be, having implemented the sort of policies on which we fought the election.
Of course, no one will know what went on within the Cabinet rooms in the Treasury when the Budget was agreed; nor indeed will we know until we see everyone’s memoirs, which I suspect will not be rushed out quite as quickly as those of the noble Lord, Lord Mandelson. However, looking at the proposals in the Finance Bill and the related announcements, there are clearly some issues where the Liberal Democrat members won the relevant arguments. I suspect that there would not be the proposed bank levy, on which we campaigned during the election, without the influence of the Liberal Democrats, and, bearing in mind the hostility that came from certain elements of the Tory party against an increase in capital gains tax, I suspect that the proposals to increase capital gains tax enshrined in this Bill came from the arguments raised by the Liberal Democrats. As noble Lords will know, we attacked over a period of years the Labour legislation under which, to coin a phrase, many of the rich paid less in capital gains tax compared with the income tax paid by those who cleaned their offices. As the Minister indicated, the coalition Government have taken the first steps to eliminate from tax altogether people with an income of under £10,000, and, as he has indicated today, those proposals are part of a process which the coalition has agreed will continue throughout the period of the Government. Most importantly, we have long advocated the restoration of the earnings link on pensions—something that Labour has always resisted—and that link is now being restored.
I have said what I agree with in the Budget and have referred to the legislation that reflects Liberal Democrat policies. However, I think that the role of the Liberal Democrats in your Lordships’ House is also to question the coalition about areas at which the Government need to look carefully. Taking up the point that the Minister made regarding the fairness of the Budget, undoubtedly both parties in the coalition have tried to demonstrate that this Budget is fair across all elements of society. However, there is no doubt that there are issues here, one of which was touched on in the intervention of the noble Lord, Lord Lea of Crondall. The Budget briefing indicates that the package mitigates,
“the impact on the most vulnerable in society”,
and that fairness will be achieved by sharing the impact across all income deciles—a wonderful Treasury phrase. It claims that, while the bottom 20 per cent will lose, on average, 0.9 per cent of income, the top 20 per cent will lose 2 per cent. However, as always, the devil is in the detail, and Robert Chote, the head of the IFS, has said that the problem is that that does not take into account alterations in welfare benefits. If the coalition is to claim that this is a fair Budget, the Government need to look at how the Treasury models the impact of the reductions in taxation at the bottom end and plugs in the impact of the loss in welfare benefits. I certainly urge the Government to do that.
A number of right wing newspapers have trumpeted the impact of reductions in housing benefit, and there have been horrendous stories of people getting hundreds of thousands of pounds in housing benefit in the wealthier parts of London; but as the noble Lord, Lord Best, indicated in the debate on Thursday, that is just the tip of the iceberg of the issue and the proposals to cut housing benefit could bear down particularly on the unemployed in London and the south-east. Why should we attempt to make life tougher for the unemployed? As some of these measures will require legislation, I urge the coalition Government to have a look at the detail in order to see the extent to which these problems can be ameliorated.
The elephant in the room, which the noble Lord, Lord Tunnicliffe, touched on, is what will happen in the comprehensive spending review in October. We are all aware that the Finance Bill and the Budget proposals have, in a sense, a relatively small impact compared with the CSR. I am sure that the Liberal Democrat Members of the Government will be arguing strongly with the Tories that—whatever happens in the CSR, and clearly there will be significant cuts—we should endeavour to ensure that they do not bear unfairly on those in our society who are less able to cope.
One point which nobody has touched on yet is the fact that managing economic policy is not just about fiscal policy or public expenditure; there is also the whole area of monetary policy, which has now been handed over to the Bank of England. I refer to a point which a former member of the Monetary Policy Committee raised today in the New Statesman. Will the Minister indicate whether, if the MPC were to lose control of its senses and significantly raise interest rates, tightening monetary policy at the wrong moment, the Government would not rule out exercising Section 17 of the relevant legislation, which allows the Chancellor of the Exchequer to overrule the committee? Although it looks like that will not be necessary, it would greatly comfort those of us who follow these matters to know that that would not be ruled out.
I listen with absolute fascination to what the Labour Party has to say on the Budget, the Finance Bill and the Government’s current economic policy. Let us look first at the point that the noble Lord, Lord Tunnicliffe, made on VAT. Not only did Alistair Darling indicate that he had been in favour of an increase in VAT when he appeared on “The Daily Politics” and “The Andrew Marr Show”; the third man has indicated it as well. In his book, he said:
“Alistair’s final pre-election PBR was due to be delivered on December 9 ... he told me his proposed surprise announcements would reduce the bill for basic-rate taxpayers … here was the shock—to balance these moves he was minded not only to restore VAT to its previous level of 17.5 per cent, but … even to 19 per cent”.
“I was impressed”, said the third man:
“These were exactly the sort of hard choices that would enable us to regain the initiative … Gordon … vetoed [it], point blank”.
Alistair Darling floated a VAT increase before the March 2010 Budget, and again Gordon Brown vetoed it. Alistair Darling disclosed that on “The Andrew Marr Show”, but he had also done so on 13 July on “The Daily Politics”, when Andrew Neil asked him whether he had considered an increase in VAT, which Gordon Brown was against. Alistair Darling said:
“This is public knowledge. It’s well known that there was this difference between us”.
So, on the question of VAT, the Labour Party really should keep silent.
Let us consider Labour’s record. Labour has left this country with the second largest deficit in Europe. On the OBR’s forecast, the UK deficit will be 10.1 per cent of GDP in 2010-11. That is higher than France, at 8 per cent, Germany, at 5 per cent, Japan, at 6.7 per cent, and—would you believe it?—Greece and Portugal, the two weak members of the euro zone, at 9.3 per cent and 8.5 per cent respectively. Under Labour the UK has had the deepest recession on record, and the longest recession in the G20. Labour cannot deny that. There have been six consecutive quarters of negative growth, and no other country has had that. There is also no doubt that the Labour Party was planning cuts just as large as those which the coalition Government are proposing. The IFS has indicated that on Labour’s own Budget plans we would have to have cuts of 25.4 per cent to non-protected areas. Those are huge cuts which Labour was committed to bringing in but which it was not prepared to disclose in the run-up to the election. As I said in the debate on the gracious Speech, to misquote Attlee on Laski: a period of silence from the Labour Party on this issue would not come amiss.
Lord Stern of Brentford
My Lords, many of the challenges we face in the world economy in the coming years are structural and profound. These include high public deficits in some countries and major imbalances in savings and investments with correspondingly large external surpluses or deficits in key economies of the world. Both can feed, and have fed, instability. Over this decade, we will continue to see fundamental changes in the international division of labour, which will imply great industrial change and some dislocation in both the rich and the poor world, and our international financial and economic system will have to change to reflect the new realities. Still more profound is the necessary acceleration of the energy and industrial revolution, which will be not only innovative, creative and dynamic but critical to our building of the low-carbon economy which is essential for managing climate change. If we see these related challenges together, we will do much better on each than if we try to tackle them one by one or in sequence. This decade in the world economy is of special importance. In the UK, we must close our deficits while avoiding tipping back into recession. We must come out of this recession by laying the foundations of long-term and sustainable growth and not, as we did in much of the world, including the UK, a decade ago, by sowing the seeds of the next bubble.
Today, in the long-term and international context I have described, I want to consider briefly three particular related issues that confront us now and which are, or should be, central to our consideration of the UK’s fiscal policy and the Finance Bill. These are first, revenue forecasting, secondly, the pace and flexibility with which we attempt to close the deficit and thirdly, tax reform.
I must declare an interest in the economics of public policy. I am currently professor of economics at the LSE and have been a professor of economics, specialising in public policy, for more than three decades. For 10 years, I was first chief economist of the European Bank for Reconstruction and Development and then chief economist and senior vice president of the World Bank, interacting with finance Ministers around the world. Closer to home, and of direct relevance to what I have to say today, I was from 2003 to 2007 head of the Government Economic Service in Her Majesty's Treasury, and for the first nine months of that time, I was Second Permanent Secretary of the Treasury with particular responsibility for the revenue side of the public finances, before I turned in my next two and a half years as a civil servant to write two major reports, the report of the Commission for Africa and the review of the economics of climate change. I was indeed fortunate in my assignments. I returned to the LSE three years ago.
On revenue forecasting, I must welcome the establishment of the Office for Budget Responsibility. My brief experience in this area at the Treasury in 2003-04 underlined very strongly the importance of independence and of transparency. In my view, in the Treasury at that time, there was a lack of clarity in setting out the assumptions, an absence of clear models of revenue and excessive use of hopeful judgment on future revenues. One result was that we went into the crisis in 2007 with inflated forecasts of structural revenues, and thus inflated expenditures which had expanded to meet the anticipated, or rather “wished for”, revenue, and with a substantial structural deficit.
There were some positive moves on the revenue front at that time. We brought Her Majesty’s Revenue and Customs together—one or two centuries too late, but better late than never—and provided much greater clarity for the formation of tax policy across the Treasury and HMRC. But in my few months working on revenue, I was not successful in bringing more rigour to revenue forecasting. Hence, my emphasis now on clarity, transparency and independence.
We must not, however, confuse independence with isolation or incoherence. It is important that the OBR is well informed about the analysis and sense of direction on policy of Her Majesty’s Treasury and the Bank of England. Independence of the OBR is perfectly consistent with discussion on analysis and policy with these two key institutions. Indeed, all three will function the better for this interaction. Bank of England independence is not compromised by constructive and detailed discussion with Her Majesty’s Treasury, which during my time was a much weaker discussion than it should have been. The reluctance to engage was not for the most part in my view on the side of the Bank of England.
I have three questions on the OBR for the Government, to which I hope that the Minister can respond. First, will he encourage the OBR to illustrate its value-added by examining how far its methods would produce different results from the less transparent methods of the past? This would be very helpful in assessing the contribution of the OBR. Secondly, will he encourage the Government to emphasise still more strongly the uncertainty surrounding all revenue forecasts and thus uncertainty in deficit forecasts? To be slightly nerdy, we should welcome the appendix on fan charts in last month’s pre-Budget forecast of the OBR. Thirdly, will he consider establishing an independent board for the OBR, advisory or otherwise, which could provide guidance to the chair of the OBR and play a role in defending its independence, as Sir Michael Scholar has so admirably done for UK statistics?
Finally, on revenue forecasting, I should like to pay tribute to the outstanding work of Sir Alan Budd in establishing the OBR so effectively and so rapidly. I have known for some months of his clear intention to serve for only a few months as its head. This was also very clear to senior Treasury officials and to Ministers, as I am sure that the noble Lord will confirm. Thus, any speculation from the press and elsewhere to the contrary is completely misplaced.
My second issue is the pace of closing the deficit. I fear that this is a subject that sometimes descends to camps and slogans. If I said that the entire structural deficit should be closed in one year, you would think that I was mad. If I said that it should be closed in a decade, you would doubt my seriousness. It is clear that we must discuss whether it should be targeted over four, five, or six years. There is nothing in the subject of economics that allows us to be very precise on this. Thus it makes no sense to denounce those who rightly draw attention to the risk of recession as narrow Keynesians who care little about budget responsibility and the future servicing of debts, just as it makes no sense to label those who rightly emphasise the dangers of large deficits and ever-increasing debt to GDP ratios as Hooverians intent on repeating the mistakes of the great depression.
Let us recognise not only that we shall have to set clear intentions on deficit reduction but also that we must feel our way on the risks of recession. These risks are very real. We will probably see strong growth in China and India, but while they are around 36 per cent or 37 per cent of the world’s population, they are around only 10 per cent of the world’s economy, although somewhat larger on a purchasing power parity basis. The US and Europe are far more important in the global economy, constituting around 45 per cent of the total. More than half our exports are to Europe where there seems to be a clear intent to go for a strong and co-ordinated fiscal consolidation with significant risks to overall demand. As Ben Bernanke said last Wednesday, the future of the US economy is “unusually uncertain”. While we have in the UK the advantage of a flexible exchange rate there can be no guarantee that rising exports and private investment will replace the demand reduction in the UK from fiscal consolidation.
It is difficult to be precise about the risks of recession in the UK, but they are not small. Let us recognise both that we will learn more in the coming months and the next year or two, and that if we fall into recession we risk not only the severe human cost of unemployment but, via the automatic stabilisers, raising the deficits we are trying to reduce. We do not know how much capacity or underlying potential have changed as a result of the crisis and recession. It is thus difficult to distinguish cyclical from structural deficits. As I have said, there are strong risks to export demand and we do not know what may happen to consumer and investor confidence. It is absurd to pretend otherwise.
Thus, while agreeing with the Government and their predecessors on the importance of cutting the deficit, I would like the Minister’s assurance that the Government will keep the risk of recession under review and stand ready to adjust their fiscal stance if necessary. While recognising that the Bank of England has a strong role to play in demand management, it cannot be left solely to the Bank. This is not lack of resolution or anticipating U-turns; it is sound economics in the face of risk and uncertainty and it is common sense.
As to tax reform, at a time when strong shorter-run decisions are necessary on the public finances, we must also recognise that tax reform is about the medium and long run. Let us not make the urgent need for extra revenue and expenditure control an excuse for yet more incremental tinkering that is not well thought through in terms of the coherence of the tax system as a whole. Tax systems suffer badly from the creeping approach to policy. Each new initiative might have had some plausibility at the time, but we now have a system with a set of major defects. These include: disincentives to work for many at the bottom end of the scale; incoherence between the various forms of personal income tax, corporate income tax and national insurance; no clear rationale on the taxation of wealth and savings; and inefficient and inconsistent ways of pursuing distributional objectives. The tax treatment of housing is a special mess. Now is the time for a strong move to correct the great market failures associated with the environment and climate change. With green taxes and other measures, including the green investment bank, we can simultaneously raise revenue, help markets work better and foster a new and cleaner source of growth. This is surely what our American friends would call a no-brainer.
There is not time to develop these points in detail. I recommend to noble Lords the work of the Mirrlees review from the Institute for Fiscal Studies which is scheduled to be published in September this year. Much of this analysis is already available and there is a clear discussion by Paul Johnson, a co-editor of the Mirrlees Review, in his lecture at the LSE last month which is available on the IFS website. Three decades after the important and influential Meade review on the tax system, it provides a most valuable analysis and sense of direction.
Let me give two examples from indirect taxation. First, the base of the VAT could be substantially broadened and the extra revenue used to more than compensate, as we should, those on low income who are most affected. Secondly, a financial activities tax, as suggested by the IMF, could be structured in a way that would be economically equivalent to a VAT on this currently exempt sector. I could go on to give examples concerned with income and other taxes and benefits.
There is also much analysis to draw upon from international institutions in other countries—for example, the expert groups of the OECD and the Fiscal Affairs Department of the IMF. At the request of an earlier Chancellor, I ran, as Second Permanent Secretary of the Treasury, a series of internal seminars on tax reform in the first half of 2004 and provided the summary paper drawing conclusions for the Chancellor in June of that year. I quite properly left my only copy with the senior management of the Treasury when I left in the summer of 2007, and I am sure they will have retained—at least, I hope they will have retained—their own copies. I hope they find the study useful.
Now is the time for a careful and considered discussion of the reform of tax and benefits in this country. I trust that the Government will play a strong, analytical and thoughtful role in this discussion and that we will see the fruits in terms of action in the coming two or three years. I seek the Minister’s assurances on this point. There is so much that we could do at this time of reform and reappraisal to move towards a system which is simpler, more equitable and more efficient. Furthermore, it could foster the entrepreneurship and creativity to drive the new forms of growth that are vital to our nation and the world in this decade of fundamental change.