House of Commons Treasury Committee · Mr Andy Love MP (Labour, Edmonton) ... The OBR explained the...

HC 818–I

House of Commons

Treasury Committee

Autumn Statement 2012

Seventh Report of Session 2012–13

Volume I

HC 818–I Published on 29 January 2013

by authority of the House of Commons London: The Stationery Office Limited

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House of Commons

Treasury Committee

Autumn Statement 2012

Seventh Report of Session 2012–13

Volume I

Report, together with formal minutes

Ordered by the House of Commons to be printed 22 January 2013

The Treasury Committee

The Treasury Committee is appointed by the House of Commons to examine the expenditure, administration, and policy of HM Treasury, HM Revenue and Customs and associated public bodies.

Current membership

Mr Andrew Tyrie MP (Conservative, Chichester) (Chairman) Mark Garnier MP (Conservative, Wyre Forest) Stewart Hosie MP (Scottish National Party, Dundee East) Andrea Leadsom MP (Conservative, South Northamptonshire) Mr Andy Love MP (Labour, Edmonton) John Mann MP (Labour, Bassetlaw) Mr Pat McFadden MP (Labour, Wolverhampton South West) Mr George Mudie MP (Labour, Leeds East) Mr Brooks Newmark MP (Conservative, Braintree) Jesse Norman MP (Conservative, Hereford and South Herefordshire) Teresa Pearce MP (Labour, Erith and Thamesmead) David Ruffley MP, (Conservative, Bury St Edmunds) John Thurso MP (Liberal Democrat, Caithness, Sutherland, and Easter Ross)

Powers

The Committee is one of the departmental select committees, the powers of which are set out in House of Commons Standing Orders, principally in SO No 152. These are available on the Internet via www.parliament.uk.

Publication

The Reports and evidence of the Committee are published by The Stationery Office by Order of the House. All publications of the Committee (including press notices) are on the Internet at www.parliament.uk/treascom. The Reports of the Committee, the formal minutes relating to that report, oral evidence taken and some or all written evidence are available in printed volume(s). Additional written evidence may be published on the internet only.

Committee staff

The current staff of the Committee are Chris Stanton (Clerk), Lydia Menzies (Second Clerk), Jay Sheth and Adam Wales (Senior Economists), Hansen Lu, Matthew Manning (on secondment from the FSA) and Duncan Richmond (on secondment from the NAO) (Committee Specialists), Steven Price (Senior Committee Assistant), Jo Cunningham and Lisa Stead (Committee Assistants) and James Abbott (Media Officer).

Contacts

All correspondence should be addressed to the Clerk of the Treasury Committee, House of Commons, 7 Millbank, London SW1P 3JA. The telephone number for general enquiries is 020 7219 5769; the Committee’s email address is [email protected]

Autumn Statement 2012 1

Contents

Report Page

1 Introduction 3 Our inquiry 3 Timing and content of the Autumn Statement 3 Budget 2013 timing 4

2 Macroeconomy 5 Overall GDP forecast 5

Forecasting 7 Business lending 9

Business lending and the impact of the Funding for Lending Scheme 9 Banks’ balance sheet transparency and forbearance 12 ‘Zombie’ companies 14 A bad bank? 16 Conclusions on bank lending 17

Output gap 17 OBR’s change in method 18 A persistently large output gap 19

Monetary policy 21 The effectiveness of Quantitative Easing 21 Monetary policy framework 24

3 The public finances 26 Changes announced in the Autumn Statement 26 Performance against the fiscal targets 26

The fiscal mandate 26 The supplementary target 27

Credit rating 28 UK cost of borrowing 29 Asset Purchase Facility transfer 30

4 Policy decisions 33 Reliance on big ticket items 33

Sale of the 4G spectrum 34 Swiss tax repatriation 36 Departmental cuts 37 Fuel Duty 38

5 Other issues 40 Measures to encourage growth 40 Reforming PFI 41 Distributional analysis 44

Estimated effect of benefit announcements 45

Conclusions and recommendations 49

2 Autumn Statement 2012

Formal Minutes 53

Witnesses 54

List of printed written evidence 54

List of Reports from the Committee during the current Parliament 55


1 Introduction

Our inquiry

1. The Autumn Statement was delivered by the Chancellor on Wednesday 5 December 2012, and the Economic and fiscal outlook was published by the Office for Budget Responsibility (OBR) on the same day. The Treasury Committee took evidence from six panels of witnesses during the three meetings we held, as follows:

11 December: Office for Budget Responsibility

Robert Chote, Chairman, Graham Parker, Member, and Professor Stephen Nickell, Member, Budget Responsibility Committee.

12 December: Experts and interested parties

First panel: Simon Hayes, Barclays; Paul Mortimer-Lee, BNP Paribas, and Simon Wells, HSBC;

Second panel: Professor Philip Booth, Institute of Economic Affairs, and Lee Hopley, EEF;

Third panel: Paul Johnson and Carl Emmerson, Institute for Fiscal Studies;

Fourth Panel: Mark Hellowell, University of Edinburgh (Specialist Adviser) and Professor Dieter Helm, University of Oxford.

13 December: HM Treasury

Rt Hon George Osborne MP, Chancellor of the Exchequer and James Bowler, Director, Strategy, Planning and Budget.

We have also made use of oral evidence taken from the National Institute of Economic and Social Research on 13 November, and from the Bank of England Monetary Policy Committee on 27 November. The Committee is very grateful to all those who gave their time to provide oral and written evidence to us, in some cases at short notice.

Timing and content of the Autumn Statement

2. The Budget this year was on 21 March 2012. The Autumn Statement was nearly nine months later, and only just over three months before the next Budget, which the Chancellor has announced will be on 20 March 2013. This has had the consequence, the Institute for Fiscal Studies (IFS) said, that the more important economic forecast and statement is the Autumn Statement, not the Budget.1 There were, furthermore, many fiscal announcements in this year’s Autumn Statement that would be more usual in a Budget. Whilst it is recognised that an Autumn Statement is useful to appraise the effectiveness (or otherwise) of measures announced in the spring Budget, and the general state of public finances and the wider economy, the Autumn Statement has taken on the role of

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being a second, full, Budget. The implications are that business and the economy needs to react to two periods, not one, of potential uncertainty and change. A return to a position of one Budget in the spring, and an updating statement in the autumn, would be desirable.

Budget 2013 timing

3. As already noted, the Budget will be on Wednesday 20 March, allowing some days for the House to debate the Budget before it rises for the Easter adjournment on Tuesday 26 March. The timings are similar to last year and will require the Treasury Committee to hear oral evidence on the Budget rapidly before the House rises.

4. Last year the Finance Bill was published in the Easter adjournment, on 29 March, and the Second Reading was on the first day the House sat after the adjournment, on Monday 16 April. This timing prevented the Treasury Committee agreeing or publishing its Report in time for Second Reading of the Finance Bill as its practice had been. The Committee agreed its Report on Tuesday 17 April and published it the following day, the first day of the Committee of the Whole House on the Finance Bill.

5. In our Budget 2012 Report we described the timings set by the Government as “highly unsatisfactory”. We recognised that the new pattern of Prorogation and State Opening in April/May risked making the timing of the stages of future Finance Bills tighter than in the recent past, and so recommended that:

the Treasury and the Business Managers work together to plan the timings of future Budgets and Finance Bills so that the House has longer between publication of the Bill and Second Reading and, particularly, between Second Reading and Committee of the Whole House. This may require the Budget to be somewhat earlier in future.2

The Government response to this recommendation was a general one which did not address our particular concern: “The Government is committed to ensuring there is adequate time for Parliament to scrutinise the finance bill”.3

6. The timing of the Budget in 2013 is equivalent to that in 2012. Bearing in mind the vague response of the Government to the serious concerns we raised in 2012, there remains the risk that the Government might schedule the Second Reading of the Finance Bill, and perhaps also the Committee of the Whole House stage, for the week of 15 April 2013. This would be wholly unacceptable and would fail to give the House the time to consider the Bill and the conclusions of the Treasury Committee. We reiterate our recommendation that Treasury and business managers ensure that the House has a longer period than in 2012 between the publication of the Finance Bill and its Second Reading and, particularly, between Second Reading and Committee of the Whole House. We believe this to be an important issue of principle going to the heart of Treasury Ministers’ accountability to Parliament.

2 Thirtieth Report of Session 2010–12, Budget 2012, HC 1910, para 2

3 Second Special Report of Session 2012–13, HC 422


2 Macroeconomy

Overall GDP forecast

7. According to the Office for Budget Responsibility (OBR), the outlook for the UK economy had deteriorated since their March 2012 forecast. As Table 1 shows, the OBR has reduced its forecast for real GDP growth in every year from 2012 to 2016. The OBR explained the most recent forecast as follows:

The economy has performed less strongly this year than we expected at the time of our last forecast in March, primarily reflecting the weakness of net exports. Looking forward, the recovery still lacks momentum. We now expect a small fall in GDP in the fourth quarter of this year, followed by a gradual pick-up next year. GDP is forecast to fall by 0.1 per cent in 2012 and then to grow by 1.2 per cent in 2013.

We are more pessimistic about the economy’s medium term growth prospects than we were in March. We expect weak productivity to constrain nominal earnings growth for longer, with a slower fall in inflation delaying the pick-up in real incomes. The outlook for the world economy and UK exports has deteriorated and we expect the difficulties of the euro area to depress confidence and put upward pressure on bank funding costs for longer. Investment is likely to be restrained by poor credit conditions and uncertainty about demand.4

Table 1: OBR’s real GDP growth forecasts (percent)

March 2012 Economic and Fiscal Outlook

December 2012 Economic and Fiscal Outlook

Change (percentage points)

2012 0.8 -0.1 -0.9

2013 2.0 1.2 -0.8

2014 2.7 2.0 -0.7

2015 3.0 2.3 -0.7

2016 3.0 2.7 -0.4

2017 - 2.8 -

Source: Office for Budget Responsibility, Economic and fiscal outlook press conference slides, December 2012, Slide 5

8. The November 2012 Inflation Report also saw the Bank of England’s Monetary Policy Committee (MPC) change its forecast for GDP growth, placing less weight on the potential for more positive outcomes for the economy.5 Sir Mervyn King, Governor of the Bank of England, explained that:

we have significantly lowered, in our view, the chances of growth being rapid. This is something that I think has been building up in our minds over the past year. It is not

4 Office for Budget Responsibility, Economic and fiscal outlook, December 2012, p 5, paras 1.1-1.2

5 Bank of England, Inflation Report, November 2012, p 40, Charts 5.2-5.3


a sudden change between August and November. Although we only made the change in these charts in November, I think it was a result of finally realising that, as we had debated among ourselves the prospects for growth and the chances of a very rapid expansion of growth—which you might have expected if this had been a normal cyclical downturn and then recovery—we do not think that the chances of very rapid growth in 2013 and 2014 are very great. So we made what we thought was a realistic change to our judgment about where the balance of risks lies.6

The Governor went on to explain why the MPC had come to that conclusion, emphasising the impact of external factors on the UK’s economic performance:

I think the underlying economic factors that have led us to make this judgment through the year—and it has built up over that period—have been external factors. We have seen two things. One is obviously continuing problems in the euro area. We have also seen a slowdown in the world economy as a whole, particularly in the emerging markets, and our colleagues in the United States are still very nervous about the prospects there. I think the consequences of that, particularly weakness in the euro area, certainly have fed through to higher funding costs for banks, which temporarily we have managed to offset with the Funding for Lending scheme. The underlying problem is one in which there is still a great deal of adjustment to be made in the financial sector and in the economy as a whole, with the need for rebalancing. In this sort of situation, it is very unlikely that we would expect to see a rapid recovery.7

The Chancellor also emphasised to us the eurozone crisis’s impact on the UK economy:

the eurozone crisis has had a huge impact on the British economy and indeed many other Western economies. It is not the only thing that is affecting the British economy, of course, and we still are living with the aftershocks of the financial crisis and we were hit by the oil price increase as well across the world. In terms of attributing a number to it, first of all the OBR’s analysis of the deterioration in the growth forecasts since the Budget is that the weakness in the eurozone is the principal cause, indeed more than accounts for the downgrade of the forecast. There is an interesting observation: if trade to the eurozone had grown as fast as trade to the non-eurozone over the last year, then that would have added 1% to our GDP. But I would stress that the impact of the eurozone crisis is not just on trade, it is also on confidence and it is also on financial intermediation. But there is an illustration of the impact. It is something of course that Britain and other countries have to work with.8

9. The over-optimism, in hindsight, of previous OBR forecasts has been a source of concern. We asked witnesses whether the OBR’s forecasts economic forecasts were reasonable this time. Mr Wells argued that such over optimism had not been the sole preserve of the OBR: “I think it is not just them, and it is not just the UK. If you look at the

6 Oral evidence taken before the Treasury Committee, Bank of England November 2012 Inflation Report, Tuesday 27

November 2012, HC (2012-13) 767, Q 3

7 Oral evidence taken before the Treasury Committee, Bank of England November 2012 Inflation Report, Tuesday 27 November 2012, HC (2012-13) 767, Q 5

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consensus, the average of economists’ forecasts over the past decade, in the UK and the US we have been too optimistic about growth and inflation consistently for nearly a decade”. 9 We discuss the OBR’s forecasting record further below. On the OBR’s present forecast, Mr Wells argued that:

I do think that their latest set of forecasts for this year and next are much closer to the averages and therefore seem much more reasonable than they did in March. So in that sense, as I said at the beginning, I do believe them. Where I still have some concerns is that if this 10-year trend towards over-optimism doesn’t actually come good this time then their forecasts for the potential growth rate of the economy, and indeed the growth rates further out beyond 2015, will turn out to be too optimistic once again. I think there is clearly a big risk of that. Everyone hopes that the UK growth prospects will pick up, but you are quite right, it is not a given.10

Forecasting

10. Under the Budget Responsibility and National Audit Act 2011, the OBR is required to prepare two fiscal and economic forecasts each financial year.11 The Treasury Committee concluded in its Report on the OBR’s creation that:

One of the ways in which we will judge whether the OBR is a success is whether there is greater public understanding of the purpose and limitations of the forecasting process, and realistic expectations of what it can deliver.

There should, and will certainly, be analysis of the accuracy of OBR forecasts. Their quality and authority can be measured over time, relative to other forecasts. Absolute accuracy is not a useful criterion.12

Underlining the inherent uncertainty in its economic forecasts, the OBR noted in its October 2012 Forecast Evaluation Report that:

Along with many other forecasters, we significantly overestimated economic growth over the past two years. This likely reflected several factors, including the impact of stubborn inflation on real consumer spending, deteriorating export markets on net trade, and impaired credit conditions, euro area anxiety and demand uncertainty on business investment. Fiscal consolidation may also have done more to slow growth than we assumed.13

Mr Robert Chote, Chair of the OBR, accepted that most OBR reports had revised downwards the growth forecast from the previous one.14 Given these errors, Mr Chote explained how he believed that the OBR’s own forecasting record had helped to meet the

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11 Budget Responsibility and National Audit Act 2011, Section 4

12 Treasury Committee, Fourth Report of session 2010-12, Office for Budget Responsibility, paras 38-39

13 Office for Budget Responsibility, Forecast Evaluation Report, October 2012, p 8

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Treasury Committee’s expectations that the OBR further the public’s understanding of the limitations of forecasting:

I think the cynical and obvious answer to that is, given the outturns for growth relative to what we said, we have probably done quite a good job in demonstrating the limitations of economic forecasting. The key thing is to underline the uncertainties that are around any forecast and for us to explain that nobody should bet the farm on a particular path being the definite outcome and, therefore, to explain how much it matters to the fiscal targets that we are ultimately here to police if the forecast turns out to be different in any one of a number of ways reflected in our sensitivities and scenarios.15

11. Mr Chote also set out why the OBR needed to undertake its own economic forecasts, rather than simply take the average of outside forecasters:

we need a particular type of economic forecast to produce a bottom-up fiscal forecast that really is not out there to pluck off the shelf. For example, you want something that has a much more detailed breakdown of different categories on the income and expenditure side of GDP than most other forecasters would need for their purposes. You need something that extends over five years, you need to take a view on potential output and the output gap over five years, and many people don’t. The other thing is that you need to be able to take into account the impact that measures will have on the fiscal forecast and that is quite hard to do if you are simply trying to bolt it on to a table you have plucked out of a compilation of independent forecasts.16

12. When we questioned City experts on the forecast record of the OBR, Mr Simon Wells, Chief UK Economist at HSBC, told us “They are doing a great service and being very transparent and very open about what they are saying.”17 He added that “The creation of the OBR was a positive step. It does add a lot of credibility to the forecasts, and we have seen that they are not afraid of marking down their forecasts really quite sharply if that is what they think needs doing.”18 Mr Paul Mortimer-Lee, Global Head, Market Economics, BNP Paribas, suggested that there might be an inbuilt optimism bias to the forecasts of the OBR: “If I was the OBR, I would be quite worried about projecting gross debt over 100% of GDP, because that would probably prompt downgrades from at least some of the agencies.”19 He argued that “what are the costs and benefits of erring on either side? If you take account of the costs and benefits, then the costs of erring on the pessimistic side are rather more serious.”20 He noted, however, that “I am not saying they are doing it on purpose, but subconsciously.”21 Mr Simon Hayes, Chief UK Economist at Barclays, however, had confidence that the OBR was giving its best judgement of the outlook for the economy:

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I think what has happened over the last couple of years is the Chancellor came up with a debt reduction plan and some fiscal rules. Then in November last year the OBR completely changed its view of the underlying potential capacity of the economy and that had the effect of almost totally eliminating the headroom under the two fiscal rules. If the Chancellor had known that assessment, I think we would have had a different set of fiscal rules, so that took us to the edge of breaching these rules. We have now had the OBR revise down not just its real GDP forecasts quite substantially but also its forecast for the GDP deflator, so the nominal GDP forecast is very much lower as well, and that has led to the breach of the debt rule. I think if you were trying to be kind to the Chancellor, you may have done neither of those things and the fact that they have suggests to me that they are, by and large, reporting things as they see them and that the consequences are something for the Chancellor to deal with.22

13. As we have recommended in the past, the OBR should do more to ensure that there is greater public understanding of the limitations and purpose of forecasting, and more realistic expectations of what forecasting can deliver.

14. The OBR’s forecasts so far have been biased to over-optimism. This would not be a cause for concern but for the fact that the OBR’s forecasts have implications for decisions on public policy. This is because the fiscal mandate is defined with direct reference to a forecast, and because the OBR’s is at present the only official forecast against which the fiscal mandate can be measured.

15. The OBR is required by statute to issue two economic and fiscal forecasts a year. The Chancellor’s own Autumn Statement, however, has now grown to be virtually a second Budget. There are good reasons for having a single substantial annual review of the fiscal and economic state of the country, not least to enable the subsequent presentation to Parliament of proposed tax measures and of Estimates of expenditure. The Treasury should re-establish the annual Budget as the main focus of fiscal and economic policy making.

Business lending

Business lending and the impact of the Funding for Lending Scheme

16. The evidence we received suggested that lending to firms was still not sufficient. Lee Hopley, Chief Economist at the EEF, provided a view on credit conditions:

We have a regular credit condition survey across our membership, and we have seen some small signs of slow improvement in both the availability of new lines of credit and some improvement in the balances on cost of credit, although more companies say that credit is getting more expensive relative to it getting cheaper. So there is still an issue. We are only taking small steps from a very low base. I think there is a lot of other evidence out there that suggests a more worrying trend that small companies in particular are disengaging from the financial sector completely. They have a

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demand for credit, they have investment plans, but they don’t want to go to their bank or external finance providers to get finance to fund those investment plans.23

Simon Kirby, of NIESR, also argued that “Finance from banks is a particular problem for SMEs at present”, although he also warned that:

Some surveys suggest that this is a significant inhibitor to them for investment, but there are also surveys out there that do not suggest that SMEs are having more than a normal inability to raise finance from banks. There is a mixed element to the story.24

17. One of the responses by the Government and the Bank of England to weakness in business lending has been the creation of the Funding for Lending Scheme (FLS). The OBR described it as follows:

The Funding for Lending Scheme (FLS) was launched by the Bank of England and the Government in July 2012. It is designed to encourage banks and building societies to expand their lending to households and private non-financial corporates, by providing funds at cheaper rates than those prevailing in current markets. Both the quantity and the price of these funds are linked to the amount of lending that banks do. The lower cost of FLS funds should then be passed on to real economy customers in lower borrowing costs.25

18. On 3 December 2012, the Bank of England published the first set of data on the FLS.26 Since we completed our hearings, the Bank of England has published the following update on progress with the FLS:

Participation in the Scheme is widespread. Thirty-five banking groups, comprising just over 80% of the stock of FLS eligible loans, had signed up by 3 December 2012. That translates into an initial entitlement of around £68 billion of funding. It was too early for the Scheme to affect net lending in 2012 Q3. And total real economy net lending was close to zero in that quarter. There was net lending of £7.6 billion, however, by those participating groups with positive net lending. That means that the total borrowing allowance increased to around £76 billion as of 3 December 2012, which demonstrates the incentives built into the Scheme. The borrowing allowance will continue to increase by one pound for every pound of additional net lending by banks expanding their loan books. By the end of September 2012, eight weeks into the Scheme, just over £4 billion in funding had been drawn from the FLS, and more has been drawn since.27

Lee Hopley, Chief Economist at the EEF, when asked what impact the FLS was having, responded:

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24 Oral evidence to the Treasury Committee, National institute of Economic and Social Research quarterly review, October 2012, taken on 13 November 2013, HC (2012-13) 750, Q 32

25 Office for Budget Responsibility, Economic and Fiscal outlook, December 2012, p57, Box 3.4

26 Bank of England, Funding for Lending Scheme – Usage and lending data, 3 December 2012, www.bankofengland.co.uk

27 Bank of England, The Funding for Lending Scheme by Rohan Churm, Amar Radia, Jeremy, Sylaja Srinivasan and Richard Whisker, Quarterly Bulletin, 2012 Q4, p 315


I think it is very difficult to say at the moment. They don’t disaggregate the data into household and business lending. We would assume that it would probably take a little bit longer to feed through into business lending. SME lending is more complex than the mortgage market. We are, however, hopeful that the banks will promote the different schemes available and that perhaps Government might even be a bit more vocal about the fact that lower costs of funding should feed through into small-business lending.28

However, she warned that a delay in seeing any results was to be expected:

I think we would like to see more concrete signs of this having fed through towards the middle of next year. Going back to the National Loan Guarantee Scheme, which had a relatively short lifespan as it was, relatively quickly we were picking up anecdotal evidence that companies were benefiting from various offers from different finance providers through that scheme. We would like to be picking up the same kind of evidence as we move into the beginning of next year.29

The potential delay in the results from the FLS was also highlighted by a recent Quarterly Bulletin article, which stated that it was “probable that it will take longer for the effects from the FLS to feed through to certain types of corporate lending because many corporate loans are tailored to the customer, and so are less standardised than mortgage loans.”30

19. The Chancellor appeared pleased with the progress of the FLS so far, noting that according to the OBR, the Scheme “is adding to GDP, it is bringing down the bank funding costs and we have published in the Green Book, if you look at the unsecured bond spreads, the impact that the FLS announcement has had, so that was a joint scheme between the Treasury and the Bank of England, and I think it has been working well.”31

20. One note of concern has, however, been expressed about the FLS. Both NIESR and the OBR have suggested that the banks using the FLS may favour certain types of lending over others. NIESR has said that:

It is noticeable that the Bank of England does not report any suggestions by banks that the FLS will stimulate lending to non-financial corporations. The FLS does not prescribe how banks should target any increase in their gross lending; rather it is designed to stimulate gross lending to the real economy in general. With mortgage lending attracting a lower risk weighting than lending to the corporate sector, it is entirely consistent for the banking sector to utilise a source of cheaper funding to increase their least risky lending.32

The OBR also came to a similar conclusion:

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30 Bank of England, The Funding for Lending Scheme by Rohan Churm, Amar Radia, Jeremy, Sylaja Srinivasan and Richard Whisker, Quarterly Bulletin, 2012 Q4, p315

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32 NIESR, National Institute Economic Review, Prospects for The UK Economy, by Simon Kirby and Katerina Lisenkova, October 2012, pp F43


FLS could prompt relaxation of non-price, quantity constraints: recent announcements suggest lower loan-to-value (LTV) limits may be one direct consequence. However, given longer-term pressures on capital, banks may be wary of taking on more risk; under the FLS, credit risk stays with the banks. This may particularly constrain new lending to SMEs, compared to relatively low-risk residential mortgages, and we expect most additional, FLS-related lending to go households, primarily as mortgages.33

However, the most recent Bank of England Credit Condition’s survey noted that:

Overall credit availability to the corporate sector was reported to have increased significantly in Q4, the first reported rise in availability for a year. This was reflected in a significant increase in availability for medium-sized firms, an increase in availability for large firms, and a slight increase for small firms. Lenders commented that the Funding for Lending Scheme had been important in increasing credit availability to the corporate sector, consistent with reports of an easing in wholesale funding conditions pushing up slightly on credit availability. In contrast to the easing in credit availability, loan tenors had been reduced.34

21. It is early days for the Funding for Lending Scheme, and it is too soon to consider its impact on business lending. We are concerned, however, by reports that there may be a bias in the effect of the Scheme that favours lending for mortgages rather than lending to SMEs. The Bank of England and the Treasury should assess whether this is the case and report their findings and any proposed action to the Treasury Committee.

Banks’ balance sheet transparency and forbearance

22. In March 2012, a report by Deloitte noted that:

One of the most striking differences between the 1990s recession and the present Financial Crisis has been the way that banks, building societies and other lenders have dealt with customers facing financial difficulties. This time round, lenders have made greater use of forbearance strategies, granting concessions to customers, both consumer and corporate, in actual or apparent distress to avoid, where possible, the pain of collecting on the debt.35

Such concessions, or forbearance, by the banks to their customers may not always be benign. The Governor of the Bank of England described the potential problem of forbearance as:

[...] Forbearance has two dimensions. Good forbearance can take place when banks feel, “Look, this company does have a long-run future. Let’s not put it in a difficult position now”. Bad forbearance is where the banks do not insist on repayment, not because they care about the customer but because they are worried about the implications for their own balance sheet, given the account conventions under which banks operate. That is undoubtedly a concern, because the issue is [...] to what extent

33 Office for Budget Responsibility, Economic and Fiscal outlook, December 2012, p 57, box 3.4

34 Bank of England, Credit Conditions Survey: Survey results, 2012 Q 4, 3 January 2013, p 5

35 Deloitte, Loan forbearance: No such thing as a free lunch, March 2012


are the balance sheets giving an accurate representation of the underlying position of the banks?36

Bad forbearance, as defined by the Governor above, is undertaken to favour the bank, which does not want to record the potential loss, rather than the customer (who of course still benefits from that forbearance). It is difficult for outside observers to identify whether forbearance is for good or bad reasons. Since this can raise questions about the true health of a bank’s balance sheet, it may also be one of the factors affecting the level of investment in banks. Dr Armstrong of NIESR argued that:

It is very difficult for outsiders to understand the quality of the assets that are on bank balance sheets. That is why they trade at half the price-book ratio. That was not just an accident of what happened in the external environment. That was our own creation over the last two decades or so, and it was about the way we approached finance. I would not like to portray it as something that is just unlucky. It is something that you have to deal with, and we are doing so, very slowly.37

23. Bad forbearance may also be a potential reason for the present weakness in productivity. Ben Broadbent, an external member of the Monetary Policy Committee of the Bank of England, explained “I have believed for some time that there is a connection between the problems in the financial system and the slowness both of rebalancing and of productivity growth. The difficulty of judging the risks on banks’ balance sheets may well therefore be very important for productivity growth.”38 Mr Paul Mortimer-Lee, BNP Paribas, emphasised the problems faced by the financial system, and how they were feeding through into the real economy, comparing the UK to Japan:

[...] almost 50% of loans to corporates is on commercial real estate and 20% of that commercial real estate is subject to some form of forbearance. I really don’t think that we have tackled the potential losses on commercial real estate. I think the banks are aware of that and that is constraining their ability to lend because they know there are losses coming down the road. To quote Mervyn King, “In judging whether the banks are adequately capitalised, we need to ensure that capital ratios do in fact provide an accurate picture of banks’ health. At present there are good reasons to think that they do not”. The Governor of the Bank of England and Andrew Bailey, the Deputy CO elect of the PRA, talked about we have to avoid becoming Japan. These gentlemen seem to think that we are becoming Japan and part of the reason is we have not tackled the problems of the banks for a variety of reasons for a long number of years, and I agree with them. If you look at the UK, the poor performance is not due to too rapid fiscal tightening. It is certainly not due to an overvalued exchange rate. What is it due to? It is due to a shrinkage in lending, particularly to the corporate sector.39

36 Oral evidence taken before the Treasury Committee, Bank of England November 2012 Inflation Report, Tuesday 27

November 2012, HC (2012-13) 767, Q 96

37 Oral evidence taken before the Treasury Committee, National institute of Economic and Social Research quarterly review, October 2012, taken on 13 November 2012, HC (2012-13) 750, Q 66


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24. This concern about the transparency and soundness of banks’ balance sheets has also been expressed recently by the interim Financial Policy Committee (FPC) of the Bank of England:

Historical experience suggested that slow progress in tackling balance sheet problems could impede the recovery of banking systems— and, in turn, the wider economy—from financial crises. A large legacy of poor lending decisions and the perception that banks may have inadequately provisioned against future losses, including on loans subject to forbearance, could create uncertainty about bank capital adequacy and prospective earnings. This could both undermine investor confidence and inhibit the ability of banks to extend new loans to the real economy.40

The interim FPC’s recommendation was that:

the FSA takes action to ensure that the capital of UK banks and building societies reflects a proper valuation of their assets, a realistic assessment of future conduct costs and prudent calculation of risk weights. Where such action reveals that capital buffers need to be strengthened to absorb losses and sustain credit availability in the event of stress, the FSA should ensure that firms either raise capital or take steps to restructure their business and balance sheets in ways that do not hinder lending to the real economy.41

‘Zombie’ companies

25. In our hearings, we discussed with witnesses how far low interest rates and bank forbearance could be a problem for the economy by creating so called ‘zombie companies’—companies that survive day-to-day owing to low interest rates and bank forbearance, but which may struggle to survive in the future. The November 2012 Inflation Report highlighted the risk that:

Evidence on company liquidations could indicate that forbearance, coupled with the low level of Bank Rate, has allowed businesses that will face lower demand in the longer term to continue trading. And a drop in the number of company births may indicate that banks may have been less willing to lend to new or dynamic companies that have the potential to achieve higher productivity.42

Dr Armstrong, NIESR, compared the UK situation with that in Japan:

The notion of zombie firms goes back to the Japanese recession back in the 1990s, and some very famous papers that were written on the back of that. The most important thing is that not only are these firms kept alive but they prevent new firms

40 Bank of England, Record of the Interim Financial Policy Committee meeting held on 21 November 2012. Publication

date: 4 December 2012, para 8

41 Bank of England, Record of the Interim Financial Policy Committee meeting held on 21 November 2012. Publication date: 4 December 2012, para 19

42 Bank of England, Inflation Report, November 2012, p 33


coming into the market. It is effectively a subsidy to existing firms. You have not only a static effect but also the ongoing ramifications.43

However, he warned against placing too much weight solely on this explanation. He noted that:

the difficult bit with this zombie idea is that, first, lending rates are not exactly low for SMEs. If the lending rates were low, it would be an easy story to tell. Secondly, firms are hiring. If they were not hiring, it would be an easy story to tell as well.44

26. Robert Chote, Chair of the OBR, noted that the slow growth in wages would also be aiding some firms.45 He argued that the problem might be a wider one of the misallocation of capital:

I think it is debatable to what extent it is the zombie firm explanation, i.e. not particularly productive or effective companies living longer than would normally anticipate versus potentially more successful and profitable companies not growing as quickly as they would in ideal circumstances. I think it is not just the zombie story. Ben Broadbent has made this argument in a couple of the speeches that he has done, that you have a misallocation of capital that could show up both in the weak firms and in some potentially strongly contributing firms not being able to contribute as much as we would like.46

The Chancellor also argued that the problem should be seen as a wider one of capital mismatch:

I think there is no doubt that the recovery from a financial crisis, the likes of which we have not seen in this country in any of our lifetimes, is having all sorts of impacts out there in the economy. One of them, which is one of the things the OBR examines, is what happens on credit intermediation and whether it is preventing strong firms expanding because they get cannot get a loan, and also because of the very low interest rates allowing so-called zombie companies to continue. The only question I would raise is it is quite difficult sometimes to tell the difference between a zombie and a good company that is just having a difficult period because the economy is weaker than anyone hoped. I am absolutely clear that trying to clear up the credit intermediation channels and get the bank system functioning normally is probably the most important or certainly one of the most important tasks I face. But I do think this whole area is one that is worthy of greater consideration. I think we should all, including the Treasury, be doing more work on how the recovery from the financial crisis has taken longer than people had hoped and what is the impact on company and household balance sheets.47

43 Oral evidence to the Treasury Committee, National institute of Economic and Social Research quarterly review,

October 2012, taken on 13 November 2013, HC (2012-13) 750, Q 39

44 Oral evidence to the Treasury Committee, National institute of Economic and Social Research quarterly review, October 2012, taken on 13 November 2013, HC (2012-13) 750, Q 39

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However, the Chancellor was not persuaded by the need for some firms to be shut to allow their resources to be used by other firms, so called ‘creative destruction’. He argued:

One of the things that we should welcome over the last couple of years, difficult as this period has been, has been the relatively strong performance of the job market and the fact that yesterday we had another fall in unemployment, another increase in employment. So those who advocate the sort of short, sharp shock that would lead to a load of companies closing and a lot of people being put out of work are not people that I would myself agree with. I don’t think that is what the British economy needs at the moment.48

The Governor of the Bank of England also warned that:

I do not like the phrase “zombie companies”. [...] the problem with the phrase “zombie companies” is that when we had downturns in the 1980s and 1990s, we were really worried that companies that did have a viable long-run future were being forced out of business because interest rates had gone up and they couldn’t get enough finance from the banks to tide them over their difficult circumstances. Now we seem to be worried about companies that ought to be forced out of business not being forced out of business because interest rates are too low.49

A bad bank?

27. Given the importance of bank lending to the real economy, and especially small firms, we explored a more radical solution to the problem loans on banks’ balance sheets: a so-called ‘bad bank’. A recent research note by BNP Paribas outlined what such a bank could achieve:

An approach we feel the UK should have had, and probably should still explore in more detail, is the creation of a ‘bad/run-off bank’ institution that could absorb problematic assets across the sector. This would allow smaller, more focussed (and better capitalised) institutions to lend to business where profitable opportunities exist. The bad bank could hold impaired assets and those targeted for disposal for much longer than a private-sector institution, thereby also limiting some of the downward pressure on asset prices from disposals.50

Mr Mortimer-Lee, of BNP Paribas, argued for such a solution:

It is not a bank; it is a management company. It looks just to manage those loans and it lets the residual good bank get on with looking for the opportunities for the future. In the UK we did exactly the opposite of this formula when with Lloyds we put the bad bank in with the good bank instead of taking the bad bank out and leaving a good bank.51

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50 BNP Paribas, UK: Capital offence, 18 October 2012

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The Chancellor, however, noted that there was already a bad bank on the Government’s balance sheet, holding some of the assets of Bradford and Bingley and Northern Rock.52 He was sceptical of the case for a new ‘bad bank’:

Although there is a superficial—and I don’t mean that in a pejorative way—attractiveness to the bad bank/good bank idea, that is not the route that was pursued in 2008–09 when RBS was part-nationalised, and it was not the route pursued when HBOS was taken over by Lloyds. So I think the question four or five years later is do you go back into these banks, which have done a lot to shrink their bad assets and are continuing to do so, disrupt everything and try and rip out of RBS the bad assets, try and value them—which would take a long time, and the experience that the previous Government had of valuing assets with the Asset Protection Facility was not a particularly happy one—in order to achieve some gain in the future that you might have created this bad bank and taken these bad assets off RBS’ balance sheet, or indeed, the old HBOS assets. I think it is very, very disruptive and I am not sure the gains outweigh the disruption.53

Conclusions on bank lending

28. Exceptionally accommodative monetary policy and bank forbearance both provide support to companies at present and will have helped many companies to survive, supporting employment. But their effect will not be costless over the long-term. Some companies may remain trading when a more prudent examination of their business plan would suggest that they should not. Loans given to such companies may act to hamper banks’ ability to lend to new firms with better prospects.

29. The supply of corporate lending by the banks remains of significant concern, especially for smaller firms. We have heard evidence that the weakness of corporate lending may be hindering some firms from expanding.

Output gap

30. One of the key forecasts made by the OBR is that of the output gap. The output gap is defined as the difference between the potential output of the economy and the actual level of activity within the economy. When the output gap is negative, there is less activity than potential. The output gap is unobservable since the potential output of the economy is unmeasurable. It is simply an estimate based on the judgement of economists and is inherently extremely imprecise. Yet the output gap is used as a primary tool in assessing the success of the fiscal policy. The size of the output gap determines how much of the fiscal deficit at any given time is cyclical and how much structural: in other words, how much will disappear automatically, as the recovery boosts revenues and reduces spending, and how much will be left when economic activity has returned to its full potential. The narrower the output gap, the larger the proportion of the deficit that is structural and the less room for manoeuvre the Government will have against its fiscal mandate, which is set in structural terms (see paragraph 43). The output gap can also be used to assist with the assessment of the potential for inflationary pressure on prices if demand cannot be met at a

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given level of capacity. Chart 1 shows the forecast for the output gap, in comparison to that provided by the OBR in March 2012.

Chart 1: The output gap

Source: Office for Budget Responsibility, Economic and fiscal outlook December 2012, Chart 3.8, page 49

OBR’s change in method

31. Since the output gap is unobservable, estimating its current position and forecasting its future evolution is also inherently uncertain. In its December 2012 Economic and Fiscal Outlook forecasts, the OBR decided to use a different method for estimating the size of the output gap. Mr Chote explained why the OBR had decided to change from the forecast method used in March 2012:

Every time we come to do a forecast we look at the key judgments that we have to make and make the best central judgment that we can on the basis of the evidence we had. As you will recall, at your last gathering you were urging us to look at different ways of estimating the output gap, to come up with a richer picture than relying too heavily just on one method, looking at business surveys. We have looked at the method on business surveys, we have compared that to what that would imply if you were looking at a production function estimate of this, and we have concluded that it makes more sense to assume that the output gap is slightly larger now than a mechanistic application of that methodology was at the time. That makes 0.4% of GDP difference to the output gap, less than 0.3% of GDP difference to the structural budget deficit, and it is more than outweighed by the other fact going in the direction.54

However, Mr Mortimer-Lee disapproved of the change of method, and the consequential forecast by the OBR:

54 Q 48


I do not like the fact that the OBR’s model said one thing and they decided to do something completely different. I do not like and I do not believe in the forecast of the sudden magical acceleration of productivity that means that the output gap stays wide despite growth picking up. To me it is just far too convenient for the Government finances.55

Mr Wells accepted that the OBR was entitled to change its method for estimating the output gap, though he questioned its judgement in certain respects:

The OBR have a usual set of models that on this occasion would have pointed to the output gap actually narrowing since March. In fact, they decided it was nearly a percentage point wider. But that is their judgment. I think you should always override a model if you don’t think what it is saying is sensible. But, yet again, I think it is the fact that they should have revised the potential growth rate down further and then the cyclically-adjusted fiscal position would have looked worse. They have applied that judgment, and at the moment it is impossible to know who is right. Certainly it would make things harder if they had assumed more of the recent weakness was due to potential rather than cyclical factors.56

Against the charge that the OBR had changed its methodology to appease the Chancellor, Mr Chote defended the OBR’s forecast as follows:

We have made an adjustment that says that the output gap is probably a little bit wider this year than our methodology would normally suggest but that is more than outweighed by a judgment move going in the opposite direction, which is that we think potential GDP is going to grow more slowly between now and the target date. So the judgments that we have made, rather than simply applying new data, make the Chancellor’s job more difficult and not less.57

A persistently large output gap

32. As Chart 1 shows, the OBR now forecasts a persistently large output gap. Mr Chote provided the following explanation as to why the OBR had made this forecast:

One is [this] story, a big output gap at the end. Ours is certainly larger than you would normally expect. It would be smaller than those people who say that we are overestimating the hit to supply from the financial crisis and so on, so there will be people further out in that particular direction. The other alternative is that you assume that economic growth is going to be a lot stronger over the next five years than we anticipate, which would close the output gap. Most people out there are not assuming that economic growth is going to be dramatically stronger than we assume, even those people who aren’t, like us, constrained to assume current policy and could therefore assume that there might be additional monetary or fiscal stimulus. The third possibility is that you believe that the financial crisis has dealt an even bigger hit to the supply potential of the economy than we are assuming but, as we have

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discussed already, people are finding it hard enough to explain the hit to supply that most people think there is at the moment so adding even more to that would intensify that puzzle. The fourth possibility is that it is not the financial crisis per se that has hit the supply potential of the economy but that the trend growth in GDP was weaker prior to the crisis and people were consistently overestimating the potential growth of the GDP before it kicked off.58

Such a persistently large output gap may damage potential output. Mr Wells noted that:

Normally, economic theory would suggest that the longer a period of slow growth persists, the bigger the permanent damage to supply capacity. It is true that the UK labour market has been relatively resilient, with the result that productivity has hardly grown over the past few years. This suggests the loss of skills in the workforce may be more limited than history would suggest. But still, the OBR is once again assuming that all is well because in a few years we will be back to a world of low inflation and high growth.59

Mr Chote also acknowledged that the potential for damage from the persistently large output gap was “one of the reasons why [the OBR] have assumed that trend GDP growth does not recover right back to the long-term rate that you have seen over the past 50 years over that horizon.”60 This risk of potential degradation in potential supply was also referred to in the December minutes of the Monetary Policy Committee:

For one member, the case for undertaking additional asset purchases at this meeting was nonetheless strong. On balance, the near-term outlook for growth seemed a little weaker. Although inflation had risen again, and seemed unlikely to fall very substantially below the 2% target in the medium term, the degree of slack in the economy, and the likely response of supply capacity to increased demand, meant that it would be possible to achieve higher output growth without causing any material inflationary pressure. That would help to avoid potentially lasting destruction of productive capacity and increases in unemployment.61

33. The forecast of a persistently large output gap by the OBR should also have implications for monetary policy, as Mr Wells argued:

Given that the independent OBR now thinks there is considerably more slack in the economy than it did previously, it may also see a much stronger case for the independent MPC to apply more monetary stimulus. The bigger the output gap, the more scope there should be for monetary policy to boost demand without stoking inflationary pressure. [The OBR’s December 2012] forecasts therefore very much put the ball back in the BoE’s court to drive the recovery. Whether or not the MPC sees things the same way remains to be seen. Our reading of recent minutes lead us to

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59 HSBC, Saved by the cycle?, by Simon Wells, 5 December 2012

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61 Bank of England, Minutes of the Monetary Policy Committee meeting held on 5 and 6 December 2012. Published on 19 December 2012, para 30


suspect it doesn’t. We could be heading for a blame game in policy, testing central bank independence further.62

Monetary policy

The effectiveness of Quantitative Easing

34. On 5 March 2009, the MPC voted for bank rate to fall by 0.5pp to 0.5%.63 Unwilling to lower interest rates further, the monetary policy tool most recently used by the MPC to stimulate demand has been purchases of assets, primarily gilts, financed by the issuance of central bank reserves: so called “quantitative easing” (QE). In November 2012, the minutes of the Monetary Policy Committee noted that “While views differed over the exact impact of the MPC’s asset purchases, the Committee agreed that demand and output would have been significantly weaker in their absence.”64 When asked how he thought QE had affected the economy, the Governor of the Bank of England replied that:

I would look at this simply through what has happened to the figures for broad money. In the absence of what we have done, I would have expected a contraction in broad money, and that would have taken us into very serious territory. I think that contractions of a significant size in the broad money stock are what led to the great depression in the United States in the 1930s, what has led to the equivalent in Greece today and would have threatened us—and indeed other countries—had we not expanded our balance sheet in the way that we did. I think other central banks have taken the same view, because the balance sheets of central banks have broadly expanded by roughly the same amount and using very similar types of instruments.65

Paul Fisher, Executive Director for Markets at the Bank of England, also argued that:

[...] in the two years in which we have done the most QE, 2009 and 2012, you have had record issuance of sterling corporate bonds. That is what you would expect, because as we take gilts out of the market, investors have to go and buy something else, and the demand for corporate bonds goes up. So you can see a very similar sort of impact in 2012 to what you had in 2009. Also, having been to the States, the evidence I have had there from market contacts is that QE, if anything, seems to be working more strongly now there than it did in the earlier phase through similar sorts of portfolio balance challenge.66

35. The November minutes of the MPC also discussed the likely effectiveness of additional asset purchases:

There remained considerable further scope for asset purchases to lower long-term yields on government and corporate debt and support other asset prices. Indeed, it

62 HSBC, Saved by the cycle?, by Simon Wells, 5 December 2012

63 Bank of England, Historical MPC voting spreadsheet, www.bankofengland.co.uk

64 Bank of England, Minutes of the Monetary Policy Committee, 7 and 8 November, published 21 November, para 36




was possible that the impact of past asset purchases on asset prices had recently become greater. As market expectations of the likely duration of asset purchase programmes by central banks around the world had increased, so too had the incentives to amend investment strategies and reallocate portfolios towards riskier assets, such as corporate bonds and equities. But there was a question over the magnitude of the impact of lower yields and higher asset prices on the broader economy at the current juncture. It was not that asset purchases had become a fundamentally less effective policy tool, but rather it highlighted that the impact of any monetary policy instrument depended on the prevailing state of the economy. At the present time, it was possible that elevated uncertainty and a desire to reduce leverage meant that real activity was less responsive to lower borrowing costs than normal. But this situation could easily reverse, and with it the traction that lower yields could have in stimulating demand and output.67

When we asked the Governor whether he believed future rounds of QE would be as effective, he said:

What I would say is that it is a proposition that is not to do with asset purchases as such, but is to do with any aspect of monetary policy that we might engage in. The purpose of monetary policy in part is to persuade people to spend today what they might otherwise have spent tomorrow. You bring spending from the future to today. The longer time goes on, tomorrow turns into today, and by now has become yesterday. This means that you have a hole to fill that you have created, which you had hoped you wouldn’t need to fill because by now the economy would have picked up, and it hasn’t. I think it is not asset purchases as such that are less effective. We are still injecting more broad money into the economy. It is about the ability to persuade people to spend more today when they know that in the long run—which cannot be deferred indefinitely—they will have to adjust to a new equilibrium.68

36. Our City experts were sure QE had reduced in effectiveness. Mr Hayes, Barlcays, told us that:

I think it has lost a lot of traction. I thought that was true over a year ago when they did QE2 in October last year, and I think it is probably even more the case now. This is not particularly to do with its capacity to keep Government bond yields low, for which I think it still is an important factor, but the extent to which that feeds through into actual spending by consumers and firms is very difficult to design indeed. If the Bank of England announces another £50 billion of QE, I would not rush away and significantly revise our growth and inflation forecasts because of that.69

Mr Wells, HSBC, when asked whether the Bank should undertake another analysis on how well QE was working, replied that “I think it becomes harder and harder, because as quantitative easing comes into market expectations the market tends to react in advance. Therefore, on the day of the announcement it is largely in the price, so the sort of event

67 Bank of England, Minutes of the Monetary Policy Committee, 7 and 8 November, published 21 November, para 36


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study that they did in the past I think becomes little bit more irrelevant”. On the effectiveness of QE, he agreed with Mr Hayes, and argued that:

is another £50 billion of gilt purchases from the Bank of England going to suddenly drive us to growth? I think that is very unlikely. Quantitative easing was a great response, an unprecedented response to an unprecedented policy outlook in 2009. It did its job. It avoided a depression, it avoided deflation, but we can’t expect more and more money creation from the Bank of England just to fine-tune the economy and drive growth.70

Mr Mortimer-Lee, BNP Paribas, believed that the current QE policy was subject to diminishing returns.71 He advocated a different sort of quantitative easing:

I think, to be honest, we have the wrong sort of QE. In the US when the Fed buys treasuries and lowers the Government bond yield it has a significant effect on the ability of the corporate sector to borrow because a lot of the intermediation is not through banks, it is through the bond market. In the UK that is exactly the opposite. The banks are the main sort of intermediation, and really the Bank of England has made the Government’s job a lot easier. It may initially have helped the economy, but in the recent rounds it clearly has not helped the private sector’s availability to credit. I would love to see them switch to buying, as the Fed has been doing. The most recent round of QE is to buy mortgage-backed securities, and I think the Bank of England should do exactly the same thing, because our problem is credit availability. The Bank could buy packages of corporate loans, but, to be honest, there is a danger of them being given lemons by the banks because there is an asymmetric information problem. With mortgages it is a much more homogenous asset. If the Bank were to take on mortgage-backed securities, that would allow the banks more room, given their capital constraints, to lend to businesses. I think that would be much more helpful than QE in gilts.72

37. NIESR also believed that there was a case for the Bank of England to widen its purchases beyond gilts:

If a further expansion of the Bank’s balance sheet were to occur in the short term, then it would surely be because the MPC feels that lending to the real economy remains impaired. Rather than just purchase gilts in an attempt to flatten the yield curve, purchases would be more effective in raising nominal spending if they were of private sector paper (see Barrell and Holland, 2010).73

Bill Winters, who conducted a review on behalf of the Bank of England into its framework for providing liquidity to the banking system, set out possible additional monetary tools:

At present, the MPC uses only the two tools of Bank Rate and asset purchases to meet its inflation target. It is, however, possible that at some time in future the MPC

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73 NIESR, National Institute Economic Review, Prospects for The UK Economy, by Simon Kirby and Katerina Lisenkova, October 2012, p F44


might wish the Bank to use other types of market operations to enable it to meet its objective, either if it thought the current tools were impaired for some reason, or because it thought some other tool would be more effective. A range of options are theoretically possible including: other types of asset purchases; setting Bank Rate below zero; tiered remuneration on reserves; and using long-term repos to influence longer term rates. Although the operational details would need to be worked out at the time, it appears that the SMF framework itself is sufficiently flexible to accommodate such additional policy measures.74

The Monetary Policy Committee itself discussed the possible use of other tools in May 2012, shortly before the Funding for Lending scheme and the Extended Collateral Term Repo Facility were announced:

Other complementary policy measures that the authorities might take could be better suited to mitigating these problems than asset purchases on their own, and some members expressed a wish for the MPC to consider additional policy tools. In this context, the Governor informed the Committee that initial discussions were underway with the Treasury on possible measures to ease banks’ funding costs and enhance their ability to lend.75

38. The evidence received suggests that quantitative easing was an appropriate response at the start of the financial crisis. As time goes on, its effectiveness may be diminishing. Some, including members of the MPC, have argued that the Bank of England should consider pursuing alternative forms of monetary easing. The Treasury Committee will be holding a detailed inquiry into quantitative easing in the coming months.

Monetary policy framework

39. The United Kingdom operates a monetary policy regime centred on an inflation target of 2% as measured by the Consumer Price Index, implemented by the independent the Bank of England. In a recent speech in Toronto, Dr Mark Carney, the Governor of the Bank of Canada and the Government’s choice as the next Governor of the Bank of England, discussed potential reforms to monetary policy frameworks. In particular, he noted that:

when policy rates are stuck at the zero lower bound, there could be a more favourable case for NGDP [Nominal GDP] targeting. The exceptional nature of the situation, and the magnitude of the gaps involved, could make such a policy more credible and easier to understand.76

40. While the decisions on, and implementation of, monetary policy are undertaken by the Bank of England, the remit is decided by the Chancellor of the Exchequer. Given the Chancellor’s announcement that Dr Carney would replace Sir Mervyn King as Governor

74 Bank of England, Review of the Bank of England’s framework for providing liquidity to the banking system, Report

by Bill Winters, Presented to the Court of the Bank of England October 2012, pp45-46, para 144

75 Bank of England, Minutes of the Monetary Policy Committee meeting 6 and 7 June 2012, para 31

76 Bank of Canada, Remarks - Mark Carney, Governor of the Bank of Canada, Presented to: CFA Society Toronto, Toronto, Ontario, Canada, 11 December 2012

http://www.bankofcanada.ca/author/mark-carney/


of the Bank of England in 2013, we discussed with the Chancellor the potential for a change in the monetary policy remit in the United Kingdom. He said that:

[...] we have an inflation targeting regime that has served this country well and has provided stability. There is a debate about the future of monetary policy, not in the UK exclusively, but in many, many countries. You saw yesterday the Federal Reserve take action on indicating the future path for monetary policy and linking it to the unemployment rate, so there is a lot of innovative stuff happening around the world. In the UK, we have the Funding for Lending scheme, which in itself has been very innovative, and other countries have looked at it closely. So there is a debate going on. I am glad that the future Central Bank Governor of the United Kingdom is part of that debate. Of course any decisions about the framework are decisions for the Government”.77

He added “I have no plans to change the framework”.78

41. As part of our hearing on 7 February 2013 with the new Governor of the Bank of England, we will examine whether Dr Carney considers that the current monetary policy of the Bank of England remains the most appropriate. We would welcome written evidence on this from others prior to that hearing.

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3 The public finances

Changes announced in the Autumn Statement

42. The impact of measures announced in the Autumn Statement is summarised below. The Government estimates the fiscal impact to be savings of £3.97 billion in 2012–13, with an increase in spending over receipts of £910 million in 2013–14. Over the forecast period, the net impact is a saving of £6.47 billion.

Table 2: Overall fiscal impact of Autumn Statement measures

£ million

2012–13 2013–14 2014–15 2015–16 2016–17 2017–18

Total tax policy decisions -870 +180 -2,385 -905 +295 +305

Total spending policy decisions +4,840 -1,090 +1,465 - - +4,635

TOTAL POLICY DECISIONS +3,970 -910 -920 -905 +295 +4,940 Source: HM Treasury, Autumn Statement 2012, 5 December 2012, Table 1, p 9

Performance against the fiscal targets

The fiscal mandate

43. The OBR is responsible for assessing the Government’s performance against the fiscal mandate and the supplementary target:

The Charter for Budget Responsibility defines the fiscal mandate as “a forward-looking target to achieve cyclically-adjusted current balance by the end of the rolling, five-year forecast period”. This means that total public sector receipts need to at least equal total public sector spending (minus spending on net investment) in five years time, after adjusting for the impact of any remaining spare capacity in the economy. For the purposes of this forecast and the spring 2013 EFO [Economic and fiscal outlook], the five-year horizon ends in 2017-18.

The Charter says that the supplementary target requires “public sector net debt as a percentage of GDP to be falling at a fixed date of 2015–16, ensuring the public finances are restored to a sustainable path.” The target refers to public sector net debt (PSND) excluding the temporary effects of financial interventions.79

44. The OBR stated in its December 2012 Economic and fiscal outlook that there was a greater than 50 per cent chance of the Government meeting the fiscal mandate, albeit by virtue of extending austerity measures a further year into 2016–17. The cyclically-adjusted current budget was forecast to be in surplus by 0.9 per cent of GDP in 2017–18—the current target year for the purposes of the mandate—and by 0.4 per cent in 2016–17.80

79 Office for Budget Responsibility, Economic and fiscal outlook, December 2012, p 173



The supplementary target

45. The OBR forecast that the Government is unlikely to meet its supplementary target. Public sector net debt (PSND) is forecast to rise by 1 per cent of GDP in 2015–16 and then fall by 0.8 per cent in 2017–18, thereby missing the target by one year. The OBR had forecast that the target would be met in its March 2012 EFO, but has since revised down nominal GDP growth, revised upwards net borrowing and factored in the effect of reclassifying Bradford and Bingley and Northern Rock Asset Management as public sector liabilities. The effects of these revisions are offset to a degree by the transfer to the Treasury of the surplus balance in the Bank of England’s Asset Purchase Facility (APF).81

46. The Government has chosen not to implement further cuts in order to meet the supplementary target. The Chancellor effectively acknowledged that doing so could harm the economy. He stated that:

one of the central judgments of this Autumn Statement was not to chase the debt target, in other words, to accept that we had missed the debt target, and had we chased the debt target, that would have required significant cuts or tax rises over the next couple of years.82

[…]

[…] faced with this choice—hit the target and potentially damage the economy in doing so, or miss the target and help the economy—I decided to help the economy.83

The Autumn Statement says that:

At this time of rising debt, the Government will restore debt to a sustainable, downward path and will retain the existing supplementary debt target. As set out in the June Budget 2012, the Government will set a new target once the exceptional rise in debt has been addressed.84

47. Mr Mortimer-Lee stated that the existence of a fiscal framework was in principle valuable but that:

[t]he fiscal framework should be a guide to action and should constrain the Government’s ability to come up with policies that suit the short term but not the long term. The rule helps to achieve that but it is not set in stone. We don’t fall off the end of the earth if we go past it.85

48. The Government is forecast to meet the rolling fiscal mandate by cutting non-investment spending as a share of GDP for a further year, but not the supplementary target. It has decided not to propose further spending cuts or tax rises in order to meet the latter. The possible failure to meet the supplementary target raises the question of the continuing credibility of that target. Successive governments have committed


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84 HM Treasury, Autumn Statement 2012, 5 December 2012, p 31

85 Q 141


themselves to, but then failed to meet, their fiscal targets. For a fiscal target to be credible, it must be durable, and therefore not subject to frequent revision as circumstances change. It must also be capable of accommodating conditions different from those at the time the target was first formulated. Nor should a fiscal target be open to manipulation. It is not the case, though, that a target is valuable only so long as it is met. A target can remain credible, and so constrain a government’s choices, even if it is not being met, so long as the political commitment that created it continues to inform policy decisions.

49. The supplementary target remains in place for the moment. The Government has said that it will set a new target, but its timetable is vague: it will do so “once the exceptional rise in debt has been addressed”. When the Government does decide to create a new fiscal framework, it should do so only after full public consultation. The Committee will return to this issue.

Credit rating

50. We questioned witnesses on the likelihood and impact of a downgrade of the UK’s AAA credit rating. Mr Hayes and Professor Booth both thought that a downgrade was likely.86 Mr Hayes, when asked if there would be a downgrade in 2013, replied:

I think it is quite likely. There are two reviews coming up that we know of. Early in the year, probably January, Moody’s is looking to revisit this, and in March I think Fitch are looking to review also. In particular as I understand it with Fitch, we are on negative outlook, and on their criteria that implies more than a 50% chance of a downgrade. That was instigated in February this year, I think, since when things have got worse. So it seems to me that things are moving clearly in that direction,87

51. As to the potential impact of such a downgrade, both Professor Booth and Mr Johnson stated that the rating agencies based their decisions on the same information available to the broader market and that therefore any expectations of a downgrade would already be priced into the cost of UK debt.88 Mr Hayes noted that France did not appear to have suffered material rises in borrowing costs following the downgrades of its sovereign debt. Mr Hayes stated that “the likelihood of a leap in bond yields from a rating downgrade is negligible.”89

52. The weight that the Government places on maintaining the UK’s AAA rating has shifted over time. The Chief Secretary to the Treasury stated in June 2012 that the “UK government […] has re-established our country’s financial credibility. And the credit rating agencies rate the UK as triple A. The low interest rates today of 1.8 per cent are a consequence of this.”90 In contrast, the Chancellor now maintains that the relevant measure is the rate at which the UK can borrow in the international capital markets: “the

86 Qq 145, 151

87 Q 145

88 Qq 152, 200

89 Q 142

90 Speech by Chief Secretary to the Treasury, Rt Hon Danny Alexander MP; Glasgow Chambers of Commerce, 21 June 2012


ultimate test is what you can borrow money at.”91 Mr Mortimer-Lee agreed on the relative unimportance of the rating itself:

The AAA rating to me doesn’t matter that much. What matters is what the UK can borrow at and that we have the right policies. Having a label attached to us might be nice in some sense, but does it really matter? I don’t think it does. I would agree that the cost to the UK might be about 25 basis points on borrowing costs of losing it, but we should do the right things for the right reasons and not just because the rating agencies will mark us down.92

UK cost of borrowing

53. The Committee heard conflicting evidence on the reasons for the UK’s low borrowing costs. Mr Portes of NIESR stated that:

we do not observe any observable correlation between changes in deficits for countries like us, which have floating exchange rates and an independent monetary policy, and gilt yields. So long as the markets perceived the Government as having some reasonable plan to balance public finances in the long-term, the particular form that plan took was not relevant.93

In Mr Portes’ view, economic theory suggested that the Government’s borrowing costs should in fact rise as the economy improves:

If you thought that falling gilt yields or falling spreads reflected increased confidence in UK plc, increased confidence in the economy and all the rest of it, then you would have to believe that, when gilt yields fell, the stock market would do well. That is pretty simple. Is that what we observed? It is absolutely not what we observed. If you look at day-to-day movements, especially around the time when we were going through this supposed crisis during 2010, the correlation between gilt yields and equity prices goes exactly the wrong way. In other words, when gilt yields went up, equity prices went up as well. In other words, when people were feeling more optimistic, gilt yields went up. When people were feeling less optimistic, yields fell. It is not about credibility, it is about what you think is going to happen to the economy. Economic weakness leads to low long-term interest rates. This is really very basic macro-economics.94

54. In contrast, Professor Booth, whilst recognising that there were several factors contributing to the UK’s low borrowing costs, believed that one factor was “reasonable credibility with regard to the Government’s financial plans.”95 But witnesses noted the difficulty of decomposing the factors explaining the rate at which the UK currently

91 Q 322

92 Q 144

93 Oral evidence to the Treasury Committee, National Institute of Economic and Social Research Quarterly Review, October 2012, Q 13

94 Oral evidence to the Treasury Committee, National Institute of Economic and Social Research Quarterly Review, October 2012, Q 44

95 Q 159


borrowed,96 with Mr Chote stating that “what is in the price clearly is the sum of the market’s views of current policy.”97

Asset Purchase Facility transfer

55. On 9 November 2012, it was announced that the cash surplus held in the Bank of England’s APF was to be transferred to HM Treasury. This means that any surplus or deficit generated as a consequence of the operation of the Bank’s quantitative easing (QE) programme is reflected in the public finances on an ongoing basis rather than as a one-off change when QE is unwound. The Government and the Bank both maintain that this decision was simply a matter of efficient cash management, and similar to the practice of the Federal Reserve in the United States.98

56. There was some discussion concerning the effects of the transfer on the fiscal mandate and supplementary target. Public sector net debt will be reduced during the spending review period by £71 billion, though as monetary policy tightens and QE is unwound, this will reverse and will lead to an increase in net borrowing.99 The OBR estimates that the net impact upon completion of the unwinding of QE will be a small gain to HM Treasury of approximately £55 billion. In assessing this potential impact on public sector net debt and the eventual outcome of QE’s unwinding, the OBR was constrained by the fact that the Office for National Statistics has yet to state how it will treat the transfer in the national accounts. The OBR presented in its forecasts the effect of the Asset Purchase Facility transfer, and set out its assumptions in modelling the unwinding of Quantitative Easing. This transparency is welcome.

57. The Governor acknowledged to us that the transfer of the APF surplus was equivalent in effect to further monetary stimulus, stating that “it certainly affected monetary conditions, in the sense that it was broadly equivalent to a stream of asset purchases over the next year of £37 billion.”100 On 8 November 2012, the Bank of England issued a press release following the monthly meeting of the MPC in which no further QE was announced. The press release did not mention the APF transfer or its effect on monetary conditions.101 The Governor confirmed to us, however, that the MPC had known about the APF transfer at the time of its November meeting.102 The information about the APF transfer became public the following day, with the release of letters between the Chancellor and the Governor detailing the transfer.103

58. This raised questions as to whether the Treasury had usurped the role of the independent Monetary Policy Committee in implementing monetary policy. Chris Giles,

96 Q 159

97 Q 91

98 Oral evidence to the Treasury Committee, Bank of England November 2012 Inflation Report, HC 767, Q 66



101 Bank of England, Press release: Bank of England maintains Bank Rate at 0.5% and the size of the Asset Purchase Programme at £375 billion, 8 November 2012


103 Letter from the Chancellor to the Governor, HM Treasury website 9 November 2012; letter from the Governor to the Chancellor, Bank of England website, 9 November 2012


in a piece for the Financial Times entitled “Policy ploys risk UK economic credibility”, argued that:

What about the independent Bank of England? Sir Mervyn King confirmed yesterday that the interest rate setters viewed the Treasury’s actions as equivalent to £37bn of monetary policy easing in the first year. So the Monetary Policy Committee appears to have acquiesced in an easing it had not initiated, after misleading the public that it had kept monetary policy unchanged when it took its monthly decision last Thursday. Allowing the Treasury to initiate monetary policy suggests the MPC has lost the plot; it certainly does not know how to communicate changes in monetary policy any more.104

59. When questioned about this possible infringement of the MPC’s independence, the Governor said that the transfer did not cause concern for him as it was within the MPC’s power to negate its effects.105 Dr Martin Weale and Dr Ben Broadbent, both members of the MPC, likewise did not feel that HM Treasury’s decision affected their capacity to reach independent decisions about monetary policy.106 Indeed, they both noted that they had in fact been minded to support further QE, but on being informed of the APF surplus transfer had decided there was therefore no need for further QE.107 Yet Mr Wells argued that the way the decision was communicated was also important:

I think it was communicated rather clumsily. I think it should have been thought of well in advance of when it was done, because it could have perhaps been announced during a Bank of England inflation report and explained very clearly. As it was, the day after quite a big policy announcement, suddenly being announced and then the MPC saying, “Oh well, if we had wanted to offset it, we knew it was coming; we could have changed”, I think was slightly unsatisfactory.108

60. The Governor acknowledged that the perception of the MPC’s independence was important in its own right:

it is very important that we go beyond [independence] and ensure that not only is our independence not compromised, which I think is the case, but has not been seen to be compromised. That also matters […]109

But when we questioned the MPC on why it had not published any announcement on the APF at the time of the 8 November press release, the Governor argued that it was not in the MPC’s gift to publicise the transfer.110 The Governor conceded that, in relation to the timing of the announcements, “I think it is unfortunate if people were misled, and I think that is a matter for regret”.111

104 Financial Times, Policy ploys risk UK economic credibility, by Chris Giles, 14 November 2012


106 Oral evidence to the Treasury Committee, Bank of England November 2012 Inflation Report, HC 767, Qq 74, 75

107 Oral evidence to the Treasury Committee, Bank of England November 2012 Inflation Report, HC 767, Qq 74, 76

108 Q 131





61. The perceived independence of the MPC is of paramount importance for the effective execution of its duties. We acknowledge that the MPC had the opportunity at its November meeting to take steps to negate the impact on monetary conditions of the APF transfer. The MPC’s actual independence was therefore not threatened. But by not announcing the monetary easing that arose from the APF transfer to the Treasury at the time of its regular November press release, the MPC gave the impression that the Treasury was undertaking monetary policy, rather than the MPC.

62. The MPC needed to be in a position to publicise the transfer at the time of its press release in order to fulfil its duty to act transparently and to demonstrate its independence. Had the MPC decided that it needed to negate the effect of the APF transfer by reducing QE, it would have had to reveal the APF transfer in order to be able to explain its decision. Deciding not to cancel out the effect of the APF transfer was also a decision that the MPC took which deserved public explanation, especially as we know that the transfer influenced MPC members’ decision-making. The Bank of England should, therefore, have ensured that the MPC was in a position to make the fact of the APF transfer public at the time of the publication of its November press release. A satisfactory alternative would have been for the Treasury to have announced the transfer at the same time as, or before, the release of the MPC’s minutes. The Treasury and to some extent the Bank were at fault for failing to coordinate the announcement of the APF transfer with that of the November MPC press release, the date of which was known well in advance. This failure created difficulties for the reputation of the MPC. This should not be repeated.


4 Policy decisions

Reliance on big ticket items

63. The Government announced a number of policy measures that are expected to have a broadly neutral fiscal impact overall in the period between 2012–13 and 2016–17. Table X shows the combined effect of the net revenue effect of the individual policy decisions in the Autumn Statement.

Table 3: Summary of Autumn Statement policy decisions

£ million

2012–13 2013–14 2014–15 2015–16 2016–17 2017–18

Total tax policy decisions -870 +180 -2,385 -905 +295 +305

Total spending policy decisions +4,840 -1,090 +1,465 - - +4,635

TOTAL POLICY DECISIONS +3,970 -910 -920 -905 +295 +4,940 Note: Costings reflect the OBR’s economic and fiscal determinants.

Source: HM Treasury, Autumn Statement 2012, 5 December 2012, Table 1, p 9

64. Thirty eight new policy decisions were announced in the Autumn Statement comprising both spending and tax measures.112 The impact of these is dominated, however, by a small number of ‘big-ticket’ items. These big-ticket items include a number of ‘give-aways’ such as the cancellation and deferral of fuel duty increases resulting in an £8.8 billion reduction in revenue between 2012–13 and 2017–18, and additional capital spending of £5.5 billion between 2012–13 and 2017–18. To offset these, the Treasury is relying to a large extent, particularly in the 2012---13 to 2014---15 period, on:

• expected proceeds of £3.5 billion from the sale of the 4G spectrum in 2012–13;

• additional revenues expected from the UK-Swiss tax repatriation agreement; and

• a £10 billion reduction in departmental spending between 2013–14 and 2017–18.113

65. In its forecast, the OBR said that it “requested a number of changes to the draft costings prepared by HMRC and DWP”, but that it had now “certified all of the final published costings for new Autumn Statement policies as reasonable and central estimates”.114 It went on to note, however, that:

[the OBR] has not scrutinised the costings of policies within Departmental Expenditure Limits (DELs) where the total cost or yield is wholly determined by a Government policy decision. This includes, for example, the additional capital expenditure announced since the Budget on housing and science and the extra capital DEL spending announced at the Autumn Statement.115

112 HM Treasury, Autumn Statement 2012, 5 December 2012, Table 2.1, p 56


114 Office for Budget Responsibility, Economic and Fiscal Outlook, March 2012, p 2 bullet 4

115 HM Treasury, Autumn Statement 2012 policy costings, 5 December 2012, Annex B - Office for Budget Responsibility: certification of policy costings, p 51 para B.2


66. Although it had certified the costings, the OBR said that “there are uncertainties around a number of the costings”116 and explained that this was because:

Policy costings are subject to a […] level of uncertainty for a number of reasons. In many cases, costings are highly sensitive to assumptions about the future behavioural responses of taxpayers or benefit recipients [...].117

67. In the light of their significance for the overall package of measures announced in the Autumn Statement, and the uncertainty highlighted around their valuation, we examined witnesses on a number of these big ticket items in our hearings.

Sale of the 4G spectrum

Table 4: Expected impact of 4G Spectrum sale

£ million

2012–13 2013–14 2014–15 2015–16 2016–17 2017–18

4G Spectrum Sale +3,500 0 0 0 0 0 Source: HM Treasury, Autumn Statement 2012, 5 December 2012, Table 2.1, p 56

68. The policy measures in the Autumn Statement include the expected proceeds of the sale of the 4G spectrum as an additional lump-sum receipt. The Treasury said that “Following formal assessment, based on independent analysis of the likely valuation of spectrum receipts by the OBR, the spectrum receipts will be reflected [...] at £3.5 billion.”118 In its certification of the policy costings in the Autumn Statement, the OBR identified the 4G spectrum sale figure as an area of particular uncertainty:

given the final details of the auction have now been announced we have been able to certify an estimate of the proceeds. However, even at this stage there remain a number of uncertainties. The estimate is based on the value of comparable spectrum auctions outside the UK, but as was the experience with the 3G auction in 2000, they may not necessarily offer a good guide for the UK. Views on future demand for mobile products and the required costs to meet this will differ between individual participants in the auction.119

69. Despite highlighting this uncertainty, the OBR accepted the Treasury’s estimate of £3.5 billion. This marks a change from the OBR’s previous estimates of the proceeds which were presented as a range from £1.5bn to £6.7bn.120 Ofcom’s reserve price for the auction is set at just £1.3 billion.121 Given the caution of the OBR’s assumptions in producing its growth forecast, we asked the OBR how it had satisfied itself of the £3.5 billion figure. Mr Chote responded:

116 Office for Budget Responsibility, Economic and Fiscal Outlook, March 2012, p 2 bullet 4

117 HM Treasury, Autumn Statement 2012 policy costings, 5 December 2012, Annex B - Office for Budget Responsibility: certification of policy costings, p 51-52 para B.6


119 HM Treasury, Autumn Statement 2012 policy costings, 5 December 2012, Annex B - Office for Budget Responsibility: certification of policy costings, p 52 para B.7

120 Office for Budget Responsibility, Fiscal sustainability report Annexes, July 2011, para A.11

121 Ofcom, Ofcom finalises 4G auction rules,12 November 2012, http://consumers.ofcom.org.uk/news


we have sought the publicly available information on what this is likely to raise. There was a study commissioned by Ofcom that is basically looking at the amounts of money raised from similar auctions in other countries. There was a PwC study doing a similar sort of thing, which suggested that £3.5 billion was about the right sum of money.122

[…]

Ofcom themselves would say that the reserve price is not a good guide to the receipts you would expect from this. As I say, what we basically did was to look to what publicly available information was out there, which is primarily drawing on an analysis of how much similar auctions have raised in other countries. They are hard to compare exactly because they are not auctioning exactly the same bits of spectrum, but certainly £3.5 billion was around the number where these independent assessments—so they were not commissioned by the Government—were coming out. But needless to say there is, as ever, considerable uncertainty around what the number will be.123

70. We note that following our hearings on the Autumn Statement, PWC has announced the results of the spectrum auction in the Netherlands. It commented that the auction “is not directly comparable, but does suggest the UK prices will be towards the high end of expectations”, and “the result [...] is bound to add to confidence that the £3.5bn will be achieved.”124 Debate remains, however, with others such as James Barford, mobile analyst at Enders Analysis, saying that “the auction may struggle to raise £3.5bn” and “should raise about £2.5bn”.125

71. Ofcom’s timetable indicates applications from prospective bidders were due by 11 December 2012 with completion of the sale in March 2013. This represents a delay of a year compared to its original plans and means completion falls only just within the 2012–13 financial period.126 The Treasury has included the receipt in its Autumn Statement figures for 2012–13. 127 When asked whether the OBR was happy that this money would arrive in this financial year, Mr Chote responded:

There is a clear policy commitment to have the auction within the current financial year. There was, if you go back a few months, some debate. I won’t go too much into it but there was some potential legal action that could have been in the way of the auction taking place because of some of the potential participants’ views on it. We have been told that all the participants are basically happy to proceed on the basis

122 Q 21

123 Q 77

124 PWC, Announcement of the results of the spectrum auction in the Netherlands increases expectations of the UK 4G auction, 17 December 2012

125 BBC News, Will the 4G mobile auction meet the £3.5bn target?, 12 December 2012, http://www.bbc.co.uk/news/business-20679818

126 Ofcom, Ofcom finalises 4G auction rules,12 November 2012, http://consumers.ofcom.org.uk/news; BBC News, Ofcom launches next-generation 4G consultation, 22 March 2011, http://www.bbc.co.uk/news/business-12811122

127 HM Treasury, Autumn Statement 2012, 5 December 2012, Table 2.1, p66 para 2.43


that the Government is currently intending to. The policy decision is to do it this year and we would assume that the money comes in on that basis.128

Swiss tax repatriation

Table 5: Expected impact of tax repatriation from Switzerland

£ million

2012–13 2013–14 2014–15 2015–16 2016–17 2017–18 Tax repatriation from Switzerland +330 +3,120 +610 +920 +180 +150

Source: HM Treasury, Autumn Statement 2012, 5 December 2012, Table 2.1, p 57

72. The UK and Switzerland have reached an agreement which has four main elements:

• a one-off levy applied to existing Swiss assets owned by UK residents;

• a withholding tax on future income and gains;

• a 40% inheritance levy applied to Swiss assets for UK investors; and

• an enhanced exchange of information.

73. There are a number of ways that those using Switzerland as a tax haven can react to the agreement. For instance they can pay the levy, make separate disclosures or just move their money.129 The Treasury claims that it has taken account of this in its costings stating that “the behavioural aspects of this measure have been captured in the tax base and an adjustment has also been made to account for identification failure.”

74. The OBR did not certify the Government’s forecast yield from the agreement in March 2012 of between £4 billion and £7 billion and excluded it from its March 2012 central projection, stating that:

initial discussions with HMRC suggested significant uncertainties and we [the OBR] currently judge that the yield is likely to be towards the lower end of the range. We will consider the available evidence further for the final costing.130

75. The Treasury now forecasts in the Autumn Statement that the agreement will bring in over £5 billion in additional tax revenues over the next six years. It expects to receive £3.1 billion of this during 2013–14.131

76. We asked the OBR what gave it confidence that its alternative figure of £5 billion had greater validity than that originally produced by HMRC. Mr Chote responded that:

“given the nature of the people and the sums of money you are dealing with here, [it] is a particularly uncertain estimate. You have to judge how much money [...] you think is out there, how is behaviour likely to respond in a whole variety of ways. I

128 Q 78

129 PWC, UK Swiss tax agreement: Action required by UK resident Swiss bank account holders, 3 September 2012, http://www.pwc.co.uk/tax/issues/ti-latest-news.jhtml

130 OBR, Economic and Fiscal Outlook, March 2012, pp97-98, para 4.43

131 HM Treasury, Autumn Statement 2012, 5 December 2012, Table 2.1, p 53 para 1.173


think our initial judgment that the original figure that had been cited in the public domain was a bit too high was primarily on our assessment that the actual amount of money out there was rather less, rather than a view that we had a particularly better idea of how people were likely to respond to the measure.132

77. The sums expected from the sale of the 4G spectrum and Swiss tax repatriation represent the majority of the additional receipts the Treasury intends to offset against the tax reductions and investment announced in the Autumn Statement for 2012–13 and 2013–14. Both are subject to uncertainty. In the case of the tax repatriation from Switzerland, the proceeds may not meet expectations if assumptions about the potential tax liabilities and expected behaviour of those affected prove not to be valid.

Departmental cuts

Table 6: Expected savings from further departmental cuts

£ million

2012–13 2013–14 2014–15 2015–16 2016–17 2017–18 Reduction in departmental spending in 2013–14 and 2014–15

0 +980 +2,400 +2,400 +2,400 +2,400


78. The Autumn Statement sets out the Government’s intention to make further cuts to departmental budgets totalling at least £10 billion over the period to 2017–18. The Chancellor announced that the “detail of departmental spending plans for 2015–16 will be set at a spending review, which will be announced during the first half of next year.133

79. The Chancellor explained that the “we have to take, again, a series of difficult decisions” but that “the default assumption of the spending review is that the money will come from the departments. It will not come from tax rises or additional welfare savings.” The Chancellor undertook that the Government was “going to maintain the protections we have put in place, for example, with health spending and school spending and our overseas aid”, adding that this represents “about half of the general government expenditure”. 134 The Autumn Statement also says that HMRC will be protected from further cuts.135

80. Taking these protected areas into account, Mr Johnson of the IFS told us that this will result in “total cuts in the unprotected departments from 2010 of nearly a third […] some of those departments have already had cuts of more than 25%, so that is very difficult indeed.”136 The IFS concluded that should the currently ring-fenced departments (constituting roughly half of government departmental spending) continue to be protected, departments implementing cuts would by 2017–18 have faced an average real-terms cut of up to 35 per cent. Asked whether this was feasible, Mr Johnson stated that:

132 Q 82

133 HC Deb, 5 December 2012, Col 875 [Commons Chamber]

134 Qq 350, 351

135 HM Treasury, Autumn Statement 2012, 5 December 2012, p 61 para 2.15

136 Q 225


if you exclude tax increases and the NHS and welfare form your calculations, that leaves you with a really extraordinary squeeze on the other sort of half. Basically, you are only looking at half of spending for really big changes, and the longer that carries on the less sustainable that looks.137

The IFS’s analysis is that the current fiscal measures would lead to an 85:15 split between spending cuts and tax rises by 2017–18.

81. Departments face considerable challenges as a result of the cuts already announced in the Spending Review 2010. About half of general government expenditure is to be protected from these new cuts. The complete protection of ring-fenced departmental budgets will be difficult for the Government to sustain while other departments are substantially affected. In some cases such protection may be difficult to justify. As we said in our report on the 2010 Spending Review, rinfencing can lead to allocative problems across government as a whole, and reduce scrutiny of ringenced departments. The forthcoming Spending Review will be economically and politically crucial. The Treasury Committee will scrutinise the Spending Review in order to assess, among other things, the process by which decisions are made, the economic impact of the decisions, the justification for any ringfencing, and the distributional effect of the Spending Review.

Fuel Duty

Table 7: Expected impact of fuel duty policy decision

£ million

2012–13 2013–14 2014–15 2015–16 2016–17 2017–18 Fuel duty: cancel January 2013 increase deferred from 2012 and delay future increases to September

-890 -1,640 -1,625 -1,715 -1,420 -1,465


82. In June 2012, the Government announced that the fuel duty increase planned for 1 August 2012 would be deferred to 1 January 2013. In the Autumn Statement 2012, the Chancellor announced that:

The Government will cancel the 3.02 pence per litre fuel duty increase that was planned for 1 January 2013. The Government will move the 2013–14 increase planned for April 2013 to 1 September 2013. There will be only one fuel duty increase in 2013. For the remainder of the Parliament, subsequent increases will take effect on 1 September each year instead of 1 April.138

This decision reduces the expected revenue from fuel duty by £8.8 billion over the period from 2012–13 to 2017–18. The Chancellor said to us that he “set out to support, where I could, people in work […] by freezing fuel duty”.139

137 Q 226

138 HM Treasury, Autumn Statement 2012, 5 December 2012, p 72 para 2.89-2.90

139 Q 330


83. This is not the first time that the Government has deferred or cancelled planned increases in fuel duty, as Table X shows.

Table 8: Changes to timing of planned fuel duty rises since the Budget 2011

Dates uprating due before Budget 2011

Budget 2011 Autumn Statement 2011

June 2012 Autumn Statement 2012

April 2011 January 2012 August 2012 January 2013 Cancelled

April 2012 August 2012 Cancelled Cancelled Cancelled

April 2013 April 2013 April 2013 April 2013 September 2013



April 2016 April 2016 April 2016 April 2016 April 2016

Source: Institute for Fiscal Studies, Presentation given at the Autumn Statement 2012 briefing, 6 December

84. Recent Government policy on fuel duty has failed to provide either the certainty or the stability that are the hallmarks of good tax policy. The Chancellor must use the 2013 Budget to set out a clearer strategy for fuel duty over at least the medium term.


5 Other issues

Measures to encourage growth

85. The 2012 Autumn Statement outlined a number of measures to promote growth in the UK economy, building upon the proposals announced in The Plan for growth at the time of the 2011 Autumn Statement. New measures to promote economic growth included:

• Developing the UK’s infrastructure with a £5.5 billion capital package and support for long-term private investment including in new roads, science infrastructure and free schools;

• A further 1 per cent cut in the main rate of corporation tax from April 2014 to 21 per cent;

• “a significant temporary increase” in the Annual Investment Allowance, from £25,000 to £250,000 for qualifying investment in plant and machinery for two years from 1 January 2013, “designed to encourage and incentivise business investment [...] particularly amongst SMEs”;

• Devolving a greater proportion of growth-related public spending to local areas from April 2015, in response to Lord Heseltine’s review of economic growth; and

• The creation of a Business Bank as well as enabling UK Export Finance (UKEF) to provide up to £1.5 billion in loans to finance small firms’ exports.140

Additionally, the Government announced that it would “strengthen the mandate of infrastructure UK (IUK) and increase its commercial expertise to boost the delivery of growth-enhancing infrastructure projects across government”. The Government stated that IUK, together with the Major Projects Authority, would “undertake a detailed assessment of Whitehall’s ability to deliver infrastructure”.141 This work is to be completed by the time of the 2013 Budget and will be led by Lord Deighton the incoming Commercial Secretary to the Treasury.

86. Professor Philip Booth stressed the importance of introducing “supply-side reforms which would raise economic growth” as well as measures to boost productivity levels which he described as “shockingly low at the moment”. He outlined what he considered should be the Government’s supply-side priorities:

I would like to see much greater planning liberalisation but also a principle of compensation introduced into the planning system so that you get a planning system that runs with the grain of people’s preferences and runs with the grain of the market and so on.142

140 HM Treasury, Autumn Statement 2012, December 2012, paras 1.77,1.134

141 HM Treasury, Autumn Statement 2012, December 2012, para 1.96

142 Q 169


Professor Booth described the Government as “playing at a supply-side agenda”, adding that “there is no one thing you can point to that has been really radical that has been done other than the reduction in corporation tax”. Lee Hopley of the EEF focussed not on the corporation tax cut, but on the increase in the investment allowance which she described as “a very welcome move”. She added that:

It comes at a time when there are lots of factors weighing down investment plans, so having a signal through the tax system that the UK is the right place to invest and now is the time to do it was welcome.143

Ms Hopley went on to point out that the EEF’s “central ask was for a temporary increase to 100% for capital allowances for a two-year basis”, which “would have covered all investment”. The difference, she explained, was because whilst the allowance would “cover over 99% of all companies”, it would only cover around 30% or 35% of the actual investment in the economy. When asked whether the positive impact on investment of the increase in the investment allowance would be outweighed by the negative impact on investment of the “weak state of demand in the economy”, Ms Hopley replied that:

Investment in manufacturing is still considerably below its pre-recession peak, but we know from all our survey evidence that there is a real appetite to invest in new plant and equipment. That is the thing that is going to secure companies’ competitiveness for the medium term. I think companies with significant investment plans will be looking beyond the demand outlook in the next three to six months when they make those decisions.144

87. The Chancellor told us that the supply-side policies he announced in the Autumn Statement were “designed to improve the structural competiveness of the British economy”. He explained that the focus on “roads and schools and the like” was because “that is right for the medium-to-long term performance of the British economy”. That was also why the Government was “switching current to capital spending”. The Chancellor suggested that his policies were already bearing fruit:

In terms of its impact, I think an interesting measure at the moment is how the UK is climbing up the league tables of competitive places in the world to do business, so we have climbed back into the top ten of the World Economic Forum list and I think we are now at number eight. So we are becoming a more and more competitive economy. I think that is a combination of supply side reforms to welfare, education, the tax system, the capital investment in key bits of economic infrastructure and the like.145

Reforming PFI

88. Alongside the Autumn Statement, the Government published details of its new approach to public private partnerships, following its review of the Private Finance Initiative (PFI). PFI was introduced in order to engage the private sector in the design,

143 Q 177

144 Q 180

145 Q 285


build, finance and operation of public infrastructure, with “the aim of delivering good quality and well maintained assets that provided value for money for the taxpayer”.146 However, PFI has been subject to a number of criticisms which the Government outlined in A new approach to public private partnerships. These “weaknesses” included:

• The PFI procurement process has often been slow and expensive for both the public and the private sector. This has led to increasing costs and has reduced value for money for the taxpayer;

• PFI contracts have been insufficiently flexible during the operational period, so making alterations to reflect the public sector’s service requirements has been difficult;

• There has been insufficient transparency on the future liabilities created by PFI projects to the taxpayer and on the returns made by investors;

• Inappropriate risks have been transferred to the private sector resulting in a higher risk premium being charged to the public sector; and

• Equity investors in PFI projects are perceived to have made windfall gains, and this has led to concerns about the value for money of projects.147

In Autumn Statement 2012, the Government stated that PF2, the successor to PFI, would continue “to draw on private finance and expertise to deliver government investment in public infrastructure and services, while addressing past concerns about the PFI and responding to the recent changes in the economic context”.148

89. These “past concerns” about PFI, referred to by the Government, have been raised in a number of studies, including the Treasury Committee’s 2011 Report Private Finance Initiative. Our principal concern was that:

private finance has always been more expensive than government borrowing, but since the financial crisis the difference between the costs has widened significantly. The cost of capital for a typical PFI project is currently over 8% -double the long term government gilt rate of approximately 4%. The difference in finance costs means that PFI projects are significantly more expensive to fund over the life of a project. This represents a significant cost to taxpayers.149

The Committee said that it had “not seen clear evidence of savings and benefits in other areas of PFI projects which are sufficient to offset this significantly higher cost of finance”. The Committee identified a number of incentives to use PFI which were unrelated to value for money. These included:

• The majority of PFI debt still does not appear in government debt or deficit figures; and

146 HM Treasury, A new approach to public private partnerships, p 5, December 2012

147 HM Treasury, A new approach to public private partnerships, p 6, December 2012

148 Autumn Statement 2012,page 38, para 1.98, December 2012

149 Treasury Committee, Seventeenth Report of Session 2010–12, Private Finance Initiative, HC 1146, Vol 1 p 3


• Government departments can use PFI to leverage up their budgets without using their allotted capital budget—the investment is additional and not budgeted for. 150

Our conclusion was that “incentives unrelated to value for money need to be removed. Stricter rules and guidelines governing the use of PFI must be introduced”.151

90. A new approach to public private partnerships outlined a series of proposals designed to address the “weaknesses” listed by the Government. In particular, the Government proposed to strengthen significantly the partnership between the public and private sector by:

• Looking to act as a minority public equity co-investor in PF2 projects; and

• Introducing funding competitions for a proportion of equity to attract long-term funding investors into projects prior to financial close.

It also introduced measures designed to accelerate the delivery of projects, to improve the flexibility, transparency and efficiency of services as well as reforms to improve risk allocation and promote future debt finance of projects.

91. We asked Professor Dieter Helm and Mark Hellowell for their views on PF2, focussing on whether it would address the weaknesses in PFI and, in particular, the Treasury Committee’s concern regarding the off-balance sheet incentives for Government to use PFI even where this option does not appear to deliver value for money to the taxpayer. Professor Helm told us that “it would be hard to make PFI worse, so it is hard to dispute that the steps that have been taken are in the right direction. Who wouldn’t want to accelerate delivery, make service provision flexible and make it more transparent?”152 Mr Hellowell said that the incentives to use PFI regardless of value for money considerations remained. He told us:

in terms of the off-balance sheet question ... The move from PFI to PFI2 or PF2 doesn’t really do anything substantially different in terms of the accounting treatment, and therefore we still have the Budgetary incentive and the fiscal incentive to pursue private financing almost regardless of the sort of value for money merits of PFI [...]

There is still an incentive to use private finance in order to leverage increase capital budgets for departments. There is still an incentive to use private finance in order to leverage increase capital budgets for departments. There is still an incentive to use off-balance-sheet financing in order to make the level of national indebtedness look a little bit better than it really is, and so those kind of budgetary or fiscal incentives still remain.153

92. We asked witnesses about the difference in costs as a result of borrowing off-balance sheet (using PFI or PF2) as opposed to borrowing on-balance sheet. Mr Hellowell told us



152 Q 235

153 Q 237


that “the cost of a conventional PFI scheme ... the weighted average cost of capital would be something like 8.5% to 9%, probably higher for a higher risk project ...” whilst it would be 2% to 3% on-balance sheet.154

93. The Government aims to move from the present debt to equity ratios of about 90/10 to closer to 75/25. The Government’s believes that a lower level of gearing would encourage more risk-averse investors such as pension funds to participate in PF2. However, Mr Hellowell told us that, as a result, PF2 would “almost certainly ... increase the weighted cost of capital” in the short-term. This was, he explained, “because of the higher equity component” where the normal rate of return expected on equity is 15% whereas “on an average project, the interest rate on debt is now around 7%”.155

94. Reform of PFI is long overdue. However, the Committee is concerned that the Government’s proposals may not address the major problems with PFI, namely the high cost of funding compared with the cost of government borrowing and the incentive for departments to use off-balance sheet financing to increase their capital budgets. The Committee will be examining the Government’s new PFI proposals in more detail in the near future.

Distributional analysis

95. The 2012 Autumn Statement contained a small but significant number of policy announcements on tax, tax credits and benefits. These included a further increase in the personal tax allowance. At the 2012 Budget the Government announced an increase in the personal allowance of £1,100 to be introduced in April 2013.156 In addition, in the 2012 Autumn Statement it announced a further rise of £235, meaning a combined increase of £1,335. From April 2013, people will be able to earn £9,440 before paying any income tax.157 Other measures in the Autumn Statement included an increase in the higher rate threshold for income tax of 1 per cent rather than inflation in 2014–15 and 2015–16, and an increase in the basic state pension of 2.5%.158

96. On benefits, the Government also announced that “In line with the general economic conditions and to ensure the overall affordability of the welfare system”:

most working age benefits (including the main elements of Jobseeker’s Allowance, Employment and Support Allowance and Income Support) will be uprated by 1 per cent for three years from April 2013;

this will also extend to Child Tax Credit and Working Tax Credit, except for those elements that are already frozen in 2013–14 and the family element; and

Child Benefit will be uprated by 1 per cent in 2014–15 and 2015–16.

[...]

154 Qq 239, 242

155 Mark Hellowell blog

156 HM Treasury, Budget 2012, p 29, para 1.73, March 2012

157 HM Treasury, Autumn Statement 2012, December 2012, p 8

158 HM Treasury, Autumn Statement 2012, December 2012, p 8


Other benefits, including the Additional State Pension and those specifically for disability and carers, will continue to be uprated in line with prices, as will the disability elements of tax credits. The Government confirms that the basic State Pension will increase by 2.5 per cent in April 2013.

[...]

The Government will uprate Local Housing Allowance rates in line with the previously announced policy in April 2013, but will cap increases to 1 per cent in most areas in 2014–15 and 2015–16. 159

The Chancellor justified his decisions as follows:

We have to acknowledge that over the last five years those on out of work benefits have seen their incomes rise twice as fast as those in work. With pay restraint in businesses and government, average earnings have risen by around 10% since 2007. Out of work benefits have gone up by around 20%. That’s not fair to working people who pay the taxes that fund them. Those working in the public services, who have seen their basic pay frozen, will now see it rise by an average of 1%. A similar approach of a 1% rise should apply to those in receipt of benefits. That is fair and it will ensure that we have a welfare system that Britain can afford. We will support the vulnerable, so carers’ benefits and disability benefits, including disability elements of tax credits, will be increased in line with inflation, and we are extending the support for mortgage interest for two more years.

However, most working-age benefits, including jobseeker’s allowance, employment and support allowance and income support, will be uprated by 1% for the next three years. [...]

Let me be clear: uprating benefits at 1% means that people get more cash, but less than the rate of inflation. Taken together, we will save £3.7 billion in 2015–16 and deliver permanent savings each and every year from our country’s welfare bill. To bring all those decisions on many benefits over many years together, we will introduce primary legislation in Parliament in the welfare uprating Bill.160

Estimated effect of benefit announcements

97. Following the Autumn Statement a number of organisations published research estimating the impact of the measures in the Autumn Statement on households across the income distribution. The Resolution Foundation concluded that:

Today’s fiscally neutral Autumn Statement was billed as one for strivers. We have already shown that around 60 per cent of the cut associated with the 1 per cent uprating of most working-age benefits and tax credits will actually fall on working households. But of course, the additional £235 increase in the personal tax allowance from April 2013 will benefit many of those in work. What’s the combined impact?—

159 HM Treasury, Autumn Statement 2012, December 2012, para 1.155

160 HC Deb, 5 December 2012, col 879


losses from tax credits and benefit credits outweigh gains from increased personal tax allowance.161

The Resolution Foundation also calculated that the measures in the Autumn Statement would mean those in the bottom decile of the income distribution would lose £152 a year, whilst those in the two deciles above this would lose £146 and £136 per year respectively.162

98. The IFS calculated that a one earner couple with children would be on average £10.26 a week (or £534 a year) worse off as a result of the measures in the Autumn Statement. This £534 figure was raised in Prime Minister’s Question Time on 12 December and in our evidence sessions with the IFS and the Chancellor.

99. Mr Johnson, Director of the IFS, explained that the Institute had produced two sets of figure—one which focussed exclusively on the impact on households of the measures in the 2012 Autumn Statement, and a second which examined the full impact of the fiscal consolidation. Mr Johnson confirmed that the £534 per annum figure referred to the impact of measures in the 2012 Autumn Statement on a one earner couple with children taken in isolation and “when fully implemented in 2015”.163 Taking the policy measures announced in the 2012 Autumn Statement in isolation meant, Mr Johnson told us:

Our number, the £500 [£534] number, includes what was announced in the Autumn Statement, which was the announced reductions in Universal Credit, so the cut relative to what would have been in place had the Autumn Statement not been there. So again, that £500 number does not include the introduction of Universal Credit, but it does include the cuts that were announced.164

100. We also asked Mr Johnson about the impact of all policy decisions taken since 2010 on the average working family. He told us that:

couples with children with one earner [...] are [...] the biggest losers over the whole period, and that comes to more like just over £3,000 a year on average. We have taken this from the beginning of the consolidation, so January 2010. That includes the tax increases in the Budget before this Government came in, and the average is clearly significantly driven by big losses among a minority of that group, including big losses at the top.165

101. We asked the IFS which groups across the income distribution had lost out most from the specific measures in the 2012 Autumn Statement and whether it was skewed against the those at the bottom of the income distribution:

If you take out the top decile entirely, then what was announced in the Autumn Statement? Some cuts to benefits—obviously that is going to impact the bottom third

161 Resolution Foundation blog, 5 December 2012, http://www.resolutionfoundation.org/blog/2012/Dec/05/autumn-

statement-strivers/

162 The Resolution Foundation’s analysis is based upon 3 measures in the 2012 Autumn Statement: the one per cent underrating of working-age benefits, the increase in the personal allowance announced at the Autumn Statement and the below-inflation up-rating of the higher rate income tax threshold

163 Q 221

164 Q 223

165 Q 229


half of the population—some tax reductions, an increase in the personal allowance and a reduction in council tax and in petrol taxes that benefits people across the distribution, and the things that hit the people at the top, effectively a fall in the higher-rate allowance and a squeeze on pension allowances. In a sense the shape was entirely predictable before we ran the model, and it is exactly as you describe: the bottom third to half lose a bit, the middle or sort of the upper third gain a little bit, and the people in the top decile lose a bit more.166

102. The Chancellor was asked whether he agreed with the IFS’s £534 figure. He told us that it was “a selective thing” which failed to:

include the total increase in the personal allowance next April nor, as I understand it, does it include the impact of Universal Credit. What it does is it takes Universal Credit as the baseline and then takes off the baseline individual decisions we have taken on Universal Credit, for example to uprate some of the disregards by 1% as well, without taking into account the stock of the impact of Universal Credit on lower income working families. 167

Instead the Chancellor insisted that “the average working family” was “£125 better off because of the measures in the Autumn Statement.” He added that, in his opinion, it was “very selective to take the policy decisions that affect Universal Credit without looking at Universal Credit itself, which hasn’t even come into effect”.168

103. The Chancellor did, however, find other aspects of the IFS analysis “very striking”:

Chart after chart after chart showed that the richest were paying the most, not just in cash terms but as a proportion of their income. I thought the IFS nailed the argument that somehow the better off have got away with it, because the better off were paying more—more as a percentage of their income, more in cash as well. Those charts from the IFS I thought were pretty compelling.169

104. We also examined the Resolution Foundation’s estimate that 60% of those affected by the one per cent underrating came from working households. Mr Johnson told us that such a figure would be “hardly surprising, given that the large majority of people are in work, and so the large majority of people affected are likely to be in work”.170

105. The Chancellor accepted that “working households in receipt of benefits ... will be affected by the decision to uprate tax credits at 1 per cent”. Indeed, the Chancellor went on to say that “if you look at 2015–16 and you look at the £3.7 billion of welfare savings, £1.4 billion comes from the tax credits upraising and around 70% of tax credit recipients are in work”.171 The Chancellor went on to argue that underrating working-age benefits “was a perfectly fair way to try and save money and to make sure we have a state that we can

166 Q 214

167 Q 331

168 Q 332

169 Q 303

170 Q 221

171 Q 301


afford”. However, when pressed, the Chancellor justified his decision by reference to the fact that out-of-work benefits had increased by more than average earnings:

For those who do not support this they have to explain why it is fair to taxpayers that out-of-work benefits for example have gone up by 20% and earnings have gone up by 10%, but more to the point they have to explain what else they would do.172

172 Q 303


Conclusions and recommendations

Conclusions

1. Whilst it is recognised that an Autumn Statement is useful to appraise the effectiveness (or otherwise) of measures announced in the spring Budget, and the general state of public finances and the wider economy, the Autumn Statement has taken on the role of being a second, full, Budget. The implications are that business and the economy needs to react to two periods, not one, of potential uncertainty and change. A return to a position of one Budget in the spring, and an updating statement in the autumn, would be desirable. (Paragraph 2)

2. The OBR’s forecasts so far have been biased to over-optimism. This would not be a cause for concern but for the fact that the OBR’s forecasts have implications for decisions on public policy. This is because the fiscal mandate is defined with direct reference to a forecast, and because the OBR’s is at present the only official forecast against which the fiscal mandate can be measured. (Paragraph 14)

3. Exceptionally accommodative monetary policy and bank forbearance both provide support to companies at present and will have helped many companies to survive, supporting employment. But their effect will not be costless over the long-term. Some companies may remain trading when a more prudent examination of their business plan would suggest that they should not. Loans given to such companies may act to hamper banks’ ability to lend to new firms with better prospects. (Paragraph 28)

4. The supply of corporate lending by the banks remains of significant concern, especially for smaller firms. We have heard evidence that the weakness of corporate lending may be hindering some firms from expanding. (Paragraph 29)

5. The evidence received suggests that quantitative easing was an appropriate response at the start of the financial crisis. As time goes on, its effectiveness may be diminishing. Some, including members of the MPC, have argued that the Bank of England should consider pursuing alternative forms of monetary easing. The Treasury Committee will be holding a detailed inquiry into quantitative easing in the coming months. (Paragraph 38)

6. As part of our hearing on 7 February 2013 with the new Governor of the Bank of England, we will examine whether Dr Carney considers that the current monetary policy of the Bank of England remains the most appropriate. We would welcome written evidence on this from others prior to that hearing. (Paragraph 41)

7. The Government is forecast to meet the rolling fiscal mandate by cutting non-investment spending as a share of GDP for a further year, but not the supplementary target. It has decided not to propose further spending cuts or tax rises in order to meet the latter. The possible failure to meet the supplementary target raises the question of the continuing credibility of that target. Successive governments have committed themselves to, but then failed to meet, their fiscal targets. For a fiscal target to be credible, it must be durable, and therefore not subject to frequent


revision as circumstances change. It must also be capable of accommodating conditions different from those at the time the target was first formulated. Nor should a fiscal target be open to manipulation. It is not the case, though, that a target is valuable only so long as it is met. A target can remain credible, and so constrain a government’s choices, even if it is not being met, so long as the political commitment that created it continues to inform policy decisions. (Paragraph 48)

8. The OBR presented in its forecasts the effect of the Asset Purchase Facility transfer, and set out its assumptions in modelling the unwinding of Quantitative Easing. This transparency is welcome. (Paragraph 56)

9. The perceived independence of the MPC is of paramount importance for the effective execution of its duties. We acknowledge that the MPC had the opportunity at its November meeting to take steps to negate the impact on monetary conditions of the APF transfer. The MPC’s actual independence was therefore not threatened. But by not announcing the monetary easing that arose from the APF transfer to the Treasury at the time of its regular November press release, the MPC gave the impression that the Treasury was undertaking monetary policy, rather than the MPC. (Paragraph 61)

10. The sums expected from the sale of the 4G spectrum and Swiss tax repatriation represent the majority of the additional receipts the Treasury intends to offset against the tax reductions and investment announced in the Autumn Statement for 2012–13 and 2013–14. Both are subject to uncertainty. In the case of the tax repatriation from Switzerland, the proceeds may not meet expectations if assumptions about the potential tax liabilities and expected behaviour of those affected prove not to be valid. (Paragraph 77)

11. Departments face considerable challenges as a result of the cuts already announced in the Spending Review 2010. About half of general government expenditure is to be protected from these new cuts. The complete protection of ring-fenced departmental budgets will be difficult for the Government to sustain while other departments are substantially affected. In some cases such protection may be difficult to justify. As we said in our report on the 2010 Spending Review, rinfencing can lead to allocative problems across government as a whole, and reduce scrutiny of ringenced departments. The forthcoming Spending Review will be economically and politically crucial. The Treasury Committee will scrutinise the Spending Review in order to assess, among other things, the process by which decisions are made, the economic impact of the decisions, the justification for any ringfencing, and the distributional effect of the Spending Review. (Paragraph 81)

12. Reform of PFI is long overdue. However, the Committee is concerned that the Government’s proposals may not address the major problems with PFI, namely the high cost of funding compared with the cost of government borrowing and the incentive for departments to use off-balance sheet financing to increase their capital budgets. The Committee will be examining the Government’s new PFI proposals in more detail in the near future. (Paragraph 94)


Recommendations

13. We reiterate our recommendation that Treasury and business managers ensure that the House has a longer period than in 2012 between the publication of the Finance Bill and its Second Reading and, particularly, between Second Reading and Committee of the Whole House. We believe this to be an important issue of principle going to the heart of Treasury Ministers’ accountability to Parliament. (Paragraph 6)

14. As we have recommended in the past, the OBR should do more to ensure that there is greater public understanding of the limitations and purpose of forecasting, and more realistic expectations of what forecasting can deliver. (Paragraph 13)

15. The OBR is required by statute to issue two economic and fiscal forecasts a year. The Chancellor’s own Autumn Statement, however, has now grown to be virtually a second Budget. There are good reasons for having a single substantial annual review of the fiscal and economic state of the country, not least to enable the subsequent presentation to Parliament of proposed tax measures and of Estimates of expenditure. The Treasury should re-establish the annual Budget as the main focus of fiscal and economic policy making. (Paragraph 15)

16. It is early days for the Funding for Lending Scheme, and it is too soon to consider its impact on business lending. We are concerned, however, by reports that there may be a bias in the effect of the Scheme that favours lending for mortgages rather than lending to SMEs. The Bank of England and the Treasury should assess whether this is the case and report their findings and any proposed action to the Treasury Committee. (Paragraph 21)

17. The supplementary target remains in place for the moment. The Government has said that it will set a new target, but its timetable is vague: it will do so “once the exceptional rise in debt has been addressed”. When the Government does decide to create a new fiscal framework, it should do so only after full public consultation. The Committee will return to this issue. (Paragraph 49)

18. The MPC needed to be in a position to publicise the transfer at the time of its press release in order to fulfil its duty to act transparently and to demonstrate its independence. Had the MPC decided that it needed to negate the effect of the APF transfer by reducing QE, it would have had to reveal the APF transfer in order to be able to explain its decision. Deciding not to cancel out the effect of the APF transfer was also a decision that the MPC took which deserved public explanation, especially as we know that the transfer influenced MPC members’ decision-making. The Bank of England should, therefore, have ensured that the MPC was in a position to make the fact of the APF transfer public at the time of the publication of its November press release. A satisfactory alternative would have been for the Treasury to have announced the transfer at the same time as, or before, the release of the MPC’s minutes. The Treasury and to some extent the Bank were at fault for failing to coordinate the announcement of the APF transfer with that of the November MPC press release, the date of which was known well in advance. This failure created difficulties for the reputation of the MPC. This should not be repeated. (Paragraph 62)


19. Recent Government policy on fuel duty has failed to provide either the certainty or the stability that are the hallmarks of good tax policy. The Chancellor must use the 2013 Budget to set out a clearer strategy for fuel duty over at least the medium term. (Paragraph 84)


Formal Minutes

Tuesday 22 January 2013

Members present:

Mr Andrew Tyrie, in the Chair

Mark Garnier Andrea Leadsom Mr Pat McFadden Mr George Mudie

Mr Brooks Newmark Jesse Norman David Ruffley John Thurso

Draft Report (Autumn Statement 2012), proposed by the Chair, brought up and read.

Ordered, That the draft Report be read a second time, paragraph by paragraph.

Paragraphs 1 to 105 read and agreed to.

Resolved, That the Report be the Seventh Report of the Committee to the House.

Ordered, That the Chair make the Report to the House.

Ordered, That embargoed copies of the Report be made available, in accordance with the provisions of Standing Order No. 134.

[Adjourned till Tuesday 29 January at 9.15 am


Witnesses

Tuesday 11 December 2012 Page

Robert Chote, Chairman, Steve Nickell CBE and Graham Parker CBE, Members of the Budget Responsibility Committee, Office for Budget Responsibility Ev 1

Wednesday 12 December 2012

Simon Hayes, Chief Economist, Barclays Capital, Simon Wells, Chief UK Economist, HSBC, and Paul Mortimer-Lee, Global Head, Market Economics, BNP Paribas Ev 16

Lee Hopley, Chief Economist, EEF, and Professor Philip Booth, Editorial and Programme Director, Institute of Economic Affairs Ev 22

Paul Johnson, Director, and Carl Emmerson, Deputy Director, Institute for Fiscal Studies Ev 28

Dr Mark Hellowell, Lecturer, School of Social and Political Science, University of Edinburgh, and Professor Dieter Helm CBE, University of Oxford Ev 33

Thursday 13 December 2012

Rt Hon George Osborne MP, Chancellor of the Exchequer, and James Bowler, Director for Strategy, Planning and Budget, HM Treasury Ev 38

List of printed written evidence

1 Paul Mortimer-Lee, Global Head, Market Economics, BNP Paribas Ev 54

2 Professor Dieter Helm, Oxford University Ev 56

3 Rt Hon George Osborne MP, Chancellor of the Exchequer, HM Treasury Ev 57


List of Reports from the Committee during the current Parliament

Session 2010–12

First Report June 2010 Budget HC 350

Second Report Appointment of Dr Martin Weale to the Monetary Policy Committee of the Bank of England

HC 475

Third Report Appointment of Robert Chote as Chair of the Office for Budget Responsibility

HC 476

Fourth Report Office for Budget Responsibility HC 385

Fifth Report Appointments to the Budget Responsibility Committee HC 545

Sixth Report Spending Review 2010 HC 544

Seventh Report Financial Regulation: a preliminary consideration of the Government’s proposals

HC 430

Eighth Report Principles of tax policy HC 753

Ninth Report Competition and Choice in Retail Banking HC 612

Tenth Report Budget 2011 HC 897

Eleventh Report Finance (No.3) Bill HC 497

Twelfth Report Appointment of Dr Ben Broadbent to the monetary Policy Committee of the Bank of England

HC 1051

Thirteenth Report Appointment of Dr Donald Kohn to the interim Financial Policy Committee

HC 1052

Fourteenth Report Appointments of Michael Cohrs and Alastair Clark to the interim Financial Policy Committee

HC 1125

Fifteenth Report Retail Distribution Review HC 857

Sixteenth Report Administration and effectiveness of HM Revenue and Customs HC 731

Seventeenth Report Private Finance Initiative HC 1146

Eighteenth Report The future of cheques HC 1147

Nineteenth Report Independent Commission on Banking HC 1069

Twentieth Report Retail Distribution Review: Government and FSA Responses HC 1533

Twenty-first Report Accountability of the Bank of England HC 874

Twenty-second Report Appointment of Robert Jenkins to the interim Financial Policy Committee

HC 1575

Twenty-third Report The future of cheques: Government and Payments Council Responses

HC 1645

Twenty-fourth Report Appointments to the Office of Tax Simplification HC 1637

Twenty-fifth Report Private Finance Initiative: Government, OBR and NAO Responses

HC 1725

Twenty-sixth Report Financial Conduct Authority HC 1574

Twenty-seventh Report Accountability of the Bank of England: Response from the Court of the Bank

HC 1769

Twenty-eighth Report Financial Conduct Authority: Report on the Governments Response

HC 1857

Twenty-ninth Report Closing the tax gap: HMRC’s record at ensuring tax compliance

HC 1371

Thirtieth Report Budget 2012 HC 1910


Session 2012–13

First Report Financial Services Bill HC 161

Second Report Fixing LIBOR: some preliminary findings HC 481

Third Report Access to cash machines for basic bank account holders

HC 544

Fourth Report Appointment of Mr Ian McCafferty to the Monetary Policy Committee

HC 590

Fifth Report The FSA’s report into the failure of RBS HC 640

Sixth Report Appointment of John Griffith-Jones as Chair-designate of the Financial Conduct Authority

HC 721

Seventh Report Autumn Statement 2012 HC 818

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