The economy

1.  We note that the lower boundaries of the Treasury's forecasts for economic growth in 2008 and 2009 remain above the average of outside forecasters, and we are concerned that the Treasury has provided little evidence of analysis of upside or downside risk and specifically may have given insufficient weight to the risks of continued financial market turbulence and has failed to be more specific about the risks associated with such continued turbulence. The Treasury's optimism is based on its contention that the UK economy is better placed than other OECD economies in the face of market turmoil. We remain concerned that some of the economy's characteristics that have proven beneficial during past crises (rapidly rising residential property prices, close links with the US and an increasing reliance on the financial services industry, for example) might prove to be conduits through which the current problems in global financial markets are transmitted to the United Kingdom real economy. (Paragraph 11)

2.  We note the establishment of a Working Group to examine market-led initiatives to improve liquidity in the mortgage-backed securities market. We expect to continue to monitor developments in asset-backed securities markets and their impact on housing finance. We believe that the Working Group should also consider any need for new mortgage support schemes for low-income homeowners in difficulty. We look forward to the Working Group reporting back to the Chancellor of the Exchequer in the Summer and producing a final report at the time of the 2008 Pre-Budget Report. (Paragraph 23)

3.  We expect to continue to monitor endeavours by the Government and the Financial Services Authority to promote the supply of, and demand for, long-term fixed-rate mortgages. (Paragraph 24)

The public finances

4.  There has been a further weakening of the Treasury's forecasts of the current budget balance from 2008-09 onwards since last year and the latest forecasts for the fiscal position are based on forecasts for economic growth that are subject to considerable downside risks. (Paragraph 31)

5.  In our previous recommendations in our Reports on the 2007 Budget and 2007 Pre-Budget Report, we argued that the Government should review the golden rule such that it becomes more forward looking and less dependent upon the dating of the economic cycle. The current inability of the Treasury to date the end of the economic cycle works against the positive attributes of a fiscal rule founded on judgements about economic cycles. We continue to believe that the golden rule should be more forward-looking, but, even on the Treasury's own current formulation, it appears to us to be premature for the Treasury to state that it is "on course" to meet the golden rule in the next economic cycle, given the lack of an end date for the previous economic cycle. (Paragraph 34)

6.  The Government has forecast that it will meet the sustainable investment rule over the period up to 2012-13. However, the margin by which it is now forecasting that it will meet the rule is extremely tight, especially considering the uncertainty surrounding the overall economic situation. (Paragraph 36)

7.  It seems highly likely that, following the move to International Financial Reporting Standards for central government, the sustainable investment rule as currently defined and interpreted will be breached in 2009-10 as a result of the reclassification of PFI projects. As such, the delay announced in Budget 2008 in the implementation of International Financial Reporting Standards gives the Government a chance to announce in advance whether and how it proposes to revise the sustainable investment rule in the light of the implementation of International Financial Reporting Standards. We recommend that the Government publish in the 2008 Pre-Budget Report any proposed changes to the sustainable investment rule and its interpretation arising from classification changes resulting from International Financial Reporting Standards. (Paragraph 39)

8.  We accept that Northern Rock's inclusion within calculations of Public Sector Net Debt should not influence decision-making under the fiscal framework. It is nevertheless important that the Government reports transparently on the effects of Northern Rock in its forecasts of Public Sector Net Debt as a proportion of GDP. (Paragraph 41)

9.  As we have noted already, the forecasts for the state of the public finances show further deterioration from 2008-09 onwards, and there are significant downside risks to the forecasts for economic growth. Should those risks crystallise, the Government would have extremely limited scope, under the fiscal rules as currently defined, to take further fiscal measures to support monetary policy. We expect to examine the role of the golden rule and of the sustainable investment rule in more detail in our inquiry into the 2008 Pre-Budget Report. (Paragraph 43)

Child poverty, fuel poverty and the poverty trap

10.  We welcome the measures in the 2008 Budget on child poverty, which will make an important contribution towards reducing child poverty. We recommend that the Government, in its response to this Report, clarify the targets that have been set relating to child poverty since the pledge to eliminate child poverty in a generation was first made and report on performance against each of those targets in each financial year. We further recommend that that response set out the Government's estimate of the effect of each measure relating to child poverty in this year's Budget on progress towards the 2010-11 target in each financial year from 2008-09 to 2010-11. We remain concerned that the Government has yet to provide a clear explanation of the linkage between its target to halve child poverty by 2010-11 and the proposed deployment of resources to meet that target. It is of crucial importance that the Government makes it clear that the necessary resources to meet the 2010-11 target are available and that the Government is committed to deploying those resources directly to support low-income families. It is also important that the Government sets out the policy instruments under consideration to meet this target. (Paragraph 52)

11.   It is important that the Government continues to tackle fuel poverty through a combination of targeted and universal measures. We look forward to a constructive outcome to continuing discussions between the Treasury and the energy supply companies, particularly with regard to lowering the differential in charges between those with pre-payment meters and those making other forms of payment. In view of the importance of measures announced in Budgets and Pre-Budget Reports to the progress of the targets to eradicate fuel poverty set by the Government itself and by the devolved administrations, we recommend that the Government report in Budgets and Pre-Budget Reports on the effect of any measures announced at that time on progress towards meeting fuel poverty targets. We further recommend that, in the 2008 Pre-Budget Report, the Government report specifically on:

• the outcome of its discussions with the energy supply companies;
• any legislative measures in this area under consideration; and
• its assessment of the effectiveness of the one-off increase in the winter fuel allowance for Winter 2008-09 in terms of progress in meetings its obligations relating to fuel poverty.

We expect to examine during our inquiry into the 2008 Pre-Budget Report whether the increase in the winter fuel allowance for 2008-09 and the additional measures proposed for the Winter of 2009-10 will be effective in reducing fuel poverty in line with the Government's targets. (Paragraph 56)

12.  The increase in the number of people facing marginal deduction rates of between 60% and 70% is a direct consequence of decisions made by Government as to how the tax and benefit system will work. We acknowledge that such decisions are finely balanced between the overall cost of a benefit, and the rate at which it is withdrawn. We recommend that the Government undertake further research into how the design of the tax credit system, in conjunction with the overall tax and benefit system, is enhancing or impeding progress on the Government's welfare to work objectives, and report on such work in the 2008 Pre-Budget Report. We recommend that, as a basic principle, the Government ensure that high marginal deduction rates are limited wherever possible, and we will continue to keep this matter under review. (Paragraph 60)

13.  Those most affected by the abolition of the 10 pence rate of income tax appear to be those below the age of 65 with an income under £18,500 who are in childless households. The effect is greatest on those households where no individual is above the age of 60 because the household does not then benefit from the higher winter fuel allowance. We accept that there are benefits in tax simplification and that there are merits to focus on both the needs of children and motivation to work. However, the group of main losers from the abolition of the 10 pence rate of income tax seem an unreasonable target for raising additional tax revenues to fund these and other initiatives. (Paragraph 61)

14.  We are concerned by the poor take-up rate of working tax credit among eligible families without children, especially given that working tax credits are intended to mitigate for low-income households the effect of the removal of the 10 pence starting rate of income tax. We expect the Treasury and HM Revenue & Customs to galvanise their efforts in this area in coming months and years. We recommend that the Government report regularly in Budgets and Pre-Budget Reports, starting with the 2008 Pre-Budget Report, on progress in increasing the take-up rates of working tax credits for those sections of society with particularly low take-up rates. We further recommend that the Treasury commission research into whether the withdrawal of the 10 pence income tax band and high marginal deduction rates are creating disincentives that could frustrate the Government's welfare to work objectives. (Paragraph 62)

Public expenditure issues

15.  We are disappointed that the Government has been forced to delay the implementation of International Financial Reporting Standards for the public sector until 2009-10, but not altogether surprised. The proposed timetable of one year for implementation was over-ambitious, and considerably more stretching than the five-year transition period enjoyed by the private sector. The Treasury appears to have misjudged the scale and complexity of the issues involved in the transition to International Financial Reporting Standards, in particular the issue of accounting for private finance initiative assets. (Paragraph 64)

16.  It is important that momentum towards the implementation of International Financial Reporting Standards is maintained and, in that context, we welcome the Treasury's assurance that those departments in a position to do so will produce shadow accounts on an International Financial Reporting Standards basis from 2008-09. It is important that momentum towards the implementation of International Financial Reporting Standards is maintained and, in that context, we welcome the Treasury's assurance that those departments in a position to do so will produce shadow accounts on an International Financial Reporting Standards basis from 2008-09. We recommend that the Government, in its response to this Report, state whether those shadow accounts will be reviewed by the National Audit Office and whether the opinions of the National Audit Office on those shadow accounts will be made public. (Paragraph 65)

17.  We are concerned about the potential for arbitrage between Financial Reporting Standard 5A and the Treasury's Technical Note 1 on accounting for private finance initiative (PFI) assets, creating the potential for different interpretations of appropriate PFI accounting treatment. We recommend that the Treasury, in consultation with the Financial Reporting Advisory Board, seek to ensure that PFI accounting under International Financial Reporting Standards is implemented across the public sector in a consistent, effective and transparent manner. (Paragraph 66)

18.  In reporting the final outcome of the 2004 efficiency programme, it will be crucial that the Treasury provides convincing evidence that the gains reported as 'final' have been achieved without a diminution of service standards. The credibility of such evidence would be enhanced by the reporting of instances where savings have not been included within the final reported total because such evidence has not been provided. The completeness and transparency with which the final outcome of the programme is reported will be an important test of whether HM Treasury can perform the roles of challenge and oversight in relation to the programme previously undertaken by the Office for Government Commerce. (Paragraph 69)

19.  There are a number of unresolved measurement issues relating to the efficiency programme for the period from 2008-09 to 2010-11. We recommend that, in its response to this Report, the Government—

• set out the value for money baselines for each department;
• explain whether a consistent method is used for calculating "counter-factual" expenditure increases and, if not, why not;
• set out the circumstances in which it is appropriate to treat reductions in service as efficiency savings; and
• clarify the circumstances in which a net reduction in expenditure arising from a transfer of costs to the private sector by charging or other means constitutes an efficiency saving.

We further recommend that the Government invite the National Audit Office to examine the published Value for Money Delivery Agreements and that the Government consider the case for publishing updated and improved Agreements in the light of such examination. (Paragraph 72)

20.  We continue to believe that there is a strong case for matching under the Saving Gateway at the level of 50 pence for every pound invested by the individual, possibly with support for the opening months at the pound-for-pound level. We recommend that, in advance of a final decision on matching rates, the Government publish estimates of the cost of implementation based on different levels of matching and associated estimates of take up rates. (Paragraph 74)

21.  We believe that, should the Saving Gateway be extended in future, the first priority should be to extend eligibility to those who would qualify initially in terms of income, but are not in receipt of a qualifying benefit or tax credit. The initial availability of the Saving Gateway only to those claiming qualifying benefits and tax credits reinforces the importance of Government efforts to increase take-up of tax credits to which we referred earlier. We recommend accordingly that the Government consider measures to link promotion of the Saving Gateway with the wider promotion of the availability of tax credits. (Paragraph 76)

22.  We recommend that the Government set out, in its response to our Report, its proposed methods for ensuring that Saving Gateway does not operate so as to provide incentives for financial providers, particularly unregulated financial providers, to lend money at high interest rates to encourage those eligible simply to borrow in order to save in Saving Gateway accounts. (Paragraph 77)

23.  Although we accept that many of those with Saving Gateway accounts will not required to pay tax on the interest earned, we believe that both the simplicity of operation and the appeal of the Saving Gateway would be assisted if it were offered on a tax-free basis. To assist the public debate on this matter, we recommend that, alongside the cost estimates that we have previously called for, the Government set out its forecasts of the total tax receipts from interest on Saving Gateway accounts. (Paragraph 78)

Tax measures

24.  We welcome the announcement of the entrepreneur's relief, which responds to some of the concerns which we voiced in our Report on last year's Pre- Budget Report. However, we believe that significant new record-keeping challenges could be posed by the new relief, and that it is important that HM Revenue & Customs gives full and early advice to potential beneficiaries of the relief and their advisers about these challenges. We note that the entrepreneur's relief does not resolve all the problems created as side-effects by the changes to the capital gains tax regime. We believe that, if the Government is seeking further to simplify taxation for small businesses, it will need to undertake a broader review and consultation which examines the fundamentals of the tax regime. (Paragraph 83)

25.  We are concerned that, as a result of the focus on wealthy individual non-domiciles, there has been insufficient consideration of the possible impact of tax changes announced in the Budget on the middle and lower income groups of non-domiciled taxpayers. Due to the complex nature of the policies on domicile and residence, and the distinction between how liability is incurred for the annual £30,000 charge and the loss of personal tax allowances, we are concerned that the new policies will create a group of non-domiciled taxpayers who would be unwittingly in breach of the new law. We are also not convinced that sufficient consideration has been given to the possible further burden that the measure will place on HM Revenue & Customs. We recommend that the Government, in its response to this Report, summarise the steps being taken by HM Revenue & Customs to deal with the potentially large number of foreign workers who may be seeking tax advice, following the implementation of the new policy. We intend to monitor the tax domicile regimes now proposed to be, or actually, created in a number of other tax jurisdictions. We believe that the Government should undertake a wider review of the off-shoring of both individuals and companies. (Paragraph 88)

26.  We welcome the Chancellor of the Exchequer's decision to undertake a further consultation on the issue of income shifting. However, we are concerned that this proposed legislation would place an additional tax burden on small businesses and we note that it caused widespread concern during the previous consultation period. We recommend that the terms of the consultation be widened to constitute a full review of the principles of small business taxation to ensure that the taxation system rests on practical, workable rules for the small business community. (Paragraph 97)

27.  We welcome steps taken by the Government to prevent tax avoidance through the misuse of double taxation treaties by UK residents. We are concerned by the suggestion that the Government has known about this abuse for some time and yet has failed to act. We recommend that the Government set out, in its response to this Report, when it was first alerted to the abuse, why action was not taken earlier and why it considers a 21-year period of retrospection appropriate. We expect the Government to move swiftly to close future abuses of the tax system that are disclosed to them. (Paragraph 99)