The real economy

1.  We acknowledge that the Government has downgraded its forecast for economic growth in 2008 due to the effects of both the rises in interest rates in the first half of 2007, and the recent disturbance in financial markets. However, the risk remains that the credit crunch will have a greater macroeconomic effect than expected. (Paragraph 6)

2.  The Treasury has forecast a stronger economy for 2009 partly on the basis that there will be only a temporary weakening in the financial sector due to the current problems in financial markets. There nevertheless remains a risk that the financial sector will remain subdued for longer than expected. We feel that the Treasury's optimism that the growth rate should revert to trend in 2009 has not been adequately explained. (Paragraph 9)

3.  We note concerns expressed by some observers about the Treasury's presentation of the risks associated with the economic forecasts outlined in the 2007 Pre-Budget Report. We recommend that the Treasury recast the way in which it presents the risks to the economic forecasts in both Pre-Budget and Budget reports. Quantification of the effects of such risks, should they crystallise, on the Treasury's economic forecasts would be especially useful, so that the order of importance in which the Treasury regards such risks can be assessed. (Paragraph 13)

4.  The housing market finally appears to be slowing, with house price inflation expected to fall. Despite this, the Treasury is not forecasting a fall in nominal house prices. A risk remains that a fall in nominal house prices could occur, posing a potential risk to households' consumption and confidence, and we will continue to monitor the situation. (Paragraph 16)

5.  While we acknowledge that most household debt is secured, and that interest payments on household debt have not reached the level of 1990, we remain aware of the risk as identified in the Pre-Budget Report 2007 that a rise in effective interest rates might have more of an effect on the disposable incomes of households than in the past due to the increase in household debt levels. (Paragraph 19)

6.  The current difficulties in the United States housing market remain a concern but we acknowledge that a more diverse global economy may mean that the emerging markets will remain buoyant in the face of a greater than expected slow-down in the United States. (Paragraph 21)

The public finances

7.  The apparent correlation between forecast errors and the economic cycle suggests that, as the economy approaches trend, a reduction in forecast errors can be expected. While the recent reduction in the size of forecast errors is welcome, it is not clear whether this reduction reflects improvements in the forecasting process or the current stage of the economic cycle. We expect the Treasury to continue to exercise vigilance in addressing errors in its forecasts of the public finances. (Paragraph 26)

8.  We note that the risk of a downturn in the financial sector that is deeper and more prolonged than expected poses a consequential downside risk to tax revenues in 2007-08 and 2008-09. We will continue to monitor this situation. (Paragraph 28)

9.  As a result of the difficulty in dating the economic cycle, it is difficult to tell for some years after the event whether the Government has been successful in meeting the golden rule. We reiterate the recommendation, made in our Report on the 2007 Budget, that the Government review the golden rule such that it becomes more forward-looking and less dependent upon the dating of the economic cycle. (Paragraph 31)

10.  We recommend that, in its response to this Report, the Government sets out details of when it intends to provide its view on the end of the current economic cycle. (Paragraph 33)

Taxation issues

11.  The Chancellor of the Exchequer did not refer in his oral evidence to us to the possible introduction of a specific retirement relief for owners of business assets. We wish any proposal in this area to be the subject of early consultation. (Paragraph 40)

12.  We are concerned that the Treasury appears not to have consulted explicitly on the withdrawal of taper relief prior to the publication of the 2007 Pre-Budget Report. Despite this lack of consultation, the Chancellor of the Exchequer has made it clear that he is not prepared to reverse his decision to replace taper relief with a flat tax rate for capital gains. He has, however, expressed his willingness to discuss the details of the changes to capital gains tax policy with those affected. We recommend that the Government, in its response to this Report, clarify on which points it is prepared to consider the representations of affected parties, in good time before the 6 April 2008 date for implementing these reforms. (Paragraph 41)

13.  We note the evidence we received that the private equity industry could be expected to absorb the changes to the capital gains tax and carry on with its business. (Paragraph 46)

14.  The 2007 Pre-Budget Report and the Chancellor of the Exchequer's statement to the House of Commons clearly link the reforms of the capital gains tax regime to the aim of ensuring that the private equity industry pays a fairer share of tax, although the Government has denied that this was the primary motivation for the reforms. (Paragraph 47)

15.  Discussing the private equity industry, in an interview in July 2007, the Chancellor of the Exchequer stated he would not make any quick changes to capital gains tax that "could result in unintended consequences and undesirable consequences". Despite this, the reform of the capital gains tax regime announced in the 2007 Pre-Budget Report will affect small businesses and employee shareholders and could affect longer-term investment. The Chancellor of the Exchequer's evidence to us suggested that he regards such unintended consequences as inevitable effects of the progression towards the goal of simplification of the tax system. We appreciate the benefits that tax simplification can bring and its desirability for all taxpayers, particularly small businesses and entrepreneurs. However, we are concerned about the possible detrimental effects that the withdrawal of taper relief could have on small businesses, employee shareholders and longer-term investment. There is a possibility that the absence of transitional arrangements might give rise to unfair costs in cases where a contract was entered into in good faith before the 2007 Pre-Budget Report announcement but where the contract terms will not be fulfilled until after April 2008. We are particularly concerned at the proposal to withdraw taper relief without adequate notice. This will particularly penalise those planning to sell their businesses and retire within the next two years. We therefore recommend that the Government, in its response to this Report, set out how it proposes to mitigate the effects of the withdrawal of taper relief, particularly for those already within the two-year qualifying period and with especial reference to small businesses. Such a statement should assist with the discussions on the details of the capital gains tax reforms that the Government has said it is prepared to have with interested parties. (Paragraph 56)

16.  We recommend that the Government provide an explanation of the link between the Treasury's figures for projected increases in tax revenue resulting from capital gains tax reform as compared with its figures for the projected gain resulting from the immediate abolition of taper relief, in its response to this Report. (Paragraph 59)

17.  The Chancellor of the Exchequer has said that twelve million couples and three million widows and widowers would be eligible to take advantage of the £300,000 increase in the inheritance tax threshold. This implies that there may be large numbers of people who have not previously taken advantage of the existing rules on inheritance tax but who may now choose to utilise the transferable thresholds under a simplified regime. (Paragraph 65)

18.  Uncertainty about the number of people who have taken advantage of the existing inheritance tax rules makes it difficult to assess the likely impact of the proposed changes to inheritance tax on the Government's finances. Without further information about the basis of the Government's forecasts of the cost of the inheritance tax reforms, we are unable to assess the plausibility of these forecasts. We recommend that the Government clarify its projections for the cost to the Exchequer resulting from the proposed inheritance tax reforms and the assumptions about taxpayer behaviour that underpin those projections. (Paragraph 66)

19.  We recommend that the Government set out the extent to which changes to the rules applicable to non-domiciled taxpayers are open to consultation. If the changes are to take effect from 6 April 2008, the Government will need to ensure that consultation with interested parties takes place in the near future. We further recommend that the Government make it clear whether people who have been resident in the United Kingdom for more than ten years will pay a higher charge. (Paragraph 72)

The role of the Pre-Budget Report

20.  We re-state our conclusion that it is important that the Pre-Budget Report retains a focus on consultation on fiscal measures that may be included in the forthcoming Budget. We continue to support the principle set out in the Code for Fiscal Stability, that the Pre-Budget Report should be consultative in nature, and should include, so far as reasonably practicable, proposals for any significant changes in fiscal policy under consideration for introduction in the Budget. (Paragraph 76)

21.  We acknowledge that the circumstances surrounding the notice given to the House of this year's Pre-Budget Report were exceptional. We trust that both the lack of formal notice to the House and the extremely short period of notice will not be treated as a precedent for future years. (Paragraph 78)