The economy

1.  The Treasury's forecast in the Budget is for the economy to begin recovering in the final quarter of 2009 before going on to register strong growth of 3.5% in 2011. There is, understandably, considerable uncertainty around the Government's growth forecasts for 2009-2011, reflecting the fact that the UK economy is in uncharted territory. This uncertainty is demonstrated by the large number of independent forecasts which are more pessimistic than the Government as well as the smaller number of forecasts which are more optimistic. In particular, we note that the IMF believes the UK will continue to contract in 2010. Whilst it is possible that the Government will meet its growth forecasts, on the available evidence, this is an optimistic assumption. We question the decision to assume that the economy will begin registering positive growth as early as the fourth quarter of 2009, and that the economy will register such strong growth in 2011. (Paragraph 11)

2.  It is clear that the recession has acted as a catalyst for the rebalancing of demand in the UK economy. This rebalancing entails a shift away from consumption with a concomitant rise in the savings ratio, with net trade also playing a more important contributory role to growth over the 2009-2011 period. We note, however, that the contribution net trade will make to growth is contingent upon a speedy recovery in the UK's major trading partners and on the fulfilment of commitments made at the G20. Consumption is forecast to recover sharply in 2011 but we are concerned that this may be too optimistic given that the UK economy will only just have emerged from a sharp downturn. Additionally, the strong rebound forecast in consumption growth from 2011 onwards has important implications for whether the rebalancing of the UK economy is merely a short-term phenomenon or whether the Government should take steps to ensure such changes prove more durable. Savings will need more encouragement. (Paragraph 15)

3.  It remains too early to judge whether the November 2008 fiscal stimulus—and in particular the VAT reduction—has been successful. There has been much discussion of whether a subsequent fiscal stimulus separate from the stimulus provided by the automatic stabilisers was necessary, but ultimately the Government decided against introducing a further large-scale fiscal stimulus at the time of the 2009 Budget. No doubt the debate around the need for a further fiscal boost to the UK economy will continue, particularly if growth in the economy fails to pick up. Any discussion of additional stimulus must take into account both the implications for the public finances of such a boost and the credibility of the Government's plans to bring the budget back into balance. (Paragraph 21)

4.  There is a strong possibility that unemployment will rise above three million, with some economists warning that it is possible that unemployment could rise as high as four million. Approximately 40% of the unemployed are likely to be young people aged under 25. We agree with Professor Blanchflower that this necessitates measures focused on assisting young people and, to this end, welcome the Government's approach of targeting resources on this group. That said, it is too soon to judge whether the Government proposal that all young people who have been on Jobseeker's Allowance for 12 months will be guaranteed a job, work placement or training opportunity, together with the monetary and fiscal stimuli, are a sufficiently timely and substantial response to the scale of the unemployment challenge. (Paragraph 27)

5.  The Asset Purchase Facility is a crucial tool of monetary policy, given the currently low level of Bank rate. We note the heavy bias towards the purchase of gilts under the facility. We note the concern of some that not enough is being done to provide adequate liquidity in the corporate debt markets. We expect the Bank of England to take every opportunity to use the £50 billion allotted to the purchase of corporate debt under the Asset Purchase Facility to ensure the effective operation of those markets. We also recommend that the Debt Management Office and the Bank of England develop strategies for the Bank to dispose of its increasing holdings of gilts and corporate debt. (Paragraph 35)

Public finances

6.  The Chancellor's forecasts for public borrowing and national debt make sobering reading. By any measure, those forecasts along with those of many other OECD countries, are extremely high: they have exceeded the fiscal rules from which the Government departed in PBR 2008 by a wide margin and these figures represent the worst fiscal outlook since the Second World War. We are very concerned about the state of the public finances. What is now of critical importance is that the public, and crucially the markets, believe that the Chancellor is working to an adequate, and credible, plan to restore the public finances to good health. The credibility of any attempt to restore the public finances will depend on an acceptance that the structural deficit must be addressed as well as the consequences of the current extraordinary circumstances. We discuss this plan in the next section of this Report. (Paragraph 44)

7.  One of the important determinants of the restoration of health to the public finances is the extent to which tax revenues are able to rebound from their current low levels. It should be recognised that even before the current crisis the UK was running a structural deficit, although the scale of that deficit has been disputed and has been justified by the Chancellor on the grounds that this was a necessary investment. In our view, any restoration is not merely contingent on the economy meeting the challenging growth projections set in this year's Budget. What is also of importance is the composition of that growth. We note the inevitable shift away from the UK economy's dependence on financial services, and the Chancellor specified several industrial sectors which had promising futures. But it would be wrong to assume that these, or other sectors, will necessarily be as profitable as financial services. We recommend, therefore, that future Pre-Budget Reports and Budget documents provide a sectoral analysis of tax revenues, so that the basis of Treasury forecasts in a changing economy can be scrutinised. The Treasury already has the means to provide this information, as evidenced by its commentary on the financial and housing sectors, so to do this should not be particularly onerous. (Paragraph 49)

8.  In the medium term, the options for returning the public finances to balance present uncomfortable choices for the Government and consequences for the public, the broad alternatives being substantial tax increases, unprecedented cuts in public services, or a combination of the two. We recommend that in the Pre-Budget Report 2009, the Government sets out a range of options for closing the projected fiscal gap. (Paragraph 52)

9.  We do not see how the Temporary Operating Rule acts as any kind of constraint at all on the current fiscal decisions made by the Chancellor, and we struggle to imagine any course of action he might have taken in this year's Budget that would have been inconsistent with it. For this Rule to have any bite whatsoever, the identification of the point in time at which "the global shocks have worked their way through the economy in full", cannot be left to the judgement of the Treasury alone, but should be subject to parliamentary scrutiny. It is clear to us that the only real financial discipline that is currently imposed on the Chancellor is the opinion of the gilt market on the sustainability of the public finances. (Paragraph 56)

10.  We believe that the Chancellor should now engage in what we regard as a crucial debate about the future of the UK fiscal framework. The majority of our expert witnesses found fault with the Golden Rule and Sustainable Investment Rule, so an eventual return to an unreformed framework would seem misguided. We sense that there is little consensus on what the best framework might be, which is all the more reason to commence a thorough analysis of all the options, drawing on international best practice, practical experience and academic theory. We are not suggesting that a new framework should be implemented now, but that the Treasury should open up a debate. To this end, we renew our recommendation made in our Report on PBR 2008 for a full public consultation. (Paragraph 60)

11.  We note the reaction of the debt markets to the Treasury's ambitious borrowing plans. We believe there are strong reasons why the costs of financing the Government debt could well remain low. But if the gilt market were to lose its appetite for Government debt, which is by no means impossible, the cost of financing that debt could climb to perilous levels. Financial markets can be very volatile, and, as we have recently learnt in the financial crisis, can be quite poor at pricing risks initially, with any subsequent pricing corrections being sudden and unexpected. Under these circumstances, we consider that it would be prudent for the Treasury to work up contingency plans for a weakening of demand for Government debt. (Paragraph 68)

Other measures in Budget 2009

12.  We acknowledge the pressure on Government finances but are concerned by the lack of any substantial measure to combat child poverty in both the Pre-Budget Report 2008 and Budget 2009. On current indicators the Government will fail to meet its 2010-11 target by a significant margin. We are dismayed that, despite our repeated warnings in past reports, the Treasury has failed to take sufficient positive action to ensure the child poverty targets are met. We recommend that the Government researches the impact of the recession on the number of children living in absolute as well as relative poverty and brings forward further proposals in the Pre-Budget Report 2009 to ensure that it achieves its targets on halving child poverty by 2010-2011 and then eliminating it. One perverse consequence of the use of a relative measure of child poverty is that a period of recession might reduce the numbers of children deemed to be in poverty even though an increasing number is suffering actual hardship. (Paragraph 74)

13.  Hitherto, those claiming the Local Housing Allowance had an incentive to seek competitively priced accommodation in order to maximise their benefit. Such an incentive will disappear in April 2010 which will cause problems for some. We recognise the prevailing economic pressures on the Government but recommend that more thought be given to creating a more stable framework for the payment of this benefit. (Paragraph 81)

14.  The recovery of the housing market is clearly linked to the recovery of the economy as a whole. It is therefore vital that the Government take steps to reinvigorate the market at this time. However, we note that the resurgence of the property market is particularly dependent on the availability of mortgage credit to homebuyers and we are unconvinced that other schemes to boost the market, such as the stamp duty holiday, will have any marked effect. We call on the Government to report in the PBR on the implementation of the asset-backed securities scheme and to provide a cost-benefit analysis of the effectiveness of the stamp duty holiday. (Paragraph 87)

15.  We welcome the help announced in the budget for homeowners. Whilst we welcome the diversity of the schemes, we regret the delays in implementation and the lack of clarity, in respect of some of the schemes, especially in entitlement to Support for Mortgage Interest. We recommend that the Government takes urgent steps to ensure that clear information is provided for homeowners on the support that is available to them if they get into financial difficulties as a result of the recession. (Paragraph 88)

16.  We recognise the importance of the car industry. The vehicle scrappage policy has been welcomed in some quarters. Although it will support 300,000 new vehicle sales, it is likely that only one-third at most will be additional sales. Moreover, of these additional or accelerated sales, just 12,600 could be new UK-manufactured vehicles, although we accept that most other cars sold contain high quantities of UK-manufactured parts and that car retailing will benefit. We note the Chancellor's reservations regarding the scheme and await the Pre-Budget report 2009 to assess how effective it has been. (Paragraph 94)

17.  We believe there are considerable uncertainties over the yield to be raised by the new 50% top rate of income tax. We therefore recommend that the Treasury, in the 2011 Pre-Budget Report, should report on the revenue raised, both nominally and as a percentage of the theoretical maximum revenue, by the new top rate of income tax. We also recommend that the Treasury assess at that time the yield obtained from the higher rate against its disadvantages. If the higher rate were to be continued it would be appropriate to consider what further reforms would be needed to prevent further leakage of potential revenue from this measure. The Treasury should indicate if it would revise the rate in the event that the estimated revenue yield fell well below their forecasts. Finally, we were concerned that the Chancellor lacked a robust basis for selecting the threshold from which the new top rate of tax would apply and for choosing what that rate should be. (Paragraph 100)

18.  We note that this budget marks a departure from the long-standing principle that tax relief for pension contributions should be given at an individual's highest marginal rate. We urge the Treasury to monitor the effect of this change on pension savings and to keep under review the possibility that a cap on annual contributions might be a more equitable way of reducing the percentage of tax relief that benefits the highest earners. (Paragraph 104)