Digital services tax and Brexit impact in the spotlight as MPs take Budget evidence

12 Nov 2018

The Treasury Committee has held three evidence sessions for its inquiry into Budget 2018, taking evidence from the OBR, economists and the Chancellor. Additionally the committee has received written evidence from CIOT and ICAEW on those organisations’ views of the Budget measures. The committee is not expected to take further evidence and is thought likely to report in the next few days.

Debate covered topics including universal credit, Brexit, the digital services tax, the annual investment allowance, the loan charge and scrutiny of the Finance Bill.

Session One: Office of Budget Responsibility (Wed 31 Oct) Witnesses: Robert Chote, Chairman, OBR; Prof Sir Charles Bean and Andy King (both members of the Budget Responsibility Committee).

Universal credit Chote said the underlying forecasting task with universal credit is particularly difficult because you are transitioning from one system to another. “It is also a reform that involves a lot of gross giveaways and gross takeaways of different varieties that have an apparently modest impact but, therefore, the uncertainty around that is greater than the relatively small cost versus the legacy system would imply,” he explained.

Brexit forecasting There is a slight disconnect between the economic forecast and the Budget this time, caused by the slightly strange timing, but ‘nothing material’ in terms of impact on growth forecast, said Chote. He said the OBR is assuming it will have to do another forecast in Spring and but the OBR will have no more information on the Withdrawal Agreement than MPs or the general public beforehand. The OBR will not produce a forecast specifically for the parliamentary vote on Brexit. Bean said until you know what ‘no deal’ looks like, it is very difficult to even start talking about economic effects. At the extreme of an acrimonious and very disorderly no deal, it would be plausible to think that there are some quantity constraints that start biting at least for a while, he said.

The fiscal consequences depend an awful lot on whether your short-term problem translates into a permanent loss of potential GDP and potential output relative to your expectations beforehand, Chote told SNP MP Stewart Hosie. In the case of a disorderly Brexit, Chote suspects that this would depend an awful lot on whether you just ‘gummed’ the whole economy up for six months but then you are back straightforwardly.

Rushanara Ali wanted to know why the OBR has not included a ‘deal dividend’ for GDP growth in its economic forecast. Chote replied that the OBR does not have any meaningful basis for knowing what the outcome of the negotiations is going to be, in terms of the key things that would matter for a medium and a long-term growth projection: what the trade arrangements would be and precisely what the migration policy is going to look like. Stronger business investment does not help the public finances in the near term because of capital allowances. It actually weakens them, he added.

Forecasting errors Conservative Stephen Hammond asked about OBR’s September report which said ‘on a simple comparison with the latest outturns, our in-year forecasts have over-predicted the budget deficit by an average of £6 billion a year’. Chote said the lesson was that you had a variety of factors, more of them on receipts than on spending. The size of the error had been declining from when the OBR had started but then you had ‘a particularly big one in 2016-17, with a number of factors moving in the same direction’. A disproportionately large part of those errors comes from non-tax receipts, which is a relatively small part of the pot, he said.

WTO Bean explained to Labour’s Alison McGovern that most trade experts would take the view that WTO rules basically mean that we have to be treated in exactly the same way as any other third country without a free trade agreement and, if we were not treated that way, other countries could take a WTO action against the EU. The Economists for Free Trade study, however, assumes that actually the basis on which we trade with the EU, even if we go to WTO rules, will not change very much. That is a key part of the difference between the results they get and other results, he suggested.

Scotland Conservative Colin Clark asked why the OBR estimates for Scottish income tax receipts for 2016-17 differ from those of the Scottish Fiscal Commission (SFC) if both used the HMRC Survey of Personal Incomes forecast. King replied that the difference between the two forecasts was relatively small, around £150 million on tax of well over £10 billion. The Scottish Fiscal Commission used the publicly available version of the Survey of Personal Incomes whereas, because OBR forecasts are processed for it by HMRC, and HMRC is able to use all the taxpayer confidential information, it is calculated on a very slightly different tax base. SFC and OBR took very slightly different views on employment growth and on the growth in incomes being taxed, but these differences were small in the scheme of things, prior to knowing the outturn. He thought the more interesting question now was that HMRC have published an initial outturn for those liabilities, which was £700 million lower than OBR forecast, £550 million lower than the SFC forecast, and that implies that a much lower share of UK-wide income tax is coming from Scottish taxpayers than the prior year SPI was telling us. OBR has signed a memorandum of understanding with the SFC, to set out practical working arrangements, to avoid these differences.

Clark then asked if the devolution of taxes to Scotland and Wales constrain the UK government’s ability to meet their fiscal target. Chote said the chances of it being material to the UK’s fiscal targets are relatively low, given the constraints on how much the Scottish Government can borrow and for what purposes.

The full session can be found here.

Session Two: The Economists (Thur 1 Nov)

Witnesses: Professor Diane Elson, University of Essex, Paul Johnson, Director, IFS, and Rain Newton-Smith, Chief Economist, CBI.

Business rates Johnson explained to Nicky Morgan that if you made a permanent change to business rates, you would expect that eventually to be capitalised into the rents that people are paying, because it is the land that is in fixed supply, and therefore, if you change the tax, you would expect the total amount that the tenant pays to remain the same, in the long run. The fact is that this is, at least in principle, a temporary change, brought in quickly, so in the short run, it will benefit tenants. If it became a permanent change, in the long run the effect would be on the rent that they pay as well. 

Business rates disincentivise improving or building business property because they are a tax on the value of the property, said Johnson. In Central London, most of that value is in the land. In many other parts of the country, most of the value would be in the building. A more neutral tax would be one that was taxing the land, he added. Newton-Smith said one of the challenges with downward transition is that it means, particularly in areas where commercial property prices have fallen, where you are likely to have seen slower regional growth, businesses across a range of sectors are having to wait for quite a while until they have relief from those lower valuations.

Gender impact Labour’s Rushanara Ali asked about the impact on women of the Budget 2018 and suggested that the freezing of the beer duty is supposed to benefit men, for instance, significantly more. Professor Elson said women will particularly benefit from increased funding for the NHS and men will definitely benefit more than women from the income tax ‘giveaway’. The professor used data from the House of Commons Library to argue that 63 per cent of the gains from the change to the raising of the threshold in income tax go to men, and 37 per cent to women, in the period 2017-18 to 2021-22. Although agreeing with the professor, Johnson said that how you see this matter obviously depends on your view of how income is shared within a household. The increase in the work allowances for universal credit will go partly to lone parents, who are largely women. That is clearly going to benefit them, but it will also particularly benefit single-earner couples, where it is often the man who is in work.

Universal credit Alison McGovern, Labour, asked what is ‘coming down the road’ on welfare. Johnson suggested there are essentially three significant cuts coming through. One is the fourth year of the freeze to benefits. Then, the other two big ones are the abolition of third and subsequent children’s support within the welfare system, and a reduction in the family allowance. All welfare recipients with children will be worse off as a result of that, and because these are being introduced in a transitional way, it will take a few years before they are fully effective, he said. The big winners from universal credit are largely low-income renters, because it is somewhat more generous to that group while the big losers are lone parents, self-employed people reporting very low levels of earnings, people out of work who have got some assets and on average homeowners who are claiming benefit.

Professor Elson added that people who are on universal credit and who would have benefited from the rise in the threshold for income tax will have a large chunk of that clawed back. They will not benefit to the same extent as somebody with the same income who is not on universal credit and will not get it clawed back. They will lose something like 63 per cent of the gain they would get from the rise in the threshold because it will be clawed back through the universal credit system.

Professor Elson complained about the design of universal credit, saying one payment once a month to one account will leave women in a very vulnerable position. The other issue, she said, is that universal credit is really designed with the labour market that we had before the financial crisis in mind—the notion that when you are in work, you have a steady job and you get a monthly wage.

Annual investment allowance On the temporary two-year increase in the annual investment allowance, Newton-Smith said it was important for two reasons. “First, we have a structural problem in business investment in this country. Business investment as a percentage of GDP averages nine per cent, but it is 13 per cent across the rest of the G7. At the same time, our overall capital allowances are much less generous than in the rest of the G7. That increase in the annual investment allowance will help to address the structural problem, but there is no doubt that Brexit uncertainty is having a big impact on business investment decisions now. Eight out of 10 businesses we surveyed say that Brexit is having a negative impact on their investment decisions.”

Digital services tax Charlie Elphicke asked about the DST. Johnson said it really has nothing to do with online sales; it was much more to do with trying to capture some of the value created from advertising and the networks created on things such as Facebook and Google. He said it is not ‘even tiny steps’ in levelling the playing field for high streets versus online sellers. Newton-Smith said if you really want to make progress on this, you have to work multilaterally. We should let that OECD process work, she urged. She added: “Most of the people who have a big physical presence also have an online presence, so we have to be careful when we introduce new taxes that we do not add additional distortions. One of the challenges with the digital services tax is that it is quite innovative but it requires government to define certain business models, be they search engines, social media platforms or online marketplaces, and tax the revenue from those business models. The challenge with that is that you can disincentivise businesses from becoming more digital and adopting digital technologies. That is an area where the UK falls behind internationally.”

The regime of subsidies to attract these large out-of-town distribution centres that function through digital platforms should end, and we should think about how we can tax, said Elson.

Taxing property and wealth Conservative Simon Clark asked which would be the least economically deleterious taxes to raise. Johnson said that wealth as a fraction of national income has grown very sharply in the last 20 years, but taxes on wealth have not grown at all over that period. “Land tax, wealth tax and gift tax. We need to think about these new tax handles”, added Professor Elson.

Conservative Colin Clark asked about stamp duty land tax for shared ownership properties and why the changes were made retrospective. Johnson suggested that the government just felt they had made a mistake in the first place.

IR35 Nicky Morgan asked about the impact on the labour market of the planned IR35 ‘extension’ to the private sector. Newton-Smith said giving businesses time to prepare is really important, particularly where in some cases it requires investment in IT systems or having someone within an HR department. You probably want to do it in a more holistic way and have a better alignment between the taxation of employment and self-employment and also the rights associated with it.

Winners and losers SNP’s Stewart Hosie asked which income deciles have been the winners and which have been the losers from this Budget. Paul Johnson said there are groups of winners. The first is those who benefited from the universal credit increase and the work allowances (bottom third of the distribution), the significant winners from the increases in the tax allowances will be in the top half of distribution.

Future taxation Johnson told Charlie Elphicke that tax increases over the next decade just will be necessary because the amount we are spending on health is rising very fast. Unless we are willing to accept a very different kind of health service, and depending on social care, pensions and so on, he said. Professor Elson added that in the longer run, the demographic changes are such that there has to be a rise in taxation and some new tax handles.

The full session can be read here.

Session Three: The Treasury (Mon 5 Nov) Witnesses: Philip Hammond, Chancellor of the Exchequer; and Dan York-Smith, Director, Strategy, Planning and Budgets, the Treasury.

Digital services tax On DST, Labour’s Wes Streeting said the frustrating thing is that what little the Treasury will raise in DST, it will give back to those tech giants through corporation tax cuts. SNP’s Stewart Hosie asked who is doing the stalling on DST – the USA? Hammond said revealing this would jeopardise future multilateral talks. He said it is the case that the US Tax Reform Act has moved the goal posts a little bit in that it has changed the perceived interests of the US versus non-US players, where some at least of the companies in question would historically have been booking profits in offshore jurisdictions. The expectation is that some of those profits will now be booked in the US, as a result of the Act. That clearly places the US in a slightly different position when it is looking at these propositions for reform. The US recognises that there is an issue that has to be dealt with, but we do not all have a similar approach as to how best to deal with it, said the Chancellor.

Hosie speculated that the UK is likely either to fall in line with the EU proposals, in due course, or simply implement the OECD proposals when the final compromise agreement is reached in 2020. The Chancellor said: “I cannot guarantee in advance that we will suspend our digital services tax in order to implement an international tax, but we will certainly have a strong disposition towards working with international partners if there is a credible proposal on the table.”

Hammond was keen to say high street businesses versus online sellers and the DST is not a direct connection. He said there was a perfectly respectable argument for an online sales tax (not DST) but ‘we would need to be very clear-eyed about what it is’ because an online sales tax is a tax that would be paid by consumers.

On why the UK cannot follow Spain and introduce a DST now, Hammond said we have tradition in this country that, where we are doing something in the area of taxation that is novel and potentially contetious, we carry out extensive consultation and do a lot of work to design it and get it right.

Loan charge Alison McGovern asked why we are retrospectively trying to recover money from people who were undertaking an activity, which we may or may not like, but that was entirely legal. Hammond retorted that HMRC was always clear that seeking to avoid payment of income tax through the use of loans was tax evasion and was not lawful. He said: “I am astonished by this line of questioning. These are people pretending to make loans to themselves from their companies, loans that they have no intention of ever repaying, and then expecting not to have to pay any tax, even though they have enjoyed the money and been able to spend it as if it were income. That seems to me to be grossly unfair and something that imposes an unacceptable burden on all other taxpayers. It is quite right that we sort it out.”

Parliamentary scrutiny Wes Streeting accused the Chancellor of having ‘contrived, very cleverly in the Treasury, by failing to table an Amendment to the Law Resolution, [to deny] an ability for this Parliament to adequately scrutinise and amend your Budget as we might see fit.’ “Why are you going to such lengths to avoid parliamentary scrutiny, and, in a hung Parliament, to give Parliament the ability to properly influence the direction of Government policy?” he asked. “Parliament has never had control through the Budget process of the allocation of funding between Departments”, said Hammond. “We have not used an Amendment to the Law motion in the last two Budgets”, he added, saying there was no obligation on the Government to table such a motion. “It is the role of the Government and it is the role of the Treasury to propose a Budget for Parliament to vote on. It is not our constitutional tradition that Parliament, line by line, amends the Budget in the way that the US Constitution allows Congress to do. That is the way the Budget process works here. It has worked very well”, charged Hammond.

Income tax cut The Chancellor said that part of bringing austerity to an end is allowing people to keep a little more of the hard-earned money that they earn.  Alison McGovern complained that most all of the money that the Treasury has put into these tax cuts will accrue to those in the top half of the income distribution and those who gain the most will be in the top 10 per cent per cent of earners in our country.

Universal credit McGovern led on questions to do with universal credit (UC). She complained that the Treasury is spending much more on income tax cuts than on dealing with the UC problem. The Chancellor responded that if you look at 2023-24, at line 10 of the Red Book you will see that the personal allowance and higher rate tax threshold in 2023-24 costs £1.78 billion and the changes to universal credit work allowance cost £1.695 billion. It is around £1.7 billion in both cases at the end of the forecast period. He added it is ‘bogus analysis to look at a single fiscal event’. Hammond said that since he became Chancellor in 2016, he has intervened at every fiscal event to support the UC system, and the committee should look at his contributions to UC over that time. When asked why England cannot use split payments like Scotland, Hammond said the welfare system is built on households.

The full session can be read here.

Written evidence to the Treasury Committee

At the invitation of the committee CIOT and ICAEW have provided written assessments of the main Budget measures, which the committee have now published.

CIOT’s main points were:

Budget 2018 contains fewer tax changes than in most recent Budgets Too many measures are being announced as ‘done deals’ or for immediate implementation, with either no or inadequate consultation (eg changes to private residence relief, Structures and Buildings Allowance) There is also a lot of ‘tinkering’ – would this be necessary if there had been adequate consultation and a higher standard of legislative drafting in the first place?

The CIOT’s analysis includes a ‘traffic light’ assessment of the main Budget measures. The Institute is most positive about the proposals to put voluntary tax returns on a statutory footing, the withdrawal of the shared occupancy test for rent-a-room relief and Universal Credit measures. The most negative reaction is for the capital allowances special rate reduction, the Digital Services Tax and the deferral of reform of HMRC’s penalties regime.

ICAEW’s main points were:

Business rate cuts are welcome news for many struggling retail businesses but will not help larger retailers trying to compete with internet-based businesses Welcome for VAT registration threshold freeze This was really a holding Budget. Attention is now on whether we will have a 2019 Spring Statement or a full-blown Emergency Budget. Hopefully by that stage we may have some clarity about how the UK will be leaving the EU and on what terms. The fall-out from Brexit is likely to have a far-reaching impact on Budget decisions and revenue and spending projections that might well dwarf those seen this time around

Evidence can be read here.