INSTITUTE OF DIRECTORS CENTRAL LONDON BRANCH

INSTITUTE OF DIRECTORS CENTRAL LONDON BRANCH

20 JANUARY 2003

Introduction: Pre Budget Report

27 November 2002 will, I believe, prove to be a defining movement in the recent history of economic policy in Britain.

That day, the day of the Pre Budget Report, was a humiliating day for Gordon Brown.

For five and a half years he has attempted to construct a reputation for prudence and caution. But on 27 November 2002, the very forecasts he had described as cautious – forecasts on growth, on revenue, on borrowing, on his deficit – were all shown to be wrong.

On that day, those forecasts, like the reputation of the Chancellor who made them, were significantly downgraded.

Growth Forecasts

The average independent forecast for growth at the time when the Chancellor’s Budget forecasts were announced was below his entire forecast range. He chose to ignore this independent advice. He actually increased his forecast for growth in 2003 - and for longer-term trend growth.

He thought he knew better. And his decision was found wanting.

Now, of course, some economists – such as the CEBR, and in respect of this year the Item Club - are questioning even his downgraded growth forecasts. Last week the Labour-dominated Treasury Select Committee, in its hard-hitting report, said GDP forecasts for 2004 and 2005 `could turn out to be optimistic’ (2002 Pre-Budget Report, HC 159, paragraph 16). `We believe that the overall balance of risks to the Treasury’s GDP growth forecasts is’, they said, `on the downside’ (paragraph 18).

The Committee also raised questions in relation to the assumed trend rate of growth – and, in particular, the revised productivity assumption included in the calculation of the trend rate. It recommended that the Treasury asks the Comptroller and Auditor General to examine the new composition of the trend rate.

Public Finances

These issues are important for the Chancellor’s figures on the public finances.

His figures on borrowing, over five years, have already leapt from £30 billion in the 2001 Budget to £66 billion later that year, £72 billion in last year’s Budget and over £100 billion in the latest Pre-Budget Report.

Yet now, Michael Saunders, Citigroup chief economist, says the `fiscal outlook looks even worse than the Treasury’s new, gloomier forecasts in November’s pre-Budget report’ (The Business, 5 January).

There are particular questions in relation to the structural, as opposed to the cyclical, position of the public finances. It is no longer good enough for Gordon Brown to gloss over the recent deterioration by claiming that everything will magically even itself out over the cycle, as set out in his much-vaunted `golden rule’. This `golden rule’ is beginning to look decidedly tarnished, not least because it depends on the timing of an economic cycle about which no-one is sure until some years after the event.

Indeed, the Treasury’s estimate of the timing of the current ‘cycle’ seems to have fluctuated somewhat, before concluding in the Pre Budget Report that it would end in 2005. In one of the most damning criticisms of all, the Select Committee Report last week said: `There is a danger that decisions by the Treasury on the determination of the economic cycle could be seen to be taken simply in order to comply with the golden rule’ (paragraph 41). The Committee’s belief that there is now a need for the Treasury’s determination of the dating of economic cycles to be `validated by an external body’, such as the National Audit Office, is an indication of just how discredited the Chancellor’s fiscal rules are in danger of becoming.

And what of his sustainable investment rule? If he hadn’t put some £100 billion of his potential liabilities off the balance sheet, Enron-style, public sector debt would already have reached the 40 per cent limit in that rule.

Today’s report from the Select Committee addresses this issue. It seems that every week a new report casts doubt on the Chancellor's credibility. This report confirms the view that the Government has been engaged in Enron-style accounting. It is clear that Gordon Brown has been cooking the books. The integrity of Government information is vital to its credibility. The Chancellor is damaging this integrity by not publishing these figures in the Budget in an open and transparent way so that taxpayers may see what they could be liable for.

Twice in a week a Labour-dominated committee has told the Chancellor to come clean over the public finances.

We have said for some time that the Government should publish all contingent liabilities in the Red Book. The Chancellor has refused to do so. It is easy to see why. If he had done so, the contingent liabilities could put him in breach of his own sustainable investment rule. It is clear that the Chancellor has been economical with the truth about the liabilities that we all, as taxpayers, may face.

So it is now clearer than ever that Gordon Brown’s fiscal rules are neither as watertight nor as revolutionary as he would have us believe. Yet these are the rules which – like his supposed caution and prudence - were meant to have formed the bedrock of his entire economic strategy.

Economic Warnings

So the Pre-Budget Report dealt a severe blow to the Chancellor’s credibility.

And there were several things missing from his statement. In particular there were precious few warnings about the real problems now facing the UK economy.

In his New Year message, Tony Blair tried to fill that gap. He talked of `economic concerns arising from lack of confidence in key parts of the world economy’. His tactic was to set down markers, in case we encounter economic turbulence ahead, and to try to avoid scrutiny of his own record by pointing the finger at the rest of the world.

But, in fact, the source of many of our economic problems lies closer to home.

Imbalances

It is abundantly clear that some very severe imbalances have been developing in our economy – imbalances which the Labour-dominated Treasury Select Committee described as `potentially serious and increasing’ (paragraph 22).

The Permanent Secretary admitted in evidence to the Committee that imbalances in economic growth in 2002 had `turned out greater than we expected’ (10 December 2002, Q69).

The ongoing plight of manufacturing industry is well documented. Since 1997, half a million manufacturing jobs have been lost. Manufacturing output and manufacturing investment are both at lower levels than they were in 1997.
Now the financial services sector has also been hit.

And more generally, over the last year business investment has fallen at its sharpest rate for more than three decades. As the Treasury admitted in a recent bulletin, `the UK still has a relatively poor performance in business investment compared to other countries’.

Meanwhile, corporate profitability is at its lowest level for a decade, and business failures in 2002 were at their highest for eight years – almost 43,500 according to Dun and Bradsheet.

Britain has recorded a trade deficit in each and every month since January 1998, and the deficit in goods is at is largest level since 1697.

Yet while business has suffered in this way, the consumer sector has been booming. The backdrop to this is not, however, an encouraging one: the rate of saving has almost halved since 1997, and household debt now stands at record levels.

Much of this debt has been fuelled by rising house prices.

As ever, economists differ on future trends.

But it is now widely acknowledged that the recent rate of increase in house prices cannot continue. There are of course some factors which will continue to put upward pressure on prices in the medium to long term – including planning constraints and the growth in the number of households. And some - the Governor of the Bank of England among them – have said they expect house price increases to continue for a while yet. But even Sir Edward George has talked of the current rate of growth being `unsustainable’ (Treasury Select Committee, 26 November 2002). Others have noted regional imbalances, and believe that sharp movements are more likely to occur in some regions – London for example – than in others. And as Professor Andrew Oswald noted in a recent article in the Times, if one set of asset prices – housing – is above its long run trend, while another – shares – is below, this cannot be sustained indefinitely (3 January 2003).

And what of the forecasts for consumer spending?

Many are not optimistic. Chris Grove, partner at BDO Stoy Hayward, has talked of the outlook for consumer spending weakening this year, with the economy being under `increasing pressure’ (Financial Times, 6 January). Roger Bootle of Deloitte Touche has talked of `too much complacency regarding the economy’ (Independent, 6 January), and says predictions for a soft landing are `wishful thinking’ (Sunday Telegraph, 5 January). He says `a painless unwinding of the economy’s imbalances is becoming harder and harder to envisage’ (Financial Times, 6 January).

Others are more concerned about the upside risk to inflation, and warn that there is little room for non-inflationary growth in the economy. Lombard Street Research (December 2002) have commented that `the Bank of England (almost certainly) disagrees with the Treasury’s views’ on the matter. `Although the Bank’s Inflation Report does not give a precise number for the output gap’, comment Lombard Street, `its comments imply far more scepticism about the room for non-inflationary growth’.

Supply Side Issues

I do not profess to know precisely what is going to happen to the British economy and nor should Gordon Brown. If 27 November should have taught him anything, it is the need for a degree of humility. Being prudent is about preparing for the worst-case scenarios while working to achieve the best.

But whatever is in store, the priority for the Government should be to strengthen the foundations of the economy, so that it can weather whatever storms may lie ahead. That means creating a competitive environment in which business can win orders and create jobs.

If the good times do come to an end, we shall more than ever need a business-friendly environment based on light regulation and a competitive tax system for the economy to bounce back quickly. If they do not, and if our national output must rise to meet demand, our needs are the same.

Yet far from providing light regulation and a competitive tax system, the Government has taken the opposite course. Its additional burdens of tax and red tape are acting as a drag on the economy.

In the last five years the Government has introduced nearly 15 new regulations every working day.

On one estimate, the total cost to business of extra red tape and tax has been put as high as £15 billion a year.

It is little wonder that productivity has grown just over half as quickly under Labour as it was growing before.

It is little wonder that Britain has fallen from ninth to 16th in the Institute of Management Development’s World Competitiveness Scoreboard.

And it is little wonder that in one survey of company leaders in November, two thirds said conditions were worse than five years ago and more than half expected the situation to deteriorate further. 95 per cent said regulation had increased over the past five years, with 80 per cent saying this was damaging to their business. 70 per cent said the Government understood only poorly or partially how business worked.

Pensions Tax

And it is not only on the supply side of the economy that Government policy has had a malign effect. It has discouraged savings too – and, in particular, saving for retirement.

Pensions are in crisis. The reasons for this are many and varied. But Gordon Brown’s decision in 1997 to tax the dividend income from pensions savings at £5 billion a year, equivalent to £400 per contributor per year, is now widely seen as a trigger for the closure of pension schemes. Today, fewer than four in ten final salary schemes are now open to new members and half of those are contemplating closure.

He justified the tax at the time by the fact that schemes were in surplus, but following three years of falling stock markets, that have wiped more than £300 billion of the value of pension funds, the surpluses have virtually all gone. Yet the tax remains.

In 2002 the Government added to pension schemes’ misery by failing to increase the contracted out national insurance rebates by the amount necessary to cover the cost of the benefits. This has been estimated to be equivalent to another tax of £130 per person per year.

The Government’s solution to the pensions crisis, the stakeholder pension, has flopped with no fewer than 9 in 10 of the schemes set up by companies completely empty of members or contributions.

The Green Paper in December was full of further consultation but contained no new incentives for people to provide for their old age. Perhaps this was not surprising, as it was based on statistics which purported to show that pensions contributions were growing sharply, statistics which – following investigations by my colleague David Willetts - the Government now admits were unreliable. A recognition of the extent of the problem is essential before a possible solution can be found. In underestimating the problem, let alone contemplating a solution, the Government hasn’t reached first base.

There is also no doubt that, in itself and by encouraging withdrawal from UK equities, the Pension Tax has also contributed to the disproportionate fall in the UK stock market since 1997. Since then the FTSE 100 [14 per cent fall] has fallen, whereas the S&P500 [13 per cent rise], the Dow [23 per cent rise], and the Cac [16 per cent rise] have risen since that date.

Public Concern

In light of these economic problems and uncertainties, it is little wonder that people are unsure about the future. MORI’s optimism index now stands at minus 40 per cent (Financial Times, 27 December).

People are uncertain about the future value of their assets – in particular the homes in which they live, and the pensions and savings they have set aside for retirement.

Many are uncertain about their future employment prospects, too.

And meanwhile, at this time of uncertainty, they seem to be hit from all sides by the Government.

There have been 53 tax rises since 1997.

The Adam Smith Institute calculates that people now have to work, on average, 164 days each year just to pay the taxman. This `Tax Freedom Day’, the point at which people start in effect to earn for themselves, will fall on 12 June, ten days later than in 1997.

In fact the Government is now taking the equivalent of an extra £36 a week in tax from every man, woman and child in the country - £87 a week from every household - compared to when they came to office.

NIC Rise

Every year they have said higher taxes are needed in return for better public services. But every year we just get the higher taxes.

And in April there is more to come.

National Insurance rates will rise by 1 per cent both for employees and for employers. A tax on income. And a tax on jobs.
The levels of income that are exempt from NICs and from income tax are also being frozen. The combined effect will be to cost someone on average male earnings around £240 a year.

The nurse consultant on £34,000 a year will be £26 a month worse off. The Police Inspector on £37,000 a year will be £30 a month worse off.

And the jobs tax comes from a Government which once talked of lower National Insurance Contributions acting `to promote employment opportunities’ (Budget 2000 Climate Change Levy press release). So what will higher ones do? Destroy jobs.

It comes from a Chancellor who said his pledge not to raise income tax was in order to `reward work’ and send a signal about the importance attached to work (Select Committee, 11 December 2001).

So what will the rise in NICs do? Penalise work, sending a signal of a rather different sort.

Tomorrow there will be just 75 days before those tax rises take effect.

75 days to go until Gordon Brown’s tax on income and tax on jobs.

A tax on jobs at a time of economic uncertainty.

A tax on income at a time when people are feeling nervous about the future. Already feeling exposed and under pressure.
This is a damaging tax imposed for the wrong reasons at the wrong time.

Failing Public Services

For many people, it will be the ultimate injustice.

Already they are paying more out of their own pockets for costs which the state used to pay. Costs such as educating their children at university, or looking after elderly relatives.

And already they are having to pay out of their own pockets, on top of the taxes they pay, because of failing public services.

A quarter of a million people spend their own money paying for their own operations each year because Tony Blair is not delivering the improvements in the NHS that he promised.

Not only are they paying higher taxes, but people are not seeing the improvements in public services which they have every right to expect.

A recent 20 per cent rise in health spending, for example, led to a rise of less than 2 per cent in the number of people receiving hospital treatment (1999-2000 to 2001-2).

In our schools, one in every four children leaves primary school unable to read to write and count properly. More and more children in inner cities are leaving school without a single GCSE.

On our streets, there is a crime committed every five seconds and street crime rose by nearly a third last year.
Why is this?

Why are we not getting the improvements in services that were promised, in return for the higher taxes which people have paid?

Part of the answer is waste.

There are, for example, more administrators than beds in the NHS. Spending on civil departments’ running costs is up from £13.5 billion (1996-7) to £17 billion (2002-3) – an increase of £3.5 billion, or £60 for every man, woman and child in the country. And over a period of four years the Government spent more than £350 million simply refurbishing its departmental buildings.

But the root cause goes deeper than this.

Because the Government refuses to reform our public services, its only answer is higher tax. When that fails, it can only turn to higher taxes still. It keeps coming back to the taxpayer for more and more money in an increasingly desperate attempt to deliver results. It is locked in a vicious circle of ever higher taxes and ever failing public services.

Tony Blair has boasted about the rise in National Insurance Contributions. He treats ever higher taxes as a badge of honour. In fact they are a sign of his failure.

The Dividing Line

It doesn’t have to be like this. There is an alternative to tax and spend and fail. There is a better way.

The challenge for Conservatives is to turn Labour’s vicious cycle into a virtuous one. And the way to achieve that is to tackle the problem at its core – by ensuring that our public services are reformed and improved. That means more decentralisation. It means giving power to patients and parents and freedom to doctors, nurses and teachers.

Reform of the public services is the only way to break Labour’s vicious circle. It is the key to everything we want to achieve. It is an urgent and pressing need.

It is only through real reform that we will achieve world class public services.

It is vital that we succeed in that goal.

It is vital for patients, parents and passengers alike.

It is vital for all the businesses represented in this hall and of the hundreds of thousands of businesses across the country.

And it is vital, too, for millions of hard-pressed taxpayers.

It’s time to give people a break.

Conclusion

So Conservatives are determined to make sure we get the world-class public services this country needs.

Of course Conservatives will always be a lower tax Party than Labour. This Government is very careless with people’s money – hundreds of millions has been thrown at the public services and we have seen little or no improvement. Tony Blair is wasting our money.

Just last week Tony Blair promised even higher taxes. In April he is introducing a jobs tax that will eat even more into the pay packets of everyone in Britain.

Conservatives in Government – as the recent Audit Commission report on local councils has shown – are more careful with people’s money and provide better services.

Raising taxes to spend more without reform wastes more.

I said at the start of this speech that 27 November will be a pivotal date for economic debate in this country.

But there were two other key speeches by Gordon Brown last year – his April Budget and his Spending Review statement in the summer. These will, in my view, turn out to be at least as important. They will prove to be a defining moment in another debate – the debate on tax and on how we improve the public services.

In the course of those statements Gordon Brown set his face against the path of real reform in the NHS and other services, and embarked instead on the route of tax and spend.

The task for my Party is to step into that breach. We must put the alternative case – the case for reform. On taxes and on public services, we must succeed where Labour have so conspicuously failed.

Rt Hon
Michael Howard QC MP