[Mr. Christopher Chope in the Chair]

Before we begin, I have a few preliminary announcements to make. If people wish, they can remove their jackets; I see that one or two hon. Members have already done so. Will all members of the Committee please ensure that their mobile phones and pagers are turned off or are switched to silent mode during our proceedings?

Adequate notice should be given of amendments. As a general rule, I do not intend to call starred amendments, so the reality is probably that the time for amendments is passed.

We are still in the early days of taking oral evidence in Public Bill Committees, so it might be helpful if I explain the procedure to make it clear to everyone. The Committee will first be asked to consider the programme motion on the amendment paper, for which debate is limited to half an hour. We will then proceed to consider a motion to report written evidence and a motion to permit the Committee to deliberate in private in advance of the oral evidence sessions that I hope we can take formally.

Assuming that the third motion is agreed to, the Committee will then move into a brief private session. When the Committee has deliberated, witnesses and members of the public will be invited back into the room and our oral evidence session will commence. If the Committee finishes its questioning at a reasonable time before One o’clock—I understand that that is the expectation—it will move on to the more familiar proceedings of clause-by-clause scrutiny of the Bill, after a short suspension to rearrange the room. I hope that that is clear. I now call the Minister to move the programme motion.

Ordered,

That—

(1) the Committee shall (in addition to its first meeting at 10.30 am on Tuesday 15th January) meet—

(a) at 4.30 pm on Tuesday 15th January;

(b) at 1.30 pm on Thursday 17th January;

(c) at 10.30 am and 3.30 pm on Tuesday 22nd January;

(2) the Committee shall hear oral evidence from the Treasury on Tuesday 15th January, and the hearing of that evidence shall (so far as not previously concluded) be brought to a conclusion at 1 pm;

(3) the proceedings on consideration of the Bill in Committee shall (so far as not previously concluded) be brought to a conclusion at 5 pm on Tuesday 22nd January.—[Jane Kennedy.]

Ordered,

That, subject to the discretion of the Chairman, any written evidence received by the Committee shall be reported to the House for publication.—[Jane Kennedy.]

Copies of any submission that the Committee receives will be made available in the Committee Room, but none has been received so far. I call the Minister to move the motion on deliberating in private.

Ordered,

That, at this and any subsequent meeting at which oral evidence is to be heard, the Committee shall sit in private until the witnesses are admitted.—[Jane Kennedy.]

The Committee deliberated in private.

On resuming—

We will now hear oral evidence from the Minister and officials from the Treasury and Her Majesty’s Revenue and Customs. I welcome the witnesses here today. Minister, would you like to introduce the witnesses, and would you be happy to go straight into questions?

Jane Kennedy: I think that you have the names and titles of the witnesses in front of you. The Committee has provided that to you; but for courtesy’s sake, there is Steven Effingham, head of the personal tax team; Jonathan Athow, head of the work incentives and policy analysis team in Her Majesty’s Treasury; and Sam Mitha on my left, who is the assistant director of PAYE and national insurance contributions at HMRC.

Q 1

Without implying that this is necessarily bad, is this just a money-raising exercise, principally because you will do anything to get money into the bank for the Exchequer?

Jane Kennedy: As you know, that in itself, as a matter of principle, is something that the Treasury would, naturally, want to have an interest in. For the serious purposes of the Bill, it is part of the overall reform that the Pensions Bill made to pensions provision, and a lot of the measures were announced in the Budget. We discussed this on Second Reading, and the broad purpose of the Bill is simply to ensure that, by making the changes that we are proposing, the anomaly that we have recognised for the higher earners—those contributing to the national insurance contributions fund—do not get a disproportionate benefit later, as a result of their pension payments.

Q 2

How was this anomaly picked up, and how long has it been in existence? 1066? Magna Carta?

Jane Kennedy: We were aware that this was possible as a likely consequence of the reforms in the discussions leading up to the Budget. Both HMRC and the Treasury were aware of this possible consequence. However, further work needed to be done in order to be clear how best to correct the anomaly in a way that would be fair to everybody, which was the Government’s intention. It did not become clear until further work had been done between the Department for Work and Pensions, HMRC and the Treasury on exactly how to do that. It was apparent to us that it was better to do it separately in a Bill of this nature, rather than to take the reform forward as an amendment to the Pensions Bill.

Q 3

I support simplification and can understand one of the ideas behind the Bill. What thought was given by the Treasury to try to make the matter revenue-neutral: in other words, by reducing the upper earnings limit to such a degree that this whole aspect was revenue-neutral? Was any consideration given to reducing the upper earnings limit, rather than to increasing the limit at which national insurance is paid, to get to that point? I can understand the idea that the Treasury would wish to simplify the entire system—that makes a certain amount of sense—but clearly, the way in which the current Treasury has decided to go about this will hit middle-income earners who are about to, or are already, paying income tax at the upper earnings limit. Why was this not made revenue-neutral in such a way that the interests of those people were protected?

Jonathan Athow: The overall reforms that were announced in Budget 2007 represented a reduction in the taxation on employment and were funded by revenue raised elsewhere in the tax system. In broad terms, there was a tax cut related to those elements around the removal of the 10p rate of income tax—the cut to the basic rate—and the alignment of the upper earnings limit with the point at which you start paying income tax.

The aim for higher income individuals—those who will be basic rate taxpayers after the reforms have been introduced—was to leave them no better or worse off. The overall package, which increases the upper earnings limit for those taxpayers but enables them to enjoy a cut in the basic rate, should leave them no better or no worse off overall than they would have been if the Budget 2007 reforms had not been implemented.

Jane Kennedy: Taken on its own, your point is valid. We have repeatedly said that this is part of a package. It is part of a major reform that we are taking forward. Overall, the families in the income bracket that you are talking about will see no change to their relative position.

Q 4

If I can just pick up on that, there is no disputing the fact that revenue will be raised as a result of the Bill—the question asked by the hon. Member for Norwich, North—but someone must be losing out. If you are saying to me that the middle-income families will find this revenue-neutral, who exactly will be losing out as a result of these measures?

Jonathan Athow: If I can explain, the position of some higher rate taxpayers, depending on their national insurance position and whether they have contracted out, is that they made a small gain from the Budget 2007 reforms. In that sense, the changes here are not disadvantaging relative to the position before Budget 2007, but they take back some of that gain. That is why this Bill can raise revenue without making anyone worse off than they were before Budget 2007. I hope that that is helpful.

Q 5

Dealing with the anomaly that the Minister referred to in her response to my hon. Friend the Member for Norwich, North, I wonder why the alignment of the upper earnings limit and the upper  accrual point is being done in two stages. Prima facie, it occurs to me that, after the first step of that alignment, which is effective from April 2008 until April 2009, when the second full step of alignment will be made, the anomaly to which the Minister refers will continue. If that is the case, why?

Jonathan Athow: There are two issues. Obviously, the intention of the Budget 2007 reforms was to introduce those changes as quickly as possible. However, there are limits to what this Bill can look at, especially with regard to any changes that can be made without legislative change to the upper earnings limit.

Q 6

I am sorry to interrupt you, but we are dealing with legislative change now. My initial response to your initial response is that we have a Bill in front of us, why could we not do it now?

Jonathan Athow: The national insurance Bill will allow those changes. From April 2009, we can fully align the upper earnings limit and the point at which people start paying the higher rate of tax. However, as part of the step in that direction, the initial stages were taken to start the alignment process from April 2008, but the words “legislative constraints” meant that it could not be done all in one go. Therefore, it is a two-stage process. The second stage is dependent on the legislation in the national insurance Bill.

Jane Kennedy: If I could just add to that, Mr. Marris, if you look at the impact assessment, which is available to Committee members, four options were considered when we were considering what to do to respond to the circumstances as we believed they would develop. One of those options was to do nothing; one was to do the change effective from April 2009, but two other effective dates were considered as well. On balance, we believed that it was better to go for the earliest possible effective date on which we could change it. Bear in mind that we are all the time seeking to simplify the tax and benefit system in the UK, and that was also an important consideration.

Q 7

I quite understand that. It strikes me that for a year, between April 2008 and April 2009, we will not have the simplification that we will have from April 2009 onwards. I wonder what the legislative constraints to which Mr. Athow referred are, given that we have a Bill before the House now.

Jonathan Athow: The constraints are that—Mr. Mitha will correct me if I am wrong—the upper earnings limit is limited to a maximum of seven and a half times the lower earnings limit and that to align that upper earnings limit with the point at which people could start paying higher rate tax would actually mean an increase above seven and a half times. That limitation means that alignment cannot happen all in one go. Currently, the point at which you pay higher rate tax is more than seven and a half times above the lower earnings limit.

Q 8

That ratio will not be broken from April 2009 onwards then?

Jonathan Athow: The Bill makes changes to that ratio to allow for alignment, so it will allow the upper earnings limit to be more than seven and a half times the lower earnings limit.

Sam Mitha: Under the current legislation, prior to the enactment of the National Insurance Contributions Bill, the upper earnings limit is set at seven and a half times the primary threshold. Once the Bill is enacted, assuming that it is passed in the form that is being proposed, Ministers will be able to set it at a level that is set by regulation, subject to affirmative resolution. At the moment, the maximum of the upper earnings limit that could be set prior to the passage of the Bill that is currently before Parliament is seven and a half times the primary threshold, which is currently £100 a week—the level at which national insurance class 1 contributions become payable.

Jane Kennedy: There is a more political point, which you are making, Mr. Marris: if we have a pensions Bill before the House, why are we not taking the measure in that? I understand that that is perhaps what you are getting at. The truth is that we felt that—rather than bring this forward as a Government amendment to a pensions Bill, which we could not necessarily guarantee would be debated in full—this was a better vehicle to use, given that we wanted to take the time to get right the changes that we believed were necessary. Rather than bring that forward in a set of Government amendments, which we all know can be dealt with very quickly and very often to the dissatisfaction of Members of both Houses, we felt that this was a better way of doing it.

Q 9

So am I right that we are getting partial simplification from this April and full simplification for April next year?

Jane Kennedy: Yes, that’s right.

Q 10

On a quick point of clarification, in this immediate year, it will stay within the seven and a half times threshold, but it will be no more simple than the current arrangements. You could say that it will be halfway between confusion and simplicity.

Jonathan Athow: As I said, it is a step on the way to a simpler system. Obviously, other changes are happening from April 2008, such as the reduction in the basic rate, looking at the package as a whole. Also, as I said, the aim was to make certain that people who are higher rate taxpayers after the changes are introduced will be no better or worse off. There was also a desire not to create a windfall gain for those people by making no change now, only to then take it away the following April, or to give them a windfall loss, only to compensate them in the following April. It is very much from the desire of leaving higher rate taxpayers no worse off this April, compared with the April before, and April 2009, compared with April 2008.

Q 11

On a point about clarification, what would stop the simplification happening with immediate effect, with the legislation being passed to enable that jump to happen in one go beyond the seven and half ratio?

Jonathan Athow: My understanding is that we would not be legislatively able to make those changes. To allow for the legislation to be passed, it was decided that we would implement it from April 2009.

Q 12

I wish to clarify the anomaly to which the Minister referred earlier. I got the impression that you were talking about the upper accrual point and the fact that we are going to run into some difficulties, as opposed to the upper earnings limit? If there is an anomaly, it is the fact that you stop paying national insurance contributions before you start paying higher rate income tax—a gap that has existed for a while.

Jonathan Athow: The long-standing anomaly is exactly as you describe it; that is clearly what the reforms in the Budget set out to look at. We then looked at consequential issues around the upper accrual point. As the Financial Secretary made clear, those issues were considered at the time, but we wanted to come back to them subsequently, because there are a number of complex issues when talking about the second state pension and how changes in the accrual point would affect state pension entitlement.

Q 13

Can we just turn to the question of Budget losers? I take your point that, in isolation, the changes to the upper earnings limit will raise revenue—£1.1 billion in 2008-09, and £1.5 billion in 2009-10. One could look at it as part of an overall package, but my memory is that the analysis done by the Institute for Fiscal Studies showed that a group of people earning in the range of £39,000 to £40,000 would lose out overall? Considering it not in isolation but overall, they would lose out. Is that analysis correct? Obviously, there will be some winners and some losers, but I want to identify who are the losers in the overall package. I think it is in that region. Am I correct?

Jonathan Athow: There will be a small number of people for whom the additional rise in the point at which people pay higher rate tax does not fully compensate for the rise in the upper earnings limit. The IFS has identified that group. However, it is a relatively small number.

Q 14

How many are we talking about?

Jonathan Athow: I do not know whether—

Jane Kennedy: I do not have a breakdown by income group, but I have one for type of household. Bear in mind that these are within the context of the overall package, including the other changes brought forward by the 2007 Budget.

Around 5.3 million households will pay marginally more. That is a lot of households, but that is in the context of the 21 million households that will be either better off or no worse off. It is in proportion to that figure. Of the 5.3 million households that will lose, about 3.7 million will have a loss of less than £3 a week.

A further breakdown that I gave in answer to a parliamentary question I repeat for the sake of clarity. About 900,000 households that contain a single adult would see their income decrease by an average of about £1.45 a week. There are 700,000 households with more than one adult but with a single earner; they would see their income decrease by slightly more—about £2 a week on average. There are 3.3 million households that are worse off in which two or more adults are defined as earners, who will see their income decrease by around £2.60 a week on average. And then there are about 800,000 single adults with an income below  £18,500 who will see their income decrease by £1.45 a week on average. About 600,000 women aged between 60 and 64 will also see their income decrease, but they will often be in households with other earners or other people in the household. We anticipate that most of them will be in households with more than one adult.

Q 15

I apologise—you might have said this, and I might have missed it—but how many of the 5.3 million are in the £39,000 to £40,000 bracket? Was that figure in there?

Jonathan Athow: I do not think I have that figure to hand, but we could provide it later.

Q 16

That would be interesting. Incidentally, when I was on the Treasury Committee, I remember asking the then Chancellor whether he agreed with the 5.3 million estimate produced by the Institute for Fiscal Studies, which he did not. But there you go.

Jane Kennedy: If it would help, I could provide an example of someone earning at the upper-earnings limit, or above, who would fall into that group. Using the 2008-09 tax year as an example, most employees earning at the upper limit, or above it, will be better off: the loss of the starting rate tax band means that they will gain about £232 per year; the upper earnings limit being raised to £770 means that they will gain a further £390 per year, and the reduction of the basic rate to 20 per cent. means that they will lose £673 per year. Overall, we calculate that they will be about £51.60 better off.

Q 17

They are the people who will be better off, but they are not the people that the IFS identified as the losers. I take your point that they are marginal losers, but there will be different groups and we must bear in mind fiscal drag. However, may I follow on from a question raised by Mr. Field about how this will work? I take the point that, in simplistic terms, the tax increase—the increase in national assurance contributions and the doubling of the 10p band—paid for the 2p off income tax. In broad terms, that is what it did. How did that work? Did an instruction come from up on high saying, “I want to knock 2p off income tax; find me some ways to fund it!”? I am curious about how the Treasury works in these circumstances.

Jane Kennedy: It is part of a very lively discussion process between Ministers and advisers in the Treasury and HMRC who talk us through the various options, the impact on fiscal take and the economy, and a whole range of other measures. That is particularly the case when we are making changes with a set of policy objectives in mind, which clearly we were in this case.

Q 18

I suppose I am asking what drove it. Was the analysis that it would be good to have two rates for personal income or was it a case of wanting to find extra money to fund the 2p off income tax, so that the Chancellor could announce it at the end of his Budget and put the Leader of the Opposition on the back foot? What drove the decision?

So you admit that he did?

It was the intention.

Jane Kennedy: I was not informed at the time. We had a number of objectives, the first of which was to seek to simplify the personal tax system in the UK. We listen to, and are conscious of, the criticisms of the complexity of the system for personal and business taxation, which is why that was one of the policy objectives of the changes. The second and very important objective was to test the current personal tax structure in order to see whether it best served our objective of reducing child poverty by bringing more children out of relative and absolute poverty. I think that I am right in saying that the changes that we are making, and have made, as a result of the 2007 Budget, and some of the changes today, mean that we will take a further 200,000 children out of relative poverty. That was an important consideration. There was a degree of redistribution in the way that we did it to ensure that we gave as much help as we could to families with children, which will help towards that objective.

Q 19

On redistribution, Minister, my memory of the IFS analysis—ignore our relatively small group of 39,000 to 40,000—tells me that it was not a bad Budget for those on middle incomes but that many people who earn less than £18,000 were losers, if only by a small amount. In that sense, from a redistribution point of view, it was a curious Budget, because some of the losers were at the poorer end of the scale.

Jane Kennedy: The redistribution was not necessarily all from higher to lower earners, as you rightly pointed out. There was a redistribution for some, particularly single-adult households, but the third important objective was to improve the incentive to work. I am sure that the debate on whether we achieved that will continue, but we are constantly reviewing policy to ensure that we do not work against the objective.

Q 20

This question might be one for the officials, because they were at the Treasury at the time. Did the Treasury, when officials were working through the process of reaching a Budget, ever model a tax-neutral realignment of national insurance and income tax? If you did, I should like to know what it looked like. I assume that it would have a higher level at which people start to pay higher rate income tax. Did you ever model that?

Jonathan Athow: A number of options would have been looked at. As I said, overall, the reforms from Budget 2007 on personal tax represented a cut of around £2.5 billion. If you wanted to use the upper earnings limit and the point at which people pay higher rate tax as the balancing item, you would have to reduce the income at which people start to pay higher rate tax. If you wanted to make it revenue-neutral within the personal tax system, it would mean a reduction, so people would start to pay higher rate tax lower down.

Q 21

I might be confused. There are two ways of aligning. You can raise national contributions up around the limit, so people pay 11 per cent. for  more, or you could reduce the point at which people start paying higher rate income tax, so rather than paying 22p—it is now 20p—they start paying 40p. In a way, the fact that the Government have raised the upper earnings limit raises less revenue than the alternative approach. Is that correct?

Jonathan Athow: Yes, that is correct.

Q 22

But if you wanted a revenue-neutral measure, you would shift up the rate at which people pay higher rate income tax. The higher rate threshold, in other words, would go up higher still. I have not done the sums, but rather than 43p, it would be 45p or 46p. Is that correct?

Jonathan Athow: The logic actually works the other way around. Once the upper earnings limit and the point at which people pay higher rate tax are aligned, the marginal effective tax rate below that point—national insurance plus income tax—would be 31 per cent. That comprises 20 per cent. income tax plus 11 per cent. national insurance. Above that point, it is 41 per cent.—40 per cent. income tax plus 1 per cent. additional national insurance charge. If you wanted to raise money, you would want people to be paying more of their money at the 41 per cent. rate, so you would reduce the threshold.

Q 23

I am asking whether, if you wanted the realignment to be revenue-neutral, you would raise the point at which you started paying 41 per cent.?

Jonathan Athow: Again, it depends on what baseline you are looking against.

Q 24

Presumably, that must be right. If you wanted to make the changes in isolation—I accept your point that they are not being made in isolation—the point at which people started paying 41 per cent. would be higher than is currently proposed by the Government.

Jonathan Athow: As a hypothetical example of doing something in isolation, that would be correct.

Q 25

I suppose that what I am asking is whether you ever looked at that as one of the options presented to Ministers, or was it always a given that 2p was coming off income tax and therefore we needed to raise more revenue from elsewhere.

Jonathan Athow: A set of reforms evolves over time; there are ideas. As the Financial Secretary said, the Government had principles about simplification, tackling child poverty, work incentives and taking pensioners out of tax. If you look at the package as a whole, the Government believe that it is a sensible set of reforms that is best placed to meet those different objectives. I am not certain that it necessarily makes sense to consider individual components in isolation, because it is very much a package. The removal of the starting rate and the reduction in the basic rate have effects for higher rate taxpayers and need to be factored in when considering their overall tax position.

Let Jeremy Browne come in on this one.

I have more questions on clause 1, but there are other issues on which I could come in.

Q 26

I have a couple of questions further to Mr. Gauke’s. If you wanted to make the proposal revenue-neutral, you could, as you said, make the point at which it kicks in at 41 per cent. higher than is proposed in this legislation, or presumably you could have raised the threshold at the lower point as well. You could have given money back to people at the lower end of the scale, rather than the people at the upper end of the scale.

Jane Kennedy: We would have asked for advice on that. In the end, when you are introducing a major change to the tax and national insurance system, which is what was proposed in Budget 2007, and along with it a whole raft of other changes to thresholds—the really complex changes that were proposed—you will consider many different scenarios. My experience has always been that you could spend a very long time working through many different options to no good purpose. In fact, Ministers would normally give a relatively clear steer on what they were looking for as an objective for such a reform.

Q 27

Was one option that was considered a halfway house whereby you would have gone halfway towards making the measure revenue-neutral—funding a 1p rather than a 2p cut in the basic rate—or was that considered less politically dramatic than the 2p cut? Or was the attraction that of having 20p and 40p as the two simple thresholds on the basis that both are divisible by 10, rather than 21p and 40p?

Jane Kennedy: My answer to that is the same as the answer that I have just given. I was not party to the discussions that took place at the time, but my experience of such discussions is that you will fairly rapidly move to a point at which, as Ministers, you are fairly clear about what your objectives are. That being the case, you will work with officials to test those objectives, not necessarily to conduct an academic exercise to see what the whole range of different options are in detail. You would give a relatively clear steer on what you wanted to achieve and then ask for proposals that met those objectives. I am not sure whether the specific option mentioned was considered, but Ministers will have given a very clear steer at the time as to what they wanted to achieve, and tax rises and other things would have been part of that discussion.

Q 28

We are talking about, I think, 5.3 million losers under the overall arrangements. The question is whether you feel that the then Minister could have said, “Wait a second. I can identify two big groups of losers.” That is those who benefit almost or completely from the lower, 10p rate but do not earn enough to benefit from the reduction from 22p to 20p in the basic rate, who are relatively low earners, and the people who benefit from the admittedly somewhat anomalous position of their marginal rate going down—the £39,000 to £40,000 income earners. Those are the two big groups that took a big hit from the Budget.

We are talking about national insurance.

Including the proposals on national insurance that we are discussing today.

Perhaps the question can be rephrased in the context of national insurance alone.

Do you want me to have another stab at that? As the Minister said, these measures are all considered as part of a package. The changes to national insurance funded the proposals, as did the abolition of the 10p rate. Interestingly, as the Minister has admitted, that meant that there was a redistribution from some people on relatively low earnings, who benefited from the 10p rate but did not earn enough to benefit from the cut in the basic rate to higher earners—something that struck many people as a curious political feature of the budget.

Jane Kennedy: We are in some difficultly here. I could answer purely on national insurance, but that would not give the Committee a full picture of the overall intention. In order to be helpful I have set the parameters fairly wide—it makes it more difficult for me and perhaps also for you.

I would like to give an example of how the process would have worked, as that seems to be of most interest. When the discussions were taking place, issues would have been flagged up with regard to who the potential losers from different packages would be. As a result of that, a package would have been brought forward that was engineered to address those people. For example, as a result of this package and because of the changes to the threshold that we have made, around 580,000 fewer pensioners will be paying income tax than would otherwise have been the case.

Where there were going to be losers as a result of the change, we were careful to ensure that those losers were not in the categories that other Government priorities clearly wanted to help. When these issues are discussed and the options looked at, any decisions that are made have to be balanced, and sometimes there will be some losers. However, as we have said, we sought to make those who lost out do so in a very small part. They are losers but not with a capital “L”, and overall, looking back at the changes that we have made to tax and benefits since 1997, there are no losers. Even those that we have mentioned are still well over £900 a year better off as a result of the full reforms that we have made since we were elected in 1997.

Jonathan Athow: If I may make an observation, the Institute for Fiscal Studies was mentioned earlier, and there are two quotes that were made by the director when he introduced its commentary on the budget. In the first he said, “The income tax and NI package has been cleverly designed to limit the number of losers”. He went on, “To reform the system in a useful way within tight financial constraints and with only modest...losses should be a cause for congratulation rather than criticism.” The intentions behind that, in terms of making a useful series of reforms while minimising the number of people who would lose from them, was exactly the Government’s intention.

Q 29

Just a couple of follow-up questions. Can I clarify whether the work done by the Institute for Fiscal Studies that looked at winners and losers was done on the Budget outcome? Presumably it did not include the quantified impact of bringing forward the flattening of the state second pension, which is the other half of this Bill. Is that fair? The figures were included in the pre-Budget report?

Jonathan Athow: As that was not announced Government policy at the time, it would not have included that.

Q 30

It was not included in the figures. Okay. My second question is brief, and it is about the Minister’s comments on incentivisation to work. The key people who were losers from the Budget were, generally, single people with no children. In terms of their typical profile, I guess that they would tend to be younger people. How does that stack up with our levels of youth unemployment? Although we all understand the desire to ensure that families with children are supported and that child poverty is tackled, that longer-term aim of ensuring that young people are in work in the first place seems to have been undermined by this aspect of the Budget. Was that matter discussed prior to the Budget?

Does anyone want to answer that? The reason that I am allowing that question is that the Minister, herself, has said that one of the objectives of all this—

Mr. Chairman, that is precisely why I am asking the question.

Jonathan Athow: There are a number of observations to be made here. First, employment has risen strongly in recent years for almost all age ranges. When we look at work incentives, there is a concern that parents, in particular, face some of the toughest work incentive problems because of the way that the benefit system has grown and changed over time. Often, they faced the biggest unemployment trap, and found it difficult to make work pay, particularly with child care costs.

Therefore, many of the reforms have been aimed at further strengthening work incentives for families with children. That was why the working tax credit threshold was increased. It will also benefit those without children who receive the working tax credit. In that sense, work incentives for many low-paid people, particularly parents, were actually improved as part of that series of reforms.

Q 31

But, it strikes me that perhaps the easiest time to get those who are unemployed into work is before they have additional barriers to work. Taking care of children as single-parent families is clearly identified as a barrier to work. Obviously, employed people who then have children will often get support from their employers. So, it seems that perhaps the danger of the Budget was that it undermined the best time to encourage people to go into employment, which is before they have children.

Jane Kennedy: The reforms are taking place in an economy in which employment itself has grown very strongly. Notwithstanding the debate that is taking  place about those not in education or employment, employment among young people has grown strongly. I know that in my constituency, as many of us will who have constituencies where youth unemployment was a serious scourge, it is now virtually non-existent. Therefore, it is within that context that we quite rightly started to look at how we could use the tax and national insurance contribution system to give more assistance to those households to which we were seeking to offer the most help and make the biggest difference, particularly in helping them into work.

The areas of greatest focus now are those people who continue to have difficulty getting in to work—those who have children. A whole range of policy measures were put in place to help families in those circumstances. All those have to be funded, and clearly those are issues that Government need to consider, when taking forward a reform of this nature. Equally, we are doing it in the context of an economy that is continuing to perform well in providing employment opportunities. In that context, you can start to consider making the kinds of decisions that were made in Budget 2007. Had we been in the context of a labour market of 15 or 20 years ago, such decisions would have been much more difficult for the individuals affected.

We will move on to something else now. David Gauke.

Q 32

Mr. Mitha mentioned earlier the ratio that exists between the upper earnings limits and the primary threshold, which is essentially being abolished within this legislation. Can I ask what the purpose of that ratio was? Why does existing legislation contain a ratio between the upper earnings limit and the primary threshold?

Sam Mitha: Historically, national insurance limits have moved basically in line with prices. Although the ratio has been in existence a long time, I think that it was designed to ensure that there was no abrupt increase in national insurance levels. The level was set at an historically high level because the annual increases were in line with the growth in prices.

Q 33

We know that it needs to be reformed because of the changes that we have been discussing about increasing the upper earnings limit. Do we know what the upper earnings limit primary threshold ratio will be for 2008-09 and 2009-10?

Sam Mitha: That will be contingent on ministerial announcements about the growth. Ministers make annual announcements about uprating the primary threshold in line with prices.

Q 34

So presumably we know the figure for 2008-09.

Jonathan Athow: Yes, we do, but unfortunately I do not have the ratio in front of me.

Q 35

Do we know what the primary threshold will be for next year?

Sam Mitha: It will be £105.  

Q 36

Do we know what the upper earnings limit will be for next year?

Sam Mitha: It will be £770 a week. I will give the figures again. The upper earnings limit will be increased to £770 for 2008-09 and the lower earnings limit will be £105.

Q 37

Do we know the upper earnings limit for 2009-10?

Sam Mitha: Yes. It will be £800. We do not yet know the level of the lower earnings limit.

Jonathan Athow: It was the intention that in the second year—because we do not know the inflation figures that will be used in 2009-10 for the price uprating—the £800 figure was the point at which we would start to pay higher rate tax above prices. Again, we reach the point at which those people paying higher rate tax will be no better or no worse off. The actual weekly limits have not yet been set.

Q 38

If, as the then Chancellor said in his Budget speech in March, that higher rate income tax will be payable at £43,000 and that there will be an alignment at which point the upper earnings limit will be at the same point, presumably all we need to do is to work out what £43,000 is on a weekly basis and that will give us our number. Or am I missing something?

Jonathan Athow: I should make it clear that the numbers quoted in the Budget speech for what the levels will actually be in April 2009 were obviously based on projections for inflation that were included in the Budget, so the actual levels—the actual primary threshold and the actual upper earnings limit—and the actual point at which people start paying higher rate tax will not be known with certainty until the inflation numbers are made clear and a statement has been made by the Treasury setting out those values. I just want to make it clear. They were given for illustrative purposes to help explain the shape of the reform. We just want to be clear about what has been given.

Q 39

I understand why you want to clarify that point, but the then Chancellor was able to make the statement that he did in March. Let us say that it was a reasonable thing for him to have said. The Treasury and the Bank of England have not changed their inflation projections. They still talk about 2 per cent., as they did then. Let us for argument’s sake use that £43,000. Is the £800 based on the assumption that it will be £43,000?

Jonathan Athow: That includes the £800 additional increase.

Q 40

We know that the primary threshold for 2008-09 is £105. Presumably we would be safe to assume that it will not be lower than £105. I do not know historically whether the pattern is that we might expect it to be up another £5 or £2. I do not know the range of the usual increase in the primary threshold on an annual basis. Can you help me on that?

Jane Kennedy: It is determined from year to year, based on economic circumstances.

Q 41

Of course, I would not hazard a guess on what the economic circumstances will be next year, but one might expect a small increase of around £2 to £5.

Jonathan Athow: Yes, that would be consistent with previous increases.

Q 42

If it went up by that sort of figure—let us say, from £105 to £110—we would stay within the seven and a half ratio, because 110 times seven and a half is more than 800. For want of a quid or two on the bottom rate, we will have to legislate to get rid of a 6.5 to 7.5 per cent. threshold that has existed for 16 years, so that it could be 7.55 per cent. or whatever.

Jonathan Athow: On our projections at the time of the Budget, we can revisit and look at exactly those questions about what the ratio would have been under the assumptions that we made at that time, but when we looked through the arithmetic, it was in excess of seven and a half times the primary threshold.

Q 43

But my point is that it is so fractional—I am struggling to divide 800 by seven and a half, which comes to something like £109. You are so close to getting within that without having to take us through this legislative process of abandoning the 7.5 per cent. safeguard as some would see it.

Jonathan Athow: I am afraid that the law is the law.

Q 44

But instead of increasing the bottom threshold to £108.50, you could increase it to £109.50, and spare us this legislative change. Some people may be suspicious that, when you have got rid of the seven and a half, there is only one way to go, which is up and up.

Jonathan Athow: As we have said, the aim of the Bill was alignment of national insurance and income tax. We have alignment at the bottom, so the point at which national insurance starts to be paid on a weekly basis is now the same as the annual limit for the point at which income tax starts to be paid. We wanted alignment at the top. Given those aims of simplification and alignment, there was a constraint within the legislation.

Q 45

But you could have achieved that objective by increasing the starting point, which now goes up to £105. Obviously, the more you increase that, the easier it is to get within the seven and a half. You have to be careful not to increase it so much that you drop below six and a half.

Jane Kennedy: I am not sure how helpful this is. The purpose of the reforms was to achieve three major policy objectives, one of which was to simplify the upper point at which there was alignment between tax and national insurance contributions. A legislative brake applied to the point at which national insurance contributions could be aligned, so to achieve the other policy objectives, primary legislation was necessary to make that change. The point is that, if the objective was simply to achieve the seven and a half times and stay within that, we would have taken a completely different route, and we would not be making the changes that we are making today.

Q 46

My final point is that the changes were made around 1992 and included the legislative safeguard that the figure would not be more than seven and a half times higher than the bottom one. A concern that some people may have is that that safeguard is being removed and is not being replaced with a higher level of eight, rather than seven and a half or eight and a half. As I understand it, there is no specified higher level, and it will not require primary legislation in future to change that. Some people will say that they understand that you want to align the two and to simplify the matter, but if you are doing that and all it requires instead is to break the 7.5 multiplier and to make it 7.52 or whatever it will be—it will be a fraction over 7.53—you are opening the doors to go up and up as high as the Government may wish at the time. It seems strange that, for 0.03, this legislative change is required. Some people may fear that Ministers in the future may exploit or even abuse it, when it would require only a tiny tweak to stay within the current limit.

Jane Kennedy: But there is no legislative requirement to meet at the lower end—at the point at which you start to pay contributions. There is none whatever, so it seems illogical to continue with the upper limit purely because it exists. There are sound policy reasons, as I have advanced, for that particular alignment spread, including not only the three main policy objectives of the 2007 Budget, but the correction of the pension anomaly that resulted from pension reform, so that we achieve the overall objective of pension reform with all-party support when we implement it.

Members may have that concern, but recognising that, we will take forward changes to the national insurance contributions upper earnings limit through the affirmative procedure in both Houses. Both Houses will have an opportunity to debate the proposals, so it is not as though the Government will be able to act with impunity; there will be very clear and robust scrutiny of any such proposal.

Mr. Browne rather took my line of questioning—seamlessly—and pursued it.

Sorry.

Q 47

I do not know whether Mr. Marris wants to come in; I was going to broaden the question to ask about the way in which national insurance contributions are changed.

Q 48

I have a specific point. Let us consider what Mr. Browne said about the limit going above seven and a half to eight and so on. Contrary to the implication of what you said, Minister, if that were to happen and the upper earnings limit ratio went to eight and a half, for example, would not people in the top slice, between seven and a half and eight and a half, pay less tax? The point at which they start paying 40 per cent. would be higher.

Jonathan Athow: In a situation where the point at which you start paying higher rate tax is aligned with the upper earnings limit, an increase in the upper earnings limit in the higher rate threshold would mean that people in that bracket saw a fall in their overall tax and national insurance paid.

Q 49

Before we return to the issue of national insurance contributions and the constitutional way in which they are changed, you said, Minister, that there was not really a restriction on the lower end. But if there is a ratio, it restricts both ways, and you cannot cut the rate at which people start paying if you have a ratio that holds you steady at the top. I have not expressed that very clearly, but it applies both ways, and the point of the ratio is that it stops a big distance between the primary threshold—it used to be the lower earnings limit—and the upper earnings limit. Is my understanding correct?

Jonathan Athow: That is very much the way in which the ratio works, as you say, by limiting the gap between the two. However, there is the existing commitment, dating back to the 1999 Budget, of the alignment, instead of the primary threshold at the point—with the personal allowance—at which you start paying any income tax at all. So that is the constraint on the bottom. Given that that is Government policy, the ratio bites only on the top of that band.

Q 50

I should advise everybody to double check any numbers that I calculate, but to follow Mr. Browne’s questions, if the primary threshold in 2009-10 went up to £107—that is at the lower end of our expectations for an increase—and the ratio of seven and a half continued, that would get us above a weekly figure of £800, I think. Correct me if I am wrong.

Jonathan Athow: That would be true. I was just looking back on the numbers, and I think that it is a little over the £43,000 quoted by the Chancellor in the Budget. That would equate to an upper earnings limit—again, I am doing some maths in my head—of about £850 a week.

Q 51

So where did the £800 come from?

Jonathan Athow: The £800 was actually the increase in the point at which people start paying higher rate tax above what would have happened with just price indexation. Once you have done that and aligned the upper earnings limit, the measure was designed to make certain people who are higher rate taxpayers no better and no worse off under the new system. Apologies if there was confusion.

Q 52

Fine. So the figure that we should be looking at is therefore £850, is it, for the purposes of this analysis of what the primary threshold would be and so on?

Jonathan Athow: Unfortunately, I have not brought my calculator with me, but we can use a figure of about £850.

Q 53

I suspect that your calculations might be better than mine. So we are looking at about the £850 figure, to achieve the objective. Therefore, if we were on £105 or £107, the ratio of seven and a half is clearly not going to work, but a ratio of about eight would work.

Jonathan Athow: I think that it would be somewhere between seven and a half and eight.

Q 54

I think it would be helpful to the Committee to have an understanding of how national insurance contributions are changed generally. Perhaps it would be even more helpful to do that in comparison with income tax. Obviously, they are both taxes on income, and the relationship between the two is getting closer by the year. Could someone guide us on how rates and thresholds of national insurance contributions are set, compared with income tax?

Sam Mitha: National insurance contribution levels are actually set annually as part of a re-rating exercise, following a report by the Government Actuary’s Department. The Government Actuary examines the balances of the national insurance fund and makes recommendations about what future increases in national insurance contributions may be necessary. The system operates as a pay-as-you-go system, and on the basis of the Government Actuary’s report, the Treasury and HMRC make recommendations to Ministers about future increases in national insurance contribution levels. Until fairly recently, most of those increases have been predicated on the basis of increases in prices, or when balances in the national insurance fund have at any time appeared to be inadequate to meet the commitments of the fund, Ministers have recommended slightly larger increases.

Q 55

I am sorry to interrupt. You mention what happens when there is a shortfall in the fund. What happens if there is a large surplus in the fund? Do Ministers ever recommend a decrease in national insurance? There is a large surplus at the moment, is there not?

Sam Mitha: The surplus in the national insurance fund is basically something that goes towards funding public services, because it reduces the level of Government borrowing. If there were not a large surplus in the national insurance fund, the Government would need either to raise taxation or borrow the money on the open market. It is not always possible to predict accurately what the calls on the fund will be. It is usually possible to predict what the major call will be, from state pensions, but the fund is used also to pay other contributory benefits such as contributory jobseeker’s allowance and incapacity benefit. It is not always possible to quantify that. The Government and the Government Actuary’s Department usually recommend that the fund be managed on a very prudent basis.

Q 56

At the moment, the Government Actuary recommends that the fund should maintain a balance equivalent to 17 per cent. benefit spending, which is around £10 billion. In March 2006—I do not know whether there are more up-to-date figures—the balance of the fund was £34 billion, which is £24 billion higher. Are those figures correct?

Sam Mitha: They appear to be correct. I have not got my numbers in front of me.

Q 57

It is essentially another tax, is not it? The relationship with spending on benefits is pretty indirect.

Sam Mitha: National insurance contributions are most empathically not a tax because they can be used for only one purpose—funding contributory benefits and, where specified, for funding the NHS. Money from the national insurance fund may be used only for those purposes, and transfers from the Consolidated Fund, into which taxation goes, can be only one way. If there is a shortfall on the national insurance fund, general taxation can be used to shore it up, but when there is money in the national insurance fund, the only purpose for which it may be used is to pay contributory benefits.

Q 58

You mention the money put aside for the NHS. To our mind, that area has totally muddied the waters between income tax and national insurance contributions. It is not, perhaps, too fanciful to suggest that a future Government—perhaps even this Government—might look to do a similar thing by putting a penny on national insurance for the education system, or some other form of moneys. You mentioned earlier that it is a pay-as-you-go system. It now seems apparent, from what my colleague, Mr. Gauke, said, that the reserves are at an historically high level. Is there a realisation that there are likely to be significant takers from that fund in the foreseeable future? Is it the perspective of the Treasury, at least, that it is a prudent device?

Jonathan Athow: Yes. Obviously, the Government must be mindful of future calls on national insurance. As we all know, certain demographic changes will be upon us and the Government have to be mindful not only of the position today but of public finances more generally, as those changes come to pass.

Q 59

Thank you for that answer. Mr. Mitha, do you regard the notion of moneys coming out of that historic fund for the health service, which has come about very recently, as undermining the very notion of having that ring-fenced fund?

Sam Mitha: That is a matter for Ministers. They made a case for that when the legislation was introduced and Parliament passed it.

Jane Kennedy: The good news is that that has not gone unnoticed.

Q 60

I understand the official hesitation about answering what is quite a political question, but the answer to the question is yes, is not it? However worthy the cause, that it is a contributory insurance scheme no longer applies—the same with the 1p running right through the system. It means that national insurance is no longer what it says on the tin. The rationale for merging it with income tax is all the greater after the changes that were used to fund the NHS and to honour the promise of not raising basic income tax made at a general election.

Jane Kennedy: If we were to merge the two into one tax on income, we would have to find a different way of funding benefits and pensions out of that general tax take. That would be an imprudent step. We would have to expend a lot of time and energy on finding a guaranteed way of funding such things, particularly in  relation to pensioners, where we have to meet a public commitment. I do not accept the argument. We had the argument about the status of the national insurance fund and NICs when the change was made, some time ago, and there has been broad public support for it. The exception was quite clearly defined in law. The House has decided on that point.

Q 61

What would be the implications of the changes that we are examining today—in other words, the increase in the upper earnings limit? Presumably, more will go into the national insurance fund, because more will be paid through national insurance contributions. Do we therefore expect this balance to rise further in the medium term?

Jane Kennedy: The surplus in the national insurance fund has more to do with the success of the economy and the fact that more people are working and paying national insurance than with the levels. Clearly, if we raise national insurance contributions at that point, more money would go into the fund.

Q 62

I shall avoid a discussion of the number of people who are on out-of-work benefits, which has remained stubbornly above 5 million; but presumably, we can expect the national insurance fund balance of £34 billion to increase yet further. That is not necessarily a criticism, but it is the implication.

Jonathan Athow: That would also depend on the calls on the fund as they are made and whether there are changes in that, either through changes in the economy or, to go back to a previous answer, in demographics. An ageing population, as it often described, will also affect the future path of the national insurance fund and whether there is a surplus.

Q 63

On that point, it obviously depends on the call on the fund. But the call on the fund will be less because the higher rate earners affected by the changes in the Bill will get a lower state second pension than they would have done, and the flat-rating, as it is called, will be achieved by 2031, instead of 2035. What will be the saving on the national insurance fund by bringing that date forward by four years?

Jonathan Athow: I do not know whether I have that information to hand or whether any of my colleagues has. We could get back to you separately on that.

Q 64

Would I be right in thinking that the calls on the national insurance fund will grow with the state second pension, or is that not coming from that fund? The state second pension is fairly new and an increasing number of people will start to draw on it as the years go by.

Jonathan Athow: Yes, the state second pension is funded from the national insurance fund, so changes in entitlement will affect calls on that fund in the future. As I said, I do not think that we have the information to hand.

Q 65

Broadly speaking, subject to the exception to which I referred for higher rate earners between 2031 and 2035, would I be right in thinking that the state second pension’s call on the national insurance fund is likely to increase in the next 30 years?

Jonathan Athow: Indeed. State second pension is a relatively recent creation. Obviously, given that and demographics, it is likely to increase.

Q 66

I would just comment as a politician that it is quite a good thing that we have that surplus if calls on the fund are going to increase anyway, even when the economy remains strong and unemployment is relatively low.

Jane Kennedy: I could not agree more.

Q 67

On a point of clarification, Minister, you said at the beginning that the national insurance fund worked in tandem with the need to increase or decrease Government borrowing. So if there is a surplus of £24 billion over what is required, does that, by definition, mean that the Government have had to borrow £24 billion less?

Jane Kennedy: Am I right in thinking that the surplus is there, and it is being used for other purposes at the moment?

Sam Mitha: It is lent to the Government, which therefore reduces the Government’s borrowing requirement.

Jane Kennedy: So the answer is yes.

Q 68

About the same amount was lent to Northern Rock. We could cut out the middleman.

Can I just return to the question about the procedure for national insurance contributions, which we started on before I sidetracked the Committee with the issue of the national insurance fund surplus? Essentially, Mr. Mitha, you are saying that national insurance contributions—thresholds, rates, etc.—are set by regulation. How does that compare to income tax, just so that we can have this on the record?

Sam Mitha: In both instances, there is an evaluation of what the requirement is. In the case of national insurance contributions, there is the report by the Government Actuary’s Department about what level of funding is necessary. Then Ministers have to make a decision, by reference to the fiscal priorities at the time, about what the appropriate level is.

Q 69

What are the respective mechanisms through which changes are made? I understand that Ministers take a view about what the economy and the public finances require and make decisions accordingly, but national insurance contributions are dealt with by regulations and income tax is dealt with—

Sam Mitha: Through the Finance Bill.

Q 70

Entirely through the Finance Bill.

Is any consideration given to reforming the way that national insurance contributions work? It seems a bit of an anomaly. I take your point about the restrictions on how national insurance is spent. Income tax and national insurance are both essentially taxes on personal income: one is done through primary legislation, and the other is done through secondary legislation. There appears to be an anomaly. Has any consideration been given to reforming that? Perhaps that is a question for the Minister.

Jane Kennedy: Not at this moment.

I have one further point on how we use national insurance contributions. My colleagues have quite rightly pointed out to me that, actually, the national insurance fund has been used for many years to support the health service. If you ask most members of the public what they consider national insurance is used for, most of them would associate it with the national health service, rather than with the benefits that we know the majority of it goes towards. That is a more general point.

There are no further plans at the moment. Other than the changes that we are making today, which would allow the process to be taken forward through affirmative resolution, there is nothing further proposed—unless you want to deal with income tax by affirmative resolution.

We certainly do not. [Interruption.] I think that I am safe in making that point. Are you suggesting that you might, Minister?

Jane Kennedy: Not at all.

Q 71

We have agreement on that, anyway.

Given that, as you say, the spending of the national insurance fund goes on the health service, as well as contributory benefits, and given the professed desire for greater simplification and the fact that we are making these changes to the upper earnings limit to align with higher rate income tax, is there any view to take this further? For example, there are currently differing definitions of earnings.

John Whiting, former president of the Chartered Institute of Taxation, partner at PricewaterhouseCoopers and a fairly resident expert on Radio 4’s “Money Box”, says: “It is worth noting that the alignment of income tax and mixed thresholds does not complete the alignment of the two levies that many, especially employers, would like to see. We still have differing definitions of the earnings subject to the levies with various anomalies.” He goes on to say: “Hopefully the review of income tax and NIC alignment started by the recent PBR will produce changes that will pay a real simplification dividend, even if this will mean another NIC Bill.” Where are we in relation to the review of simplification in this area?

Jane Kennedy: I will deal first with the different definitions of earnings. I would be happy to look at those that you are drawing to our attention. I was not aware that there were different definitions, but I am more than happy to look at them. My colleagues might want to respond on the other point that you made.

Sam Mitha: The Government’s review of the further alignment of income tax and national insurance was published in the PBR and the document is available. It concluded that, on balance, the costs and benefits for employers of collecting national insurance contributions on an annual and cumulative basis did not justify making any radical changes to the existing mechanisms. Ministers decided to take forward a number of other measures consequent upon the review.

Q 72

Thank you. That answer was helpful in informing the Committee, but I come back to this point, Minister: is there any concern that the parliamentary scrutiny of reforms to national insurance  contributions, compared to income tax, is inadequate? We go through this process of separate Bills, but why do we not debate these changes as part of the Finance Bill, as we do with every other tax?

Jane Kennedy: The Finance Bill will be coming much later in the parliamentary year. It will come after a Budget, at some time in the late spring or early summer. The timing would mean that it would be difficult to achieve our objectives even for next year if we were to do it that way. I am not conscious of any criticism of the process, other than the criticism that you, as Opposition Members, may have of general scrutiny. I do not intend to consider further reform of the process of scrutiny.

Q 73

I take your point on timing, but the issue with the ratio that we have been debating is not an issue for 2008-09. We know that the ratio will be below seven and a half. The issue is for 2009-10. If this were debated later in the year, whether with the Finance Bill or not, there would still be time to make the changes for 2009-10, so that the ratio is reformed. What is the cut-off point at which it is too late to amend the ratio for 2009-10?

Jonathan Athow: Traditionally, it has been the practice to give employers good notice of changes, particularly with national insurance, because of the nature of the system. Because it is non-cumulative, it is not possible to make changes during the year in the same way that you can with income tax. There are different constraints on the system. As I said, the decision to make full alignment only in April 2009 was to give us good time for a Bill, knowing that parliamentary timetables can be very busy and compressed. Therefore, it is possible that this could be done later, but the earlier we can do it, the more certainty we can give employers about what the changes will be.

Q 74

So there is not a specific cut-off point, as such. It is a case of giving notice to employers, because there is an administrative burden involved in any change.

Jonathan Athow: Indeed. National insurance contributions are collected by employers. We need to give them good notice. The Bill on this current timetable gives us plenty of time, but it is difficult to give a singe cut-off date.

Q 75

But, for example, we are debating this Bill, but we cannot tell employers what the primary threshold will be for 2009-10. When will that announcement be made?

Jonathan Athow: Traditionally, it is made in the pre-Budget report. Because of the link to the September retail prices index, the announcement has to be made after those data are available.

Q 76

So October, November or December.

Jonathan Athow: October, November, December would be the normal time for that decision to be made.

Q 77

Is there a huge administrative gain for employers in knowing today what the upper earnings limit will be for 2009-10, when they do not know what the primary threshold will be? Presumably, they make their adjustment together. I ask that in curiosity; I do not know the answer.

Sam Mitha: In normal circumstances, if the upper earnings limit was going up with prices, it would be announced with the primary threshold. At the moment, we are talking about a very large increase in the upper earnings limit in order to align it with the higher rate threshold for income tax. That will necessitate some procedural changes, because the legislation will bring forward the upper accrual point. That is why employers need a greater degree of certainty about it. They will need to update their procedures and software, so that employees are ready to deal with the changes.

Q 78

So the administrative burden from this Bill is the upper accrual point?

Sam Mitha: That is it, yes.

Q 79

So I come back to my point, as long as the announcement for the upper earnings limit and the primary threshold is made in October, November or December, there should be plenty of time to do what they need to do. I do not necessarily mean in this year but in future years. Is that a reasonable thing to say?

Jonathan Athow: That is usually the timetable, so that is what we would assume is reasonable.

Q 80

We are, therefore, coming back to our comparison with income tax and national insurance contributions. The Finance Bill does the changes for income tax for that year—the year that we are in. Therefore, this summer’s Finance Bill will deal with everything from 2008-09. At the same time, we need to do the national insurance contributions. For argument’s sake, we could not do it at the same time because we are actually a year ahead. Therefore, the two could not be aligned in that sense.

Jonathan Athow: Yes, that is correct. One of the reasons why that is the case is because national insurance is collected over a pay period, which means either weekly or monthly. Income tax, on the other hand, is balanced over the year. It is possible to make changes to the income tax parameters during the course of the year and the system will balance out over the year as a whole. Whereas with national insurance, everything needs to be tied down before the start of the tax year.

Jane Kennedy: There are two totally separate structures for considering the rates of income tax and national insurance. For ease of reference, Erskine May describes national insurance contributions on page 782. He stated, “To the extent that they are payable into the National Insurance Fund, contributions paid by earners, employers and others under the provisions of social security legislation are not regarded as charges upon the people or as subject to the rules of financial procedure”. We would have to implement primary legislation to be able to consider national insurance in the Finance Bill. It would certainly not be possible to achieve that by 2009-10, and I am not even persuaded that it would be desirable.

Q 81

That is very helpful. I come back then to one of the points that we started with. We have a very different system for national insurance contributions. If we go back to the mid 1970s, the Executive’s ability to make changes by regulation to the system was restricted by things such as the ratio between what was the lower earnings limit, now the primary threshold, and the upper earnings limit. That structure is now being dismantled in this Bill.

Jane Kennedy: Yes.

Q 82

I want to probe some more. If national insurance contributions and the figures and thresholds have to be nailed down by the September before the April, and income tax is not nailed down until the June after the April when the Finance Bill goes through, how will we get continuing alignment for the years 2010-11 onwards? That cannot be done unless you pull out your calculator after the September nailing down of the national insurance figures to tell you what income tax will be from the following June without a political decision on what that income level will be.

Jonathan Athow: As I said, the process of alignment started with aligning the personal allowance with the primary threshold, and since they have been aligned they have both been announced together in the autumn before the start of the tax year. This autumn, we announced both the primary threshold and the personal allowance at the same time because they are aligned.

Q 83

Will that be the case for the upper earnings limit as well?

Jonathan Athow: As we keep that alignment, I envisage that we will be making announcements at the same time for the upper earnings limit, the point at which people start paying the higher rate of tax.

Q 84

Do correct me if I misunderstand you, but in terms of what I might call the political landscape, the income tax thresholds and so on are going henceforth to be moved from the March Budget to the September pre-Budget report, otherwise we will not be able to have the alignment that the Bill seeks?

Jonathan Athow: As I said, we already announce the personal allowance in the autumn; in October, we announced the personal allowance for 2008-09. That is what has happened since the alignment was achieved. It therefore seems that the same process will apply to the upper earnings limit and the point at which people start paying the higher rate of tax. However, there are many other parameters within the income tax system rates—

Q 85

What other parameters besides rates?

Jonathan Athow: There are special higher allowances for people aged over 65. There are ways in which they are tapered out, which are other parameters in the system. As I said, we already have an approach in which the pre-Budget report traditionally announces the personal allowance for the year ahead.

Q 86

So, understandably, we are going to continue with the system of not having alignment for those over the age of 65 who have earned income.

Jonathan Athow: People aged over 65 do not pay national insurance.

Q 87

Is there a masterplan, a head sheet of what will happen year by year and month by month? Have you done that?

Jonathan Athow: You can take the assumptions for inflation that the Government produce—

Q 88

We do not like assumptions, because you sometimes get blown off course. We want facts and good statistics to back them up—a bit of analysis.

Jonathan Athow: We publish for the year ahead. Given certain accepted practices, with the default being indexing by prices, if inflation turns out to be different, we have to have different numbers.

Q 89

Does the Minister agree with Mr. Marris’s question that, as far as the political landscape is concerned, this is going to make the PBR a more significant event than it currently is? Does it throw up any practical concerns? We know that the state of the public finances can change fairly dramatically from the autumn through to March, when the Budget is announced. Indeed, that has happened a fair bit in recent years. Therefore the decision as to what you do with income tax is going to be made at a time when you are less sure of the state of the economy and public finances than previously was the case. Is that a concern?

Jane Kennedy: I do not think that it is necessarily as fundamental and deep a change to practice as has been suggested. I hope to reassure the Committee that there is a very well established role for the pre-Budget report. The fact that this will bring about certain changes to further pre-Budget reports is just a step along the road that we are taking. It is not a fundamental change of direction.

Q 90

I presume that we are talking just about thresholds, rather than rates. There is no reason why the rates of income tax could not be changed in the March Budget.

Jane Kennedy: Exactly.

Jonathan Athow: As I said, there will be other parameters as part of the income tax system which could still be varied in the Budget.

Q 91

One of the issues that arose on Second Reading was the chronology of when the fact that the flattening of the state second pension needed to start earlier was identified. When was that consequential issue identified by the Treasury?

Jonathan Athow: As I think I indicated earlier, this was a result of the changes that were considered in the preparation for the Budget. It was realised that it was a very complex issue and it was decided that we needed to look at whether there was a need, and therefore what sorts of changes would be needed and how they would be delivered after the Budget. That was exactly the process that was followed and the conclusions were therefore reached in the pre-Budget report.

Q 92

Was there a reason why this particular impact was not flagged up in the Red Book at the time of the Budget?

Jane Kennedy: The fact is it was, but the necessary changes to correct the impact on the state second pension needed to be fully worked through with cross-Government Departments, before we brought forward a set of proposals to correct it.

Q 93

Where is the narrative highlighting that in the book?

Jonathan Athow: There are a number of issues that you have to consider when you are making these changes. These were quite large and fundamental reforms to the system. There were a number of consequential issues. We knew that we had to deal with the entire knock-on effects to lots of different systems. We were looking, for example, at the way it affected charities. These were all things that we knew about at the time and we had to have a process, once the Budget had got out of the way, of reflecting on those further, having had informal conversations with key stakeholders. We knew that there were a number of issues that we were looking at. We set out quite a clear narrative in the Red Book around all the issues, but then we knew there were some other issues that we needed to look at.

Q 94

Where in the Red Book? I just want to find which paragraph outlines the impact on the state second pension and the flattening period and the possibility of bringing that forward.

Jonathan Athow: Sorry, I do not think that we specifically mentioned that.

Q 95

So that was not mentioned?

Jane Kennedy: It was not explicitly raised in the Red Book; my apologies.

Q 96

Okay, was there a particular reason why that was not specifically mentioned?

Jonathan Athow: Some of the reasons are for space. As I said, there were a number of consequential issues that we needed to look at following this large reform. Those were some of the ones we knew we had to deal with. I think if we noted everything that needed to be looked at after such a large reform, we could probably have filled a whole book with such consequential issues. There were merely constraints on space.

Q 97

Was there a sense of the size of this impact in terms of revenue? In the pre-Budget report it totals up to £730 million over the comprehensive spending review time frame. Was there a sense that it was of that order, in terms of impact?

Jonathan Athow: It was noticed as a significant issue, on which we needed to return and to talk to others and understand the nature of the issue. I do not know if exactly those numbers were being considered at the time of the Budget. I would doubt that we would have such accurate projections, or that they would not have changed since, but it was noted as an issue and noted as a significant one that needed further work and discussions with interested parties.

Q 98

If you had got through that process of assessing the financial impact of this and if those figures had been understood at the time of the Budget, have you made any assessment of the changes that would have been made to the winners and losers conversation that we had earlier this morning about the numbers of households who would have been better off? Do you have any understanding of how that would have differed.?

Jonathan Athow: I think it is very difficult to know what decisions you would have made if more information or other things had come to light at the time. The intention here was that for those who were paying the contracted-out rate of national insurance there would actually be a small windfall gain. What we were trying to do for the majority of those people was to claw back some of that small gain, so that we could fulfil our objective of not making higher rate taxpayers better or worse off. That is the primary way in which that money is raised. I do not have the figures to hand, but I cannot envisage that it would materially affect the number of people who would lose.

Q 99

I suppose that the context for my question is that the total policy decisions for 2008-09 and 2009-10 were, I think, pitched by the Government as essentially revenue-neutral. Obviously had those impacts been included, that picture would probably have changed.

Jonathan Athow: If other decisions were made to do other things in the Budget, that would have changed the costings. That is true, but this decision was taken subsequently and was part of the decision about the overall stance of the pre-Budget report. It needs to be considered in that context, as that was the fiscal event in which it was considered.

Jane Kennedy: The consequences for revenue and cost would have been dependent on which options were decided upon to address the concerns raised about this. It is sensible to deal with the issue in slower time, after we have had an opportunity to look at the range of options that are available.

Q 100

How long did it take you to get through that process? When did you first have an understanding of what the likely revenue and costs would be? Was it two or three months after the Budget?

Jonathan Athow: I do not really remember the exact evolution of that. Obviously there were other commentators—the Pensions Policy Institute for example. It is not a matter of simply doing the analysis and getting to an answer; it is an ongoing process. It was considered in the run-up to the pre-Budget report when many different options were being considered. There were different ways of dealing with this matter and the income impact assessment sets out those different options.

Q 101

Why did you not start that process earlier, so that it was finished by the time of the Budget?

Jane Kennedy: Because presumably Ministers at the time were not requesting that sort of detail. We were working on a major package of reform for pensions, and had been doing so for a period of years. In the  income impact assessment we openly concede that when the personal tax package was announced in the Budget 2007, it was never intended to give the state second pension benefit and the extra benefits to higher earners that were perceived as being likely as a result of some of the other changes. Because of that, we wanted to do further work to see how we could correct that within the framework of our reforms, and within a framework of simplification of the overall tax system. That is one of the reasons why the process took the shape that it did.

Q 102

I absolutely understand that those are complex calculations, but I am just trying to understand why that process did not start well before, presumably at the time of discussion about the overall Budget package. Why was that not included as part of the discussion and calculation process?

Jonathan Athow: As we have said, this was an extremely large package of reform. We were making some big changes to the income tax system. Obviously, that analysis and undertaking is in itself an extremely long-winded process.

Q 103

You managed to do some calculations on things in the Budget such as gift aid and an increase in benefits that had a net impact of £5 million. What I am trying to find out is why calculations on that—which over two years toss it up to £730 million, a substantial sum of money—were not prioritised to be done in time for reflection in the Budget.

Jonathan Athow: Traditionally, Budgets are put together under tight security. This was a very large set of reforms, and there was necessarily the usual Budget purdah process.

We can work at some of these issues more easily on our own. We have the resources of Her Majesty’s Revenue and Customs to help us do that. In other areas, we need other sets of input. For example, we wanted input from the Department for Work and Pensions and other parties interested in pensions to find out the right answer there. For some of these, as I said, there are limits to what you can do in-house. Therefore, it is sensible to make the changes that you can make, and, when you know that there are other issues that you need to follow up, to do that as quickly and sensibly as you can after the event. Realising that the changes were affecting a series of pension reforms that had been through extensive debate and commentary, we wanted to think very carefully before making those changes, and not simply to spring them on people.

Right?

Actually, I still have some questions. I was just pausing for thought over whether to pursue that particular line. Perhaps I will move on.

David Gauke.

Q 104

I would just like you to clarify something about the figures in the Red Book, Mr. Athow. I apologise if you do not have a copy in  front of you, but items 20 and 21 deal with income tax and national insurance contributions. The first regards the phased alignment of five thresholds; the second relates to raising the higher rate threshold and upper earnings limit. As far as the projections of the financial implications to the Exchequer for, say, 2009-10 are concerned, is that figure net of the additional rebates that will need to be paid to opted-out second state pension funds as a consequence of the higher national insurance contributions?