 Good morning and welcome to the 13th meeting in 2021 of the Finance and Public Administration Committee. A first item on our agenda is to take evidence from the office for budget responsibility as part of our budget scrutiny. We are joined today by Richard Hughes, director, Professor Sir Charlie Bean, budget responsibility committee member and Andy King, budget responsibility committee member. This is the first time that we have taken evidence from the OBR this session, and I thank Mr Hughes and his colleagues for making the journey to Edinburgh. We have 75 minutes for discussion, and we will need to finish promptly just before 10.30 am in time for our second session. We have been given a small but perfectly formed statement by the OBR, so I would like to open up the question session by first asking, and I do not really mind who answers this question. It is really a matter for yourselves, which members of the panel answer one or more can do so. I would like to ask in reference to your overview of the October 2021 economic and fiscal outlook from 27 October. You stated in the third paragraph that there are supply constraints in several markets, and you say that these supply bottlenecks have been exacerbated by changes in the migration and trading regimes following Brexit. We expect CPI inflation to reach 4.4 per cent next year. I am just wondering in terms of the consumer price index, what is your view on how that will impact on the Treasury GDP deflator, because that is obviously very important for the setting of budgets in Scotland. In terms of the supply situation in the bottlenecks, is this situation improving, and when do you expect the situation to return to as near normal as possible? I can start out and then I will ask my colleague Charlie to supplement. It was the case that compared to our forecast back in March when we put our forecast together for the October budget that the recovery and demand over the course of the first part of the year was stronger than we had anticipated. That meant that that demand started bumping up against supply bottlenecks. It is easier to open up a shop and get customers into that shop than it is to provide goods to fill it and provide those customers with goods and services. We did not end up seeing stronger inflation than we had anticipated when we did our last forecast back in March going into the autumn. I should say we closed our forecast in late September in anticipation of it being published in late October. At that point we were forecasting inflation of above 4 per cent, but by the time we took a read of the latest gas prices and developments in prices since then it looks as inflation was getting closer to 5 per cent. That obviously has an impact on not just CPI but also the deflator which has an impact on the Scottish budget. From the point of view of the Westminster budget it has for the moment some beneficial effects in the UK tax system, both personal allowances and thresholds of frozen, which means you get more what is called fiscal drag coming out of that higher inflation than you would if the Government had gone ahead with the indexation of those rates and thresholds. It does deliver some fiscal benefit to the UK budget, some of which was spent by the Chancellor in his budget. He took the benefit of both the higher taxes that he had raised but also the additional fiscal drag to increase public spending, which then has consequences in terms of block grant for the Scottish budget. While it has a challenging implications for the macroeconomy, it did deliver some fiscal benefit to the Chancellor in the budget, which then have knock-on consequences for the Scottish block grant. Will it, Charlie, you want to say more about the inflation? Yes, on these supply bottlenecks it is worth saying that some of these are global in origin. If we think of things like chips for electronic components and cars and things like that, there has been a rotation in demand to consumer electronics during the pandemic, which has led to a diversion of chips that previously would have gone to car manufacturers into electronics, and Chinese have been buying up a lot of them. The consequence of that, for car manufacturers, is that they have not been able to get enough chips, which is why you have a long delivery lag for getting a new car. There have obviously been particular issues in the gas market. Again, some of these are global forces that are working through, led on top of which there are particular UK features. In terms of the duration of these, it is reasonable to expect businesses to respond to shortages by adjusting their sources of supply, adjusting the way they operate, changing the mix of what they put in, going back to the car example and so forth. However, we think that it is reasonable to think that it will take the best part of next year for some of these supply shortages to solve themselves. The other thing that is worth laying in here is that there are also issues in the UK labour market that are relevant to this. We are seeing shortages of particular sorts of labour. A classic example is HGV drivers, but that is not the sole example. Our forecast was assuming that some of these would be relaxed as the furlough scheme closed and some workers who were on furlough would flow into the labour market looking for new jobs. It should be said that the data that has been coming in since we closed our forecast suggests that the consequential rise in unemployment as the furlough scheme ends is going to be less than we expected it to be, so there will be less of a supply of extra labour going in, which leaves the labour market looking relatively tight. In the past, we have relied quite a lot on inward migration, particularly from Europe, to ease those sorts of shortages of labour. That is less of an option at the moment with the new migration regime under Brexit, so one of the issues going forward will be how those labour market shortages play into wage pressures and into inflation in due course. Our central forecast has inflation easing from around about 5 per cent in the spring. This is taking account of the recent gas news that Richard referred to, back towards the Bank of England's 2 per cent inflation target over the course of the next year and a half. However, we would say that the risks are very much to the upside of that. If the supply shortages take longer to ease and, in particular, if there is more domestic wage pressure as well. I will stick with inflation. No-one has answered the question about CPI, I have to say, versus the Treasury deflator. I was quite struck by the difference in the OBR's assumed nominal earnings growth in 2020 to around 3.9 per cent compared to 1.3 per cent in regard to the Bank of England's monetary report, which is quite a huge differential. Most people would think that the OBR was probably nearer the mark on that, frankly, but I am just wondering whether the Bank of England, from your perspective, is looking again at that and whether you feel that there will be implications for interest rates going forward. We know that the Bank of England voted 7-2 against an interest rate last month, but what is your feeling on that and how will that impact on your forecasts as we go forward? The first thing to say is that it is a little bit dangerous comparing their wage numbers with our wage numbers, because they refer to different measures. So, their forecasts are about the standard average earnings measure that the Office for National Statistics produces. Because we are interested in producing fiscal forecasts, we use a constructed wage measure from total wages and salaries in the national income accounts divided by the number of people, and those two measures can sometimes move in quite different ways. This particular example is one where it is due to the different measure that one is really looking at. In terms of monetary policy decisions, that is obviously in the lap of the NPC who are meeting shortly to take their latest decision. Having spent 14 years on the committee myself, I know that it is a pretty hard task, so I am not going to tell them what they should be doing. I am sure that what they will be doing though is looking very closely at sources of inflationary pressure. They will pay a lot of attention to things like measures of inflation expectations in financial markets. They have surveys of businesses that they also look at for measures of inflation expectations. They will be very alive to any sign of inflation expectations picking up. The point that I was just making about the labour market really looking surprisingly tight to vacancies are at a historically quite high level, despite the fact that the economy still has not regained its pre-pandemic level of activity. It is about a percentage point below where we were before the pandemic broke in early 2020, but the labour market does look really very tight. Some of that is because there are some people who have left the labour force, people who have retired earlier, in some cases migrants who went back home during the pandemic or migrants who might have come here did not come. That effective reduction in the labour force has meant that there are more signs of tightness in the labour market. I am sure that the committee will be very mindful of those in deciding whether it is appropriate to tighten policy. Of course, you have got the factor going in the other direction, which is the new Covid variant, the Omicron variant, which, given that there is still uncertainty about the consequences of that, they may feel, well, let us wait a little bit longer till the scientists have a better hold on the implications. You asked about the implications for arts. Of course, a key factor in determining debt interest is the level of interest rates. Debt interest is more sensitive now to changes in monetary policy than it was in the past. It is partly because the stock of debt is bigger, but it is also because the average maturity of the total liabilities of the public sector, so that is adding the Bank of England together with Government, because the Bank of England has been buying government debt and issuing reserves to finance it under its quantitative easing programme. Those reserves pay bank rate, the rate that the Monetary Policy Committee sets. When the NPC decides to raise bank rate, it will have a pretty immediate pass-through to debt interest effectively. One of the issues with the OBR is that it does not necessarily have access to the kind of data that it perhaps requires to look specifically at Scottish circumstances. Is there any specific data streams that you believe could be added to make your forecasting in a Scottish context more accurate? We approach our forecasts for Scottish taxes differently from the SFC, and I think that there is value in doing those forecasts from different perspectives because they provide checks on each other. We take a necessarily top-down approach when we look at estimating the tax basis for things like Scottish income tax by just estimating what we think is the Scottish share of the tax base and then applying the policy rates on top. We have had the benefit of out-turn data starting in 2016-17, if memory serves, which then provides a check against what were initially just estimates on what we thought the tax base was rather than what the actual tax base was. We have also more recently had the benefit of RTI data, the real-time information that HMRC has started to produce about how much tax is coming in and the composition of taxpayers, which comes in on a high-frequency basis, which started during the pandemic. That has provided us with much more real-time information about who is paying tax and how much on an in-year basis. In terms of what more information we would like, I might have to end here if there is anything that he wishes that he had in putting together those forecasts. As Richard Lylew says, the volume of data that we have now that we can look at in a Scotland-specific way for the majority of the taxes that we forecast for Scotland is good. Now that the property tax system and the landfill tax system are fully devolved, that means that the tax data is the best current information that we can have. We are now, I guess, more practised in using the real-time information for the PAYE part of income tax. In terms of the starting point for the forecast, I think that that is as good as you will get. That is better data than labour force survey data on the tax base because it is a census in effect rather than a survey. What we miss out on is in particular the self-assessment population, about 10 per cent of the income tax base, where the tax system only provides information once a year with a long lag when people pay in January and it takes another month or so for the data to be cleaned up and analysed. What we miss out on is if there are the way we produce forecasts, if there are differential trends in self-employment or other parts of the non-saving, non-dividend, non-PAYE tax base, we will not pick them up. For the SFC, similarly, there is no cross-check for them from the tax system for the bottom-up way they produce the forecast. For both of us, the non-PAYE part of income tax is where the data is least helpful. All of those things are essentially talking about the data that helps you to understand the starting point. Because the income tax system has been devolved on a liabilities basis, not the way the cash arrives in HMRC, there is a certain amount of forecasting what has already happened because you will not know the out-turn for a very long time because of the self-assessment lag. What is common to both SFC and us is the forecast challenge. When we are looking to forecast the share of the UK total that will be Scottish, we have population projections that we take into account. All the other things that determine the trend in tax per head versus UK-wide, those are all forecast judgments. It is not lack of data, it is the rather more standard problem of predicting the future given the information that you have to hand. How accurate over the last few years has the OBR been relative to the SFT? Over the next five years, there are significant differences. In fact, the SFT predicts that, in five years, the tax take will be £486 million more in Scotland than the OBR does. What is interesting is that Scottish landfill tax predicts £78 million, but the SFT predicts only £18 million because of the impact of policy, which is £60 million of a difference between £78 million and £18 million. It is quite a huge difference in terms of that particular aspect of tax. For now, I will look at how the OBR is doing relative to the SFT. How have you done over the last few years in terms of the accuracy of the predictions relative to each other? In the devolved tax document that we produced alongside the budget, we looked back at the accuracy of our forecast versus outturn. In chart A, you can see that we got it quite wrong at the beginning, but that was basically because nobody knew what the tax base was until we got outturned data in 2016-17. We were out by about £700 million. Since then, I think what you have seen on both our parts, but I think also the Scottish Fiscal Commission has been a learning process, which has helped to reduce those forecast errors. They are now down to within £200 million a year. Most recently, they were less than £100 million in terms of forecast errors for Scottish income tax. I think that does show that we are learning how these systems operate as we go. We are taking advantage of hard data as it comes out. One of the things which we have started doing in our publications and the SFC have done the same is in all of it. When they produce their forecast, we produce hours to always produce a comparison and where we can, a reconciliation for where we have produced different estimates of those taxes from the SFC and what explains them. Because we produce our forecast at different times, that often times explains the differences in what we expect to be the yields from different taxes, and especially over the last 18 months it has been a particularly volatile environment in which to try and forecast. As we have learned more about the evolution of the pandemic, the effectiveness of vaccines, prospects for reopening the economy, pace at which that would be done, and the outlook for inflation, all those things have had implications for what we have each forecast for for taxes. I think a lot of the explanations that you find for any forecast differences between ourselves just comes down to the fact that there are a few months between us and a few months is a long time in forecasting these days. I think if one hopes that things start to settle down a bit economically and that that would mean that you would see a bit more consistency between what we say in one month and what the fiscal commission says in another. Just one final question from me before we open up to colleagues around the table. That is basically with regard to taxation. You have said in your submission that the level of GDP that will be raised in tax will be 36.2 per cent. It is high since the early 1950s by 2026-27. You have said that taking the last two budgets together, the chance of raising taxes more this year than any single year since Norman Lamont and Ken Clark's to 1993 budgets in the aftermath of Black Wednesday. Six weeks have passed since he wrote this paper on 27 October. What impact do you feel that this is having on future growth projections given the weeks you have had to analyse us further? In terms of the implications, our growth projections are consistent with what was announced in terms of tax policies. One thing to say about those forecasts is that the government has decided to raise a very large amount in tax over the coming five years, both from personal taxes and from corporate taxes. We take account of the second round effects of those taxes on incomes and on economic decisions. But it is the case that this is partly the beginning of the UK's demographic transition, which is that we have an ageing society. Fewer and fewer people are in work compared to those in retirement. Much of those tax rises are to fund basically a larger post-pandemic state. I think that some people have allied those tax increases to somehow paying for the pandemic. That means that there are somehow temporary tax rises because they deal with the temporary cost. If you look at what they are actually paying for out over the medium term, they are for dealing with net zero, paying for a larger health service, they are for paying for the government's other public spending plans, all of which are a permanent increase in the size of government. So, from the point of view of if the government wants to meet its fiscal rules based on our forecasts, these are permanent tax rises that need to be delivered if the government is going to meet those borrowing targets and they reflect the fact that you've got a working-age population which is shrinking, you've got to tax it more compared to a population in retirement that is benefiting both from the welfare provision as well as a health service to which provides the services that they're looking for. The Ministry of Fiscal Studies has said that the policies have been led by the OBR, so we'll be asking them out with that subsequently. Deputy convener, I really wanted to follow on very much from the convener's line of questioning on income tax forecasts. This is of critical importance since the introduction of the fiscal framework is a very large component of what we have available to spend in Scotland. I'm interested in understanding why the OBR is projecting, albeit that there is projected growth on income tax receipts in Scotland, that that growth is slower than the rest of the UK. For no other reason, it seems to me that if that is the case, that should be a real focus for public policy in Scotland to see what we can do to mitigate that. I was just hoping that you would be able to explain the underlying assumptions behind that forecast. First and foremost, the driver of that relative growth rate is the population projections that we take into account. These are ONS population projections, but they show a slower growth in the working age population, slower growth in the adult population in Scotland than in the UK as a whole, which is largely down to differences in net migration assumptions. However, that relative decline in the share of the population that lives in Scotland we feed through proportionately to the income tax forecast. As we described, we use the real-time information from the PAYE system to look at how income tax liabilities in Scotland are likely to have changed since the most recent out-turn year, which is 18 months ago up to now. That at the moment is showing quite a significant decline in the Scottish share of income tax liabilities. The combination of the two are the factors that we take into account when judging the share of UK-wide income tax liabilities that will be raised in Scotland. That is the sum total of the story. We also take into account where UK Government policy measures are likely to have different effects in Scotland than in the UK as a whole, but those effects are much smaller than the top-down adjustments about the population and RTI. Thank you. I am just following on from that and bearing in mind what Mr Hughes was saying regarding the attempts of the OBR and the SFC to reconcile their methodologies. I note from your paper that it looks as though there will be a £380 million difference between what you are forecasting in terms of income tax receipts and the Scottish Fiscal Commission. Can you just provide a summary of what that difference of opinion is? Given that, I am assuming that the SFC is looking at the same demographic figures that you are? Yes. As Richard mentioned, one of the key things is timing. At the moment, there are such large movements in tax receipts as the economy is closed, reopened, and there are surprises relative to assumptions about how winding down the furlough scheme will impact. We had two or maybe three months more data on RTI when we closed our forecast than the SFC would have had, and that was a negative surprise. That was a downside surprise that we would have factored in. However, there are more straightforward differences of forecast judgment around the labour market. Our forecast for wages and salaries growth is very similar, but ours is more employment-rich, the SFC's is more average earnings-rich and the latter is more tax-rich. We may be right, more likely than not, but those are more straightforward forecast judgments. Taking those things in mind and stepping back a little bit, and being very much in mind what Sir Charlie was saying earlier about, we are in a situation that is not panning out as predicted. We are seeing significant labour market frictions, and we are seeing significant differential frictions between different sectors in the economy. It strikes me that, in that situation, making those sorts of predictions around future earnings becomes a lot more difficult, because you need to forecast, rather than a macroeconomic basis, what is happening in each of those individual sectors? Is that a fair summary? Indeed, what is the OBR doing to look at how we can drill into some of those very specific issues in specific sectors and extrapolate for the wider economic outlook? That is exactly how we have had to change the way we forecast over the course of the pandemic, because it has been such a sectorally differentiated shock with some sectors like hospitality at the beginning losing about 90% of their output, while other sectors where you could easily work from home or remotely, like financial services facing much less, sort of 10% max, sort of falls in output at the peak of the first lockdown. We have had to necessarily take a more sectorally differentiated approach to try and to understand the implications of the pandemic for the near term outlook. If you look at our forecast documents since the pandemic started, we've provided a sort of month by month sectoral breakdown of how output evolves to support our overall macro judgment on where we think GDP is going. It is very difficult to predict because it comes down to we start by talking to epidemiologists and public health experts about when they expect different parts of the economy to be able to be reopened. When that goes to plan, that tends to support where our forecasts go in the areas where we end up locked down for longer, our forecast turned out to be wrong. The other thing which we've had to take account of is how consumers and businesses have changed their behaviour over the course of the pandemic. Charlie was alluding to this sort of rotation and consumption that you saw over the course of the pandemic where early on consumption just fell, but then consumers figured out ways of buying what they used to buy in shops online and then suddenly consumption popped up again in retail, then of buying goods and services. When the service sector opened up, you saw consumption rotate back again into services and lessened to goods and trying to keep up with the changing composition of consumption and how people have adapted to the pandemic has also been a challenge for us. I think it's fair to say that we've consistently underestimated how adaptable consumers and businesses have proven to be to the pandemic and one of the things which explains why we're putting out a publication on Thursday looking back at our forecasts for the pandemic period for 2020 and one of the things which we did is consistently underestimated basically how much consumption there was going to be and how much businesses were going to be able to sell people because as you went through the pandemic, more and more consumers found ways of shopping online, businesses found ways of either operating through deliveries or providing services through other means, which meant that the economy has become increasingly resilient to pandemic conditions and public health restrictions, which meant that there's been some upside surprises on the way in which we forecast, but you still have some sectors like air transport where restrictions still play a really significant role in holding back output even going into next year. Specific to the income tax forecast, one of the real benefits of the RTI data is that it can be cut into whatever breakdowns you need to understand what's happening and it is very close to real time. We were able to analyse why the Scottish share had fallen in the outturn period with the oil and gas sector playing a significant role. Understanding where you are, having a good understanding of where you are, is obviously beneficial for forecasting, but there's still huge uncertainty over what assumption you should make about how permanent or temporary an event is and how, if it's temporary, how quickly it will unwind. Even taking those micro-style forecasting rather than pure top-down macro-forecasting, there's still just a series of judgments to make about what happens next, and so it will always be the case that the SFC, even if we were faced with precisely the same information set, the reason why you have two expert committees is that you will get two views or maybe not the reason why, but the reality is that— You had both come up with exactly the same answer. We'd be asking much tougher questions, on that basis, so I'll finish there and hand over to the next time. Thank you very much. Professor Beane, can I take you back to some interesting comments that you made when you were referring to your impending meeting with the MPC committee and what was focusing their minds about inflation and specifically on the causes of inflation? How easy is it with economic data to hone in on what are the cost push factors in inflation, many of which have been spoken to us about in previous economy sessions where people have come to us with a strong feeling that cost push inflation has been very strong, and what is demand-led inflation? The key thing for the MPC when you get supply shocks, cost shocks, if you want to call them that, is whether they're going to lead to sustained inflation. The standard mantra of inflation targeting central banks is if you have one-off supply shock, you look through it, you let it feed through into inflation, you don't try and offset it in the short run, you accept higher inflation temporarily, but what you really want to guard against happening is that blip up in inflation feeding through to generate an ongoing wage price spiral of the sort that we saw in the 1970s. That's why central banks, including the Monetary Policy Committee, pay a lot of attention to inflation expectations indicators because that's something that tells you when people's inflation psyche has shifted unless they are going to presumably be starting to mark up prices more because they expect their input costs to be rising, looking for higher wage increases to compensate them for the inflation they expect to be coming down the road. So that's always the thing that central banks will be on the lookout for, and I would be certain at this juncture that that would be something that the MPC would be looking very closely at, their indicators of inflation expectations. So would it be correct to assume that, because of some of the blockages in the system that you mentioned earlier, specific some of the tight things within the labour market and not necessarily being able to fill some of the jobs that are available, is it your understanding that that expectation factor might actually be increasing? I think that there's a good argument for the shortages in goods markets, the chips shortages that I started talking about earlier, for instance, or for that matter, actually, in the gas market where we would expect gas prices, hotel gas prices, to be falling back once the short-term issues ease. It's reasonable to think that those sorts of issues will solve themselves. For me, the concern would be much more whether we may see problems developing in the labour market because the labour market is tight and there are shortages of some sorts of labour. These are more like the circumstances when you might see the supply shock that we've had, having some so-called second round effects with wage inflation starting to pick up and so forth. That will be a key judgment that the MPC has to draw on. How easy is it to understand when it comes to these labour market problems how much of that is being caused by the Brexit issue, how much of it is being caused by people who not necessarily have the right skills available to take up the jobs but who are willing to do those jobs? How easy is it to drill down on that? You will certainly try to get relevant indicators of those sorts of factors. The issue of what economists refer to as skill mismatch, where people have the wrong skills for the job openings that are opening up, and obviously the potential solution for that is retraining and if you drive up the pay in the occupations where the shortage is and that sucks people into it, it encourages them to get the skills and so forth, but it takes time. You can look at indicators of that, so obviously splitting up vacancies by occupation, by region, even by sector and comparing that with the skills of the people who are looking for work, where they are and so forth would be what you do. Actually, we will do some of that in the book that we published, The Economic and Fiscal Outlook. There are some examination of that, so you can dig into some of these things. You raised the question about Brexit then. I think it's difficult to deny that potentially has a role because if you go back to the period in the years immediately before the financial crisis and for that matter after the financial crisis, but before the vote to leave, an important safety valve for firms, if they couldn't get laboured domestically, would be to look overseas to hire, so there was a very elastic supply of labour. That labour is no longer so elasticly available because of the migration regime. The key thing is how the migration policy regime operates here. It's not necessarily Brexit per se because you can operate a migration regime that would allow relatively free inflows of labour, which is in short supply. Everything hinges on how the Government chooses to operate that migratory regime. If it's operated in a way that is quite restrictive, that will increase the bargaining position of labour and it will tend to generate more of the second round effects that I was talking about. Thank you very much. In Scotland, we have specific sectors such as hospitality and some of the tourist areas where there has been a very significant problem, so I am interested to know how that sort of measured. My final question is very much about the Chancellor's budget, which he made a decision to be a bit more demand-led, in other words to ensure that public spending was at a higher level than it might have been, and to increase some taxes. Do you feel that that budget has led to some increase in the demand side of the economy, so that that is having an impact on inflationary pressure? Certainly our assessment in the effort, because we quite specifically do an estimate of the macroeconomics, of the macroeconomic effects of the package, and it added about half a percent of GDP as my recollection to a sort of net demand stimulus, and that would add a bit to inflationary pressures, precisely through the sorts of channels that I've just been talking about. Richard alluded earlier on to the recovery having been stronger than we and some other forecasters expected. I think what's also the case is that it seems like demand has rebounded more rapidly than supply. If you go back to early on this year, we and I think the NPC and a lot of other forecasters thought that demand might lag behind supply, so you needed supportive policies to bump up demand as the economy reopened to match supply. I think what we've seen suggests that demand had enough legs on its own and that it was running a little bit ahead of supply, and that our forecaster embodied that judgment. Thank you, John, to be followed by Michelle. Thank you so much, convener. Quite a lot of areas that we've covered already that are quite interesting. One of the points that was made was that people have adapted, I don't know if it was yourself, Mr King, more than you maybe had expected through the whole system, and that made me think—do you think that people have learned that they actually need some savings in case they hit another pandemic or a crisis of some kind? Would that have an impact going forward if people were to save more, or is there just no evidence that people are going that way? It is the case that the savings ratio went up a lot during the pandemic. I think that one has to ask the question to what extent people decided that they wanted to save more or basically people being forced to save more because they couldn't find ways of spending their money either because they couldn't go to shops or they couldn't go on things like holidays, which is what people oftentimes save money for. We saw the savings ratio hit post-war highs in double digits at the height of the pandemic. Initially, we did think that it might stay high, but we revised it progressively down to something closer, which is the historical average of around 5% over the medium term, but you still have that built-up savings people accumulated over the course of that pandemic, which we expect to be unwound relatively slowly at the pace of about 5% a year, if memory serves. That is because all the surveys of how people spend windfalls is that they don't spend it all at once. They tend to want to smooth their consumption over time. I think what we haven't concluded really is that there's a significant increase in the rate of precautionary saving over the medium term. People unwind that kind of war chest they built up slowly, but what they don't do is permanently save significantly more than we'd estimated before, and that's just based on surveys of households suggest that that's not the lesson they learned from the pandemic. The vaccine has to some extent allowed much of our lives to go back to normal, but with important caveats about the emergence of new variants. Having also government support for those out of work was very generous in the form of the furlough scheme and other kinds of support, which has meant that government borrowing came to people's rescue rather than them having to save up to deal with hits to their income themselves, and so they may well have learned a lesson that government is there when they need it to provide them with support through these kinds of events. Charlie, is there anything more to add to that? Well, first of all, it's worth saying that these are pretty large amounts of money that you're talking about, so there's this sort of forced savings that households have undertaken. It's of the order of a couple of hundred billion. The big picture of the pandemic, if you like, is that government policy is pretty much preserved incomes, but households have not been able to spend because the economy is being closed, so they've accumulated it. Some of it has leaked into the housing market, probably. Some of it will have been invested. A lot of it appears to be still held in liquid form in bank accounts and so forth. The key question that forecasters have been grappling with is how quickly those savings might be unwound. As Richard says, a sort of standard view is that people don't blow it all at once. There's only so many slap-up meals and exotic holiday and so forth. It's more that you have a higher standard of living for many years in the future, and about 5 per cent a year would be consistent with empirical evidence from lots of study of how consumers behave when they have these sorts of windfalls. I think that the other thing that I'd inject here is that it's important to realise that the impact has been different across households. It's not that every household has had this windfall in income for some often older, higher-income households, something like me. I stopped doing lots of spending that I would normally do, but my income was largely preserved. There are also plenty of households who, because of the safety net that the Government was providing, were less effective for them, maybe self-employed, some sorts of workers in more fragile jobs and so forth. For them, they haven't been in the happy position of being able to accumulate savings. Some of them have had to accumulate significant debts, so you do have important heterogeneities across the population. That also complicates assessment of what happens going forward. That's helpful. That's looking specifically at one area, i.e. savings. If I'm understanding you correctly, there's going to be a short to medium-term impact, but in the long term you're really expecting things to go back to normal. On the wider issue of scarring in the whole economy, is that basically the same story? In the short to medium term, both the pandemic and Brexit are having a scarring effect, but in the long term we'll get back to normal without them? We assume that there is literally a permanent effect of the pandemic. If the pandemic had not happened, the level of GDP would be higher than the trajectory it is now on. The hit that we have in the medium to long term is 2 per cent. There's a lot of uncertainty around that. We've always been very clear. This is territory that we're very unsure about. The sources of that hit come through a variety of channels, so there's an effect on essentially the labour force. Part of that is just a population effect because there's been a significant number of deaths, but also the migration effect that we've talked about. That plays in and the pandemic potentially has affected some of those migratory movements permanently. It is likely that some older workers have decided to leave the labour force earlier than they would otherwise have done as a result of the pandemic, in some cases because their job disappeared, in other cases because they've become more conscious of their own mortality. We do know some younger workers went into or stayed on in education. Now they will come back in in due course. It's also true that more flexible ways of working, the ability to work at home may encourage some people, particularly, say, married women, may be able to participate more easily, so there's factors going both ways there. There's an effect that may not be fully permanent, may take quite a long time, which is accommodating structural changes in the economy of the sort that we were talking about, people not having the right skills and having to retrain and so forth, and that can raise the level of unemployment, the equilibrium level of unemployment for a while. There's a bundle of things in terms of the effective size of the labour force. Of our 2 per cent hit, memory serves right, that's 0.8 per cent each point in that sort of indicative decomposition. Don't take these numbers too literally because they've already stressed a lot of uncertainty mountain. Sorry, I'm not understanding that point. 2 per cent is the permanent effect, what's the 0.8 per cent? That's the labour force component. I'm going to give you two more bits of it, which will all add up to the 2 per cent point hit. The second bit is that investment has been depressed during the pandemic. Businesses not surprisingly have held off investing, the uncertainty and so forth. There we've got some data, so we've got a pretty good fix on how much investment has not taken place, which otherwise probably would have done, and you can work out roughly the output consequences of that. That's worth 0.6 percentage points. The other bucket is the bit that economists really don't understand but is the big driver of the improvement in living standards, which is improvements in knowledge, in the way you do things, new products, stuff that's generated from R&D, all of that sort of stuff. There, we think, the long run level hit from that because investment in intangibles, research and development, things like that have also been hit in the same way as physical investment, the hit there is again 0.6. It's coming from lots of different channels and this is not something that you make up, particularly since it's been a global pandemic, so lots of countries have gone through the same experience. The world would have been a better place or richer place if we hadn't had the pandemic and that's completely aside from the health consequences. Good morning. Possibly following on the pandemic, I suppose that I'm a bit surprised at the reaction of the emergence of Omicron in that, if you'd spoken to lots of people, they would have suggested that it was highly likely that another variant would go into the population. I'm interested in exploring with you to what extent you have baked the impact of those waves into your economic modelling and specifically the points that you've made about separation of sector and so on. There's a whole range of variables that I totally appreciate. I'm interested in understanding the extent to which you've done that and how you'll reframe your modelling going forward, given that I think it was yourself, Sir Charlie, that you made a comment about QE, how, in effect, it's here to stay and the impact it's having on debt going forward. It's just some of your reflections, what you're doing differently now, what you will absolutely definitely do differently in the future and, in particular, what that means for Scotland if you get any insights on that in terms of your modelling. I can supplement it, but the risk of a new variant has always been on our radar as a risk and one of the things that we did over the course of the pandemic was always look at not just a central scenario but a set of scenarios, one where you had very effective vaccines rapidly rolled out and the economy reopened and we quickly got back to a pre-pandemic world but another where you did have new variants against which vaccines were ineffective. In our central forecast, which we did at the end of October, we did assume some rising cases over the winter, not necessarily of a new variant, just a rising cases of the old delta variant because people were mixing more in closer quarters called the weather. We knew that that was going to have an impact on transmission and we also know that regardless of what the government does with public health policy, when people see case numbers go up, they tend to rain back on consumption through what's called voluntary social distancing. We already baked in some slowdown in consumption going into the winter on the basis of what we expected to be a rise in case numbers. What we don't know yet is what the public health response is going to be to the new Omicron variant. We don't know very much about the science of it. The one thing that I would say, though, is that even if it leads to another lockdown of the sort that we've seen in response to rising hospitalisations and deaths in previous pandemics, what we do now know and what we can try and anticipate better in our forecasts is that our economy is increasingly adapted to these kind of conditions. The first lockdown lost us about 25% of output. The second lockdown lost us less than a half of that. You'd sort of anticipate that we are learning how to live with the virus more effectively even when we can't walk into shops and buy things even when we can't go to restaurants and eat there. So one thing which we are trying to get better at is not just looking at what the sectoral impact of different restrictions could be but also trying to anticipate how well adapted they would be when those restrictions are put in place. Obviously, another uncertainty is if there is a need for tighter restrictions, what kind of government support is going to be provided to those sectors alongside which, again, if that support is rolled out, we sort of know the kind of effect it has in dealing with it. So I think the short answer is we did have some rising cases some sort of under consumption just based on the old variant. What we don't know yet is how different the Omicron variant is going to be to the Delta variant in terms of its impact. If it is similar to Delta, then it basically has a relatively modest impact on our forecast. If it requires much tighter restrictions or something closer to lockdown conditions, then you are looking at hits to output on the order of what we saw back in January of last year. Charlie, anything you want to tell us? Yes. I think it is pretty clear that there is going to be some impact even just through December. You are going to have less spending in hospitality and on travel, presumably. So there is bound to be some negative impact on consumer spending. Then, as Richard said, there may be an issue that it carries through into next year if you need more substantial health measures for longer. It is worth saying, though, that the impact on GDP can sometimes turn out to be not what you expect because it is easy to pick out what is happening to consumption. Of course, a consequence of Omicron is that the Government is stepping up vaccinations, and that boosts GDP because of the way that GDP is measured. It treats that as output of the health sector, as indeed it should do. The GDP numbers may or may not reveal something, but, as far as consumption is concerned, you will see some slowing over the Christmas period. Just leading on to another area that we have not touched on in today's session is, again, that it is a similar idea of how specifically you are baking in an assumption around climate change expenditure off the back of COP26. It is something that has just not come up today. Where is your current thinking in your modelling that you are baking in up-front costs and that will filter all the way through and longer far-side implications? Anyone can answer that. Our forecasts always take the UK Government's spending plans as a starting point. In the spending review in October, there was, I think, over the three years—in fact, they presented it over the four years, including the current year—about £25 billion worth of net zero capital spending within the plans that have been presented. I think that the most important thing when reading our forecasts for understanding that is that that was the allocation of sums from a total that had already been set. It was not additional capital spending on top of the capital plans that were in our March forecast. It was the bottom-up allocation of the capital that was already there. We did a lot of work in the summer on scenarios for net zero capital spending. The first four years of our scenario from the summer are remarkably similar to what has transpired as Government policy in the spending review. Thereafter, in our scenario, the amount of net zero capital spending continued to increase until peaking around the end of the decade. That is obviously hugely uncertain. It was a what-if. The biggest uncertainty in there, I think, by far, is what happens on people's homes, domestic heating and insulation, where, fortunately, I'm a mere forecaster and analyst, so I just have to look at the numbers rather than think about what 25 million homes disrupted with building work feels like to make those decisions. That's the biggest cost. It also, to me, looks like the most difficult one to deal with via tax as an incentive. The revealed preference across other sectors has been that regulation, banning things, is the preferred policy lever at least once a process is underway. I think in the housing area, the fiscal impact might be larger in existing homes, whereas the regulatory lever is much easier to pull when you're talking about new builds and you can tell the builders what they have to do. The flip side of all of this is what happens on the tax side, where there is one very large existing carbon tax that is not known as a carbon tax, it's known as fuel duty, which the government has frozen for 10 years now. As electric vehicles takeover and petrol vehicles are bound, that tax, which is worth about one and a half percent of GDP, simply goes away. Then there are other more environmentally labelled environmental taxes, most obviously the emissions trading scheme, where there are choices that the Westminster government can make about how many sectors are covered by that, how much that is used as an incentive to get carbon out of the system, where clearly that's a big uncertainty, a policy uncertainty over the future of our forecasts. The one thing I really learned from our work over the summer was just how successful the carbon price floor as a tax incentive had been in wiping out coal from the energy mix. The UK does provide one good example of a carbon tax doing what it is intended to do, raising some money along the way, but ultimately the revenues go away because it's successful in reducing carbon. Thank you. That was a follow-up round. Ross, thank you convener, it actually follows on pretty well from what Michelle was saying. So obviously it's good to hear that the net zero plans, well capital plans are sort of in the forecast. I guess I've got a concern about oil and gas and the capital plans that are under pressure not to be spent going forward. So it's really just to have some sort of idea if those investments didn't happen, you know what that would do to the forecast. I presume it would have a greater impact on the Scottish economy as the rest of the UK. I guess it would then have a greater divergence between the Scottish tax intake and the rest of the UK. So has there been any modelling done on what would happen if some of those new investments, especially in the North Sea, didn't take place? Not that we have done, but it is the case that you've already seen in the data as a result of the pandemic, not so much as a result of any action on net zero and climate change, of a differential impact on the Scottish economy compared to the rest of the UK, both on the income tax take has been a bit lower here, because the oil and gas sector hasn't done well during the pandemic, but also Scotland's exports have been much more affected by the pandemic than the rest of the UK's exports because there's a stronger oil and gas component to Scotland's exports than there is to the rest of the UK. So we've seen it a bit already in the forecasts that we produce. We haven't confessed on any detailed analysis of the sectoral impact of particular projects going ahead or not, because that's at a level of disaggregation that's below what we would do for our own forecasting purposes, but we have seen it show up in the macro data on tax take as well as on exports. The forecast that you're presenting, they are assuming many of the investments in the North Sea would take place and that's—and if those didn't happen, then they would have to be revised and it would probably be a negative impact to the Scottish economy. I mean, they're based on the sort of work plans that we get from the firms themselves and the taxes would come from those. I couldn't speak to what specific projects are in those plans in here because we don't provide them at that level of disaggregation. Just to add, in respect of our forecast for the revenue from the North Sea, so the offshore corporation tax, we use the Oil and Gas Authority's survey as the basis of our forecasts, which is a project by project and field by field survey. We don't look at that detail because they have access to commercially sensitive information, so they package it for us. I think the key thing that I say at this stage is investment today rarely yields tax revenues within a five-year forecast horizon, so these are longer-term issues. That's just purely from the North Sea revenues. Now, obviously, investment activity is an economic activity that will support income tax revenues, so there are two different ways of looking at that. I'm quite interested in the issue of stranded assets, but, given that time is one other area that I'd like to touch on, Charlie Ewing in particular mentioned a few times the impact of upward pressure on wages throughout this session. I'm interested in the knock-on effect that that would have on the relative value of different sectors to the overall tax base. If hospitality and road haulage recover from the pandemic as smaller but higher-wage sectors, that will have a differential impact on income tax versus corporation tax versus fuel duty, etc. How soon are you expecting to have a strong indication of what the direction of travel is on the sector-specific differences in recovery there? As far as the tax point is concerned, Andy will be able to expand on this, but one of the great virtues of having access to the real-time information is that you get this information quite quickly. Of course, what we would be doing when the numbers are coming in would be trying to think why are these numbers stronger than we expected or weaker than we expected and those sorts of sectoral issues might well be the hypothesis for why they're coming out a particular way. Ahead of that, we certainly will be looking at sectoral pressures in labour markets and to the extent that we can get information on mismatch by skills and by occupation. I think that that will be something that in coming forecast rounds we will be doing. I should say that I'm about to leave the committee, but my replacement has just been announced by another former NPC member, David Miles. I'm sure that he will want to pursue this territory. He'll be used to looking at those sorts of numbers during his time at the bank. Do you know offhand what the early indications are in terms of hospitality specifically, thinking off the back of the questions that Liz Smith asked? Has any changes to the impact and contribution that the hospitality sector makes to the tax base will have a disproportionate impact on Scotland in the same way that, say, agriculture would? One of the surprising things about hospitality is that we know that there are lots of people on furlough who came from the hospitality sector. We know that there are a lot of vacancies in hospitality and you sort of think, well, they are able to match up. Of course, the hospitality sector does rely quite heavily on migrant labour. It's clear that net inward migration has fallen during the pandemic. There is some uncertainty about the numbers because the main source of information—the international passenger survey—was suspended during the pandemic. The Office for National Statistics has tried to make indirect inferences. I have to say that our experience in the hotel we stay at overnight is indicative that there are significant labour shortages in the hospitality sector. Thanks very much. I'm conscious of the time, convener, so I'm happy to leave it there. Thank you very much for that very positive note. We shall end the session. We won't ask what the name of the hotel was. I really wanted to thank Mr Hughes and his colleagues for taking the time and the trouble to come all the way here to Edinburgh. It's really appreciated in current circumstances. It definitely gives you lots of brownie points from the committee because we much prefer evidence in this face-to-face situation if we can possibly get it. Thanks again for all your evidence. I think we could have asked a lot more, in fact, if we had the time, but of course we have a very full agenda. Thank you very much for coming to see us. We hope to see you before too long. Our next day of work will be Carole Emerson of the Institute of Fiscal Studies, who will join us remotely. I now suspend the meeting to allow final connection checks to take place, and we'll be back at 10.29. It's ready for our 10.30 start. Thank you very much. We now turn to our second budget scrutiny evidence session for which we are joined remotely by Carole Emerson, deputy director of the Institute for Fiscal Studies. Mr Emerson is standing in for the director of the IFS, Paul Johnson, who is unwell. We wish him a swift recovery. I thank Mr Emerson for making himself available to give evidence at short notice, and I welcome him to the meeting. I remind members that our broadcasting team will operate their microphones, so they shouldn't touch them. We have an hour for this session, so it would be helpful if members could keep their questions concise. Before opening the discussion, I invite Mr Emerson to make a short opening statement. Thank you very much and thank you for the best wishes for Paul. I know that he's very sorry that he was unable to make this session. I just very briefly wanted to highlight that, in terms of Westminster budgets, there were three very substantial fiscal events in the current calendar year. The budget in March, when the OBR set out a set of forecasts under the assumption that the pandemic and the economic response to it would permanently damage the economy by about 3 per cent in the medium run, led to the chancellor deciding that he wanted to try and put borrowing in that medium term back on track. He trimmed a bit off the spending plans, but he also announced very substantial tax rises through freezes in the personal allowance and income tax, the high-rate threshold in income tax and a big increase in the rate of corporation tax. We then got to September, when the Prime Minister announced the manifesto busting national insurance rise to be followed by the new health and social care levy in order to spend more on the NHS over the next couple of years and provide some money for social care too. Then we got to October, when the OBR decided that, because the economy had performed more strongly than they had expected this year because unemployment wasn't as bad as many had feared, the OBR felt that it was reasonable to lower the assumption of scarring in the medium term, so it presented to the chancellor a better set of economic forecasts. Having an interesting in response to that, the chancellor decided to top up his spending plans and not row back on any of the tax rises that have been set out so far this year. We got us back to a position where there's more money for the NHS over the next couple of years in particular. Spending elsewhere looks like it's in line with what was expected prior to the pandemic. Most areas of spending will now avoid cuts, but there are big tax rises coming through, in part, justified by the big damage to the economy that was expected back in March, which, if the latest forecasts are right, wouldn't have been needed. In some sense, the chancellor has very actively decided to go for higher taxes and higher spending going forward. In part, that's probably for pressures that aren't really to do with the pandemic. There's a reasonable case that says that if the pandemic had never happened, we might well have seen tax rises to spend more on things such as the NHS and social care anyway. Okay, thank you very much for that. I'll open up with some questions and then, of course, I'll widen the discussion to include the colleagues around the table. On 27 October, Paul Johnson said that the budget was, and I quote, very disappointing. It shows that household income will be pretty stagnant at around 0.8% growth this year. He then goes on to say that this is awful, pointed to high inflation, rising taxes, poor growth-keeping, and living standards are virtually stagnant for another half a decade. He went on in his speech that day to say that average gross earnings could have been 40 per cent higher had pre-crisis trends continued. However, I'm just wondering how that compares to other western countries. I guess that certainly the period since 2010 has been one of terrible productivity growth, and that's been associated with terrible earnings growth in the UK, and that's the figures that Paul set out. It's certainly the case that other economies have experienced pretty terrible economic performance over that period too. I think that it's fair to say that the UK was harder hit by the financial crisis because it had a bigger financial sector to start with, so the legacy of that is bigger. Part of the effect is due to the economic consequences of Brexit, which clearly is something that was felt largely by the UK economy and not others. Then there's the effect of the pandemic, which is having an assumed scarring effect, although it's too early to tell whether the UK, in five or six years' time, will end up being hit harder or less harder than other economies. However, so far, the UK economy has been pretty hard hit by the pandemic relative to others. Paul said that the decisions taken by the Chancellor were, I quote, almost entirely set of policy choices unrelated to the pandemic. High inflation, rising taxes and poor growth still undermine more by Brexit than the pandemic, and that will see real living standards bailarising and for many falling over the next year. Is this something that we're seeing elsewhere? Is the UK unique in this situation? If it's not, then one could argue that the UK is battling with not only the same issues, others face Brexit excluded, of course, but we can't particularly criticise the UK Government if, indeed, other countries are doing just as badly. Is the UK doing specifically poorly in terms of those issues? Well, there's different factors that are causing this. Next April, for example, there is a rise in national insurance contributions. That's to pay for more spending on the NHS and social care. That will reduce take-home money in working-age people's pockets predominantly. That's an active policy decision to do that to deliver better public services, and I'd argue that there's a strong case to say that that kind of measure perhaps wouldn't have been such a surprise even if the pandemic hadn't happened. That's an explicit choice to take money out of people's pockets in order to spend more on public services. There's a freeze in income tax thresholds coming in next April, which was announced last March. It is now the case that higher inflation, which other economies are experiencing to, means that that freeze will bite harder than what it would have done had inflation only turned out with what we did expected last March. Indeed, over the four-year period where that freeze is expected to be in place, we now think that the Government will raise taxes by about 11 billion rather than 7 billion, so it makes a huge difference. In particular, there's a bigger squeeze next April, and that's an explicit choice again by the chancellor to put up taxes to try and deal with the damage to the public finances caused by the pandemic. Other countries may well have to do measures at some point. They'll have choices about how they do it. They want to cut spending on public services, so they want to put up taxes. They'll also have choices about how soon they go. My suspicion is that the UK is going relatively soon, so it might be that other countries are essentially avoiding the pain next April, but it's pain delayed, not pain that they will never go through. Then, of course, there's rising inflation, as you just heard in the last session, which is occurring in many other countries, too, which clearly eats in to take-home pay for workers. It also means that, for those reliant on interest income, it's eating into their incomes. There's also a phenomenon for those who are interested—who are reliant on benefit income—in that their benefits next April will go up by the inflation rate that we saw in September. Of course, if inflation is now accelerating post-September, their living standards are going to be squeezed for a few months, too, and in a couple of years' time, they will catch up when their benefits are uprated by inflation at that point. Certainly, the next few months are going to be very difficult. I'd stress in particular for out-of-work households on benefits, because the price rises are on energy. We know that low-income households spend a relatively high share of their budgets on that. Out-of-work households who have recently been benefiting from the £20 a week uplift in universal credit, which ran out relatively recently. They don't directly gain from either the increase in the national living wage or the increase in universal credit that was announced in the budget. I know in the report that the primary of asset accumulation, the importance of asset holdings, has been prioritised over improving living standards through earnings, and that impacts particularly on low-income households. Would that be fair to say? The fact that people with assets have done relatively well over the past 18 months is because of reductions in interest rates. If you have an asset that bears a set amount of share income and interest rates are lower, that asset increases in value. You can see that in the housing market and in the gilt market, too. Clearly, those kinds of effects are things that can benefit those with assets. Perhaps one lesson from the legacy of the financial crisis is that maybe when making fiscal policy decisions going forward, the chancellor should pay a lot of attention to the distributional consequences of what is happening to interest rates and, in particular, long-run interest rates. If interest rates are going to stay low for a long while, that is going to reward people who went into the most recent crisis with assets. That is a consideration that needs to be reflected in any fiscal policy choices that the chancellor is making. With hindsight, the decisions that were made in the early 2010s did not take enough account of the fact that, for example, those who have already got on the housing ladder did relatively well over that period. If people are incentivised to invest in assets that are less likely to invest in productive elements of the economy, which are perhaps high-risk, that impacts on productivity and growth. Is that not the case? There is certainly a risk that lots of accumulated savings over the last 18 months are good reasons to think that they will not be spent in consumer spending very quickly. The question is how do they get invested? Maybe they will get invested in very productive things across the economy. I am sure that that will be part of the use of it, but maybe they will be plowed into things such as residential housing. There is certainly a risk there that the UK economy might not be as strong as it could have been if lots of that money does go into residential housing rather than other productive uses. Of course, inflation is leading to fiscal drag, which is a windfall for the chancellor. What is the impact, particularly on middle-income earners? I think that it is particularly important because of the freezing income tax threshold, the personal allowance and the higher-rate threshold that was announced in the October budget. What that means is that the freeze was announced in the March budget, so that freeze means that, as incomes rise in cash terms, more and more people are brought into income tax and more people are brought into higher-rate tax. It means that the higher inflation that we are now experiencing means that those measures are going to bite harder than was previously expected. We were seeing quite a shift in the nature of our income tax system, in particular the numbers brought into higher-rate tax. As I said before, if you asked me in March, I would have pointed out that this four-year freeze is expected to raise about £7 billion a year by the end of the fourth year. We now think that, on current inflation forecasts, it is going to raise more likely £11 billion a year. It is a substantially bigger tax rise as a result of inflation being higher and, therefore, a bigger squeeze on household incomes, too. Just one more question for myself before I open out to colleagues. In his report, Paul said that, over the period since 2010, health Spain will have increased by over 40 per cent in education by less than 3 per cent. That is the south of the border, which implies a remarkable lack of priority afforded to the education system, with spending per student in FE and six-film colleges remaining well below 2010 levels. He goes on to say that this is not a set of priorities, but it looks consistent with a long-term growth strategy. What has been the impact on growth of those education policies over the last decade or so? The key point is that we know that spending on schools is going to if it is spent well, will have effects on future productivity. That is certainly one of the motivations for doing the spending. Where spending on health is a nice to have is clearly good welfare reasons to do it, but much of the spending will not lead to higher GDP in five to ten years' time, simply because much of the spending is going on people who are sadly in the last few months and years of their lives. It has a good purpose and a good reason, but it is not about future growth. The NHS, in particular, in England, has not had particularly large increases by historical standards over the last decade. It has been under pressure because of an ageing pressure putting demands on its budget. Because of cost pressures, it is very difficult to make the health system more efficient and for its efficiency to keep up with the economy or widely. That has led to budget decisions to increase its budget pretty substantially, something like 40 per cent over a decade. The school's budget has not been prioritised to anything like that. In fact, we saw it in the Chancellor's Budget speech, where he made a big feature of the fact that, over the next few years, we will get spending per pupil in England on schools back to the level that was at in 2010, undoing the austerity that was experienced over the last ten years. That does not seem to me something to brag about. We will be spending the same per pupil in real terms in about 2024, as we were in 2010. That is a remarkable period with no real increase in spending per pupil. If we kept spending at that level and had been done well, you would think that it would have some positive effect on future productivity. I am afraid that there are no estimates of how much of an effect it would have had. First, colleague to ask questions will be Deputy Convener Daniel Johnson. Thank you. I just really wanted to ask what the Institute of Physical Studies view is of the Comprehensive Spending Review for Scotland. My understanding is that we will see a 7.7 per cent increase in real terms in the first year, but then it is very front-loaded and small real terms decreases. It reminds me that 7.7 is a historically high increase in terms of the grant, but that profile leads to some challenges in terms of what that means over those three years. Is that a fair characterisation? Are there any particular insights that the IFS has in terms of the decisions that the Scottish Government has in front of it? The spending review overall is clearly more generous than what the Chancellor told us, even in September, that it would have been because of his decision to top up the spending plans for the Westminster budget, which clearly has knock-on effects for the block grant that Scotland will receive. There is some front-loading. The Chancellor has, for example, a reserve in the near term that is bigger than usual, which I think is sensible behaviour given the uncertainty around the pandemic. The money for local government in England and Wales is very noticeably front-loaded as well, which will mean that perhaps the first year for local authorities in England and Wales might be okay. After that, they might find that they are quite reliant on council tax rises, which clearly has consequences about how they want to do those rises and the areas that get the money from an increase in council tax might not be the same areas as where perhaps the spending needs and pressures are. The capital spending is also relatively front-loaded, although there I would stress that the Government is essentially locking in what has already seen where there has already been pretty big increases in capital spending. The Government is really looking to hold capital spending at a pretty high share of GDP across the UK by historical standards. The spending plans overall look like ones that do not imply cuts for most Government departments. They are much more generous than we expected in September. They will imply bigger increases in the block grant than we would have expected. Back in the run-up to the Scottish elections, we commented on some of the party's manifesto plans at the time. Looking at the SNP's manifesto, we highlighted that there were several increases in spending in that manifesto, extensions of universal provision, and we questioned whether they would really be deliverable given the UK Government's relatively tight spending plans. As it has turned out, the UK has decided to make the spending plans relatively more generous, and it may well now be the case that the SNP can afford more if not all of the promises that were made in that manifesto. However, I do not pretend that there will not be some pressures going ahead, not least because no further austerity for English departments does not mean that you are undoing the austerity of the past in all those budgets. There will be some areas where spending is going to remain below the 2010 level for some time. Yes, we are returning to 2010 levels in schools. We are not in FE colleges. We are not in further education. We are certainly not in areas such as the Ministry of Justice and the Home Office, where spending has been cut very substantially. I think that there are some pretty big challenges still for many spending departments, although the budget increases will not be anything like as challenging as what they have been perhaps used to over the past 10 years. Yes, if I remember correctly from the election that the IFest was very fair that you were equally weathering about all the manifestos, which is very good of you. Just more specifically in the last session, we were looking quite specifically at the nature of the rise of income tax receipts, the fact that Scotland was not seeing as big increases and the fact that we were seeing big differentials between sectors, and that brings with it challenges. Do you think that there is sufficient public policy focus on how we plug gaps in particular labour markets or address those differentials? That seems to be a new challenge and one that is more challenging because of Brexit, but it does not seem to be getting the focus from public policy north or south of the board if it needs to. Brexit is clearly a very big change to the structure of the UK economy, and you can imagine that some sectors are doing relatively well out of it and some sectors are struggling. Clearly, if you are reliant on exporting to the EU, it is going to be a much harder time for you, at least for the near term. For example, if you are a sector where previously you were competing against EU companies, for example. You can imagine that the pandemic also is as challenges that are also going to be very different across sectors. Most obviously, if, for example, people's working patterns change, if their shopping patterns change, there will be some sectors well placed to take advantage of that and some sectors that will take some time to adjust. I think that there is a big challenge for the UK economy as it goes through these big changes. I think that the shift to net zero is another one where again some sectors will gain, some will lose and that transition may well create some pain and some friction. I think that this is all of these areas where I think that there needs to be a lot of attention of policy makers. In terms of the devolution settlement, I think that what it throws up also is that, in some sense, the shock from Covid and the economic lockdowns were a shared shock right across the UK. Broadly speaking, it was not the case that this was a shock that really hit Scotland or really hit England. In some sense, I think that that is fortunate, given the fiscal arrangements that we have. I think that the lesson from it is that we need to think carefully what would happen if we had another big negative shock. In particular, what if a very big negative shock came along that was very concentrated on Scotland? Would our fiscal arrangements have really proven robust to that? I suspect that the answer is no. In some sense, we were, luckily, probably not the right phrase, but to the extent to which broadly Covid was not disproportionately harmful in Scotland compared to England, which was fortunate, given the arrangements that we have in place. Thank you. In the interest of time, I will hand over, but I am hoping that one of my colleagues will pick up on that. That is a very interesting insight. We will soon see. John Torff by Ross. Well, I will change my plan and follow that up. Do you think that we should be seeking, in the fiscal framework review, changes to the present system? I think that the UK-wide should be thinking through the risks of the ball framework and reviewing it in the light of big negative shocks come along. We have seen that after the financial crisis. We have seen that with Covid. We must very much hope that the next negative shock will not be anywhere near as harmful as those. The other thing that we need to remember is that the next recessions never like the last. Covid was a shock that, as I said just now, was something that, very broadly speaking, was UK-wide. We really need to think about what about negative shocks that were very concentrated on one part of the UK. The framework that we have strikes me as something that is not well placed to deal with a very bad negative shock that hits Scotland and not England, or indeed not very well designed for one that hit England and not Scotland. I think that it is those kinds of stress testing. I think that, if the way is what does the UK be better served by something that is better, more robust to the localised shocks, I think that the answer is yes. I think that we shouldn't be complacent that the next shock will prove to be as general as the shock we have just been through. On that point, would the answer to that be to give the Scottish Government or Scottish Parliament more borrowing powers? Would that be the way to deal with a more geographical specific shock? I think that either giving more borrowing powers up front or having the flexibility to announce extra borrowing powers very quickly were a negative shock to materialised. I think that that does not just apply to Scotland. It also applies to English local authorities, where we saw very uneven shocks depending on their income streams, depending on their spending needs. The Government in England decided to compensate local authorities with broad brush compensation that, across the board, looked reasonably generous given the pressures that they were facing, but you can still imagine that some local authorities are not getting enough. It is very hard for compensation packages to suit that. I think that emergency borrowing powers are perhaps the obvious solution to that or, alternatively, setting up in advance how those borrowing powers might work. However, I think that you certainly want them in your toolkit, so that is what I am saying. To move on to a different point, I was asking the OBR about the long-term scarring effects. We actually only really got as far as the pandemic and their figure is 2 per cent, so I was going to ask you if you agree with that. If you reckon that there is this, they were basically saying a permanent effect that we will never recover from if we had not had the pandemic. The other part on that link is, what is the long-term effect of Brexit? Is that also a permanent effect or is that something that we overcome in due course? I think that it is fair to say that economists pretty much, as much as economists ever agree, agree that the economy will be permanently smaller as a result of Brexit compared to what it would have been. I think that there is good reasons to think that the economy will be permanently smaller as a result of the pandemic relative to what it would have been. On the pandemic, I think that it is pretty clear that, while very fortunately, unemployment has not been anything near as bad as we have feared, it is still the case that some people were in good jobs and have lost those jobs and they may never get back to as good a job as they would have had if the pandemic had not happened. I think that it is pretty clear that, while bankruptcies have been running very low, I still think that it is the case that some businesses that would have been viable have proven to have had a bad shock and have been knocked out of business as a result of the pandemic. Some investments in the UK are probably not located in the best places, given, for example, shocks to working patterns. We have also had a huge shock within our education system, where face-to-face tuition schooling has been messed up, where exam grading has been messed up, and it would be remarkable if that did not have negative consequences going forward. I think that there are good reasons why those effects are negative. Where we do not agree is on a number, it is very uncertain. I do not have a number for the 2 per cent. IFS has not produced one, but I would stress that it is very uncertain. The OBR thought that it would be 3 per cent back in March. It is 2 per cent now. It is good reason to think that there will be a number. It will not be zero. It will be a negative hit. We must hope that the next movement goes lower than two, but what moves in one direction could easily move the other way. It is also a reason to think that the Chancellor does not have a lot of wiggle room relative to the amount of uncertainty in the economy at the moment. You have mentioned, and others have mentioned, the whole concept of a skills mismatch that we seem to have vacancies in some sectors and other people looking for jobs, perhaps not at the right skills, and that has been exacerbated by Brexit and the pandemic. Is that something that is going to sort itself over time, or is it something that we should be seriously concerned about? I suspect that, in large part, it will be sorted over time. You can imagine when you shut down parts of your economy and then reopen them. It is natural for there to be very high levels of vacancies and when the economy is changing. It is structure. It is natural for people to take time to adjust. It is natural for investments to take time to move. Where we need to be particularly worried is where there are groups who we know find it harder to make those kinds of adjustments. For example, if you had asked me earlier in the pandemic, I would be highlighting not just older workers who are thrown out of work, but younger workers thrown out of work, ethnic minorities thrown out of work, where they were disproportionately on furlough and were disproportionately losing their jobs. The evidence now is that younger people and ethnic minorities have bounced back pretty remarkably strongly. That is a big part of the good news story that we have on unemployment. Maybe they found that they are more able to move sectors, that they are more able to move to different employers. However, the story on older workers has not got a lot better. It is true that their unemployment rate has not shot up, but there are many who have moved into economic inactivity. The worry is that they have moved into essentially biding their time before they reach the state pension age. Maybe some of them are lucky enough to have decent private pension arrangements, and maybe some are not in that position. I think that there is a worry that they are prematurely moved out of the labour market in a way that may prove to be permanent. I would suggest that policy makers, relative to what I would have thought earlier in the pandemic, need to perhaps be a little less worried about ethnic minorities and the young and a lot more worried about relatively speaking older workers. I guess that the other group that I would always be concerned about in recessions are people who have low formal levels of education but perhaps were working in jobs that looked pretty skilled and had quite a decent wage. In particular, there is quite a lot of men working in productivity manufacturing that is geographically located, Brexit in particular is a risk to those kinds of industries. We know from the past that those kinds of workers find it very hard to get jobs that pay as well as the ones that they currently have. Ross, do you want to follow in with Michelle? Thanks. I second with that point around skill shortages and skills mismatches. Carl, could you expand a little bit on the sectors that are specifically experiencing a skill shortage as opposed to a labour shortage for other reasons such as wage pressure, migration issues, etc? I think that it is hard to disentangle the two. The work that we did is to look at the sectors that people tend to move to. Lots of people stay in the same sector, so the vacancy rate in their own sector is very important, but some people in some sectors move to other sectors, so the vacancy rate in other sectors also matters. If you are the kind of person that works in a sector where you might tend to move into nursing or social care, for example, your vacancy rate is actually pretty high at the moment. It is pretty clear that health and social care is going to be a growing part of our economy for some time to come. It is pretty clear that the shortages in areas such as well-publicised shortages in areas such as lorry drivers are partly caused by the pandemic and partly caused by issues around Brexit. However, it is quite hard to identify from the work that we have done, how much is a skill shortage versus other frictions that have come into the system. Of course, in the long run, the solution to even if it is a short-run friction that has come in might be that domestic workers need to retrain to get skills for that sector and move across and maybe more people who are British citizens will end up doing, for example, the lorry driving around Britain. That may well be an outcome that we see over the next few years. You mentioned in your initial remarks that most areas of UK Government spending are going to avoid cuts over the next few years and are basically going to be at the level of spending that was expected pre-pandemic. I am interested in how you are accounting for the specific effects of Covid. Take transport as an example. Real-time spending and transport, taking aside the capital issues around HS2 and so on, are relatively steady over the next few years, but patronage of buses and trains is still way down and operators are still requiring significant subsidies. If the budget is essentially frozen real terms and there are no cuts, but a substantial chunk of that money is having to go into operator subsidies that were not accounted for pre-pandemic, is that not going to essentially result in a dis-policed austerity. There will be cuts not to the overall budget, but within UK departmental budgets there will be areas that are cut because they have to cover for the effect of Covid in other areas. That is a good point. In the health service, we have done some work estimating how big we think the effects of Covid on the budget needs over the next couple of years will be. There is a lot of uncertainty but, broadly speaking, we think that the Government has found enough money there already for the next couple of years to cover the normal increases in NHS spending that you would expect throughout a pandemic, plus the additional that we think will be needed as a central best estimate from the pandemic. There are question marks about year 3 and whether there is enough money there. It would not surprise me if the NHS ends up getting a top-up towards the back end of this UK Parliament. Transport is an area where you are right to highlight that budget increases are an area where there will be challenges to the rail budgets and bus budgets if passenger numbers remain very low. That is one of the areas where I would recommend a chance of staying live to where he might have to allocate some of the big reserves that he has set himself. If train numbers do not come back as strongly as he expects, that might be exactly the kind of area where he would expect him to use the £10 billion or so that he has got squirled away. That is an area where there are budget increases, but I certainly agree that pandemic pressures could be substantial and could persist for longer than we expect. I think that the other area where people highlight pandemic pressures is in the courts, but there the sums of money involved are quite a lot smaller. There will be logistical issues about getting through the backlog, but I think that the money issue is not the reason why the courts will be struggling over the next few years. I will leave it there, convener. You mentioned various groupings that have been affecting in certain ways ethnic minorities young at all. You did not mention women, given often the flexibility that they will look for in various roles and their predominance in care and hospitality. I wonder if you just wanted to put on record your thoughts about them as a very vital grouping and your thoughts going forward of how specifically the public spending outlook might impact them. In terms of the raw employment numbers, the story there is not as bad as we feared earlier in the pandemic. So far, it is not the case that women have suffered disproportionately from losing paid work following the Covid pandemic. In part, lots of women are disproportionately working in the public sector, which clearly has not had the same shedding of jobs as some parts of the private sector. I think that there are obviously big uncertainties about how things will play out going forward. We know that much of the burden of the increase in caring responsibilities through the pandemic was borne by women, rather than men. Men did more than normal, but women still took on more. We do not know how, for example, widespread continued working from home will play out, whether, for example, fathers will continue to do more of the domestic chores that perhaps they were participating in through the pandemic, or whether an increased and prolonged period of working from home will mean that it will be increasingly women who are trying to juggle doing two tasks at once—paid work alongside, for example, caring for children. The other thing that we know that, in particular pre-pandemic, we know that, for graduate women, it is periods of part-time work that really leave to them falling behind graduate men. That is a big driver of the gender wage gap. Women with degrees are essentially doing okay relative to men with degrees until they have that first child, then they move to part-time work and then they fall increasingly behind in terms of their hourly pay—not just their weekly pay falls behind, they are working fewer hours—but their hourly pay falls behind. I do not know how that will play out with environments where, if more flexible working does that lead to more wet men working part-time, which could lead to perhaps a more favourable situation for mothers who are working part-time, or will it be that women who do more of the part-time work from home when working from home becomes more common? I think that there are reasons why you could be optimistic or pessimistic on that. It is certainly interesting to think about going forward. Just another wee question. We have not touched much on structural issues highlighted in the economy as a result of Covid. You were talking earlier about assets. It is commonly held to believe that asset values across the UK are just overinflated. That has been perpetuated for a long period of time because it is in a lot of people's interests. I would appreciate your view of what your current thinking is on that. Is that a view that you agree with and what you see happening going forward? There may well be other structural issues that you want to bring out as well. If you have an asset like a house and the rate of interest falls, the value of that asset will grow, and that does not make it undervalued in a financial sense. A £200,000 house will be worth a lot more if interest rates are 1 per cent than if interest rates are 2 per cent, simply because the person who you are trying to sell it to can perhaps finance their mortgage less expense more cheaply. I hesitate to use the phrase overvalued, but what I was not very clear about earlier is that if we are seeing another prolonged drop in interest rates, which is what markets are indicating, interest rates are not just staying very low from post-financial crisis, but if anything edging down even further. That has consequences. It means that people who already have assets do well, people who have not got those assets too badly. People who have just bought their house, for example, will do very well because they have made a geared purchase. They own a small fraction of that asset and yet the whole value of that asset is increasing in value. Fiscal policy decisions need to take that into account. The concern is that, maybe through the 2010s, there was not enough attention on who was winning from those asset effects and what does that mean for the tax and the benefit reforms that we want to be carrying out. What role do we want, for example, for the taxation of capital income, the taxation of inheritances versus the taxation of earnings? One thing that I would point to is, for example, that the health and social care levy, for example, was levied on dividend income, yes, but also entirely on the earnings of those in paid work. It is not levied on those who are getting rental income from a property. It is not levied on those who are getting private pension income, so people who have got investments that have shot up in value. The health and social care levy was a missed opportunity. I understand that it is hard, politically, to introduce the tax on pension income, but the moment to do it might be the moment when you are saying, well, we are increasing this tax on everybody, so workers will be paying in too, and the money is pretty clearly going to go on the NHS and on social care, which will benefit again everybody, but I guess in particular it is going to benefit those of pension age and those who, for example, for whom health care use and social care use might be on their immediate horizons. I think that it was a missed opportunity, and I think that it is going to be quite hard for a subsequent Government to say, oh, we are just going to include pension income in the health and social care levy. That would look like a very targeted tax rise on a particular group, rather than doing it at the outset when you are doing it on earners too. I think that it is those kinds of decisions that policy makers need to think through in the light of what is happening to asset values, in the light of who is gaining and who is not gaining from those changes in our economy, regardless of whether we think that those assets are overvalued or not. It is just one question. Quite a few of the witnesses that have come to this committee have indicated that they think that consumer behaviour has changed quite markedly under Covid. Do you have any way of estimating whether you think that change is likely to be permanent? I think that it is pretty hard to say. We know that there have been lots and lots of changes essentially by design. This was a recession caused actively by Government policy. Stay at home is an instruction not to spend in the economy, and lots of spending opportunities were clearly shut. As you heard in the last session, that clearly led to Government stepping in with lots of financial support, Government borrowing rising and household saving going up very large amounts. Clearly not everybody was able to save, but many in particular middle and high income households did. That has a number of consequences. If consumers in bounces back to where it would have been without the pandemic, that would be a huge increase in consumer spending in the economy. That is even if no one runs down the savings they have accumulated. I guess that your question was also more focused on spending patterns. I think that it would be quite surprising if at least some of the change in behaviour did not prove to be permanent. I think that it would be surprising if, for example, people were not spending a bit more on online spending opportunities, be it streaming opportunities, be it online shopping and perhaps a bit less on other entertainment and social spending. At the margins, it would be surprising if there was not a bit more working from home, which would change the location of where people are spending. Perhaps they would still go to cafes for lunch less. If they do, they will perhaps be going to them a lot less in city centres and a bit more in other parts of the economy. We have also seen evidence, for example, that an early indicator of a permanent change, which I thought was striking, was the number of people applying to primary schools in London fell. That looks to me like a large number of people deciding that it is a pretty permanent decision that they are going to live further away from the centre of London than what they would have done. I think that there are good reasons to think that there will be permanent changes. I think that the hard thing to know is that all of the changes that we have seen will not be permanent. For example, I am now working in the law office in London three days a week. I was doing that four days a week pre-pandemic, whereas during the pandemic I was clearly in London zero days a week. I think that there will be a large adjustment back to where we were, but not all of the way back to where we were. I think that where we are on that scale is hard to judge and it will have big distributional consequences between industries, between parts of the economy at a very local level and between different types of households. For implications for savings patterns as well? Yes, particularly as I say that the observation that it is middle and high income households who have really been able to increase their savings, mainly because many of those were lucky enough to be able to work from home, so they didn't suffer any drop in their income. They just received their wage as usual and lots of their spending opportunities were shut down, so they had a painful pandemic for many reasons. Nomically, they were not able to do the spending that they would like to do, so their welfare was hurt in that sense, but their bank balance really was not hurt. Also, they found that if they had, for example, investments, if they had owner-occupied housing, if they had a private pension, a defined contribution pension, they may well have found those assets shoot up in value too. Thank you. The Institute of Fiscal Studies has been quite excoriating in its critique of the UK budget. I noticed that one of the comments was that a crucial ingredient in this year's policy decisions has been the way in which OBR forecasts appear to have driven policy. You have touched on it a wee bit in response to Michelle's questions, but what can and should UK and Scottish Governments do differently in terms of fiscal policy? There has been a lot of critique and I understand that, given your role, but what more positive suggestions do you have in terms of how we can make things better? I think that the critique comes mainly from the fact that Chancellor in September, as recently as September, was asserting that he was going to keep the spending plans, which involved spending less, not more than we were planning pre-pandemic, which I think looked pretty implausible and now the Government is not planning to do it. I think that the policy decisions being determined by the timing of OBR events comes from the OBR in March, thinking long-run scarring was 3 per cent, Chancellor responding with big tax risers, OBR in October thinking that the scarring was only going to be 2 per cent, Chancellor responding with topping up the spending plans, not raining back on the tax risers, so it looks like an asymmetric response. I think that it is an interesting thought experiment to think where would we be now had the OBR in March produce the same forecast as it did in October, had it said 2 per cent in March and just not changed its mind. Would the Chancellor have done still done as big tax risers or would he have done smaller tax risers and would we now be talking about smaller tax increases and perhaps much more tighter spending plans? That is the questions that we are raising. What do policy makers need to learn from this? I think that, as ever, there is always a huge focus on the central forecast. How much is growth going to be over the next two years? What does that mean for revenues? Do we think that there is going to be 3 per cent scarring? It is hard for policy makers, but not enough focus on the what if things turn out to be 25 per cent better? What if they turn out to be 25 per cent worse? How do we keep our plans to be… How do we give the certainty to spending departments to tax payers that they want while remaining appropriately nimble to changing environments, borrowing more when we need to, borrowing less when that is appropriate and tweaking policy when we want, but being clear that that is what we are going to do? That is the on-going challenge to try to move away from a focus on a central set of numbers and to see why they need to be produced, but more understanding of the kinds of alternative scenarios that OBR produce, hope for the best but perhaps prepare for the worst type of environment. I think that politically it is very difficult to do, but that is what we need to hear more of. What would the UK chancellor and what would policy makers do if the Omnicron variant turned out to be much, much worse than we are hoping that it would turn out to be? What would be the response then? What is the credible plan that we have? What happens if, for example, as we must all hope, scarring turns out to only be 1 per cent, the chancellor's priority to cut back on taxes? Is it more spending in some priority areas? Just more clarity over how our policy makers will respond to a changing environment would be a big step forward. Okay, but whether we move away from the numbers or we keep the numbers, the IFS has talked a lot about fairness, stagnating incomes, lack of growth, lack of productivity. What could ensure that the chancellor has done differently in October? In what lessons are there for Scotland, given that our budget process begins on Thursday? The one thing that he did that I think was clearly right to do was set out a four-year spending plan for spending apartments. For several years in a row now, we have had one-year spending plans for understandable reasons, uncertainty around Brexit and uncertainty around being in the middle of the earlier waves of the pandemic. I think that the decisions for one-year were defensible and, indeed, something that we called for at one point. However, on the public service side, I think that the chancellor has done the right thing, set out clarity for spending plans, but keep a big reserve in your back pocket that might be needed should plans need to be topped up, like the transport budget that we talked about earlier. I think that he's got that broadly right. I think that he's done well there. What we haven't seen from the chancellor is where is his strategy for tax reform, where is his long-run planning, which can both help fairness and help growth. He did do a very good set of alcohol tax reforms in the budget, facilitated by Brexit, the set of reforms that we couldn't do before. The taxation of alcohol is going to look a lot better now than what it did under our membership of the EU, and he should be applauded for that. However, there are many other areas of government where we haven't seen coherent thinking. We haven't really seen a coherent plan of what the long-run future for business rates should be. We saw pretty small tinkering around air passenger duty. We heard yet another freeze in fuel duty with no plan for how we're going to replace that revenue when pretty much everyone will be driving around in electric cars and there'll be very little fuel duty revenue, there'll be very little VED revenue. Lots of areas where lack of thinking, and as I mentioned before, the new health and social care levy, is it really the case that we want to make it—it's a progressive tax rise, it's broad-based, there's lots to think that it's a good tax rise, but could it not have been a bit better if we just expanded that tax base a little bit more? Would that have been a bit more efficient? Would that have been a bit fairer too? So even when we have seen tax changes, I question whether they have gone as far as I could have done. Okay, and what about Scotland? What kind of lessons can we learn here from what the UK has done in terms of our own budget? We had six weeks to actually look at what's happened and reflect on the UK Government, so for Scottish ministers they'll be taking forward their own proposals from Thursday, so what pitfalls can they avoid and what kind of things can they do in a positive sense? Given the restrictions that they have on policy, of course. Indeed, my advice would be to pick a subset of taxes. You're not going to suddenly try and do big tax reform across the board. Pick a subset of taxes that are your priority, where you think you've got the support plus the wins from making the changes. You don't want to be rushing to things, you want to consult widely, you want to set up the appropriate processes to get the reforms right, but whatever area you pick, getting council tax right, getting business rates right, getting air passion to duty right, whichever tax it is, I think you can pretty much pick any tax, however good it is at the moment, it can be made better. You can do it in a way that raises revenue, which would obviously create losers but make it work better. You can do it in a way that can be a giveaway, but it's almost a case of pick what your priority is, be very clear about what your broad objectives are. There's plenty of experts out there that can help you, given those broad objectives, to get the reform right. It won't be easy to sell, it won't be completely plain sailing, the worse the tax, the more arbitrary there'll be some groups who are winning for bad reasons who will almost certainly not appreciate the tax reform happening, but the wins are there in terms of a fairer tax system, in terms of a more efficient tax system. That is more given that we're going to have a high tax burden in the UK by historical standards, so there isn't a right answer to how high should our tax burden be, but I can certainly guarantee you the higher the tax burden we have, the more costly it will be if that tax system isn't well designed. In terms of spending priorities, what should they be? Do you believe for Scotland, given what's already been asked by Daniel about the fact that there'll be a jump in resources this year, but it will then decline in real terms over the following two years? Sustainability of the public finance is obviously a major issue for us here in Scotland. Indeed, and I guess that just like in England, I think that the main determinant of how much money is for many government departments will be exactly how much money does the health service need. It's such a large part of public service spending. You can see it essentially driving budget decisions, fiscal policy across the board, let alone when you've got a kind of, you know, this is how much cake you've got to share across public services. Clearly what you determine is the right allocation for the NHS is going to be a huge determinant of what's left over for everyone else, so in getting that decision balancing the needs of the NHS versus everyone else is going to be crucial. There's clearly a big decision about the social care budget, where big reforms in England to make the system more generous, to what extent Scotland also wants to make its system more generous. Does it need to spend that money on social care or would it rather spend the money elsewhere? I think that the education budget is clearly a priority. We spoke earlier about the fact that that really hadn't been prioritised over the last 10 years. I think I'd also add to that the fact that there's been a lot of clearly, there's been a generation who've had a bad experience in the last couple of years moving through the education system, but those who are still well within the education system, those still at primary school for example, there is time for the system to make up the losses that they have had. It's clearly harder for those who are older, who perhaps have less left education, but for those who are still well within the system, I think that this is our chance to make investments to make up for that lost in-person teaching, which risks harming them for some time to come. Daniel? I just had one final question, very much following on what I was asking about in terms of labour markets, but taking a longer view. The last two years have been a pretty brutal shock exposing our reliance on importing labour to make up gaps and indeed fulfil certain tasks that either the UK population doesn't want to do or indeed a kind of essentially low-wage, low-skill jobs. In the longer run, if you look at global population growth, population growth globally was around 2 per cent just under through the 1970s. It's fallen to about 1 per cent. It's projected to fall to half a per cent in the middle of this century and come to almost sort of an equilibrium by the end of the century. Strikes me that any kind of model that assumes that we can continue to import labour is flawed regardless of the other things that have happened. My question is, would you share that assumption? If so, does there need to be more focus on increasing the productive capacity of the existing population? That's what the economy will require. It's working-age people to be more productive, whether that's skills or automation. Does there need to be more focus from public policy on that issue? A consequence of the population growth figures that you point out, one is that as that works through the system, that will drive an ageing of the population, which is a little bit different to increases in longevity. Increases in longevity can be people living longer in healthier states than not putting demands on the NHS. Changes in birth rates and changes won't be a benefit for the NHS. It just means that you'll have more people at older ages relative to the numbers at younger ages. The consequence of that is that a higher proportion of people will have to work in health and sexual care and those types of services, which raises a challenge of productivity performance given that those areas of the economy that are very labour intensive have been ones that historically were found very difficult to deliver productivity gains. The UK is a high-wage economy relative to most of the world, and we are a small part of the world. If we want to, we will be able to attract people from overseas. I think that that's always going to be an option to the UK, and indeed any small economy that has relatively high wages relative to most of the world. That will always be an option. If we don't go down that route, the consequences for different industries will depend on, as you said, the willingness of the domestic population to work in those sectors, which may require moving location, and it may be a different kind of work—the ability of those sectors to increase wages to attract people. If you're talking about lorry driving within England, that's always going to be something that needs to happen. It seems quite plausible that wages in that part of the economy can rise, and it won't have that bigger effect on the prices that people face in the shops. That seems quite plausible, whereas there are some sectors where increasing prices is not a plausible strategy. They are competing against other parts of the economy. Maybe they are in hospitality in a remote part of the country, where big price rises will mean that people won't want to go. Maybe it's in agriculture where big price rises for those goods will mean that people will just buy rather by something else or they rather import something. Essentially, in the long run, those sectors will move away from doing those sectors, and there will need to be an adjustment to getting in again. That points to your point about skills, training and what people will need to be doing. A focus on that would be a good idea. A focus on ffervor education, which has often been ignored in the UK, around half of young people going to university and getting university education rights is therefore important. My guess is that it gets more than 50 per cent of the policy attention. The issue of productivity is crucial, because the sectors where more and more people are needed, such as social care areas, where it is hardest to deliver the productivity gains that we would require. The issue of having a shortage of skilled labour for the high tech and more productive jobs that we need to keep the economy going and create the additional resources that we would want to invest in health and social care, etc. Obviously, we are going to force up wages over the short and medium and, indeed, long term. How will this impact on our international competitiveness as a global trading economy? Like many of the forces that we are seeing, a global one. I think that if we get higher skilled people who are high productivity and getting paid more for it, they will be producing more. I do not think that that will be a particular problem. I think that I would point more at the bigger challenge to the adjustments that firms have got to make to the markets that they are accessing. I would highlight that between the Brexit referendum and the actual date of Brexit, exporters had in some ways a relatively good time, because they were still members of the single market and they had a depreciated currency, and therefore were able to compete more easily with them. Perhaps they would have been able to do had the referendum not actually happened or had the result gone the other way. I think that the bigger challenge is that we know that countries are typically trade with the countries that they have used to trade with. Opening up new options is always harder than protecting your existing market or expanding markets in countries that you already trade with. That is where the adjustments will be harder. I think that I would see the challenge more around trade policy and companies being able to adapt to those new trading arrangements being a bigger challenge than the labour market. Thank you very much. We have had 60 minutes for this session and we have taken just 15 seconds over that. I want to thank Mr Emerson for his short, sharp, direct and very stimulating answers to his questions. I will now have a two minute break while we move into private session.