 Good morning and welcome to the third meeting in 2022 of the Finance and Public Administration Committee. The first item on our agenda is an evidence session with the office for budget responsibility and the UK autumn budget statement and wider UK context with your to inform your scrutiny of the upcoming Scottish budget 2023-24. We are joined remotely by Richard Hughes, chair of the Budget Responsibility Committee, Andy King, member of the Budget Responsibility Committee and Professor David Meill, CBE member of the Budget Responsibility. Good morning and I welcome you all to the meeting. We are going to move straight to questions and can I ask that we direct our questions to the chair and Mr Hughes, who can then bring in other members of the panel, as he wishes. However, other panellists, please do not indicate if you wish to speak. I should say to our guests this morning that we are two members down. I believe that this is due to weather conditions and at least one should be here within the next 30 minutes. In terms of our own pre-budget scrutiny, we called for an open and honest debate with the public about how services and priorities are funded, including the role of taxation in funding wider policy benefits to society. I am just wondering if you believe that that is currently happening, either north or south of the border. Good morning and thank you very much for the chance to appear before the committee. I apologise for not being able to do so in person, but between the snow yesterday and the transport strikes today, we figured that it was better to be safer online than sorry on route and very much hope that people before the committee are in person on our next appearance. By the time that we got to the autumn statement, it was possible to have a more informed debate about tax and spending and the outlook for both, and the policy choices that are involved. It is south of the border. It has clearly been a challenging process over the course of the autumn to get to a position where you had a set of forecasts from ourselves and a set of policy decisions from the Government that aligns to their objectives of fiscal policy over the medium term. The context for eco and policy making has changed dramatically since both the Westminster Government presented its last budget in March and the Scottish Government produced its budget in May. That changing context also has required adjustments to both tax and spending policy to accommodate new realities. I think that we are in a more optimistic place, at least in terms of knowing what is happening going forward. I think that the OBR's position has been strengthened by events in recent months, as I am sure you would no doubt agree. In terms of the UK economic and fiscal outlook, you have said that the medium term fiscal outlook has materially worsened since your March forecast due to a weaker economy, higher interest rates and higher inflation, and you talked about a number of those areas. For example, you said that rising prices are owed real wages and will reduce living standards by 7 per cent in total over the two financial years 2023-24, wiping out the previous eight years growth, despite more than £100 billion of additional Government support. Obviously, that 7 per cent is not going to fall on everyone equally, so can you advise us to where the OBR feel that who will be most adversely affected by that fall on living standards? Let me start out, but I am sure that my colleague Professor Miles of Water will come in as well. The 7 per cent figure is a UK economy-wide figure. Its distribution clearly would be felt more acutely by those on lower incomes, because so much of the rise in prices has been a rise in prices related to essential goods, so electricity, heat and food, which accounts for a larger share of the budgets of people on low incomes and where people are likely to find it hard to substitute away from those expenditures. If you have one house, you obviously have to heat it. If you have more than one home or more rooms in your home, you have more choices about how much heat you consume, so one would expect rising heating prices, rising electricity prices and rising food prices to hit those on lower incomes harder. They also have potentially fewer opportunities to find other sources of income or increase their hours on the employment side. I do not know whether David Watt would want to add to that. Just before David Watt comes in, can I ask you a wee bit specific? Obviously, I anticipated people on lower incomes, but it is just to get a wee bit more detail on who you mean by lower incomes. Do you mean people on benefits? Do you mean people on low wages, who are having below inflationary pay rises, or pensioners or some elements of the above? In terms of expenditure, people on benefits and people on low incomes would clearly be seeing a larger share of their income being taken up by higher costs of living. One thing to say about people on benefits is that they are, along with pensioners, unique at the moment in getting inflation-linked uprises in their benefit payments. Their incomes are keeping pace with the 11 per cent rise in CPI this year, whereas people who are not on benefits and are just earning based on earned incomes are sitting their nominal wages rise by something much less, something closer to four, five or six per cent, so something around half of what the increase in benefits would be or what the increase in the basic state pension would be. Okay, thank you. David, do you want to come in here? I want to make the point that it is hard to imagine that any group can avoid seeing their standard of living for quite materially. That is partly because the underlying drivers are likely to hit people pretty much wherever they are in the income distribution, and that is increases in heating, lighting, in the car with petrol and also interest rates. Anybody who has got a mortgage is likely to find pretty soon that their monthly payments are going to go up fairly sharply. I think that Richard Wright is right that it is probably people towards the lower end of the income distribution. Perhaps those who are not on benefits but are just above it and earning pretty low wages will find it tougher than most, but there probably is not any group that will escape material cut in their standard of living over the next year or 18 months or so. Yes, and people just above benefits are likely to be hit by fiscal drag, are they not? That is right. People will get pushed up into higher tax brackets or become tax payers because of the freezing in the thresholds that we are going to see. Although I think that everyone should be fair, there is going to be a hit by fiscal drag between now and 2028. Andy, you want to come in as well? Thank you. I was just going to add that amidst all the pain that the energy crisis is inflicting on everyone, there is fairly enormous amounts of fiscal support being added through the energy price guarantee and also through the cost of living payments to those on means tested benefits. So, there is a degree to which the sharper or proportionately larger hit to those on lower incomes is being offset for those who are receiving means tested benefits. Okay, thank you for that. I am pleased to see that I have been joined by the remaining colleagues of the committee, John Mason and Ross Greer. You go on in your paper to talk about higher borrowing, pushing underlined debt sharply from 84.3 per cent of GDP to last year to a 63 year high of 97.6 per cent in 2025-26. Of course, GDP is predicted to contract by around 2 per cent in your analysis, but I noticed that one of the main concerns that you have touched on when you talked about, for example, the impact on householders with mortgage rates going up, but in terms of servicing UK debt, you have said that a near tripling of interest rates since March means that the shares of revenues consumed by servicing that debt rises from under 5 per cent in 2029-20 to 8.5 per cent in 2027-28, leaving the public finances more vulnerable to future shocks or swings in market sentiment. What does that mean in cash terms? Obviously, the UK economy is over £2.2 trillion in GDP, so what would we be talking about as the economy does grow after the recession ends? In cash terms, 8.5 per cent work with their eyes be now to their eyes then. The debt payment is now to 27-28. So debt interest spending is about £45 billion higher by the fifth year of our forecast than we forecast back in March. That is driven partly by the fact that we have a higher debt stock than forecast, because the Government is borrowing more on the near term to fund additional support for energy bills and the cost of living that Andy was alluding to. Most of it is driven by the fact that we have seen a big jump in global interest rates, which have started to renormalise after a period post-financial crisis where they were very low and then during the pandemic when they dropped even lower, almost close to zero. As you alluded to, they have now nearly tripled since we did our March forecast from below 1 per cent to just under 3 per cent. With the Government that now has a debt stock of approaching 100 per cent of GDP, that just has a very big impact on the public finances. For reasons to which we can come on to, the maturity of our debt has been getting shorter and shorter over this period. So rises in interest rates also hit the public finances much more quickly, because the Government is rolling over more of its debt in a given five year period than it used to be, which means that more of that interest rate rise feeds through to the Government's stock of debt more quickly than it has in the past. So this has been a really abrupt and dramatic turnaround in Government borrowing costs and it eats into the headroom that they have to fund other public services as well as meet their fiscal targets to get debt under control by the fifth year of the forecast. What would be the debt repayment level in 27 to 28 on current forecasts? So how much will the UK be paying in debt interest in 27 to 28 on current forecasts? Yeah, so it's 102 billion pound final year of the forecast, which is 48 billion pounds higher than we forecast back in March. It's unusual for a forecaster almost double over the space of a few months, but that, as Richard has explained, is this big rise in global interest rates is by far the biggest reason for that change, but also higher debt. Okay, one of the other things that we've talked about is fairness. The United Kingdom Government has, for example, abolished the cabinet bank as bonuses, as we know in 23 August, didn't reverse that. The Office for Tax Simplification is also going to close. What are the implications of those? Andy, please come in on what bank as bonuses does to our income tax. Thinking more about what the impact you think it's going to have on the wider economy, not because of the amount of bonuses, because frankly it's not necessarily significant in itself, but what impact do you think that has in terms of other people and how they perceive their own position to be with regard to asking for increased pay, et cetera, and perhaps feeding that view that certain people in society are being favoured over others and, therefore, it makes other people feel that they should get the pay rises that they deserve? Sure. We have to be a bit careful in that our remit doesn't extend to either distribution analysis or commenting on Government policy decisions. In terms of the overall distributional impact of the decisions made in this autumn statement, you can say that there are two groups whose incomes are, in essence, protected from the cost of living increase, and that is people who are on indexed linked benefits like universal credit, and then those that are on the basic state pension. To that extent, especially for those on benefits at the lower end of the income scale, they get some protection. Working people, in essence, almost all the thresholds are now frozen, so they are seeing substantial fiscal drag. At the top end, there is a reduction in the high-rate threshold, which means that there is some additional income tax being taken from the top end of the distribution. One of the things that you have said is that borrowing will take the strain in the near term, with the great majority of the planned consolidation—sorry, this is Paul Johnson, what Paul Johnson is saying in the two fiscal studies. He is saying that borrowing will take the strain in the near term, with the great majority of the planned consolidation due only after the next election. What we are really doing is reaping the costs of long-term failure to grow the economy, the effects of population ageing and high levels of past borrowing, and we are in for a long, hard and pleasant journey that has been made more arduous and might have been by a series of economic goals. Is that something that you would agree with? Possibly leaving out some of the adjectives, but I think that the general assessment of the profile of policy action taken over the next five years, there is a fairly consistent pattern that you see in budgets presented by successive chancellers, which is to have a fiscal loosening in the near term to provide support to businesses and households to get them over the latest shock to their incomes, be it from the pandemic, be it from the energy crisis, and then committing to clawing that back in year 3 to year 5. In previous statements, you have seen that coming from the tax side with the rises in corporation tax. In this statement, what you have seen is much of that consolidation coming from cuts to public services in years 3 to 5, so beyond the current spending of your period that we have here in Westminster. I caveat to that is that the Government is currently planning to cut about £30 billion out of the overall envelope for departmental spending by the fifth year of our forecast, but the Government does not have any detailed spending plans beyond 2024-25. The Government also has a pattern of when it comes time to do its own spending of views and allocate out public spending to departments around Whitehall. It tends to put back in approximately £30 billion into the envelope to grease the wheels of those negotiations and make the numbers add up to meet their political priorities. One has to cast a sort of drawn desire on Government plans to reduce the level of departmental spending five years out without having detailed plans to support them, because when it comes time to set those departmental plans, Governments tend to find ways of greasing the wheels by putting a bit more money into the pot to make the numbers add up. The plan to address the debt, most of the difficulty of being left until after the next general election? It is certainly the case that debt only begins to fall in the last two years of the forecast, so in 2027-28. Up until then, debt is still rising, and the Government only meets its fiscal objective to get debt falling, in essence, by starting to cut back to departmental spending in the final two years of the forecast to deliver that trajectory. In terms of the forecast for Scottish Shed tax receipts, you have been quite optimistic over the next few years in terms of the growth in Scottish tax receipts. Quite solid growth, actually, about 25-30 per cent, it seems to me. Is that mostly through fiscal drag or through economic growth, a combination of the two, where does a balance sit? I might ask Michael again, I need to come in on that. Yes, thanks. The nominal economy of which the wages and salaries in which in contact is levied is the largest part that will be growing over that period. Essentially, in the near term, the downturn in the economy is in the real economy because it is driven by high inflation, so in cash terms the economy is not hit as hard. We are also seeing wages and salaries perform better than the economy as a whole, partly because high inflation is, to an extent, feeding through to higher wage growth. On top of that, as you say, there is a lot of fiscal drag in the system because all the thresholds are frozen. Normally, growth in income tax is driven by the difference between wage growth and inflation, but that is because thresholds rise with inflation. However, with the thresholds frozen, growth in income tax is entirely driven by wage growth. Although real wages are doing badly, nominal wages are rising at a faster rate than they have for quite some time, and that boosts income tax. In the medium term, our forecast assumes that as energy prices come down, the economy will recover, and that is good news for income tax. The Scottish Government is at the level of the UK. You have said in touch with energy that a rapid end to Russia's division of Ukraine that stabilised energy markets and lowered prices would be a positive risk, and that would certainly reduce inflationary pressure. However, there is no sign that that will happen in the foreseeable future. It seems to be from what I can see pretty much stalemate. Do you feel that, even if that conflict continues, there will be stabilisation of reduction of gas prices as we go forward, as countries look to find a way around it? David, do you want to come in on that one? Yes. I agree very much with your assessment of where the situation is in the Ukraine, and it is grim and no obvious end in sight. I guess that that has been true for some months now—several months, probably. What we have done is not pretend that we have any great insight into where oil and gas prices are going, but to use the futures prices, the market assessment of the most likely outcome of oil and gas prices in the future. Despite the rather grim news from the Ukraine, there has been a consistent pattern now over several months of those futures prices being materially lower than they are right now. That is particularly true for gas less extent for oil. If you look at 18 months to three or four years down the road, those oil and particularly gas prices are a lot lower than they are right now, but they are much higher than they were a year or so ago before the Ukraine invasion—certainly relative to the middle of last year, 2021. For many years before that, gas prices were dramatically lower, but it looks like the longer-run level might settle down a few years down the road. Who can know exactly how that thing plays out? It seems plausible at least, even if you are not optimistic about the Ukraine situation, that it is more likely than not perhaps that oil and gas prices will be somewhat lower a few years down the road than they are now. That is what underpins our, some people might call it, optimistic forecast that the inflation rate very high at the moment and high for much of next year actually drops back pretty sharply once we get into 2024 and beyond. That is one of the Government's arguments for trying to ride out some of the paid demands at the moment, to be honest, so that they do not build it into the system. On energy, if we have stability in gas prices at a lower level than it present, but it is still higher than before, will that not make other forms of energy such as renewables more competitive and that would perhaps in the longer-run open up in the market a bit more? That seems entirely plausible. Again, using those futures prices, the level of gas prices is three or four times as high as it was to go back to the middle of last year and before. It is hard to imagine that that does not have some impact on the relative use of different sources of energy. Okay, just to be one word, the positive side effects, if there is any positive side effects of higher energy prices. I was trying to put a positive spin on what is a very depressing situation as you pointed out. Just a couple of points further from me, and then we'll open up to colleagues around the table. One is that the Institute for Public Policy Research has suggested that in relation to Scotland, there should be a route and branch review of the tax system ahead of the 24-25 Scottish budget to examine reforms to rates and bans and how local tax-raising powers could be used to address wealth inequality in Scotland. I'm just wondering if there will be a view on that. Maybe I can offer a few reflections and then Andy, who is much deeper into the workings of this, I'm sure will also have some thoughts. My main reflection is that we reflect the political settlement that there is between Westminster and Holyrood, and there has been a progressive devolution of taxation and spending responsibilities to the Scottish Government. The political decisions have economic and operational implications, which are really important to take into account. Colleagues on both sides of the border work very hard and earnestly to make them operate well and effectively, but we bump up against some fundamental limitations, often times which are around the availability of data and the availability of information. Devolving more tax powers down to Scotland presumes that one can identify who is a Scottish taxpayer, what the tax base is, and in the year in which you're collecting it. Between ourselves and the Scottish Fiscal Commission, we spend a lot of time trying to improve data sources so that we can provide decision makers like yourselves with the most up-to-date picture of what things look like UK-wide and what things look like particularly in Scotland. As one thinks through those decisions, I think that it's important to also think about the plumbing that sits behind them to make sure that you're making timely decisions and that you're making decisions based on information that is reliable and that actually exists. I think that we're just getting to a point where the information that we need to accurately and effectively forecast the things that have already been devolved, such as Scottish income tax, is improving and becoming more and more timely, but that's been a process of several years to get where we are now, and Andy may want to come in on that as well. Just to reinforce the message, reading through the previews of this week's Scottish budget, it's just very striking how many pages are devoted to the difference between Scottish income tax and the block grant adjustment, and it's just a very technical thing that I have to relearn each time we go through the forecast, and I can't imagine it's very easy for people every day, the man in the street, to understand what's going on with the Scottish budget and why. Those reforms, you can see why each item of it was put in place, but you can also see why it generates challenges for those scrutinising. That's why we need an office for tax simplification. Just to the last point, Andy, this will probably be in your area. I don't know if you have a time to look at it, but it was only published on 5 December. In a paper commissioned by the Scottish Trade Union, Lansman Economics, a proposed package of tax increases to fund an increase in public sector pay and investment in public services in Scotland, including short and long-term measures, which it argues would combine, raise £3.3 billion. I don't know if you've had an opportunity to look at that and what the implications of that might be, not just in terms of service delivery but behavioural change, et cetera? I'm afraid I haven't seen that paper, but in general, when we look at tax measures, if they were on that scale, I presume that that is an income tax package. Those are the areas where the evidence base on the behavioural responses, where the one that I think one would really worry about is people who are able to move, not to pay higher taxes in Scotland, or perhaps a bigger concern, those who have two residences and are able to choose which one is their main residence and therefore where they pay their tax, the risks around behavioural responses can be quite large, because if someone does change their residence, then they lose all the tax that they pay, or the Scottish Government loses all the tax that they pay and the Westminster Government gains it. Okay, thank you very much for that. I'm now going to open up the session to colleagues around the table, and the first person to ask questions will be our Deputy Convener Daniel, to be followed by Liz. Just on an initial point, the fiscal commission made a recommendation in the last set of forecasts in the summer that the Scottish Government should prepare its budget on the basis of the OECD cofod principles. I'm just wondering if the OBR had a similar view both about the UK budget and what improvements it could make in terms of transparency, and whether it had any particular views on the way that the Scottish Government sets its budget in terms of transparency and clarity. I think that there are so, just to do some acronym busting, cofog is a way of classifying government spending into standardised categories, which are consistent over time as well as comparable internationally, which I think was the OECD's recommendation. Cofog is the classification of the functions of government. One challenge that you have looking at UK data has always been that, because the Government is constantly chopping and changing ministerial boundaries and combining ministries and separating ministries, it can sometimes be very difficult just looking at UK data to look at what has been transport spending over the past 20 years and what has been health spending over the past 20 years. I think that it is very useful to be able to have a standard classification, and regardless of whether transport is being moved in and out of an infrastructure department or is in its own department, you can just see what is being spent on transport over a long period of time. It is also really important for being able to make international comparisons and benchmark ourselves against other countries. I would very much support the idea of presenting and classifying spending based on standardised classifications, which are consistent over time and consistent across countries. For the UK, that is done by the Treasury at a publication, but only for historical data. We have on occasion in our own forecasts presented a version of a cofog classification looking out over the next five years, but you have to ask an awful lot of questions of government to allow yourself to do that, because ministerial boundaries do not always coincide with cofog definitions of health education transport defence. It can require a lot of work on the part of government accountants to decide based on vague five-year plans where exactly a certain amount of money is going to fall between those boundaries. From the point of view of transparency and consistency in communication, I think that following international standards in the presentation of spending helps to inform the debate and helps to put our own numbers in context. Thank you very much. I quite agree and it's useful just to hear that on the record. Just following on from the early set of questions from the convener, I think that we were all aware about the interactions in the economy between different budget decisions before, but I think the autumn certainly brought that into very sharp focus, including in terms of spending plans versus debt. The other thing that has become very clear in recent months as we look at UK economic data in comparison to other countries is that our difficulties are not just confined to recent months that actually over the last decade UK growth has lagged at our comparator nations, and that seems to really be a function of investment. This is a question that I asked our previous week's panel, which consists of the IFS and others. Do you think that we need a renewed focus looking at what spending within either UK Government budgets or indeed Scotland are genuine investment so that we track that consistently so that when we see funding being altered that we have a good overall view of what the level of Government investment and therefore what the longer-term impacts on the economy are likely to be from an individual budget and over time? I might ask David to come in on the business investment side and then maybe Andy might have some thoughts on the public investment side. David, do you want to start off with on business investment? It's certainly true that levels of investment spending across the UK are low. They are low relative to other comparable economies. They are probably also low relative to the more distant past of the UK. In terms of classification of Government spending into things that are clearly investment and things that are what you might call consumption or transfers that are not investment, it is a murky area to be honest. A very high percentage of education spending is not considered investment. Teachers' salaries are not counted as investment yet we probably all agree that investment in human capital is crucial for productivity and long-run growth in the economy. There are probably examples of things that are counted as investment spending and capital spending and perhaps don't generate much increase in longer-term productive potential. It's a murky area quite where you want to draw the line. Having said that, it's certainly true that if you look at how the Government has responded to the very difficult fiscal situation and cuts in spending down the road, capital spending has taken quite a substantial hit. Andy, do you want to come in? I want to add a little flavour on the things that count and don't count in public investment. The way that I tend to think about it is that public sector net investment is the economic category that is covering investment, whereas capital spending by departments is the administrative one. Within public sector net investment, there are things that you would think about as investment in public assets such as road building. There are things that are better thought of as investment in private assets where the Government transfers capital to a private entity that is investing. However, there are a lot of things that are not what you would think of as investing in the capital stock. The biggest of those by far is that the student loan system these days, because a lot of what is transferred to students in loans is not expected to be repaid. The portion that is not expected to be repaid is accounted for as a capital transfer to those students, so there are scores in investment. However, after what David said, you might think that that is an appropriate investment in human capital or you might think that writing off the loans is not what you are thinking about when you are thinking about the capital stock. However, I would just agree that it is difficult to look at any particular number and think that that is what we are thinking about with public investment. Flecting on the answers that you have just given, whether, in effect, what you are saying is that this might be one of those things that politicians cannot be trusted to categorise themselves and that that maybe more objective bodies should be taking a broader—because it is clear to me that we need to have a much clearer and tighter focus on this. Otherwise, we are just going to be doomed to a downward spiral. Is there something that perhaps the OBR—indeed, the Fiscal Commission in Scotland—could take a broader view and, indeed, be incognisant of that there are lots of grey areas that could be categorised either as consumption or investment? Nonetheless, it is important to at least try to take a view as the overall balance between consumption and investment over the longer term. Is that potentially an area of focus for your work or, indeed, maybe other bodies? Let me say two things on that point. One is that we are at pains to follow international standards on financial reporting rather than partly getting back to your point about if we start making up our own standards, it becomes very difficult to compare things before and after or between countries. The standards that we use to classify investment are, in essence, UN international statistical standards, which say that, if it creates a fixed asset, then it is investment. If it does not create a fixed asset, then it is current spending. We use that definition when we say that something is current spending or investment, where Government's fiscal frameworks make an explicit distinction between spending on those two different things. You may remember that, in the UK, we used to have a golden rule that allowed the Government to borrow to fund investment but not to fund current spending, so it just had to balance the current budget. We then monitored that very closely and reported on whether the Government was meeting its commitments in that area. One thing that we would be reluctant to do would be to try to identify some category of spending that goes beyond purely fixed investment but which also captures things that are good for growth. That is too lively and too inconclusive a debate at the moment about what elements of public spending are good for growth. If you just think at the moment that David made a strong case for education, one could also make a strong case for health spending at the moment because we have so many people on waiting lists who, if they got off NHS waiting lists, might conceivably be back into the labour force. You would quickly find a lot of people knocking on your door explaining through an elaborate chain of logic why spending in their area would get you growth in the long run. That is why, in some ways, we are left with this slightly unsatisfactory category of whether it creates a structure that is around for more than a year—that is investment—if it just goes into someone's bank account and gets spent. That is correct. It sounds like you are saying to me, no luck. I am afraid that it is back to you, politicians, to make those sorts of tricky decisions. In all seriousness, I think that that is a really interesting point. I am very clear that we need to have a sharper focus on that. Likewise, that is my final question. Sorry, I apologise. Andy, I was cutting you off. I was not at all. I was just going to add that what we present is all based on national accounts, as Richard Smith said. Your earlier question about co-fog classification is useful here, because you can have a co-fog classification within investment that allows you to look at things in different ways. As Richard Smith said, it is only available for the past, not the forecast. The other thing that I was just going to add is that these are all inputs. I have been around these debates for long enough to remember the cycle that you go through of inputs. That is only the start of it—what we want is the outcomes via the outputs. It gets beyond things that, typically, the OBR or, I guess, the fiscal commission would do. What you really want to see is how the input translates into not just the output of the physical asset but the outcome of is it a growth-enhancing physical asset. Thank you very much. Are there any other points from the panel before I—great. The final thing that I was going to add is that, in recent weeks, there has been an interesting discussion from Francis Gray from the TUC and Ross Foy from the STUC about the true cost of public sector wages. The base point is that, given that there is tax paid on those wages, it is not the gross amount that the Government needs to consider. It is essentially the net amount, which is one point. I wonder whether there is a sharper point in Scotland, given that we have a higher proportion of public sector workers and the way in which the fiscal framework works, given that it is about per capita growth and tax receipts. Do we need to be a little bit sharper focused about the true cost of the public sector wage bill and how that works its way through the tax system, in particular the fiscal framework in Scotland, in terms of what the actual true net cost of public sector wages increased, especially given that that is such a topic of sensitivity at the moment? In terms of the way in which we forecast and the UK Government controls departmental spending, departments are set a cash limit for their budgets for the period up over the next now two years. That includes the period for which pay negotiations are happening. To the extent that departments get larger pay rises than were otherwise assumed at the time in which those budgets were set, that means that they can employ fewer people doing fewer things over that period. The total amount of departmental spending that we do not assume goes up because the Government has given a higher wage settlement. It just means that they can hire fewer doctors and nurses to do the additional activity. In that sense, it does not push up Government spending. What it does is probably just reduce the overall amount of public sector activity that can be done. Unless the pay settlements being given in the public sector were far out of line with those being given in the private sector, it would not generate more on the income tax side either. We have an economy-wide forecast for income tax receipts. It makes assumptions about settlements for public sector workers and private sector workers. In the absence of any explicit public sector pay policy, we assume in the long run that those things grow more or less in line with each other because otherwise we have recruitment and retention problems. From a fiscal point of view, I do not think that the effects are as dramatic as that might suggest. Are there any particular points given the way that the fiscal framework works and the size of the public sector workforce that might have some additional considerations in Scotland? I think that that is definitely possible, particularly in the short term. I think that there are two worlds that you could be describing here. One is where the amount of public spending in Scotland shifts towards pay and away from procurement and other things, in which case the composition is changing. That could have effects, but I think that the thing to always bear in mind and the thing that I always think about when reading these things is that there is more than just the one effect. It is probably easier to see that if you pay public sector workers more, they will pay more in income tax. If you cover that cost by reducing what is spent on procurement, that reduces the income of the companies that provide goods and services to the public sector and that will reduce income tax. If it is done by increasing public spending, that is a fiscal loosening and that would tend to have a short term positive effect on income tax, but if it were big enough to move the dial for the Bank of England managing the size of the economy, there would be an offset there. The Bank of England would have to raise interest rates and reduce bear down on other private sector activity because it wants to balance supply and demand, but there is always further knock-on implications. I imagine that, in a very short term, if it were Scotland specific, it is unlikely that that would move the dial for the Bank of England, but it would depend on the size. If it was compositional, more being spent on pay and less being spent on other things, then that less being spent on other things also has implications for income tax in Scotland. I will leave that there, although I think that that is an interesting topic. Good morning. Professor Miles, can I just take you back to the issue of inflation when you were speaking with the convener when you rightly identified the problem with Ukraine, which is very much in line with some other evidence that we have taken that the larger part of the inflationary situation just now is due to cost factors? I am just interested in your November forecast. You said that CPI inflation in the UK is probably set to peak at a 40-year high of 11 per cent in the current quarter, but it is expected to fall back sharply during the course of next year. I am just wondering where the sharply comes from, given that cost push factors are likely still to be quite strong. Even if there were not to be a reduction over the next 80 months or so in oil and gas prices, even if they just levelled off, in terms of the percentage change then in the cost of loosing the households, that would start falling quite sharply, certainly as you get toward the end of the next year and into 2024, simply because those huge increases in energy prices and the cost of people filling up the car with petrol are showing up right now when they are a big driver. That would fall out of the year on comparisons from a roundabout next year. That in itself would bring inflation down pretty sharply. In fact, our forecasts go quite a bit beyond that by using the markets forecast of where the central gas—and it is not much more than a gas—is for gas and oil prices, which is actually that they fall particularly for gas quite significantly as you go through next year and into 2024. That really is the big factor behind our sharp fall—and it is a very sharp fall—in the consumer price inflation rate as you go through next year. For that to be wrong—there are multiple ways in which it might be wrong—I think that the most likely way it would turn out to be incorrect is if, instead of either levelling off or declining those oil and gas prices actually have another very substantial spike. Who can say whether that will happen? It does not look like the most likely outcome, thankfully, and it is not what the financial markets are—the people who trade in these forward contracts for oil and gas. It is not what they have been thinking pretty consistently for many months, even though there have been quite substantial changes in the short-run price of gas, in particular, spikes and sharp falls. It has been a consistent story that the markets have at least anticipated that we are not going to stay at the current levels of 350 or so pence per thermal. On the demand side of the economy, given that the nominal wages are obviously increasing, when do you expect there to be an uptake in the demand and the economy that might again have some impact on inflationary pressure? Our central forecast—there is a lot of uncertainty yet—is that we are probably already in a recession right now in the UK and that output might be historically declining by relatively small amounts but, nonetheless, declining right throughout next year. Historial standards are a relatively short recession and it is relatively shallow, nonetheless, it will knock almost 2 per cent off GDP next year 2023. Our central forecast is that, after that, there is something of a recovery that prevents unemployment continuing to go up. To a significant extent, that does depend on what we were just talking about, which is a view that the squeeze on household incomes will come to an end and it will do so largely because of falling inflation reflecting lower oil and gas prices. That is very much linked in with the view on inflation. If that turns out to be right, it does seem pretty plausible that, with significantly no longer contracting household disposable incomes and consumption spending, we will get back to something that looks a little bit more normal in terms of the rate of growth with GDP in 2024 and the years after that. If I might briefly say that one of the reasons why we are, I suppose that you would call it relatively optimistic, certainly relative to a Bank of England forecast that we saw relatively recently, one of the reasons why we are relatively optimistic that it is a short-lived recession and we get back to more normal growth a little bit down the road, is that we are going to assume in this forecast, and I think that it is plausible, that households' savings just drop to very low levels as they dip into past savings or those who have been saving money actually stop saving to push in the blow of much higher cost of living. That means that consumption expenditure is protected a little bit, if you like, from the shock to disposable income by people when they can, anyway, dip into savings, perhaps those who are able to smooth in consumption by borrowing a bit more as well. We have a very low household savings rate for the next couple of years in this forecast. Partly that is a belief that the extraordinarily high savings rates on average anywhere in the UK in 2020-21 generate what you might call a bit of four savings during lockdowns when it is more difficult to spend money, and some people, at least, might be significantly dipping into that over the next year or so. Again, thank you very much for that. Can I just ask you one more question? I mean, there are obviously predictions in America that America is likely to have a recession in 2023, not a real crisis but nonetheless quite a downturn. I just wondered if you have any thoughts as to how that might impact on the British economy or on the world economy, but on the British economy? In some ways, what happens in the US is rather significantly less important for the UK than what happens in the rest of Europe. That is certainly true in terms of trade and trade links. Nonetheless, the US is very important because I think that what the US Central Bank does, the Fed, has an impact on global interest rates. I think that part of the reason that the cost of borrowing for the UK Government and for households has risen very sharply is a reflection of what the Fed has done and a perception that interest rates in the US were just much too low. It has been a global phenomenon in which the US plays a disproportionate weight. What you might find, if those views are correct that the US is going into a recession and will calm down quite rapidly and perhaps inflation will come down more than people thought a short while ago, might mean that there is a reappraisal of where the US Central Bank is taking the Fed funds rate, its interest rate. It is possible that that will have a favourable effect on interest rates in the UK. I think that we have seen a bit of that just in the past month or so, when longer-term interest rates on UK Government bonds have softened a bit. That is certainly already having an impact in the mortgage market, where it looked back during the course of October as if households might be facing mortgage rates of six, six and half, seven per cent. That looks at a less grim position right now. Thank you very much, convener, and firstly I apologise for being late. I will not blame the buses or the trains or anything. Sorry, I missed the first couple of minutes of questions and answers, so hopefully I am not duplicating anything. However, at the beginning of your report in the forward, you go over the kind of timescales that you had for this year's forecasts and make the point that it was a little bit different from normal and took 16 weeks instead of the usual 10. Are we now where we would have been to begin with if we had not had all these changes of government and such like, or has it had any actual material impact on your forecasts? I think what I would say in terms of the process is that at the end we got to the place where I think we feel most comfortable and I think reflects what the legal framework for fiscal policymaking in Westminster says should happen, which is that the government presents all of its tax and spending decisions together in one comprehensive fiscal statement, which was the autumn statement presented by Jeremy Hunt, and that is presented alongside and informed by an up-to-date economic and fiscal forecasts produced by us. It was clearly quite a journey to get there in the end, but I think the destination was the right one. I know that here in Westminster the Treasury, the Treasury Committee of Parliament and ourselves are reflecting on the lessons for exercise and I am very conscious that there are consequences for the budget process that you have in Scotland as well, and so I think that there are lessons to be learned from. Okay, thanks for that. You make the point that the tax and use of the word burden is going to be rising from 33.1 per cent to 37.1 per cent of GDP, and I mean I was interested in your use of the word burden because that did suggest a slightly negative connotation. I don't know if that's what you intended, but I just wondered how that compared with other countries in Europe in particular, is that just much the same? I should stress that tax burden is not meant to be a normative statement. It is in essence a term of art, much like investment spending always sounds good to the ear, but sometimes it involves spending money on tanks and other things that don't necessarily do very much productive in the world. Tax burden is a term of art. It's used by the IMF and OECD. It's why we use it in our documents because people understand it. Alternatives are just very wordy, so that's why we use the term, but it is in essence the share of GDP going in taxation. It's not meant to be a normative statement in any way. It is going up over the medium term. It is in part because of historical decisions taken by previous councillors, and it is in part as a result of decisions taken in this autumn statement, and in particular this time around the freezing of the remaining income tax thresholds that hadn't been frozen in the previous budget. It means that it continues to rise over the next five years. Comparing internationally, it doesn't put us at the top of the international league table by any measure, but it means that we go from being a relatively lower tax jurisdiction among advanced economies to being one that is closer to the OECD average. Okay, that's very helpful. Yes, I just picked up on the word burden because the committee had a conference on taxation recently, and we were just discussing the way we talk about tax and trying to make the public more enthusiastic about it. However, another point of figure that you come up with is that the debt is rising from 84.3 to 97.6 per cent of GDP. I just wondered if we'd been concerned about that. We also talk about interest rates, and interest rates are currently well below inflation, but traditionally one of the reasons for raising interest rates would be if a country's currency was struggling, and presumably the higher the debt, the more questions there are about the currency. I just wondered if we should be concerned at 97.6 per cent, or the fact that it's planned to come down again should reassure us? I think there are reasons to be more concerned about the level of debt today than one might have been six months ago. That is because the interest rate has risen very dramatically, and what appeared to be a steady state that persisted between 2010 and March of this year, where interest rates were very low for some years below 1 per cent, that era appears to be over. For the reasons that David mentioned, other central banks started even sooner than our Bank of England to raise interest rates. That has driven up the cost of borrowing globally. That is pushing up our own interest rates. What that is doing is eating up fiscal space that Governments would otherwise have depend on public services to spend on welfare benefits if they wanted to cut taxes to cut taxes. The single largest increase in the Government's costs in this fiscal event has come from the fact that interest rates have risen so dramatically. Just to illustrate it, as a share of public spending in the course of just three months in our forecast, what the Government is spending on its interest has gone from below 5 per cent to 8.5 per cent in a very short period of time. That is a dramatic eating away at the Government's effective spending power, because a much bigger share of what it used to be taking in taxes is now going out to pay interest on its existing debt holdings. Next year reaches a peak of over 12 per cent of the share of revenues, which is something that we have never seen at any point in UK history. A dramatically higher share of Government resources is now being eaten up by interest rates. It probably is a cause for concern, whether you care about public services, the tax burden or the overall sustainability of public finance. You finished that paragraph in your report saying that leaving the public finances more vulnerable to future shocks or swings in market sentiment. What all goes into market sentiment? Is that confidence in the Government or the country? Another thing that has changed over the course of the past decade has been a growing share of our Government debt, which has held abroad by foreign central banks and foreign investors. That means that perceptions of the UK as a whole, as an investment proposition, matter more to the cost of our borrowing than it would if all the people who lent us money were here in the UK, were earning money in sterling, had their outgoings in sterling and were invested in the economic future of the UK. Foreign investors have a lot more choice about where they put their money, and if they suddenly take a different view of a given country as an investment proposition, either for fiscal reasons or for exchange rate reasons, that means that the Government's cost of borrowing can start to change quite dramatically as we saw happened in mid-September. Excuse me a second. Do you want us to come in? Were we supplementary here? Not a supplementary on that particular point, convener. Right, so when do you want to come in? I can come in at any point that sits here. Sorry, I understood you wanted to come in at this point. Apologies, John. Thanks, convener. You talk about several measures where costings are particularly uncertain, and one is around the DWP and HMRC, because you highlight that both there is meant to be efficiency savings, but there is also meant to be more resources to tackle fraud. It says that you sought a reassurance from the Treasury, and then you quote that. Are you satisfied with that? Has the balance been assorted there between trying to do more but also be efficient? Andy, is the person who sold those reassurances, do you want to comment on that? The short answer is yes. We have sought this kind of reassurance before. It's particularly important when, essentially, the Government is putting additional resource into something like tackling fraud and error beyond the point at which it's given DWP or HMRC a budget in a spending review. In a sense, they're adding to something that doesn't exist yet. In order to do that, we always seek reassurance that when they come to allocate those sums in a spending review, the baseline will have been protected. We had something very similar in 2015. There's a degree of uncertainty around that, but we'll have to see. Another one that was completely new to me, I confess, was the pillar 2 corporate tax reforms which are meant to be yielding £2.3 billion a year. Am I right in saying that that's part of a kind of international effort to sort out corporation tax or corporate tax? Is there also quite a lot of uncertainty around that then? On the first one, yes, that's correct. There are two parts to the OECD-led base erosion and profit-shifting BEPS agenda. This is the one that relates to a minimum effective corporate tax rate, where several jurisdictions are already signed up. The UK is one of the earlier to implement and start the process of getting this on the statute books. The reason for the uncertainty is two-fold. One is that these are relatively complicated reforms that will take time to implement. The other is that the calculations that underpin them require new information. There are cross-border agreements in the corporate tax world that require new forms to be filled in. That takes it to a new level. It's worth saying that the uncertainty around that could be in both directions. This is not saying that we don't think that the indicator will really raise money. This could raise more if the calculations have been worked through incorrectly in the other direction. What was done to calculate this number was to use information that is available currently via other systems to try and proxy what will become available when all the new forms are in place and the information is flowing across jurisdictions. I think that I followed some of that. Another point that you made, which I hadn't realised, was that the energy price guarantee and the business equivalent EBRS impact inflation, in that they reduce inflation, but the £400 rebate that everybody got for energy doesn't impact on inflation. I hadn't quite realised the distinction. I don't know for splitting hairs here, as we were previously with capital and revenue expenditure. Can you explain why those are treated differently? Yes. The Office for National Statistics has to look at the policies against the international guidance for price indexes. The EPG and the EBRS, the EPG lowers the price of energy that is faced by consumers. The EBRS does the same for businesses, so they respectively affect the consumer price index and the producer price index. The £400 rebate, because it is £400 for every household, is treated as a £400 boost to their income, rather than a £400 reduction in the price of their energy. There is a line in the statistical guidance that says that, if it doesn't change the unit price, it's a transfer to income and therefore doesn't affect measured prices. It is, of course, splitting hairs, but at the same time, it's quite important because anything that affects the measured price index feeds into any other part of the public finances that is indexed, and particularly important is the index-linked Government debt, where, for everything that does affect the price index, that reduces the cost of Government debt in the short term. Just a couple more points, if I may, touching on things that have already been issued. One was the health impact and the fact that investment in health might get people back to work. Is there a concern about long Covid and the effects of Covid and waiting times at hospitals and all of that? Is that having an effect on the actual economy? It likely is. There has been a big fall in the participation rate, the size of the labour force in the UK. While the unemployment rate looks to be back where it was or recently has been where it was before Covid, total employment is still well short of that. It's a reflection of the fact that maybe 500, 600,000 people seem to have left the labour force and not come back. It's a bit hard to know how much of that is related to health and specifically Covid. It seems plausible that part of it is. The participation rate has been particularly low or fallen most among people who are in their 50s and 60s. It seems likely that health may be a factor there. It's a bit difficult to work out because people don't have to fill in a form that says, here is the main reason why I've left the labour force. There could be other reasons as well. Some people just deciding to retire a little bit early, they can afford to do so, work has become a bit less fun and maybe they discovered during lockdowns that actually there were more interesting things to do than work. It's a bit hard to be sure quite how much is health related of the reduction in the size of the labour force. It seems plausible that a significant part may be. That certainly affects our forecast for the size of the economy, the level of GDP and that has knock-on effects on the fiscal situation. It is likely to be a material factor. It's one that we will certainly, over the summer, spend time investigating a bit more in depth. That's very helpful, thanks. My final point, something that was also mentioned before, was the fact that the debt stock has a historically short-average maturity. I wondered why that was. My understanding is that that makes it more susceptible to the changes in interest rate. Shall I have a quick go at that, since my microphone is on? It certainly does make the impact of any change in market interest rates is going to feed through much more quickly across the Government debt when that debt is rolling over more frequently. A very big chunk of that debt, in effect, is rolling forward every month, depending on the interest rate that the Bank of England is setting, because asset purchases by the Bank of England have effectively made a large chunk of Government overall debt in directly paying the Bank of England rate, holding something like £800 billion of Government bonds, which is now paying the short-term interest rate set by the Bank of England. That's the main reason why the maturity of debt has come down so very significantly. As I said, what it does is it accelerates the period over which some change in interest rates in the financial markets affects the debt interest cost to the UK Government, and that's been very material. It's been building up really over the period since the Bank of England started buying Government bonds back in 2009. I want to bring in a totally different matter that's not come up this morning, and that is the B word, Brexit. I noted in your economic fiscal outlook of November that you commented that Brexit had a significant adverse impact. I'm quoting trade volumes to decline falling 8.3 per cent below present by Q4 2023. However, the area that I find very interesting, you also commented in this report about trade intensity being 15 per cent lower than if the UK had remained in the EU. Given that I understand that trade intensity is a measure of country integration with the world economy, given that we're not really going to be able to replicate that with fairly paltry and thin-grew deals thus far, what comment do you have to make about trade intensity increasing or maintaining the same percentage that you call out in your report over the next five years and beyond that abuse? Anyone in particular is best-placed to answer that. Since the referendum we've had in our forecast had to make a judgment on the impact of leaving the EU on both the volume of UK trade with the rest of the world and the implication of that for long-run potential growth of the UK economy. Based on looking at a wide range of independent studies and also taking into account the fact that in 2016 we didn't actually know the outcome of the Brexit referendum, we had assumed that, ultimately, the deal that we would strike with the EU would look something like the free trade agreement that the EU had struck with Canada, and in the end the trading cooperation agreement we did conclude looks very much like the kind of trade deal that the EU has done recently with other advanced country trading partners. That's based on an assumption that in the long run, which means over a 15-year period, trade intensity, which means the volume of trade that the share of trade in UK output would fall by around 15 per cent, and it's a measure of the UK's openness to the outside world. If you look at the gearing ratio between trade intensity and productivity that you see in the macrogomic literature, then in the long run the effect of that on the UK's potential output. Supply capacity after a 15-year period would be about 4 per cent lower. Based on what we've seen in the trade data since we've made that assumption, so far it hasn't given us any reason to diverge from that assumption. As you cited, we've already seen trade intensity start to fall since 2016. Some of that may have temporarily been the effect of the pandemic interrupting trade, but even post-pandemic, the volume of our trade has not recovered as quickly as trade volumes have in the rest of the world. They've recovered but have been leveled off at a lower level. We seem to be so far more or less on that trajectory, but it's an assumption that we keep under review. I suppose that this session I commented at the beginning that we had talked about that. I do understand and appreciate that it was difficult to disaggregate the data and the impact of Covid, the pandemic and Ukraine, but we are now able to predict with slightly more certainty the impact of Brexit over the long term. Do you think that it's being talked about enough? I mean, I've read your report from November 2022, but it keeps disappearing as though it's not going to have a long-term impact when, quite clearly, based on your figures it is. We talk about it in every forecast. We've done separate papers on it. From time to time, when there are new and important pieces of data, we do in-depth analysis of its impact. Not just on trade flows but on things such as migration flows. We have revised our assumptions that we expected our departure from the EU and the fact that we set our own migration policies with regard to EU migrants means that we'd see a significant reduction in migration volumes. After that new regime came in in 2020, what we appeared to have seen based on the latest data is actually a significant higher volume of inward migration. To the extent that that is, more people coming into the UK and into the UK workforce support the UK potential output over the medium term. One thing that we did revise in this forecast was our assumption for net migration into the EU starting upwards. It's mostly coming from non-EU countries, not from the EU, but it's compensating from the fact that net migration from the EU has turned negative. I read that as well. I think that that's an interesting area to look at, because it relates to the skills agenda, as well as labour shortages, for example. Another question is more about the kind of scope of what you do in terms of looking at sustainability of public finances. The convener mentioned it earlier, the removal of the office of tax simplification. One area that I often like to ask about—indeed, I asked at IFS last week—was about the cost to UK GDP of money laundering and corruption, which is billions each and every year. It's absolutely significant. I'm not entirely certain what you have in terms of starting to make an assessment of that, because that's a real cost. I wondered how does it fit within your organisation how the cost of that in UK GDP terms has an effect on the sustainability of public finances. I'm not sure where you have it in your organisation to consider the implications of it, or if at all. It's not something that we take an explicit view on. To the extent that it is included in our forecast, it would probably show up in tax that gets avoided and not paid. I don't know whether Andy would have any to add on whether we've ever made any explicit assumptions about money laundering or other forms of criminality in that tax. No, I think that you're right. It's not something that we have an explicit view on. We take some issues, one at a time, when there have been various attempts to clamp down on funds being held overseas and not paying income tax. To a large extent, those issues are implicit in where our forecasts start from, such as the O&SS, the GDP and what we can actually see in tax revenues. HMRC makes efforts to understand and quantify tax gaps, but we don't use those except where policy measures are trying to close tax gaps, because we forecast how the revenue that we're seeing today will grow as a consequence of growth in tax bases. Is that something that you would consider having an explicit look at? With the removal of the Office of Tax Implification, we know that complexity in tax codes is what gives the regular room in a variety of areas. Given that we know from the national crime agency and transparency international, although there's an estimate that we're talking about a loss to UK GDP of around £267 billion each year, that will have a resulting flow-through in the availability of public finance for doctors, nurses, teachers and so on. You don't need to answer just now, but I would ask if you would consider looking at that explicitly, because it's a very real issue and could ultimately have quite a significant impact on the sustainability of public finances. If it's implicit, it's not really understood, and it's that of a very understanding that will drive action. Any comment on that? Let us take that away. Every summer, we produce a report into fiscal risks that look at what are the issues that are potentially eroding the sustainability of the public finances or where are the areas that sometimes are missed opportunities for raising revenue for the Government. That's a report where we try to take a comprehensive look at the things that aren't in our forecast but potentially pose a risk to that forecast. It would be in that context that we might take a look at those issues. However, as Andy said, when Governments make heroic assumptions about how much revenue they can raise from tackling those things, we play a role in looking at the realism of those policy measures. We have to be careful about giving the Government advice on where to look, because that's not our role, but in terms of analysing risks to the tax base, risks to the public finances going forward, and the resources that might erode Government revenue going forward. I appreciate the complexity and your role, but it strikes me that it must at least be approaching the tipping point where it is of interest from the point of view of public finance. Just to follow on from that, what Michelle has talked about, fraud, corruption, money laundering, can obviously be called tax evasion. However, what about tax avoidance, which obviously is somewhat different? Is there any analysis undertaken by the OBR in terms of the impact of tax avoidance on the public finances? The short answer to that is certainly yes, and Andy can say even more, but one of the big sources of tax avoidance that has progressively eroded the Government's income tax base has been the fact that tax-motivated incorporations, setting yourself up as a one-person corporation and then paying tax at the corporate rate rather than paying income tax and paying national insurance, has been something that has been steadily eroding the Government's tax base over time. Various tax changes that the Government makes can either make that problem better or worse, depending on the income tax differential between corporate and income tax. We do look at that, and that has played a significant role in eroding the income tax base over time. Andy, do you want to add to that? Yes, maybe we've given the wrong impression, but the monitoring how tax gaps are evolving and looking into what we can learn from them is very important for the forecast, because if they change, if they get larger or smaller, that will affect growth in tax revenues. Three years ago, our fiscal risk report looked at complexity in the tax system and what that seemed to imply for tax gaps. It did not reveal things in the international money laundering sphere, but it did reveal lots of areas where tax gaps did seem to be affected by changes in the tax system. One example is that the R&D tax credit, as it became more generous for small firms, seemed that not only was it incentivising R&D, but it was incentivising people to badge their activity as R&D to get the subsidy. That is something that the autumn statement, one of the policy measures, did look to address to some extent. The other area that we are seeing is not in the tax system, but in the universal credit system, where the rate of fraud and error, as DWP calculates it, has risen very sharply. I do not think that we understand that fully yet, but that is one of the reasons why the autumn statement announced very large numbers of new staff to work through this. Because universal credit covers lots of previous legacy benefits, the award is large, and that increases the incentive for criminal attacks on the system that seems to have risen. We look at all the time at the issue of money laundering that has not come across my desk recently, but those are forecast issues day to day and, of course, they are policy issues for the treasury and others. Andy, of the tax avoidance measures, if you want to call them that, broadly speaking, tax gaps, tax avoidance, what we are talking about in terms of the tax take that could potentially be lost across the UK? The HMRC's estimate of the tax gap is a little over 5 per cent at the moment, and it varies greatly. In the pay-as-you-earn income tax system, it is as low as 1 per cent, because people do not have an opportunity to gain that system. It can be as high as 20 per cent in the self-assessment income tax system, where there is much more. 5 per cent of the total tax income, perhaps, is that what you are saying, or 5 per cent of GDP? The tax take could be 5 per cent or so higher if there were no tax avoidance or evasion, no tax gap. What would that mean in cash terms? I do not have the number in front of me, but it is of the order of £35 billion. Thank you very much for that. Sorry, dogglist to be followed by Ross. Just got a question around negative inflation. Obviously, we are due to have negative inflation by the middle of the decade. Should that be universally welcomed, or does that provide any risks to the Scottish economy as well? David, do you want to have a go at that? Negative inflation and the danger of falling into deflationary traps and all that. In that case, if it turns out that inflation dips a little bit negative, as our central forecast suggests, it will likely be a good news story because the most likely reason that happens is that energy prices, gas in particular, or oil to some extent, will probably fall back a little bit. That is what will bring inflation down very sharply and possibly take it into negative territory. That is a good news story for the UK and for disposable incomes because those are things that we are major net importers of. It will reflect the reduction in the cost of something that generates income outside the UK and is a cost to the UK. In that case, and it is not always true, but inflation sitting underneath the bank of England is targeted by a significant amount for a relatively long period, maybe 18 months or two years, will not so much be a cause of concern. It will actually be a side effect of something that will ease the pressure on households. Do you expect interest rates to almost come in back down as quickly as that as well? I doubt whether we will get back in terms of bank of England policy. I would be very surprised if we got back to the level of interest rates that we were at at the beginning of this year, which is still very close to zero interest rates. However, it seems plausible that interest rates will probably go up a bit further from where we are right now. We will see at the end of this week on Thursday what the bank of England's latest decision is. Slightly that they do go up, our own forecast was based on an assumption that interest rates might get very close to 5 per cent in the very near term but then start falling back down and might end up at 4 per cent, maybe a little bit under 4 per cent. It seems to me quite likely that, even if inflation were to fall to zero or be slightly negative, I would rather doubt whether the bank of England would react to that by cutting interest rates right back down to zero because we would undershot the inflation target by a meaningful amount, because they probably see it and certainly this is the message of our own forecast. They probably see it as a temporary undershoot of inflation, just as we have a very much larger but, hopefully, temporary overshoot of inflation right now, and they would look through that and think that, probably looking a little bit further down the road, we are likely to get back to the 2 per cent target level and it would be a mistake to overreact to that by cutting interest rates right back down to zero where they have been for most of the last, well, almost 14, 15 years now. I guess we would expect to see wage inflation almost come down as well to almost zero and I guess that may have an impact on forecast for income tax intake. Yes, you are right. At the moment, wage settlements on average right across the economy may be coming in somewhere in the 5, 6 per cent range. It would be very unlikely that that would be true if inflation were down at zero. It is reflecting inflation at 10 per cent at the moment. Probably, we will see wage settlements not falling right back down to zero, which would mean that there would be no increase in people's real income, but they might fall back to 1.5 per cent or 2 per cent. At least that would mean an increase in people's real income as opposed to where we are now with wage settlements on average at 10.5, 6 per cent, but inflation at 10.11. You have said that fiscal policy changes over the past six months have added 40 billion of borrowing by 27.28. Can you give us a breakdown of what has caused that and what is that? Is that due to the Bank of England having to step in on the bond market? Is it because of policy decisions such as the energy price guarantee? What is behind that rise? It is a net figure. It is basically the total change in the borrowing outlook now compared to what we were forecasting back in March at the five-year horizon. By the time we get to the middle of the decade, how much more is the Government borrowing compared to what we thought back in March? On the upside, the single biggest factor is higher interest rates. That creates pressure on the order of £45 billion to £50 billion, whether the extra spending that the Government has to accommodate. On top of that, because it has indexed universal credit, basic state pension and other welfare equipment, that has also added to the cost of welfare spending. If the Government had just left that alone, that would have added £75 to £80 billion in total of extra spending that the Government needed to find from essentially nondiscretionary sources. The way that it gets back down to 40 is the fact that the Government has taken around £40 billion out of public spending. I was at £30 billion out of public spending and it has taken another £5 to £10 billion in terms of tax rises to offset those additional spending pressures. That is where you get to the £40 billion overall increase in Government borrowing as a result of all the changes that have happened since March. There are lots of forecasting pressures that have been pushing up on interest costs and on welfare and the Government has taken some policy action mostly through cutting departmental spending but also some net tax rises from the fact that it has frozen some of the personal ounces and thresholds and reduced some others on the gross increase tax. Most of that £40 billion is due to inflation, which is really a global factor anyway. Would that be correct? Most of its interest rates and then the second biggest factor is inflation. Unlike John, I apologise for being late this morning. It also wasn't to do with buses or trains. It was a much more mundane issue about my pass and gaining entry to the building. I am not wasting time this morning in your initial questions that I missed. Did you go through anything in relation to the GDP deflator? No, no, Grant. You only missed five minutes. Excellent, thanks. Richard, that may be best for you in the first instance. I have been interested in your thoughts on how appropriate the GDP deflator is as a measure of inflation for Government at the moment. Obviously, there is quite a gulf between the 3.7 per cent that it is saying versus CPI and RPI, which are into double figures. There seems to be broad recognition in the wider debate around that. Neither are quite right when you are trying to measure the impact of inflation on a Government, but the GDP deflator is obviously the one that is officially used. I would be interested in your thoughts on how appropriate it is in the current financial context. That is right. The distinction between the two different measures of inflation is that CPI inflation is a measure of the increase in the cost of the things that consumers purchase and which we buy in the shops. That reflects, in particular, in recent months, that has reflected a big increase in the cost of energy, heating our houses and the cost of food, so putting food on the table. For consumers, prices are rising very dramatically, and that is eroding our real spending power a lot in double-digit figures. The GDP deflator is used in order to measure the increase in the cost of the things that the UK produces. Because the UK does not produce all its own energy and all its own food, we import a lot of that. It has not been rising by as much because those have been the things that have been driving increases in consumer prices. What does that mean for the effective volume of Government spending? Traditionally, we use the GDP deflator as a way of measuring real increases in Government spending. In essence, Governments provide public services mostly with things that we produce here in the UK. Their single biggest cost is payroll and personnel. As we have been discussing, economy-wide wages are rising on the order of five or six per cent, so they are not rising in double digits. In that sense, one of the single biggest cost pressures for Government is not rising anywhere near 10 per cent or 11 per cent. It is rising on the order of five or six per cent depending on where wage settlements are up. Governments also do not spend as much on energy to produce what they do as we do to live our lives. Governments tend to not spend very much amounts of money feeding people, but they have to deal with the consequences of paying people wages that are sufficient for their employees to feed themselves. It is also important to say that some of the things that Governments provide, they have to pay world prices for. Governments do purchase fuel. Things such as military equipment can have very high inflation rates, especially at the moment when there are shortages of military equipment, which the Government wants to procure. It is for that reason that we say that it is probably the best measure of Government services and the best way to adjust the provision of Government services for inflation lies somewhere between the lower number—the GDP deflator—and the higher number, which is a CPI inflation. Is there a measure that at the moment lands somewhere between the two that would perhaps be a more appropriate one to base assumptions around the impact of inflation on Government spending at present? I do not know where that end, but there is something called the Government consumption deflator that measures the increase in the cost of providing a given volume of Government services. That is calculated in a different and even more complicated way. Things like the pandemic had a very big effect on it because there was a big reduction in the volume of activity in some parts of the public sector as a result of the pandemic. That number has jumped around a lot in the recent past and can also be subject to some very big measurement changes. I do not know whether Andy wanted to come in on different measures of inflation. I guess that there is no simple answer on that, because it will vary for different departments, depending on public services, depending on the share of their costs that are wages and the share that are other forms of procurement and whether they are imported or not. The Government consumption deflator, which is like a public services specific number, is measured in some places by the cost of providing education. The volume is the number of pupil days of teaching, and you reveal the price between them. The main issue that I see is that the difference between the GDP deflator and the CPI inflation is a very good measure of how much poorer the country as a whole has become because of the energy price shock, because it is imported to prices that have pushed CPI inflation above the GDP deflator. None is perfect for a price measure for public services, but it is a good indication of how much more difficult it is for both public and private sectors to maintain what they intended to do when there has been a shock like the energy price shock. David, I think that you want to comment on that. Just one very small point. It is certainly true that CPI inflation is much higher than the inflation of the GDP deflator rise at the minute. On our central forecast for what is worth, that situation flips around in 2025-2026. The rate of change of the GDP deflator is 1.5 per cent higher than CPI inflation. That is great. For that context, we are all limbering up to have yet another debate on Thursday about whether the Scottish budget has gone up or down in real terms, and that depends entirely on how we are measuring real. I have just got one final question for yourselves around the income tax makes up the majority of our devolved tax base. As we have just mentioned, the rate of growth in wages at the moment is far less than inflation, but wages are certainly set to grow by far less than the wealth, particularly the wealth of the wealthiest people in our society. Given that income tax is devolved makes up the majority of our devolved tax base and the land share of what is left is LBTT and council tax. Are Scotland's public finances overexposed to short-term shocks in the economy compared to UK-wide public finances, which can be supported by a much wider range of taxation measures, particularly taxation around wealth, corporate taxes, as was mentioned earlier? You might want to say something more, but I think that the short answer to that is probably no, just in the sense that of all the taxes that government benefits from in terms of revenue, income tax tends to be one of the more stable sources. As a devolved source of taxation, it is less volatile than other things that rely not just on how much people are earning every year, but if you think about things such as capital gains tax that relies on what is happening to asset prices, which can be very volatile, and what happens to the volume of transaction in assets, which could also be very volatile. When stock markets do very well and there are lots of transactions, the Government makes lots of money and when stock markets don't do well, the Government can lose money. The same is true of things that I stand duty on shares. For that reason, one of the more volatile items of Scottish revenues is on the property tax side. LBTT is proving very volatile in the coming year because both prices and volumes are dropping because of higher interest rates and fewer people moving houses when they do paying less on the transaction. At the moment, Scotland has a mix of relatively stable tax and more volatile tax. I know that there are debates about devolving some of that VAT-based to Scotland, which has traditionally in the UK been a more stable source of taxation because consumption tends to be more stable than other sources of tax, but I don't know whether Andy Warne wants to add anything to that. Yes, I think that's right. I think that the other aspect of it is the block grant adjustment that means that the Scottish budget is insulated from shocks that hit the whole of the UK. It would need to be volatility in the tax base in Scotland relative to the other parts of the UK, which one might expect to see. There are certainly risks of that in the coming period with very high energy prices that could boost the income tax base in Scotland, relative to the rest of the UK, given the composition of the economy. Thank you very much for your comprehensive answers this morning. It has been much appreciated. That concludes our public session, so I will now call for a 10-minute break as we go into private session. Thank you very much to the OBR once again this morning.