The Conservatives’ tax-cutting gamble looks almost certain to fail
The new Chancellor Kwasi Kwarteng today announced an extraordinary ‘mini-budget’ involving the biggest set of tax cuts in half a century alongside a raft of deregulation plans that he claims are part of a ‘new era focused on growth’.
In reality, this is a return to a discredited model of trickle-down economics which dominated Anglo-Saxon policy making in the 1980s and early 1990s. The policy package will drive up inequality, house prices and interest rates and may well entrench more general inflationary dynamics as markets lose confidence in sterling.
The most notable new announcements were scrapping the 45p top rate of income tax, cutting the basic rate of income tax from 20p to 19p and reducing stamp duty to help first-time buyers. In conjunction with the pre-announced reversals of the planned rise in National Insurance (NI) and corporation tax, this amounts to £45bn in tax cuts.
The tax cuts will mainly benefit the rich. An individual earning £200,000 stands to make annual tax savings of nearly £4,500 in 2023–24 compared with 2022–23, a saving of 2.25%. In contrast, a worker on a salary of £20,000 will save £218, just over 1%. The better off will also benefit disproportionately from the price cap on energy costs as they typically live in larger homes. In distributional terms, this budget is one of the most regressive in living memory.
Combined with the £60bn required for the energy price cap and rising general costs because of inflation on government borrowing, the package amounts to £161 billion over the next five years — the biggest single giveaway by the Treasury since 1972.
Will this gamble work in terms of achieving the 2.5% growth target the Chancellor has set for the Treasury? Almost certainly not.
The policy package has multiple problems. Firstly, it is well-established that tax cuts have a weaker impact on growth than public spending, as households and firms save a proportion of the new income. Second, wealthier people tend to spend a smaller proportion of any new income than poorer households, so further weakening the multiplier effect of the borrowing. Third, the major challenge facing the UK economy is a lack of public and private capital investment; and there is no evidence that cutting business or personal taxes results in more investment, employment or growth.
What firms need to encourage investment is the long-term commitment of the state to industrial policy objectives, alongside public investment. In other words, the state needs to provide a direction for growth. Without this, firms spend profits on existing financial assets, rising pay for senior executives or dividends for shareholders; whilst households spend on housing and consumption fuelled by an ever-increasing house prices, which themselves are supported by rising household debt.
The policies announced today simply enhance this approach whilst shifting some of the debt burden on to the state. The cuts in income tax and NI will encourage the wealthy to spend more on housing and consumption, boosting house prices and consumer price inflation. The cut in Stamp Duty will further boost house prices as was demonstrated only too well during the pandemic. House price growth is already at a 20 year high, whilst consumer price inflation is at a 40-year high.
Not unsurprisingly, financial markets appear to have lost confidence in the government. At the time of writing, the pound was at a 37-year low against the dollar, almost reaching parity, whilst the yield on 10-year government debt had jumped to almost 4%, after averaging 0.5% for most of 2021. The UK is a sovereign currency issuing nation that cannot default on its debt. But it can suffer from crippling inflation. The collapse in sterling that these policies have initiated will add even further inflationary pressure via rising import costs, in particular energy which is denominated in dollars.
Put together, these multiple inflationary pressures mean the Bank of England is almost certain to ratchet up interest rates at an accelerated rate. This will further squeeze those on low incomes and small businesses and counteract any boost to personal finances from the tax cuts for many households.
In sum, this budget is highly regressive and economically illiterate. In the short-term, it remains to be seen whether the loss of confidence in sterling is permanent or temporary. But in the medium term, there is nothing here to suggest the government will achieve its growth objective. Rather it’s a budget that will primarily benefit the financial sector, homeowners and the wealthy in general at the expense of the majority of the population.
