This ‘mini-budget’ is a naked exercise in redistributing wealth upwards
Instead of investing to actually grow the economy, Truss and Kwarteng are borrowing big to fund tax cuts for the rich
Instead of investing to actually grow the economy, Truss and Kwarteng are borrowing big to fund tax cuts for the rich
Kwasi Kwarteng leaves 11 Downing Street to deliver his mini-budget.
Photograph: Aaron Chown/PA
THE GUARDIAN
Fri 23 Sep 2022
When is a budget not a budget? When the government does not want there to be any informed analysis of its economic impacts. The only reason the Treasury has insisted Kwasi Kwarteng’s statement was a “fiscal event” and not a budget – despite a range of measures far exceeding the contents of most budgets – is that, since George Osborne’s tenure, chancellors of the exchequer have been required by law to ask the Office for Budget Responsibility (OBR) to conduct an independent analysis of the measures taken.
And why has the government been so keen to avoid such scrutiny? Because the economic impacts are likely to look very ugly. It is more or less impossible to find an economist who supports the government’s approach, or an economic model able to justify it. Indeed, the financial markets have already given their negative verdict.
The problem is not the prime minister’s ambition to “grow the economy”. Many economists would actually agree with Liz Truss’s attack on “Treasury orthodoxy”, which has focused far too much on reducing public borrowing and debt, and not nearly enough on raising investment and productivity. The UK’s poor economic performance over the past decade has much to do with the tight fiscal policies pursued by Conservative chancellors.
But there are three big problems with the way Truss and Kwarteng are seeking to reverse these policies. First, the government’s attempt to stimulate the economy through income tax cuts is deeply inefficient. As the UK slides into recession, with businesses failing and unemployment rising, it is not unreasonable for the government to inject some demand into the economy to counteract those effects. But income tax cuts are a really poor way of doing this.
This is not simply about their distributional effect. As the Resolution Foundation has shown, by reversing the national insurance hike and abolishing the 45p tax rate on incomes above £150,000, Kwarteng has performed a remarkable act of redistribution to the rich. But the wider economic problem is that much of the tax cut will not lead to higher spending. Give households more money and they will spend some of it, but also save some. And the higher their income bracket, the more they will save.
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A much better way of getting money into the economy is through investment. Wise investment – in infrastructure and business – will raise productivity, and therefore increase long-term economic growth. Investment creates jobs, and therefore raises wages and spending. Economists call the rate at which an injection of cash into the economy raises national income the “multiplier”. As the OBR has noted, the investment multiplier is around three times larger than the tax multiplier. Today the best form of stimulus is green investment, in areas such as home insulation and renewable energy, which would also help to reduce fossil fuel demand and meet the UK’s climate goals. (This is Labour’s plan, it might be noted.)
Second, cutting corporation tax (or not raising it as planned) and cutting stamp duty are really not good ways of stimulating economic growth either. There is almost no evidence that lower corporation tax stimulates investment. At 19%, the UK’s corporation tax is already the lowest in the G7, yet UK business investment is also the lowest. (Germany’s corporation tax rate is 30%.) Meanwhile, cutting stamp duty without building any more houses simply raises house prices – which are already growing at their fastest rate for 20 years. This will price more people out of the housing market, and benefit only existing homeowners.
Third, the fact that the government is using borrowing to pay for all these tax cuts makes them an even worse idea. At a time when the chancellor is tearing up his own government’s fiscal rules, it is worth noting that the one fiscal rule almost everyone accepts is the so-called “golden rule”: that, in normal times, governments should borrow only to invest. This is because investment generates growth, which helps repay the borrowing. Almost no economist would agree with borrowing to fund tax cuts. (This is not what Margaret Thatcher did: she only cut tax when there had been sufficient growth to fund it.)
Fri 23 Sep 2022
When is a budget not a budget? When the government does not want there to be any informed analysis of its economic impacts. The only reason the Treasury has insisted Kwasi Kwarteng’s statement was a “fiscal event” and not a budget – despite a range of measures far exceeding the contents of most budgets – is that, since George Osborne’s tenure, chancellors of the exchequer have been required by law to ask the Office for Budget Responsibility (OBR) to conduct an independent analysis of the measures taken.
And why has the government been so keen to avoid such scrutiny? Because the economic impacts are likely to look very ugly. It is more or less impossible to find an economist who supports the government’s approach, or an economic model able to justify it. Indeed, the financial markets have already given their negative verdict.
The problem is not the prime minister’s ambition to “grow the economy”. Many economists would actually agree with Liz Truss’s attack on “Treasury orthodoxy”, which has focused far too much on reducing public borrowing and debt, and not nearly enough on raising investment and productivity. The UK’s poor economic performance over the past decade has much to do with the tight fiscal policies pursued by Conservative chancellors.
But there are three big problems with the way Truss and Kwarteng are seeking to reverse these policies. First, the government’s attempt to stimulate the economy through income tax cuts is deeply inefficient. As the UK slides into recession, with businesses failing and unemployment rising, it is not unreasonable for the government to inject some demand into the economy to counteract those effects. But income tax cuts are a really poor way of doing this.
This is not simply about their distributional effect. As the Resolution Foundation has shown, by reversing the national insurance hike and abolishing the 45p tax rate on incomes above £150,000, Kwarteng has performed a remarkable act of redistribution to the rich. But the wider economic problem is that much of the tax cut will not lead to higher spending. Give households more money and they will spend some of it, but also save some. And the higher their income bracket, the more they will save.
A much better way of getting money into the economy is through investment. Wise investment – in infrastructure and business – will raise productivity, and therefore increase long-term economic growth. Investment creates jobs, and therefore raises wages and spending. Economists call the rate at which an injection of cash into the economy raises national income the “multiplier”. As the OBR has noted, the investment multiplier is around three times larger than the tax multiplier. Today the best form of stimulus is green investment, in areas such as home insulation and renewable energy, which would also help to reduce fossil fuel demand and meet the UK’s climate goals. (This is Labour’s plan, it might be noted.)
Second, cutting corporation tax (or not raising it as planned) and cutting stamp duty are really not good ways of stimulating economic growth either. There is almost no evidence that lower corporation tax stimulates investment. At 19%, the UK’s corporation tax is already the lowest in the G7, yet UK business investment is also the lowest. (Germany’s corporation tax rate is 30%.) Meanwhile, cutting stamp duty without building any more houses simply raises house prices – which are already growing at their fastest rate for 20 years. This will price more people out of the housing market, and benefit only existing homeowners.
Third, the fact that the government is using borrowing to pay for all these tax cuts makes them an even worse idea. At a time when the chancellor is tearing up his own government’s fiscal rules, it is worth noting that the one fiscal rule almost everyone accepts is the so-called “golden rule”: that, in normal times, governments should borrow only to invest. This is because investment generates growth, which helps repay the borrowing. Almost no economist would agree with borrowing to fund tax cuts. (This is not what Margaret Thatcher did: she only cut tax when there had been sufficient growth to fund it.)
In fact, the government’s fiscal strategy is even more extraordinary than this. The tax cuts announced will cost about £27bn next year, net of the oil and gas windfall tax already announced. The energy bills subsidy schemes for households and business will cost £60bn. Not yet announced, but very likely in the coming full budget, are spending increases: perhaps £18bn to maintain the real value of public service spending given inflation, and perhaps £25bn to raise defence spending from 2% to 3% of GDP. In total, it seems likely that the government will be borrowing up to £130bn more in 2023-24. Last year, the government borrowed £169bn (a historically high figure; before the pandemic it was about £50bn). So that is a remarkable 75% increase in borrowing.
Can the government borrow this much? Certainly. But only at a price. That price can already be seen in the yields purchasers of government bonds (“gilts”) are now demanding. Already today, UK bond yields are up sharply, having already been rising for the past couple of weeks since the new government took office. Coupled with the interest rate rise announced by the Bank of England on Thursday (with more almost certainly still to come), that makes the government’s borrowing more expensive, creating an even bigger deficit.
And that’s not the only reaction of the financial markets. Over the past two weeks the pound has fallen to its lowest level against the dollar for 20 years, and it is also down against the euro. It fell again after the chancellor’s speech. The markets are signalling their anxieties about the government’s strategy and its impact on the economy. Why does this matter? Because a lower pound raises import prices, thereby pushing inflation up. And it also makes gas (which is priced in dollars) more expensive, thereby raising the cost of the government’s energy bills scheme even higher.
This is a potent brew of economic reaction. There is open talk now of a possible run on the pound, and gilt yields rising even further. A former member of the Bank of England monetary policy committee said this week that if he were an investor he would short (bet against) the pound. If their radical fiscal plan goes wrong, Truss and Kwarteng might find themselves shorted in the political markets.
Michael Jacobs is professor of political economy at the University of Sheffield
Analysis
History suggests Kwarteng’s gargantuan economic gamble won’t end well
The belief that low taxes and light-touch regulation are good for everyone is about to be tested to the limits
History suggests Kwarteng’s gargantuan economic gamble won’t end well
The belief that low taxes and light-touch regulation are good for everyone is about to be tested to the limits
Kwasi Kwarteng leaves 11 Downing Street in London before
delivering his mini-budget statement in the House of Commons.
Photograph: Kirsty Wigglesworth/AP
Larry Elliott
Larry Elliott
THE GUARDIAN
Fri 23 Sep 2022
A struggling economy. An unpopular Conservative government. A dramatic change of course. Britain has been here before. Just like Reginald Maudling in the early 1960s and Tony Barber in the early 1970s, Kwasi Kwarteng has gone for broke, with a massive package of tax cuts designed to put Britain on a higher growth path.
The chancellor will be crossing his fingers that his experiment has a happier ending than those of his predecessors, neither of which ended well. It is one huge gamble on supply-side reforms boosting enterprise, tax cuts paying for themselves, and the financial markets remaining onside. The initial reaction from the City was far from reassuring.
As was only too predictable, sterling took a thumping on the currency markets. City currency traders might well be among the big beneficiaries of Kwarteng’s tax cuts but that didn’t stop them selling the pound down through the $1.10 level against the US dollar. Parity against the US currency is not that far away.
No question, this was a big package, a full-scale budget in all but name. Kwarteng delivered on all the tax pledges made by Liz Truss during her leadership bid – and more. The 45% rate of income tax for the highest earners has been scrapped; a reduction in the basic rate from 20% to 19% pencilled in by the former chancellor Rishi Sunak for 2024 has been brought forward by a year.
Put together with the removal of the increase in national insurance contributions and the decision not to go ahead with next April’s increase in corporation tax and you get a £45bn giveaway, not quite as big as Barber’s in 1972 but hefty by historical standards.
As the Institute for Fiscal Studies pointed out, this was a deeply regressive mini-budget, with the biggest percentage gains going to the top 1% of earners. The much more modest help for those on the lowest incomes will be wiped out by the higher cost of imported fuel and food caused by a weaker pound.
Kwarteng’s insistence that the government was committed to fiscal responsibility was greeted with derision from Labour MPs, particularly given the lack of independent scrutiny of the chancellor’s arithmetic from the Office for Budget Responsibility. Such an exercise might have questioned the newfound belief in the Treasury that new investment zones, slashing red tape, tougher welfare rules and an end to the bankers’ bonus cap will raise the trend rate of growth to 2.5%.
In effect, the mini-budget was a triumph for free-market thinktanks, such as the Institute for Economic Affairs and the Adam Smith Institute, which are true believers in the idea that low-tax, light-touch regulation, small-state economies are not just good for the rich but good for everyone.
That conviction is going to be tested to the limits in the months ahead. Britain has inflation at close to 10% and to the extent it boosts demand, the mini-budget will add to inflationary pressure. It will do nothing to discourage the Bank of England from continuing to raise interest rates and if borrowing costs go as high as the markets are predicting the sugar rush will be short-lived.
What’s more, the main beneficiaries of the package will be the better off; the politics of the package depend heavily on less well-off voters being convinced of the theory of trickle-down economics. They might take some persuading.
But the biggest immediate threat to the chancellor comes from a crashing pound and soaring bond yields. No chancellor can avoid the scrutiny of the financial markets, which is why Kwarteng’s gamble has only two feasible outcomes: complete success or abject failure. History suggests it won’t be the former.
Fri 23 Sep 2022
A struggling economy. An unpopular Conservative government. A dramatic change of course. Britain has been here before. Just like Reginald Maudling in the early 1960s and Tony Barber in the early 1970s, Kwasi Kwarteng has gone for broke, with a massive package of tax cuts designed to put Britain on a higher growth path.
The chancellor will be crossing his fingers that his experiment has a happier ending than those of his predecessors, neither of which ended well. It is one huge gamble on supply-side reforms boosting enterprise, tax cuts paying for themselves, and the financial markets remaining onside. The initial reaction from the City was far from reassuring.
As was only too predictable, sterling took a thumping on the currency markets. City currency traders might well be among the big beneficiaries of Kwarteng’s tax cuts but that didn’t stop them selling the pound down through the $1.10 level against the US dollar. Parity against the US currency is not that far away.
No question, this was a big package, a full-scale budget in all but name. Kwarteng delivered on all the tax pledges made by Liz Truss during her leadership bid – and more. The 45% rate of income tax for the highest earners has been scrapped; a reduction in the basic rate from 20% to 19% pencilled in by the former chancellor Rishi Sunak for 2024 has been brought forward by a year.
Put together with the removal of the increase in national insurance contributions and the decision not to go ahead with next April’s increase in corporation tax and you get a £45bn giveaway, not quite as big as Barber’s in 1972 but hefty by historical standards.
As the Institute for Fiscal Studies pointed out, this was a deeply regressive mini-budget, with the biggest percentage gains going to the top 1% of earners. The much more modest help for those on the lowest incomes will be wiped out by the higher cost of imported fuel and food caused by a weaker pound.
Kwarteng’s insistence that the government was committed to fiscal responsibility was greeted with derision from Labour MPs, particularly given the lack of independent scrutiny of the chancellor’s arithmetic from the Office for Budget Responsibility. Such an exercise might have questioned the newfound belief in the Treasury that new investment zones, slashing red tape, tougher welfare rules and an end to the bankers’ bonus cap will raise the trend rate of growth to 2.5%.
In effect, the mini-budget was a triumph for free-market thinktanks, such as the Institute for Economic Affairs and the Adam Smith Institute, which are true believers in the idea that low-tax, light-touch regulation, small-state economies are not just good for the rich but good for everyone.
That conviction is going to be tested to the limits in the months ahead. Britain has inflation at close to 10% and to the extent it boosts demand, the mini-budget will add to inflationary pressure. It will do nothing to discourage the Bank of England from continuing to raise interest rates and if borrowing costs go as high as the markets are predicting the sugar rush will be short-lived.
What’s more, the main beneficiaries of the package will be the better off; the politics of the package depend heavily on less well-off voters being convinced of the theory of trickle-down economics. They might take some persuading.
But the biggest immediate threat to the chancellor comes from a crashing pound and soaring bond yields. No chancellor can avoid the scrutiny of the financial markets, which is why Kwarteng’s gamble has only two feasible outcomes: complete success or abject failure. History suggests it won’t be the former.
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