In August I wrote a Blog about ‘The embedded structural cost of tax cuts’. Find using the ‘search’ box at the top of this page or under August in the indeax of blogs on the right hand side of the page.
In the blog I observed that official forecasts in 2017 implied that lower tax rates for the self-employed and company owner managers relative to employees will cost about 15 billion in 2021-22. If there are tax cuts, that cost will rise. Independently, and in parallel, the cost of government borrowing may increase. UK general government gross debt exceeds £2,365.4 billion (Quarter 1 – Jan to Mar 2022) = 99.6% of gross domestic product (GDP), see my previous blog ‘What is the economic impact of Brexit on the cost of living crisis?’ ‘[HMRC] research highlights that most [SME] owners … are not employing others, investing or growing – let alone doing anything that produces positive ‘spill-overs’ to wider society. … This serves to demonstrate how poorly targeted the tax breaks are.’ (‘Principles and Practice of Taxing Small Business’, by Stuart Adam and Helen Miller, Chapter 5 of ‘The Dynamics of Taxation’, edited by Glen Loutzenhiser and Rita de la Feria).
£50bn (not taking any account of the £15bn I mentioned) will increase GND by 2.1%. [An article in the Observer Newspaper that day stated], ‘Truss, … has gone much further, pledging tax cuts she claims will cost £38bn annually, but which economists believe could actually cost more than £50bn a year. She claims this will promote growth, but these kinds of tax cuts will do nothing to address the real reasons for Britain’s dire productivity growth – a lack of investment in infrastructure, skills and other forms of capital – while significantly reducing the resources available for public services at a time when inflation is eroding the real value of budgets in hospitals, schools and care homes. Most of the conversation about the cost of living crisis has, understandably, been framed through the lens of household budgets. But it will have just as damaging an impact on Britain’s public services. … Inflationary pressures, including higher wage bills and energy costs, are predicted to cost the NHS billions this year.’ If this economic analysis proves to be correct, then:
(i) tax cuts will not increase economic growth; and
(ii) the economic cost of cuts will be GND = 101.71% of GDP.
That is an economic tipping point.
Excluded from the calculation is the reduction of revenue (i.e. to fund public services) which resulted from BREXIT. Figures produced by the Centre for European Reform show that by the end of 2021, the UK economy was 5% – or £31 billion – smaller than it would have been if the UK had stayed in the EU. ‘The CER’s analysis shows that Brexit has cost the UK billions of pounds in lost trade, lost investment and lost tax revenues.’ (ITV News Business and Economics Editor Joel Hills 10.06.2022). The Government’s mini-budget has been estimated to contain total tax cuts of £45 billion by 2026/27. What is the actual cost of the tax cuts announced today?
What is the social cost, i.e. what signal does it send if a Government:
(i) passes laws to restrict access to welfare benefits during a recession & cost of living crisis;
(ii) passes a law encouraging reckless speculation by Bankers;
(iii) gives what is estimated to be a £55K hand out to every millionaire; and
(iv) passes laws making it illegal to strike.
Answer – The Government does not care about “us”. It is looking after “them.”
In other words, the social cost is an even more divided society.
Sending out this message is not a catalyst for economic growth.
Instead, could it turn out to be a potential catalyst for general strikes and civil unrest?
Are we heading back to 1973?
If I am right, and I really hope that I am wrong, and that the new Government is economically competent, could this also be political suicide for the Conservative Party? Will the red wall collapse?
As I write, gilts are in freefall and sterling is dropping off a cliff! Unless this is put into reverse, it appears that the market is not confident that the mini-budget will result in stable conditions for investors. In which case, if the market is proven to be right, what was the point of the tax cuts?
‘The Chancellor’s massive package of tax cuts will boost growth in the short term but drive up interest rates and spark an additional £411bn of borrowing over five years, a major think tank has warned.
The Resolution Foundation, which analysed the numbers in the absence of an official OBR forecast, said the worsening economic outlook and new energy support are estimated to have increased borrowing by £265bn over the next five years.
Tax cuts of £146bn raise that to £411bn – the biggest increase in borrowing by any Chancellor.
Torsten Bell, chief executive of the Resolution Foundation, said: “Without significant cuts to public spending, debt will be on course to rise in each and every year.
“This is not what sustainable public finances look like. Every scrap of Treasury orthodoxy has been torn up.”’ [The Telegraph Newspaper 23.09.2022 at 3.34pm].
‘The Institute of Fiscal Studies (IFS)
said he was “betting the house” by putting government debt on an
“unsustainable rising path”. Only those with incomes of over
£155,000 will be net beneficiaries of tax policies announced by the
Conservatives, with the “vast majority of income taxpayers paying more
tax”, said the respected financial think tank in a scathing assessment of
The Resolution Foundation think tank said the chancellor’s
measures would involve an extra £411bn of borrowing over the next five years.
It said the tax cuts
do very little to boost the incomes of those who need it the most, pointing out
that someone earning £1m a year would gain more than £55,220 a year, while
someone on £20,000 would gain only £157.’ (Sky News 24.09.2022).
See also: Mini-Budget response | Institute for Fiscal Studies (ifs.org.uk)
‘Our findings on the effects of growth and unemployment provide evidence against supply side theories that suggest lower taxes on the rich will induce labor supply responses from high-income individuals (more hours of work, more effort, etc.) that boost economic activity … they also show little support for the influential political–economic idea that tax cuts for the rich ‘trickle down’ to boost wider economic performance. They are, in fact, more in line with recent empirical research showing that income tax holidays, windfall gains and tax cuts targeted at the top decile of the income distribution do not lead individuals to significantly alter the amount they work. …
Overall, our analysis finds strong evidence that cutting taxes on the rich increases income inequality but has no effect on growth or unemployment. …
Our results have important implications for current debates around the economic consequences of taxing the rich, as they provide strong evidence that cutting taxes on the rich increases top income shares, but has little effect on economic performance. These findings are in line with a growing pool of macro-level panel studies on the economic consequences of cutting top marginal rates of income taxation.’ (‘The economic consequences of major tax cuts for the rich.’), by David Hope & Julian Limbergg, Socio-Economic Review, Volume 20, Issue 2, April 2022, Pages 539–559).
economic consequences of major tax cuts for the rich | Socio-Economic Review | Oxford Academic (oup.com)
The market is betting on failure. ‘Speculators have ramped up bets against the pound after sterling fell to its lowest level against the dollar in nearly four decades. Investors are betting on a further fall amid concerns that the new Government will need to borrow more to fund its economic growth plan. That includes an energy package for households and business costing up to £150billion. The pound’s value has dropped almost 8 per cent against the US dollar in the past month. It has now shed 20 per cent of its value against the greenback since January – hitting $1.09 on Friday. This shows there are almost 55,000 contracts out against sterling. … The Bank of England increased the cost of borrowing by half a percentage point to 2.25 per cent last week in an effort to tame rampant inflation, running at just under 10 per cent. [A] weak pound can fuel inflation as it increases the price of imports like oil or products made in China, such as clothing. ‘Tax cuts are not a guarantee of a sustained boost to growth,’ said Jane Foley, head of foreign exchange strategy at Rabobank.’ (Speculators ramp up bets against pound after sterling falls to lowest level against dollar in nearly four decades Patrick Tooher, Financial Mail On Sunday).
companies are braced for higher costs after sterling tumbled to a record low on
Monday, with the prospect of an accelerated rise in interest rates also
weighing on industries such as housebuilding. Sectors including retail,
hospitality and aviation are affected by the falling pound, which will make
imports of commodities and goods more expensive for many companies already
facing a cost-of-business crisis. “The dollar is very, very strong . . . and it
has an effect,” said easyJet chief executive Johan Lundgren. “We have lots of
expenses in dollars and we have revenues coming in pounds.” About 40 per cent
of airlines’ operational costs are in dollars, including jet fuel and
maintenance. Kate Nicholls, chief executive of UK Hospitality, which represents
pubs, restaurants and hotels in the UK, said “a weak pound was not helpful for
companies across the sector”. Smaller businesses, which are less likely to
have in place hedges against currency movement, also expressed alarm about the
lack of stability.’ (‘UK business braced for higher costs as sterling falls’
published in the FT 26.09.2022). https://www.ft.com/content/7ded25f4-8348-433e-ba50-cf27f9c3d9ab
‘The savage sell-off in the pound in east Asia overnight was further evidence – should any be needed – that confidence in the new Liz Truss government is rapidly draining away. Sterling fell to its lowest level against the dollar, and despite an attempt at a rally in early London trading, the likelihood is that parity against the dollar will be tested before long. [O]nce a currency hits the skids it is hard to stop it. Momentum trading took over in the aftermath of Kwasi Kwarteng’s mini-budget and it has proved hard to halt. Kwarteng committed a schoolboy error by pledging further tax cuts in a full budget planned for later this year. If the markets are worried about the state of the government’s finances and the increase in borrowing needed to fund your plans, it is not the wisest course of action to add to those concerns. Kwarteng’s inexperience has been exposed.
Threadneedle Street raised interest rates by half a point last Thursday but there has been speculation of an emergency meeting of the Bank’s monetary policy committee as early as Monday.’
(‘Kwasi Kwarteng refuses to comment as pound hits all-time low against dollar’ Guardian Newspaper 26.09.2022). Kwasi Kwarteng refuses to comment as pound hits all-time low against dollar | Kwasi Kwarteng | The Guardian
‘Letters of no confidence in the premiership of Liz Truss have begun stacking up amid panic over her government’s economic proposals, a former Conservative minister has claimed.
An ex-minister in Boris Johnson’s government told Sky News that the letters which could trigger a confidence vote have already been sent to 1922 Committee chair Sir Graham Brady.
The MP accused Truss and her Treasury ministers of “playing A-level economics with people’s lives”, adding: “The issue is government fiscal policy is opposite to Bank of England monetary policy – so they are fighting each other. What Kwasi gives, the Bank takes away … You cannot have monetary policy and fiscal policy at loggerheads.”
It comes after the pound plunged by nearly five per cent to an all-time low as investors ran for the exits in the wake of the new government’s fiscal plan.
The currency tumbled to an unprecedented $1.0327, extending a 3.61 per cent dive from Friday when finance minister Kwasi Kwateng unleashed historic tax cuts’.
(‘Pound – live: Tories ‘submit no-confidence letters in Liz Truss’ as sterling falls’ The Independent at 14:45 26.09.2022).
plummeting value of the pound has sent the interest rate on government debts to
a 12-year high, with money markets now predicting the Bank of England base rate
could almost treble to 6% next year. Traders expect the central bank to convene
a meeting of its monetary policy committee (MPC) soon to hike interest rates from
2.25% to 3% before increasing them further at a scheduled meeting in November.
One analyst described sterling’s situation as “toxic”, while another said
investors had digested the implications of Friday’s mini-budget, … and
“seemed inclined to regard the UK Conservative party as a doomsday cult”. A
further rout of the British currency could take it below parity with the dollar
and into uncharted territory on international exchanges. … [S]everal MPC
members have highlighted the fact that a drop in the value of the pound can
fuel inflation via the higher cost of imported goods and raw materials’.
(‘Markets warn sterling slump could lead UK
interest rates to triple by next year’, the Guardian at 15:30, 26.09.2022).
Markets warn sterling slump could lead UK interest rates to
triple by next year | Interest rates | The Guardian
Bank of England is understood to be preparing an intervention after the pound
crashed to an all-time low against the dollar. The Bank is expected to issue a
statement as soon as today amid mounting pressure on Governor Andrew Bailey for
an intervention to help shore up the economy. This could be a verbal
intervention to calm markets or, in a more extreme case, an unscheduled
increase in interest rates – which were raised to 2.25pc just last week. It is
understood that a statement today is probable, but not definite. The Bank
declined to comment on the nature of any intervention. The possible
intervention comes amid market turmoil after Chancellor Kwasi Kwarteng last
week unveiled the biggest package of tax cuts in 50 years and hinted at more to
come. The measures, which include scrapping the additional rate of income tax
and cutting stamp duty, are aimed at fuelling economic growth. But markets have
been spooked amid fears Prime Minister Liz Truss is pushing up public borrowing
to unsustainable levels. (‘Bank of England preparing emergency intervention
after pound slumps to all-time low – live updates’, the Telegraph, 15:40,
Britain sends investors fleeing with historic tax cuts and borrowing | Reuters
UK pound has not crashed yet, but here’s why it will probably suffer in years
to come (theconversation.com)
did the British pound collapse? A look back at economic history. | Fortune
has Brexit affected the value of sterling? – Economics Observatory
U.K. could trigger a global crisis as pound collapses while
bond yields soar, Larry Summers says (msn.com)
Liz Truss and Kwasi Kwarteng ‘ignored warnings’ from officials their mini-Budget would spark market chaos (msn.com)
of England takes emergency action to prevent ‘material risk’ to UK financial
Pound tumbles despite Bank of England intervention in markets – business live (msn.com)
Bank’s £65bn move driven by pension fund panic – BBC News
New UK Chancellor of the Exchequer announces significant tax
cuts | STEP
Update on Growth Plan implementation – GOV.UK (www.gov.uk)