So much for a “mini-budget”. Barely two weeks into his new job as UK chancellor, Kwasi Kwarteng announced the biggest tax cuts in half a century. This will be a tax-cutting, regulation-slashing and energy-subsidizing government on a historic scale — funded by borrowing and the hope of future economic growth. Fiscal discipline will take second place to stoking the economy. With sluggish growth since the 2008 financial crisis and inflation near 40-year highs, Britain’s economic model needs a revamp. Yet this opening salvo in “Trussonomics” represents a hefty political and economic gamble.
True, the growth plan was pro-business, offering up lower taxes, improved investment reliefs and reduced red tape. The Liz Truss government aims to build on Britain’s strengths in financial services and accelerate infrastructure development, and acknowledges the importance of simplifying the tax system. Striving for higher growth is a good thing. But relying entirely on achieving such growth to fix the hole in public finances that the overall economic strategy will create carries huge risks.
Some fiscal easing was necessary to tackle the cost of living crisis, but the chancellor’s splurge borders on the spendthrift. Britain’s economy is fragile. Debt as a percentage of economic output is at its highest since the early 1960s. Upward pressures on borrowing costs are worrying: the Bank of England this week signaled further interest rate rises — partly in anticipation of higher borrowing — and will sell gilts, via its quantitative tightening program. The £45bn of newly announced tax cuts, alongside the package already unveiled to help consumers and businesses with soaring energy costs, will leave the country with debt on an unsustainable path.
Rigidly sticking to fiscal orthodoxies in a crisis is not always wise, but boldness must be balanced with the need to maintain confidence in the UK’s economic credibility. Sterling has been tumbling, auguring more imported inflation. It fell again, to a 37-year low against the dollar of below $1.09, following Kwarteng’s statement. Gilt yields jumped too. Plugging Britain’s record current account deficit also relies on international financiers buying British assets or lending to it. Presenting such a radical plan without independent forecasts from the Office for Budget Responsibility is not reassuring.
This makes the specific measures in the growth plan all the more pivotal. Raising trend growth significantly is one way to put the public finances back on a solid footing, but the odds are stacked against achieving this. In the short run, tax cuts will only stimulate demand in an already supply-constrained economy. This will stir up price pressures, which the BoE will push back down on, setting up potential tensions with the government.
Measures that raise the economy’s supply capacity will be more important. New Investment Zones could bolster capital expenditure, but will take time to develop — and may simply displace activity from elsewhere. Accelerating infrastructure projects and supporting business investment is commendable, but will also take time to lift potential growth. The plan contains little to boost skills and reverse the surge in economic inactivity since the onset of the pandemic.
While the details are yet to be finalized and policies may evolve, it will now be up to the government to prove that it can deliver its growth ambitions. The need to meet other spending commitments — including on stretched public services and defense — will only test the strategy further. Financial markets will continue to pile on the pressure. This fiscal statement has set the British economy down a dangerous path.