“Casino economics” that will “end in tears” with a possible run on the pound.
That’s a spliced together assessment of Liz Truss’s hotly anticipated economic plan for the UK, released on Friday to some of the worst reviews I’ve personally ever seen in any sphere, from markets to movies, from budgets to books.
The largest tax cuts in 50 years, including the complete elimination of a top tax bracket, an accelerated time table on a cut to the basic rate and the abandonment of a planned corporate tax hike, were eyed with extreme consternation under the circumstances, especially given the conspicuous absence of a plan to replace lost revenue.
The cut to the basic rate was brought forward by a full year to April. At 19%, it’ll be the lowest in the modern history of the nation’s income tax system. The last cut was during the financial crisis. According to the Truss government, “basic rate taxpayers will be £130 better off” on average, while those who pay a higher rate will be £360 better off.
Remember: This comes at a time when the Bank of England is trying desperately to curb domestic demand in an effort to bring down inflation. In the policy statement accompanying Thursday’s 50bps rate hike (the second large increment in a row, and the seventh consecutive increase overall), the bank said fiscal initiatives, including a cap on energy bills, mean “spending is likely to be less weak than projected.” “All else equal,” and relative to the bank’s previous forecasts, “this would add to inflationary pressures in the medium-term,” policymakers gingerly remarked.
Abolishing the 45% “additional rate” on income above above £150,000 hands a tax cut to some 660,000 individuals, a decision the Treasury justified by noting that the 45% rate is “higher than the top national rate of income tax for G7 countries,” including the US and Italy. It’s also “higher than social democracies like Norway,” the government dryly remarked, before lamenting that despite a 2013 cut to the additional rate, the top 1% of UK taxpayers still ended up with a higher relative tax burden a decade later. Some might suggest that’s not necessarily a bad thing, but the Truss government plainly thinks it’s intolerable.
Ultimately, this is trickle-down economics, and wishful supply-side thinking at its “finest.” “The government is committed to cutting the overall tax burden, making the UK more competitive as well as an attractive place to start, finance and grow a business,” the government said Friday, adding that cutting personal taxes “rewards enterprise and work, and helps attract the best and brightest to innovate in the UK.” The higher taxes are, the less incentive there is to work, Truss’s government mused, in a section called (somewhat unfortunately in the context of Friday’s market meltdown) “Why has the government done this?”
According to a snap analysis by The Resolution Foundation, nearly two-thirds of the windfall from the personal tax cuts will accrue to the most well-off households. Nearly half of the benefits will go to the top 5%. Looking at the extremes, that means a household earning £1 million will enjoy a £55,000 handout, whereas a poor household would get less than £200 — so, nothing, basically.
On the corporate side, cancelling a planned hike from 19% to 25% (figure below) for firms making more than £250,000 profit will mean corporate taxes in the UK stay “significantly lower than the rest of the G7 and the lowest in the G20,” something Truss is evidently quite proud of.
The policy paper explaining the decision to abandon the increase cites “a range of academic evidence which suggests that cutting corporation tax[es] can boost investment and growth by providing immediate support to businesses in the short-term, and increasing business investment, productivity and growth in medium- to long-term.”
Again, that’s just trickle-down economics. And, with apologies, there’s also “a range of academic evidence” which suggests it doesn’t work at all. Nixing the rate increase will save companies almost £19 billion per year by 2026/27 and nearly £68 billion over time. Truss also reversed a 1.25% payroll tax increase. All of that is revenue the government won’t have, unless you believe, as Truss does, that it’ll be more than “paid for” by taxes collected (at a lower rate) on extra income generated by better growth outcomes attributable to lower taxes. You can draw your own conclusions on that.
The Truss plan also raises the threshold for stamp tax collection. I’m not in a position to weigh in on the relative merits of that particular decision, but what I can say is that Truss relies on ludicrous extrapolation to explain it. “Doubling the nil-rate band will enable up to 29,000 more people to move home each year, in turn boosting household consumption, which will increase confidence in the economy and support the hundreds of thousands of jobs and businesses which rely on the property market,” the government said Friday, on the way to suggesting the move will materially brighten the economic prospects not just of “real estate agents, builders and contractors,” but also those of “removals companies, plumbers, decorators, cleaners” and unspecified “others.”
As for Truss’s energy relief scheme, the cost will be £60 billion over six months. It’s projected to save the typical household £1,000 per year and halve the cost of business energy bills, ultimately reducing peak inflation by around 5 percentage points. That’s welcome news for the BoE, but only in the (very) short-term. Truss’s overall growth package will almost surely be inflationary and it could be fiscally ruinous. There was virtually no mention of any concrete plans to raise revenue.
The pound and gilts were aghast. Absolutely aghast. Sterling plunged more than 3%, a horrific slide that made an already bad year much worse (figure below).
Bloomberg’s pound index hit a record low. Parity by year-end is possible. It might even be likely. The pound’s decline left it the weakest since 1985.
Truss’s package is projected to cost £161 billion over five years. It was mercilessly derided on Friday. “The biggest single giveaway by the Treasury since 1972” (as Bloomberg, and everyone else with even a passing interest in the matter, dubbed the plan), could result in a wholly perilous spiral. This is massive government spending paired with tax cuts, with inflation running rampant and the currency in free fall. Worse, Truss’s energy pledge is tied to wholesale gas prices, over which she has no control. That’s an uncapped liability.
Finally, as noted here on Thursday, the BoE is set to actively reduce its gilt holdings by £80 billion over the next twelve months. That, at a time when yields are rising and the Truss government is embarking on expensive fiscal stimulus presumably funded by large additional borrowing. The private sector will need to absorb both the new issuance and the gilts sold by the BoE.
Yields staged an unthinkable surge (figure above). The curve shifted some 50bps higher.
This is a case where I’m compelled to state the obvious: Developed market currencies aren’t supposed to collapse when bond yields soar. If this continues, the BoE may have to resort to an emergency rate hike of epic proportions to prevent an outright catastrophe.
Larry Summers called Truss’s plan “naive.” “This is simply not a moment for the kind wishful thinking, supply-side economics that is being pursued in Britain,” he sighed.
Speaking to Bloomberg on Thursday, Martin Weale (a former BoE policymaker) suggested Truss’s plan will end in a crisis. “There will probably be a clear run on the pound, and then the bank will be forced to put up interest rates to stabilize the exchange rate,” he said. “Other experiences where the [Chancellor of the Exchequer] has gone for growth ended in tears. I expect the same sort of thing will happen.”
It does not make sense to decry this tax giveaway to the rich as supply sided trickle down nonsense and fear it’ll stock inflation. Rich people don’t consume their tax cuts.
This could be a concern with the energy price shielding, though I’m still not clear on how it’s supposed to help if there’s just not enough quantity of energy to go around…
This goes way beyond that. This is a potential disaster. They’re an emerging market now. The fundamentals are in tatters. The setup is conducive to a growth-inflation-rates death spiral. On the FX front, there’s some serious blood in the water here. If speculators want to push the issue, they could trigger a crisis.
Only in EMs will you consistently see stock prices, bond prices and currency decline in unison. It occassionally happens in developed markets but that kind of move rarely or never persists. The British are still paying for Brexit and for electing the Tory Party and Boris Johnson as PM. Hard to believe but this is worse for Britain than Trump was for the US- although if Trump was re-elected the US would no longer have a functioning democracy. This is looking now like Truss and the Tories are going to get wiped out next go around in 2 years.
They don’t consume their tax cuts, they consolidate them. The UK is basically on their way to recreating the wealth inequality that exists in the US.
Margeret Thatcher’s ideas about maanging a modern economy were based on the model of her father’s grocery store. Conservatives constantly love to frame their explanations of economic policy in this way, wagging their fingers and telling you to “take your medicine” . In this case “you will have more incentive to work for the beneficiaries of our policies”.
I dunno. Cranking up interest rates to support the pound will only work if they can push up short-term interest rates to levels where it is too expensive to borrow pounds to sell. CBs in smaller countries have been able to carry off such targeted measures now & then. But could the UK do that? Or will they have to raise interest rates across the whole economy which ends up driving rates down later as the economy craters.
At least the Brexiteers can rest happy knowing that they are in charge of their own destiny, right?
I hope Scotland and Northern Ireland are on board.
MMT at work????
No. You’ve made it pretty clear time and again that you don’t have a solid grasp on what MMT actually is, so I’d gently suggest that until such a time as you expend the necessary effort to figure it out, you eschew the temptation to make what you mistakenly believe are sarcastic comments. Because nothing looks sillier than a would-be sarcastic comment that’s actually an uninformed comment.
Someone who actually knows a little about MMT:
https://stephaniekelton.substack.com/p/the-mini-budget-is-a-maxi-giveaway?s=09
Truss has no core principles or convictions, just pandered and postured her way into power. Wish the Tories had not made that choice.
Unless other levels of government in the UK also levy an income tax, her statement that 45% is the highest in the G7 is not really true. Combined federal and provincial effective rates in Canada range from 48 to 53%.
The highest combined marginal rate in California is 48%.
Sterling 4% lower now.
I wonder what the pain threshold is for Truss to get booted ad hoc. Would GBP/USD parity do it?
This politician is delusional, thinking that supply-side economics works since we can prove from the experiment that Reagan started that it does not work and can’t work mathematically. If implemented, this policy will cause the British to end up in tears. Unfortunately, the British won’t realize it until they have 15% inflation, and the Bank of England will probably have to raise the interest rate from 0.5% to 6%. Also, the current pay ratio for the top 350 corporations in Britain is 44:1 with their existing responsible tax structure. This new policy will get them closer to the irresponsible level of the US, which is 324:1. I hope Britain can find a way to get Truss out before she implements this inconsistent policy.
I have fears, probably expressed here a little too often, of something breaking due to the dollar, so will skip over that
But H — I’m guessing you are already a fan, or would soon be, of John Oliver’s show on HBO, assuming you haven’t completely eschewed pay cable alongside the rest of civilization. Sometimes when reading your posts, I find his voice creeping into my head. Yeah, I know the accent is probably way off, but he’s a fast talker unafraid of mixing in multiple 4-syllable words in multiple compound yet incisive sentences, while simultaneously trying to jam opaque and complicated concepts into our lizard brains. So hopefully you’ll be flattered or at least understand the comparison. But his recent show focusing on the UK and the US TV show Law & Order was one of the best ones I’ve seen.
He has a funny/alarming takedown of Truss’ first week or so in office which you would appreciate, including predicting (then) that the Queen’s shocking death at the age of 96 due to natural causes was perhaps the greatest favor anyone has ever done and will ever do for Liz Truss. Now that the Queen is gone and buried, the UK is left with a pent-up yet already fading new King Charles and a new Prime Minister seemingly hell-bent on making everyone forget, or perhaps long for, the last Prime Minister as quickly as possible. (If she starts dyeing her hair jet black, denying it, and selling arms to Ukraine to fund insurgents in Argentina, watch out!).
In the same show, he also references the smelly Wal-Mart shopper often-portrayed on Hannity, which I had not seen before, but which you might appreciate next time you cross the bridges. (But should one of your sojourns lead you past a psychic’s or medium’s shingle you had failed to notice before, I think Paulie Walnuts would lose a shoe to warn you to avoid at all costs).
Unfortunately, I could not find these segments of the show online, as they only seem to post the main segment of each show, which in this case concerns the Law & Order procedural I mentioned. Still worth watching, IMO, but if you can catch the lead-in segments on Truss and Wal-Mart, I highly recommend.
And to conclude, I cannot resist the dark side in re-emphasing this blog’s noting that America’s two closest non-continental allies are now engaged in levels of Central Bank and/or fiscal nonsense that only Erdogan might find prudential. What worries me most is who, right now, is going to be providing external financing to the rest of the world (unless on a predatory basis), at the same time we already have spiking prices and/or rates, famine, potentially existential war, and climate change the likes of which no one has ever seen or thought possible? Risk on, cuz light positioning? On my personal list of tail risks, deydrating to death has officially made an appearance and I’m not a young man and I live on the East Coast.
I wonder if this will accelerate not only the departure of Scotland from the UK, but also Wales and Northern Ireland?