“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.”