Well. After this, no one will ever accuse Kwasi Kwarteng of “caution” or “managerialism”, so in that sense, he has achieved his goal. The new Chancellor’s “fiscal event” yesterday was hailed as the most radical of its kind in more than a generation. He unleashed a tax-cutting stimulus amounting to £45 billion per year by 2026-27, on top of an estimated £60 billion to be spent this winter on capping energy prices. Underlying this was a new mission: growth at any cost. The focus on growth is very welcome. The worry, however, is the lack of focus on costs.
Before hamming up Mr Kwarteng’s big fiscal bonanza too much, a reality check is in order. By far the biggest lines in his Budget were acts of damage control. He reversed the two mega tax rises mooted by Rishi Sunak – corporation tax and national insurance increases. Only one of these has actually taken effect. In other words, the vast majority of this “stimulus” – £37 billion in 2026-27 – consists of decisions not to implement measures that either haven’t been implemented yet or have been in place for less than a year. To call this, as the economist Larry Summers has, behaviour worthy of an “emerging market” is something of an exaggeration. One could argue that it was shadow chancellor Rachel Reeves who came closest to the truth when she exclaimed, sarcastically: “Some new plan!”
Indeed, much of the criticism lobbed at Mr Kwarteng smacks of ignorance and hypocrisy. When Mr Sunak announced his plan to put up national insurance last year, Labour called it “a regressive tax on working people”. Naturally, they now oppose Mr Kwarteng’s plan not to put up national insurance this year, calling his decision an example of “trickle-down economics”. Even the usually staid Institute for Fiscal Studies, which on Thursday produced stacks of slides showing the damaging effect of the national insurance rise on household incomes, declared on Friday that the decision to cut the tax was part of an “unsustainable” and “dramatic” turnaround in fiscal policy.
But the biggest game of smoke and mirrors is the one played around corporation tax over the past decade. When, in his first budget as chancellor in 2010, George Osborne announced plans to slash the tax over several years from 27 per cent to 24 per cent, he declared that this would enable “a sign to go up over the British economy that says ‘open for business’ ”. The critics now claim that Mr Osborne was wrong and that cutting the tax has not stimulated any new business investment since 2010. The headline figures seem to bear that out: a very slight recovery in business investment was cut off in 2016 after the Brexit vote and overall, it has flatlined since the Tories took power. These figures featured prominently in Mr Sunak’s argument for putting the tax up and they seem to bear out critics of Mr Kwarteng.
Unsurprisingly, however, the headline tax figures do not tell the whole story, as highlighted recently by the economic researcher Ben Ramanauskas. Mr Osborne’s tax cuts were not what they seemed. That’s because even as he cut the headline rate of corporation tax, his policies sucked more and more business activity into the corporation tax base by abolishing all sorts of reliefs aimed at encouraging investment. What one hand giveth, the other taxeth away.
The result was that the total corporation tax burden stayed exactly the same. It was merely its composition that changed. In short, none of this has taught us anything conclusive about whether cutting the tax will or will not stimulate investment. Mr Kwarteng is perfectly justified in suggesting that it might. He is not, however, actually cutting the tax. He simply isn’t putting it up. So the politicians, and their various economic supporters and critics, are, as usual, fighting a phoney war.
Aside from these well-flagged, blockbuster tax U-turns, there were some genuinely new measures in Mr Kwarteng’s budget. Most of them were positive, if small compared to the huge numbers discussed above. Reducing stamp duty is a very welcome move, given the huge damage this tax does to our housing and labour markets by keeping people stuck in homes that are unsuitable for their needs. In an ideal world, the whole tax would be replaced or abolished altogether.
Likewise, the decisions to freeze alcohol duty and reduce taxes on freelancers and contractors will help to alleviate some of the pressure on struggling or small, dynamic entrepreneurs and businesses. On the other hand, Mr Kwarteng’s surprise move to slash taxes the most for the highest earners is hard to defend in the current economic circumstances, unless it can be shown to increase revenues in the long run by luring the wealthy back to Britain. Let’s just say the jury is out on that one.
The real underlying risk of this Budget, however, is that it helps to push the economy into an inflationary spiral that we can only escape with huge rises in interest rates, for which we are very poorly prepared. This takes us back to the heated economic debate that played out between Liz Truss and Mr Sunak during the leadership race. Stimulating an economy during a recession makes sense if there is a lack of demand – if people are not buying or spending enough. But our economy has the opposite problem.
We are short of supplies: energy, workers, food and, increasingly, financing. Pumping money into an economy with a supply shortage, whether it’s through the energy price freeze or tax cuts, ultimately just feeds through into wage rises and price rises. In the short-term, the energy price freeze mechanically cuts inflation by loading most of the cost of gas prices onto the Government. But in the medium term, it feeds inflation by giving people more money to spend on goods and services that are in short supply.
On the headline numbers, Mr Kwarteng’s stimulus is outdone in the history books only by the tax-slashing budget unveiled by Anthony Barber in 1972. That budget infamously unleashed “the Barber boom” ahead of the Arab oil shock, all of which triggered spiralling inflation. It took the Thatcher government’s brutal monetarist medicine to undo the damage.
Mr Kwarteng is betting on two countervailing forces to avoid this outcome. The first is that his Budget will cause a big increase in investment and thereby boost productivity, which will alleviate supply shortages and ultimately bring down prices. Of course, he could be right. But if so, the fruits of this investment are likely to materialise a few years down the line, by which point we could already be in the throes of the dreaded wage-price spiral, whose beginnings are already in evidence. Maybe it’s the right bet to make for the long term and the only way to avoid continued decline, but it certainly isn’t a surefire one.
More importantly, there are still enormous barriers to investment in the form of over-regulation (planning, employment law, environmental regulations and so on), misguided elements of net-zero policy, slow and insufficient infrastructure development and a lack of sufficiently skilled workers. Mr Kwarteng name-checked all of these problems in his speech and claimed he will soon unveil plans to address them. That would be most welcome, but talk is cheap. Governments have been talking about these problems and promising to solve them for years.
Indeed, this is the sixth “growth plan” wheeled out by successive Tory governments since the party took power in 2010. Instead of fixing the litany of problems they all enumerated, successive chancellors have simply succumbed to them. If Mr Kwarteng can genuinely deliver a better investment environment, cheaper energy and a better trained workforce, then he will go down in history as the best chancellor of our generation. But can he?
The second counter to the Budget’s inflationary effect is, in theory, the Bank of England. The Chancellor’s letter to Andrew Bailey on Thursday strongly suggests that he is relying on the Bank to tame inflation by raising interest rates harder and faster. But the Bank has been consistently behind the curve, once again going slower than markets expected this week, and its credibility is shot. Just look at the reaction to the Budget as a result: sterling plunged and gilt yields shot up. That is not a sign of investors having confidence in our institutions’ willingness to fight rising costs.
Unfortunately, even if the Bank does do its job, it’s not a pretty picture. The effect of rising interest rates will be devastating for many households and businesses that have become utterly reliant on rock-bottom borrowing costs. The result could be to undo all of the stimulating effect of Mr Kwarteng’s Budget and send us even deeper into recession.
This week could be the moment Britain finally arrested its economic decline and used this crisis to start building a new economic model that will be fit for a world of higher interest rates and slowing trade. Or it could be the start of a rapid acceleration into decline. The Chancellor has the chutzpah to weather criticism in Westminster. Whether he has the guile and gumption needed to deliver the growth he has promised is another question.