The author is executive director of the think tank Resolution Foundation
We all make mistakes, it depends on the extent. Britain is making by far the worst unforced economic policy mistake of my life. Large, unfunded tax cuts that the government claimed would boost growth have instead convinced markets that the UK’s entire macroeconomic framework is at risk.
The short-term consequence was turbulence, with soaring borrowing costs and faltering pension funds. Forcing the Bank of England to resume buying gilts in the week before it is due to start selling gilts does not look like success for a new Chancellor. But it’s important to step away from the hourly rush of markets because the effects of this abrupt shift in economic policy will be felt well beyond the trading floors.
The short-term impact of lower taxes is higher interest rates, which matter for family finances, not just financial markets. With 1.8 million households – including mine – due to the outflow of fixed-term mortgages next year, the pain is ahead rather than behind.
Policymakers also face tougher compromises after last week’s mess. The immediate focus was on the Bank of England, but in practice they know the levers to pull. The markets determine the extent of the necessary measures. Sterling’s rebound over the past few days reflects increased confidence that it is to follow: a big rate hike is imminent on November 3rd.
Who did Kwasi Kwarteng’s “mini” budget actually assign the most difficult political task to? The chancellor himself. He now has a maximum of eight weeks to plug a huge budget hole.
The deteriorating economic outlook (particularly rising debt interest costs) meant that even before the flood of tax cuts, all fiscal leeway had largely disappeared. But the new government has boosted the problem. Biggest tax cuts in five decades need to be funded while scaring markets means another £12.5bn a year added to debt interest bills.
Kwarteng says he remains committed to eventually bringing the debt down. In the absence of the Office for Fiscal Responsibility, the belief means the new government will miraculously mean higher growth, requiring around £37bn-47bn of fiscal tightening by 2026-27. More could well be needed to ensure tax revenues cover day-to-day expenses, or even just for a small margin of error.
A reversal of some tax cuts would make this much more achievable. Yes, it’s politically painful, but so is the alternative: announcing massive spending cuts. Kwarteng is on track to announce cuts as big as George Osborne’s in 2010.
The Treasury is now desperate to find out what these will contain, but history offers clues as to what is to come. Experiences with budget consolidation in the 1990s and 2010s indicate that it will be easier to build fewer roads in the future than it is for firefighters or teachers today. A cut in public investment to the 1996-2016 average would undermine our growth prospects but save £25bn.
Slowing pension increases to allow inflation to erode their real value is also a Treasury staple. Next year, we expect to raise working-age pensions by income rather than by inflation – a 4 percentage point real cut that the Treasury will charge 500 billion a year. We should be clear what that means: permanent benefit cuts to fund tax cuts for top earners in Europe’s most unequal major country.
Significantly lower taxes mean less public spending. This compromise was ignored when these tax cuts were announced, but market pressures have now brought it to the fore. The new government may have dreamed of emulating Margaret Thatcher, but the reality could be that they will look a lot more like Osborne in the years to come.
https://www.ft.com/content/db085f10-417b-49a9-a7d1-3d70019d3219 The lasting effect of the “mini” budget will be felt far beyond the trading floor