A barely-known Prime Minister, a mysterious chancellor – and a plan with the feel of a 1980s fancy dress party.
It’s back to the future in Downing Street for the UK’s third policy reset in a decade.
The UK government’s 2022 Mini Budget [1] cuts taxes and aims to boost growth even as the Bank of England is elsewhere applying the brakes.
Which is not to say that PM (and sometime [2] royal stand-in) Liz Truss and chancellor Kwasi Kwarteng aren’t doing the right thing in cutting taxes now and putting off the bill for later.
Time will tell. But the UK economy was hardly humming under the prior plans, and there’s case for trying something different.
In particular productivity has been in a rut for a decade:
[3]Source: LSE [4]/ONS
Truly woeful, and there’s something for everyone when it comes to allocating the blame.
That LSE paper points to Britain’s exposure to financial services during the 2008-2009 crisis, the follow-up austerity drive, too little investment in infrastructure, and the ongoing drag from Brexit.
A right-wing perspective would foreground the relentless expansion of the State.
Others might blame UK PLC’s reliance on cheap labour rather than investing in technology.
More recently, the pandemic won’t have helped.
Pick your poison. There’s clearly a sickness here.
As for the cure, I’m sure there’s a political dimension to the bottle that PM Truss has reached for. But at least I’m heartened by her claim she’s willing to be unpopular [5]. Her admission – six years after Brexiteers blathered that it would be an easy prize – that no US/UK trade deal is coming anytime soon [6] is a start.
Populism has done great harm in recent years. The spell can’t be broken soon enough if we’re to make the best of where it’s left us.
The 2022 Mini Budget highlights
Which brings us to those tax cuts and reversals and the other just-announced measures.
Here’s a summary of Friday’s Mini Budget from the BBC [7]:
– The basic rate of income tax will be cut by 1p to 19p from April 2023
– The 45p tax rate for top earners over £150,000 will be abolished, also from April next year
– The level at which house-buyers begin to pay stamp duty is doubled from £125,000 to £250,000
– First-time buyers will pay no stamp duty on homes worth £450,000, up from £300,000
– Planned rise on corporation tax from 19% to 25% is scrapped
– A 1.25% rise in National Insurance to be reversed from 6 Novemnber
– Cap on bankers’ bonuses, which limited rewards to twice the salary level, is axed
– Cost of subsidising both domestic and business energy bills will cost £60bn for the next six months
-Strike action: unions will be required to put offers to members during pay talks
– UK to introduce sales tax-free shopping for overseas visitors
Expect more to emerge as journalists and wonks dig into the detail.
Just one example – the controversial IR35 legislation is to be repealed [8].
The big picture take is the UK government is cutting its income even as its outgoings rise with inflation and the higher cost of servicing debt.
Oh, and the rich have just gotten richer.
Short-term this looks optically bad, but it isn’t entirely mad. You could even argue its conventional counter-cyclical Keynesian economics.
But it will be a tricky balancing act.
Singapore sling
The stated goal is growth. If one was to turn to the toxic B-word, it’s a tentative step towards the Singapore-lite model of a ‘business first’ post-Brexit Britain.
Lower taxes, lighter regulation, and a smaller state (/safety net) traded off for higher growth.
Let’s leave aside whether this is anything like what most disgruntled working class Brexit supporters voted for. Once you add up any small pros and take away the huge cons, I don’t see any economic advantage for Brexit. But in purely economic terms, I’ve long said diverging from the European model towards a more cut-throat US-style capitalism is the closest we’ll get to neutering the economic downsides
Again, it’s not what I voted for. But there is an economic logic to it.
Still I remain skeptical about how far Britain can go in this direction.
We’re not Singapore – demographically, culturally, or geographically. We don’t live in small apartments in a single city with our elderly parents. UK politicians can enable [9] sewage to be dumped in the sea [10], but the EU won’t allow shoddy goods to be dumped on the continent. We’ll have to meet the standards of our largest trading partner and it will naturally resist regulatory arbitrage on its borders.
As for state spending? We’re getting older and sicker. The National Health Service is the nearest thing the UK has to a religion. And I’d argue the population’s sense that government should solve its problems has only grown under the years of populist magical thinking.
It’s hard for me to see growth coming wide and fast enough to offset the pain from really taking an axe to state spending, if that’s the follow-up punch to come.
There’s an election coming in 2025. We’ll get a verdict then I suppose.
Interest rates could spoil the party
Making life even harder is the macro-economic backdrop that’s (mostly) neither of the government’s making nor under its control.
Inflation is rampant, and Truss has already (rightly) signed up to borrow billions to ease the energy crisis for individuals and businesses [11].
We are more or less at war with Russia – and if a few hundred billion [12] is the ultimate price of victory (or even a negotiated stalemate) then it’ll be cheap compared to the priciest [13] charges on the menu.
Yet while energy price caps should curb official inflation figures in 2023, still more borrowing piles greater pressure on the UK’s creaking balance sheet. That could be longer-term inflationary.
Already the Bank of England hiked [14] interest rates this week by another 50 basis points, to 2.25%.
That’s the highest level since 2008. But scarier still is this chart (courtesy of Ed Conway [15] from Sky News) showing how expectations for peak rates have soared in just a few months:
[16]The expected peak is up by 2% to 4.75% in just a matter of weeks!
And while that might not sound especially high to old hands, Conway correctly highlights we’re far more indebted than when higher rates last prevailed.
Indeed he calculates that if rates were to hit 6% – outside expectations but again look at the rate of change above – then the mortgage burden would be similar to that which precipitated the property market crash of the early 1990s.
Debt markets are also a downer
We can then see the contours of the economic struggle taking shape.
The Truss government has decided to go for growth, as we used to put it. Today’s tax cuts take tens of billions a year out of the Government coffers and puts it back into our hands.
But the UK State is hugely indebted. And the cost of maintaining that debt is already soaring with rising interest rates.
Indeed the 10-year gilt yield jumped nearly 0.5% higher following Kwarteng’s mini-budget:
[17]Source: MarketWatch [18]
Lower taxes and austerity out the window means less fiscal tightening – perhaps even fiscal easing – exactly when we face huge inflationary pressure.
Which – given the Bank of England’s inflation target – in turn means higher interest rates. And that will strain household balance sheets and even risk a housing crash.
It sets up a push me pull you between the Chancellor and the Bank of England.
Politically this takes some pressure off Truss. Her government will be tax-cutters, leaving more money in people’s pockets. The Bank of England can be the bad guys, taking money back with higher rates.
The hope must be that faster growth will – among other things – reassure the capital markets and keep a lid on borrowing costs.
The risk is it doesn’t.
The pound has dropped nearly 2% this morning as gilt yields have risen.
I wouldn’t say that’s a huge vote of confidence, although to be fair it probably more reflects a ratcheting up of uncertainty.
Giving to Peter to pay Paul
How the push me pull me will resolve itself is anyone’s guess.
A similar-ish Thatcherite [19] direction in the 1980s did deliver a growth spurt. I’d also argue it helped wrench Britain out of secular decline.
But inflation was a fading threat by the time the Thatcher boom really kicked in. We also had the windfall of North Sea oil revenues to paper over the cracks.
Perhaps a better way to conclude is to ask what this means for the typical Monevator reader who is saving hard and aiming for financial independence?
Well, firstly I don’t think it should change anyone’s long-term strategy.
Again, UK governments come along like buses these days. The 2025 General Election could easily shift things again.
But in broad strokes I’d say it’s tactically advantageous for us – but strategically less certain.
From a personal point of view, it’s hard to argue with lower taxes. More money in your pocket means more to save and invest.
I’d also imagine ISAs and SIPPs are safe under Truss and Kwarteng. Perhaps savings allowances – particularly the Lifetime Allowance [20] for Pensions – could even start to rise again.
In the best-case scenario the UK escapes its low productivity trap, GDP grows, and we manage our expanding national debt thanks to higher cashflows from a larger base.
But there’s definitely a downside scenario to this steady accumulation of debt combined with more polarizing economic outcomes. (Plus I don’t see much here for infrastructure).
Careful what you wish for
The UK FIRE1 [21] movement is also a kind of two-headed beast.
We benefit from laissez-faire policies in the accumulation phase – especially our favourable tax shelters like ISAs [22].
But we implicitly lean on state support as we keep taxes low in de-accumulation and – crucially – assume the NHS will be there to take care of our health needs.
Very different from US FIRE [23]-seekers. They can earn and save more but face huge health insurance costs. This may keep them in jobs long after their British brethren would have called it a day.
There’s also the State pension to keep in mind. It’s a huge boon for the typical UK FIRE-ee.
Hence most of us wouldn’t benefit from too-much rolling back of the state and its services. Let alone grimmer potential scenarios that I won’t dwell on today.
Of course there’s not much we can do about it individually – aside from saving more, investing sensibly, paying attention, and hoping for the best.
But what do you guys think? Let us know – focusing on the economics rather than the politics, as much as you can – in the comments below.
- Financial Independence Retire Early. [↩ [28]]