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What caught my eye this week.
I honestly don’t want to keep returning to the UK’s fiscal and political kerfuffle, week after week.
But like a newspaper’s travel correspondent who finds herself the only reporter in town during an air raid, the battle keeps thundering in.
This week was one of truth and reconciliation – in as much as the truth hit home and it had to be reconciled with a hostile political reality.
Most notably, with senior Conservative MPs openly stating that they wouldn’t support it, PM Liz Truss caved on scrapping the 45% tax band.
Instead it was her proposed tax cut that was scrapped[1]. A twitch of fiscal sanity, sure, but from her party not her chancellor. And as it only saves a couple of billion pounds, the bond vigilantes’ Excel spreadsheets won’t have budged much anyway.
Indeed the Office for Budget Responsibility would likely confirm a black hole in the nation’s finances, were it to release its independent forecast today.
Bean counters
The Guardian[2] quotes Sir Charlie Bean, an ex-member of the independent watchdog and a former Bank of England deputy governor:
“It will be in the order of £60bn to £70bn relative to its previous forecasts,” he said, adding that Kwarteng would face three options: further U-turns on his tax-cutting plans, deep cuts to public spending, or risking the ire of already rattled financial markets by substantially adding to the national debt.
“What he’ll be confronted with, and I don’t think to be honest most observers and MPs have really woken up to this yet, is the extent to which the public finances has deteriorated since the spring,” Bean said.
“It will be interesting to see what the chancellor comes up with, what rabbits he can pull out of the hat. They could U-turn on the tax cuts they announced a fortnight ago, but that of course I’d say would be politically terminal for the Truss government.”
I’m starting to suspect it was no accident that big concrete spending cuts – as well as the promised supply side reforms – were put off until November, even though this is what roiled the markets.
The tax cuts were perhaps meant to prepare the ground for future pain by obviously straining the country’s finances – in the same way that a patient is less inclined to complain about an imminent amputation if gangrene has already set in.
Create a frightening shortfall, then you’re swinging the axe not as a mad man but as a surgeon.
But if that was the idea, it looks a long shot now.
With her party in open revolt and many Tory MPs fearing for their jobs, the politically difficult decisions that Truss said she sought – some of which in isolation may be well-judged – seem as hard a sell to Parliament as to the country.
Bad medicine
Many Monevator readers might be sympathetic to those who suffered a real terms benefits freeze, but fewer would be directly affected. (State services such as a flailing NHS are another matter).
No, we’ll mostly feel the ongoing pinch at the tax rather than spend end of the equation.
And on that score it’s still widely under-appreciated just how static tax allowances – combined with raging inflation – amplify the tax take.
According to the Institute for Fiscal Studies[3], taxpayers are set lose twice as much from frozen allowances next year as they will gain under the promised tax cuts, writing:
Freezes to personal tax parameters alone will reduce households’ income by £1,250 on average by 2025–26.
Adding in freezes to benefits and gradual policy roll-outs brings that figure to £1,450, or 3.3% of income, and means a £41 billion boost to the exchequer.
That is double the £20 billion gain in household income (and loss to the exchequer) from the high-profile personal tax giveaways – the reduction in National Insurance contributions and 1p cut to the basic rate of income tax.
In other words, on average for every £1 households gain from high-profile cuts to rates of income tax and National Insurance, they lose £2 from the freezes and policy roll-outs.
My co-blogger The Accumulator has been banging this drum for months. He even made a rare foray off the fence in our comment thread[4] on the Mini Budget to say:
It’s a joke. The tax thresholds are still frozen until April 2026 with inflation rampant. Most will pay more tax not less.
This is a conjuring trick.
T.A. has had a draft article knocking about since early summer that tried to unpick very precisely how much not raising the various allowances would cost a person, versus a counterfactual world where allowances rose with inflation.
However I felt it was too confusing for readers. It also teetered on a vast and fairly unfathomable spreadsheet that underlined how difficult it is to do these sums for yourself.
My bad for not publishing it anyway, in retrospect, though like my warnings[5] about imminent contact with sequence of returns risk and my urging readers to stress test[6] their mortgages, it might have been a little early to truly hit home.
Here’s how the IFS sees the upfront damage in terms of where the various bands would be if they’d risen with inflation:
Reading this table doesn’t really reveal how it all adds up for you, however. And you can try to do the sums like The Accumulator did, but it’s mind-bending stuff.
Which is why of course politicians prefer this conjuring trick to hiking tax rates directly.
First, do no harm
Sympathizers might ask who can blame them?
We have a perma-sluggish economy afflicted with poor productivity growth that – borrowing aside – must fund ever-growing commitments and a relentless string of one-off spending splurges, most recently the energy support measures.
Tax as a share of national income income is already getting on to[8] its highest level since the aftermath of World War II.
The tax cuts may well been chosen for their political bite. But at least they take the edge off.
Look, Liz Truss and Kwasi Kwarteng have clearly bungled the delivery of their chosen hardcore medicine. And it certainly appears to be more from the chemotherapy end of the spectrum than a holistic retreat to the Alps to take in the air.
It’s not the treatment course I’d prescribe. The ordering has been back to front. You’d hope for more competent doctors.
But as I said in my ambivalent response[9] to the Mini Budget, I don’t quibble as much as some do with the diagnosis.
Post-mortem
As has been the way of Tory politicians for half-a-dozen years though, they soon exhaust my short store of sympathy with their lofty disregard for the facts.
This time saw Truss and her followers claim the drama[10] of the Bank of England having to intervene to shore up reeling pension funds was all down to global matters.
Ukraine was even mentioned a few times.
Luckily the Bank of England remains independent enough to shoot that down.
The Bank’s Deputy Governor Jon Cunliffe told MPs that some pooled investments in the now-notorious liability-driven pension investment funds would have been worth zero[11] if it hadn’t acted by stepping in to buy gilts.
His letter[12] to Parliament also directly linked[13] the crisis to the Mini Budget (or fiscal event, as it was formally called), not Russia’s war or even the US Federal Reserve.
See if you can spot the correlation that Truss and Kwarteng strain to notice:
As I say, I’d love to talk about something else next week. But we can’t duck how this all impacts our finances in the here and now, let alone the never-never of future government borrowing costs.
There are links below to the ongoing stress in mortgages, for example, and to reports of a sudden nosedive in the housing market.
The big danger now is this administration doesn’t have any political capital left to push through the controversial cuts and reforms that are required even by its own lights.
That could leave our economy in an 18-month limbo, until the next General Election.
Eat The Rich or die trying (a review, of sorts) – Monevator[16]
From the archive-ator: Mortgage risk checklist – Monevator[17]
News
Note: Some links are Google search results – in PC/desktop view you can click to read the piece without being a paid subscriber. Try privacy/incognito mode to avoid cookies. Consider subscribing if you read them a lot!1[18]
Public won’t be told to curb energy use after No. 10 reportedly objects – BBC[19]
Panmure Gordon: lower gas prices cuts 40% from cost of price cap [Graph] – via Twitter[20]
Fitch cuts UK’s credit rating outlook to negative, citing fiscal risk – Business Standard[21]
“Uninvestable” UK market loses £300bn in Liz Truss’s first month – Bloomberg via Yahoo[22]
Property sales collapsing at the fastest rate since the pandemic – Yahoo Finance[23]
[24]
“Kicking myself I didn’t move faster”: fear and panic grips the house market – Guardian[25]
Products and services
UK mortgage rates are soaring. What can you do? – Guardian[26]
Time to give annuities another look as rates rise 50% – ThisIsMoney[27]
Aldi was the cheapest supermarket in September – Which[28]
Open a SIPP with Interactive Investor and pay no SIPP fee for six months. Terms apply – Interactive Investor[29]
In the US, an Inverse Cramer ETF will enable you to bet against the pundit – ETF Stream[30]
Do higher rates mean it’s time to switch to fixed-rate savings accounts? – ThisIsMoney[31]
11 ways to save on heating bills this winter – Which[32]
Pretty mews homes for sale, in pictures – Guardian[33]
Comment and opinion
Time for investors to learn a new game [Search result] – FT[34]
Lunch with Elon Musk: “Aren’t you entertained?”[Search result] – FT[71]
The 2022 crash has taken its toll on financial influencers, but spam has replaced them – M.I.[72]
Why do you like the music you like? Science weighs in – The Washington Post[73]
And finally…
“For all that has recently been said about ‘the wisdom of crowds’, the authors prefer to fly with airlines which rely on the services of skilled and experienced pilots, rather than those who entrust the controls to the average opinion of the passengers.”
– John Kay, Radical Uncertainty[74]
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