Can tax-cutter Truss work a miracle?

The Boris ‘years’ are over, with new Prime Minister Liz Truss introducing her cabinet, confirming Kwasi Kwarteng as her chancellor and revealing how she will help households and businesses with skyrocketing energy bills through a funded support package. with loans.

Truss has cast herself as Britain’s new Iron Lady, and while her credentials in that regard have yet to be proven, it’s no exaggeration to say that the challenges ahead – including strikes, inflation, an ailing NHS approaching breaking point as usual, poor productivity growth, geopolitical tensions) are at least equivalent to the problems Margaret Thatcher faced when she came to power in 1979. Like Thatcher, she may be planning her own reforms of the Big Bang, and a planning revolution, and it seems likely that it will force through rule changes to release capital reserves of around £95bn from insurance companies for projects to boost the economy.

But the energy crisis that threatens homes and businesses cannot be ignored and is the first priority. So the national debt must grow, the timetable for reducing it must be stretched, the £30bn fiscal space identified by the Office for Budget Responsibility (OBR) earlier this year has been implemented, and discussions about how it will all be paid back the money was left for another day. Truss has confirmed that energy bills will be frozen for two years for families and businesses to protect them from economic disaster. The cost could be £150bn and the new chancellor is working out the details (these days, it seems, that’s what chancellors do: deliver huge state aid packages).

But Truss has also promised tax cuts, incentives and reforms designed to revive the economy and support growth, and to put money back in people’s bank accounts. But can tax cuts and general fiscal relaxation cure Britain’s problems?

That depends on the extent of the tax cuts, how long their growth-promoting policies take to work, whether or not the benefits of the cuts outweigh their cost (a big if), whether growth can be achieved in a more hostile macroenvironment. beyond government control, and how and when additional government borrowing will be reduced, which will put a rocket under the UK’s high debt-to-GDP ratio. The OBR predicted in July, when it warned of future economic crises, that public debt could reach 100 percent of GDP in the early 2050s. That day could now come much sooner.

There may be unexpected gains. Freezing energy prices could result in a several-point drop in the UK’s inflation rate, which would also help with government debt payments. In a high inflation environment, the Bank of England will offset looser fiscal policies with higher interest rates.

The new prime minister’s view is that high taxes are poison for growth and hamper investment. But talk of VAT cuts, and adjustments to tax thresholds and a reversal of the new national Insurance tax may come to nothing if the government bears the brunt of capping energy prices. In 2021-22 VAT raised around £132bn and a cut here could create a significant hole in Treasury revenue – around half of all household spending is exposed to this tax according to the OBR. Income tax delivers around £228 billion or nearly 25 per cent of all public income each year; even a 1 per cent reduction would cost more than £6bn a year, says RSM’s Chris Etherington. Reversing the NI changes would lose around £13bn.

But the planned rise in corporate tax to 25 per cent, initiated by Rishi Sunak to help restore public finances after £69bn wasted during the pandemic, may yet go away, and the incentives to encourage companies to invest they will be a priority given this. the government’s strong desire to boost business-led growth and investment.

Will these policies create the ideal conditions for growth, given that there are so many other factors at play? Corporate tax cuts will not ensure that companies spend the money on new projects and/or productivity boosts, especially in this high-stakes macro environment when there are jitters about protracted war, poor relations with the EU and generally what is around the corner. But encouraging innovation and investment is important, while putting more money in people’s pockets doesn’t mean the economy will grow, it just might soften the recession. A miracle is not realistic. Keeping the country in balance (with the invoice delivered later) may be the best we can hope for.

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