Keeping up with Rishi Sunak’s recent shifts in political identity is bewildering. For most of his first year in office, he seemed happy to be cast as a sober technocrat who could restore political and economic stability in the wake of the Liz Truss debacle. Then came his bout of summer madness when he sought to reinvent himself as the agent of radical change, setting himself in opposition to all previous governments of the last 30 years. That fever seemed to have passed last week when he appointed David Cameron, who was prime minister for six of those years, as foreign secretary. Yet within days he was threatening to ignore international law over his unworkable and now confirmed illegal Rwanda Plan and talking up the prospect of tax cuts.
This sudden talk of tax cuts ahead of tomorrow’s Autumn statement is particularly perplexing given that the government has spent the last year insisting it would be irresponsible to cut taxes while inflation is still high and the public finances are under strain. The change of heart apparently stems from October’s larger than expected fall in inflation to 4.6 per cent and buoyant tax revenues thanks to rising wages and frozen thresholds. Despite an unexpected rise in borrowing last month, the second highest October borrowing figure on record, the Office for Budgetary Responsibility is expected to forecast that the government has around £25 billion of “headroom” to hit its fiscal target of reducing debt as a percentage of GDP in five years.
Yet these arguments don’t wash. Inflation is still more than double the Bank of England’s target of two percent, and with wages rising at close to eight per cent and a million job vacancies in the economy, it is far too soon to be declaring victory over inflation. Debt is still likely to be close to 100 per cent of GDP in five years, this year’s budget deficit is likely to be more than four per cent of GDP and interest costs are set to rise to their highest level since the 1980s, leaving little capacity to absorb future shocks, including a possible recession. What’s more, the fiscal space only exists if one believes whoever is in government after the next election can deliver on the eye-watering spending cuts currently pencilled into the fiscal forecasts. According to the Resolution Foundation, these require real terms cuts of 16 per cent over five years for unprotected departments, similar to 2010 levels of austerity.
Broken Britain
Is a new dose of austerity to pay for tax cuts really the right priority for Britain in 2023? Over the past year or so, there has been a near universal consensus across the media about the state of Broken Britain. There has been acknowledgement across the political spectrum at the dire state of the country’s infrastructure, public services and mediocre growth prospects. There are 7.7 million people currently on NHS hospital waiting lists, the prisons are full and over-crowded, the courts struggling with severe backlogs, school buildings are crumbling and curriculums are being cut. Much of the public sector faces severe recruitment and retention issues following a decade of falling real wages, resulting in waves of disruptive strikes.
Sunak is clearly calculating that many people would rather have tax cuts than see these problems addressed. Of course, who doesn’t like a tax cut and it is true that taxes are at a 70 year high. But the idea that Britain is over-taxed does not stand up to scrutiny. Its overall tax burden at 33.5 per cent of GDP in 2021 was 2.2 per cent below the average of other advanced economies and 6.4 per below the average of other western European countries. A higher tax burden is in any case surely warranted in the wake of three consecutive one-in-a-hundred year shocks in the form of a global financial crisis, a pandemic, and a major ground war in Europe. Nor need the current tax burden be a drag on growth: the 1950s, when taxes were last this high, were a time of unprecedented growth in Britain, as it was in all major western economies.
As if prioritising tax cuts in the current economic climate was not perverse enough, there is also the question of who ministers will prioritise tax cuts for. The initial kite-flying hinted at cuts to inheritance tax, a bizarre suggestion given the severe cost of living pressures facing many households, with the Joseph Rowntree Foundation reporting last month that 3.8 million people in Britain, including one million children, had faced destitution during 2022. On average just 3 per cent of estates pay this tax. Now the focus has switched to a possible cut in income tax or national insurance. Yet as the Resolution Foundation has noted, these too would disproportionately benefit the well off, particularly if tax thresholds remain frozen since the cut would not be sufficient for most taxpayers to offset the effects of fiscal drag.
The Truss Delusion
Almost as absurd are the government’s arguments to justify tax cuts. According to the Sunday Times, ministers are trying out the line that a 1p cut in income tax should in fact be considered a supply side reform on the basis that it would create an incentive to work harder. This borders on the Trussonomics delusion of self-funding tax cuts. In fact if the government was seriously concerned about work incentives it would engage in wholesale tax reform, not across the board cuts. The tax system is littered with eye-wateringly high tax rates throughout the income distribution as various benefits and allowances are removed, for example child benefit is withdrawn from families where one person earns over £60,000, while the tax free allowance is withdrawn from those earning over £100,000, leading to effective marginal rates of over 60 per cent. Graduates with loans to repay can expect a marginal rate of nine per cent above that.
All that the government’s invoking of supply side reform does is draw attention to how little the government has delivered of it. The only significant supply side reform attempted by the Tories since 2019 was planning reform, which it was forced to abandon because it could not reconcile the tension between its southern Nimby voters and obligations to the wider economy. Meanwhile the dire state of public services remains a huge drag on activity. Sunak has attempted to present his tinkering with investment allowances in the corporation tax regime, likely to be extended on Wednesday, as a supply side reform, but in reality it is hard to spot any discernible impact of corporation tax rates on investment flows over the last few decades either in Britain or any other advanced economy. On the other hand, what has clearly damaged investment is the government’s hard Brexit deal and years of Tory political chaos.
What Sunak’s sudden embrace of tax cuts shows, like his tactics on Rwanda, is that the political drama of the last seven years is going to continue right up to the election. Under pressure from his party’s right-wing and rattled by his inability to shift a 20 point deficit in the polls, he has clearly decided to abandon the mantle of cautious technocrat in favour of establishing clear dividing lines with Labour, whatever the cost. Fortunately, the potential for renewed financial turmoil is limited; with investors now fully discounting the probability of a Labour government, the only thing that could seriously unsettle the markets now is a narrowing of the polls that suggested the Tories might return. Nonetheless, with every new concession to Tory populists, Sunak’s likely legacy to Labour becomes that much bleaker.