A struggling economy. An unpopular Conservative government. A radical change of course. Britain has been here before. Much like Reginald Maudling in the early 1960s and Tony Barber in the early 1970s, Kwasi Kwarteng went bankrupt, with a massive package of tax cuts designed to put Britain on a higher growth trajectory.
The Chancellor will be crossing his fingers that his experience ends happier than those of his predecessors, none of whom ended well. It’s a huge bet on supply-side reforms that boost business, tax cuts pay off and financial markets remain supportive. The first reaction of the City is far from reassuring.
As was all too predictable, the pound sterling took a hit in the currency markets. The city’s currency traders may well be among the big beneficiaries of Kwarteng’s tax cuts, but that hasn’t stopped them from selling the pound through the $1.10 level against the US dollar. Parity with the US currency is not that far off.
No doubt it was a big package, a grand scale budget in all but name. Kwarteng has delivered on all of the tax promises made by Liz Truss during her leadership bid – and more. The 45% rate of income tax for the highest earners has been abolished; a reduction in the base rate from 20% to 19% planned by former Chancellor Rishi Sunak for 2024 has been brought forward by a year.
Add to that the scrapping of the National Insurance contribution increase and the decision not to go ahead with the corporate tax increase next April and you have a $45 billion giveaway pounds sterling, not as large as Barber’s in 1972, but heavy by historical standards.
As the Institute for Fiscal Studies has pointed out, it was a deeply regressive mini-budget, with the largest percentage gains going to the top 1%. Much more modest aid for those on the lowest incomes will be wiped out by the higher cost of imported fuel and food caused by a weaker pound.
Kwarteng’s insistence that the Government was committed to fiscal responsibility was met with derision from Labor MPs, particularly given the lack of independent scrutiny of the Chancellor’s arithmetic by the Office for Budget Responsibility. Such an exercise could have called into question the Treasury’s new belief that new investment zones, reduced red tape, stricter social protection rules and the end of the cap on bankers’ bonuses will increase the trend growth rate. at 2.5%.
Indeed, the mini-budget has been a triumph for free-market think tanks, such as the Institute for Economic Affairs and the Adam Smith Institute, who sincerely believe in the idea that a low rate of light taxation and regulation, small state economies are not only good for the rich but good for everyone.
This conviction will be put to the test in the months to come. Britain has inflation close to 10% and to the extent that it stimulates demand, the mini budget will add to inflationary pressure. This will do nothing to deter the Bank of England from continuing to raise interest rates and if borrowing costs rise as high as the markets are predicting, the sugar rush will be short-lived.
Moreover, the main beneficiaries of the package will be the best off; the politics of the package depend heavily on less affluent voters believing the theory of trickle-down economics. They might take a little persuading.
But the biggest immediate threat to the Chancellor comes from the collapse of sterling and soaring bond yields. No chancellor can avoid scrutiny in the financial markets, so Kwarteng’s gamble has only two possible outcomes: complete success or dismal failure. History suggests it won’t be the first.