I am finally catching up on the mini budget, which was announced on September 23rd. The market reaction has been almost as frenzied as the Twitter reaction, but I shall do my best to look at it constructively.
Firstly, as Ryan Bourne points out here, it reveals a strong conviction that:
a combination of marginal tax rate cuts and supply-side liberalizations of important markets will raise GDP by increasing hours worked, improving productivity, attracting more talented people and businesses to the UK, and raising net investment
I think that’s broadly accurate, but won’t be transformative. The political calculus is probably dominating the economic one. The actual growth agenda was more of an intent, in terms of:
deregulation in the provision of all of energy, infrastructure, childcare, and housing
As a work of PR, that combination of surprise announcements and vague intentions clearly struggled. But policy wise it is encouraging, and I’m broadly in favour of these types of supply side reforms. I’m honestly not sure whether the criticisms are that these are bad policies and shouldn’t be pursued, or that they weren’t sufficiently fleshed out to warrant a confident assessment about their impact on growth. Maybe the problem was that it was a “mini budget”, whatever that means.
That said, it is refreshing to see a reframing of the public policy objective from redistribution toward growth, and whether or not a 2.5% target is too optimistic, it could well serve as a useful focal point.
But that seemed to get sidestepped by the noise and chatter. I really noticed the low quality of public debate within the context of social media and increased political polarization. I saw several tweets that would be commented on and prompting great derision that had entered my feed quite long after being outdated. Imagine having a real time discussion about a football match where key events are revealed out of sequence. I’m not sure a rolling ticker is conducive to sensible analysis. People are freaking out that the pound is below $1.06, but it wasn’t. A 3% depreciation is big, but how much has it fallen over the last 6 months? Are these events or continuing trends?
I also noticed the odd situation where the left used the immediate response from financial markets as a judgment of the validity of the plans. It would be absurd for them to argue that a positive verdict from financial markets should be an objective of a budget. Maybe they would argue that for a Conservative budget, where the stated objective is to stoke markets, such attention is justified because it reveals that the policy has failed on its own terms. I’m not so sure though. I wish people would identify their success criteria before they, or their political opponents, announce something…
Putting the various reactions to one side, the main point I’d like to make is that in isolation most of these measures are pretty sensible. The main criticism, therefore, is about (i) choosing priorities; and (ii) how the plans were presented and communicated. But firstly, let’s look at the pros.
The pros
“Moving house” tax - stamp duty is stupid and everyone agrees. Cutting stamp duty isn’t the best way to improve the housing market, but it does, at the margin, improve allocative efficiency, which is good. As Paul Johnson said, “Perhaps a smaller change that we might have hoped for from such a radically tax cutting chancellor, but welcome nonetheless”. A key priority for any government should be moving toward a system where we tax property/land values rather than property transactions, and any attempt to reduce stamp duty is to be commended.
Corporation tax - corporation tax is a hobby horse of mine because it’s such a counterintuitive policy. Superficially it appears like an alternative to taxing labour, but not only does a large share of the incidence fall on employees, it contributes to the inefficient ways in which we tax capital, which in turn harms labour. And UK corporation tax is particularly bad. No sensible economist would advocate a large increase (i.e. 6 pp) in corporation tax as we head into a recession, therefore it’s perfectly reasonable to take the opportunity to maintain the current rate at 19%.
Income tax - this is where most of the headlines have focused, but the fact that these are the “biggest tax cuts in 50 years” also tells us something about how high the starting point is.
Revoking planned increases in NICs is a good move and has been largely ignored in the analysis because it’s a good move.
It also seems a good idea to scrap IR35 (which forces companies to withhold tax from self-employed labour as if they were permanent employees).
Reducing the basic rate from 20% to 19% is a meaningful policy to help typical workers, and a step in the right direction. I would like to see larger tax cuts for lower rate payers, but notice that more than twice as much of the “cost” of this budget is from cutting the basic rate rather than removing the top rate.
Removing 45% top rate - this is probably a useful way to encourage high productivity workers to increase output without forsaking a large amount of potential revenue. I’d have liked to see more simplification, particularly with the absurd marginal rate of 60% on income over £100,000 (which occurs because the personal allowance is removed above that amount), but there clearly is some attention to the costings here.
Overall, some would argue that this isn’t sufficiently targeted at lower income taxpayers. I agree with this, but the fact that the chart below became so widely shared reflects a really stupid approach to the debate. Of course tax cuts disproportionately affect people that pay more tax. Of course people that don’t pay tax won’t benefit from a tax cut. Come on.
There also seems to be something refreshing about a Conservative budget so clearly focused on undoing policies that were controversial at the time. Let’s not forget that when Labour introduced the 50% top rate in 2009 it was supposedly an emergency response to the global financial crisis. There was no strong economic case for such a high marginal tax rate and it would have been highly controversial outside of such serious conditions. When the subsequent Tory/LibDem coalition reduced it to 45% this seemed to take the psychological edge off the punitive rate, but was hardly a return to an optimal amount. A top rate of 40% is not particularly high, and by removing an entire band a welcome step toward simplification occurs. Labour turned this into a political football, and I think it’s strategically understandable for Truss’s team to send a credible commitment that such gestures get swiftly undone once power changes hands. Perhaps it incentives both sides to engage in sensible policy rather than contentious point scoring.
Cons
Regardless of how desirable those announcements are, in isolation, however, let’s consider the two big counterpoints.
Choosing the the wrong priorities - the headline tax figures are all focused on the top end and that presents bad optics in a cost of living “crisis”. To be fair to Truss, however, she is an incoming Conservative Prime Minister and Tories are going to Tory. I would have liked to see more focus on poverty reduction but we shouldn’t ignore the previously announced energy price cap (which may actually be a more sensible policy than I first feared, given the difficulties in targeting direct support where it’s needed). Maybe I am paying attention to the wrong vocal critics of the mini budget, but I’ve struggled to see a viable and plausible alternative being proposed.
Bad expectations management - the big lesson should be the importance of traditional public finance responsibility - the encouragement of independent impact assessment and some form of baseline forecast. I think a large part of the market reaction was the disregard for any fiscal rule and lack of attention to costings. And this is what I find most interesting about the issue. If Cameron/Osborne held an overly tight commitment to fiscal discipline (arguably overstating the threat from financial markets for unfunded spending commitments) then May/Hammond/Johnson/Sunak all took a hybrid position of paying lip service to Conservative commitments to fiscal prudence while in practice demonstrating immense profligacy. (Perhaps profligacy is the wrong word here - recent Conservative spending is insufficient in some areas that desperately lack investment, and is entirely justified given the Covid-19 pandemic and situation in Ukraine). The difference with Truss/Kwarteng is the complete sidestep of fiscal concerns in the favour of a bigger growth perspective. In doing so, they actually reveal that 2010s austerity might not have been such an unnecessary act of self harm. It almost feels as if they’ve seen how Labour have behaved in opposition, downplaying market discipline, and flirting with MMT, and thought “sod it, let’s do the same.” ERROR.
I think it’s uncharitable to conclude that these plans are chaotic and have been exposed as lacking coherence (of course an alternative narrative is circulating, that the Pound crash was a deliberate ploy, because Kwarteng used to work for a hedge fund. This ties into an existing conspiracy theory relating to how Brexiteers supposedly profit from economic chaos. It’s interesting, but thus far unproven. Personally, I don’t see evidence that the market response was the intention).
Interpreting the market reaction isn’t straightforward, but Ryan Bourne provides the most thoughtful response that I’ve seen:
Working out the precise economics of why we saw the combination of the falling pound and rising gilts is difficult to parse from financial market data, but can only really logically be explained as a fear in markets that the UK might engage in “fiscal dominance,” with the Bank of England eventually being too permissive on inflation, and keeping rates too low, to help out a government with high and rising debt.
This means that I also have some sympathy for the view that the markets reaction is in part an assessment of the Bank of England’s ability to deliver a soft landing.
Kwarteng: here are our plans. Assuming the Bank of England does their job, it shouldn’t have a reckless impact on inflation.
Bailey: hmm, we’ll let you know what we think of all this in November.
Ultimately, this mini budget is a fascinating reversal of typical strategy, which ordinarily sets out spending commitments and then attempts to retrospectively finance them through some combination of tax rises or additional borrowing. Instead, we see a clear focus on taxation, and spending plans are (thus far) treated as a secondary consideration. I think this is the right way round, although such a radical decision may have surprised and jolted market response. But let me outline a possible scenario:
Truss doubles down on a growth objective
The political legitimacy of the Conservative Party rests on achieving it
Usual resistance to serious supply side reforms is weakened
It’s bold, naive, and possibly reckless. But if you have identified low productivity growth as the biggest problem facing the long term prosperity of the British people, it might be a gamble worth taking.
Note: The two best insights on Truss’s economic policies are Ryan Bourne and Julian Jessop. I highly recommend their commentary.