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Prime Minister Liz Truss says a mix of tax cuts and deregulation is needed to jump-start Britain’s sluggish economy. Investors, economists and some in Truss’s own party disagree.
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Britain’s economy has wobbled along since the financial crisis more than a decade ago, in 2008, with weak productivity and low pay. Recently, it lost its place as the world’s fifth-largest economy to India.
While the global economy faces a slowdown, Britain has many unique challenges. Brexit has erected barriers to Britain’s largest trading partner, the European Union, deterring business investment and breaking a connection to a large pool of workers. The overburdened National Health Service, pushed to the brink by the pandemic, has an immense backlog of patients needing care, keeping many of them out of work. And now inflation, running near a 40-year high, is squeezing household budgets.
This is the quandary that Prime Minister Liz Truss of Britain says has forced her to make “controversial and difficult decisions” to put Britain on a path to higher growth. Within weeks of taking office, she and Kwasi Kwarteng, the chancellor of the Exchequer, made their big pitch, which was heavy on tax cuts and deregulation and echoed the policies of Margaret Thatcher and Ronald Reagan.
On Monday, after a backlash from investors, economists and members of his own party, Mr. Kwarteng reversed one of the government’s proposals, deciding against abolishing the tax rate of 45 percent on the highest earners. That plan had drawn a lot of criticism, but proposals for other tax cuts worth tens of billions of pounds remain intact, as the government insists it is on the right path.
“I know the plan put forward only 10 days ago caused a little turbulence,” Mr. Kwarteng told members of the Conservative Party at their annual conference on Monday. “I get it. We are listening and have listened, and now I want to focus on delivering the major parts of our growth package.”
Reversing the cut to the top income tax rate has “limited fiscal significance,” Paul Johnson, the director of the Institute for Fiscal Studies, said in a statement, adding that the government will need to do more to restore its credibility after such a tumultuous beginning. Bigger U-turns will be needed to avoid large cuts to public spending, he said.
Many economists, including at the International Monetary Fund, have condemned the government’s plans as misguided at a time of high inflation and rising interest rates, especially because billions of pounds in additional debt will need to be raised to finance tax cuts on top of a previously announced pledge to cap soaring energy bills.
The markets also delivered their verdict, provoking a severe sell-off in British government bonds and a plunge in the value of the pound, which briefly touched a record low against the dollar. The Bank of England had to step in to bring order to the markets, as the portfolios of pension funds teetered and mortgage lenders withdrew loans from bewildered borrowers.
In recent days, the opposition Labour Party has pulled far ahead of Ms. Truss’s Conservatives in the polls, putting her leadership on shaky ground from the outset.
On Sunday, Ms. Truss told the BBC that, in retrospect, she “should have laid the ground better.” But she stood by the plan as urgent and necessary to jump-start the economy. “To grow the economy, we really must do things differently,” Mr. Kwarteng told members of his party on Monday.
Many are not convinced that “Trussonomics,” as some are calling the prime minister’s economic approach, is the right mix of policies.
The turmoil began on Sept. 23, when Mr. Kwarteng stood before Parliament and announced sweeping tax cuts and an easing of rules, including the removal of a cap on bankers’ bonuses. He also abandoned a proposed increase to the corporate tax rate as well as a reduction in levies on house purchases. The policies were delivered without an independent assessment of their economic and fiscal impacts — a typical step in making major policy announcements. That spooked investors.
“It’s quite a bold hypothesis to say the reason that our productivity performance is so dismal compared to other countries is that we just haven’t gone low enough in terms of tax and regulation,” said Diane Coyle, a professor of public policy at the University of Cambridge. “There’s no evidence that it’s going to work.”
For the government to turn around Britain’s low productivity and sluggish economy, it will need to find ways to increase the supply of workers, change the rules that govern how residential and commercial spaces are built and used and commit to investments in public health, education and infrastructure, economists argue.
Critics have argued that Ms. Truss’s plans are little more than a return to the so-called trickle-down economics of the 1980s, the belief that tax cuts for companies and the wealthy will eventually benefit those with lower incomes. Worse still, the amount of borrowing planned to fund the government’s policies raises the specter of cuts in public spending to reduce the fiscal strain.
“No one’s denying that the private sector is ultimately the source of productivity,” said Jagjit Chadha, the director of the National Institute of Economic and Social Research, a think tank in London. But the British economy suffers from a poor and inequitable supply of public goods, such as education and transportation.
“If you don’t implement policies that provide the necessary initial conditions, as we say in economics, then the private sector can’t necessarily thrive,” he said.
The government’s overarching goal isn’t controversial: to increase Britain’s trend economic growth to 2.5 percent, much higher than what has been achieved for the past two decades. More contentious is the belief that lowering taxes could generate that growth, which would ultimately raise government revenues to spend on public services.
Lower taxes and less regulation are guiding principles for Ms. Truss, who was elected to Parliament in 2010. She and Mr. Kwarteng wrote a book with other newly elected lawmakers, “Britannia Unchained,” which warned that “a bloated state, high taxes and excessive regulation” were holding back Britain’s economy. The authors wrote that they were “unembarrassed” by their “support for business, the profit motive and the individual drive of the wealth creator.”
But evidence that tax cuts for higher earners create incentives for broad-based economic growth is weak. A recent study by two researchers at King’s College London, which examined 50 years of tax cuts for the rich in advanced economies, found that those cuts did not have a significant effect on economic growth or unemployment and did increase income inequality. Studies of former President Donald J. Trump’s 2017 tax cuts suggest that they did not deliver the steep gains in investment and productivity as promised.
“It’s a strange leap of faith, really, to say cutting taxes for the rich somehow will transfer across” to big investments in public services, said Josh Ryan-Collins, the head of research at the Institute for Innovation and Public Purpose of University College London, which advises governments.
There is a risk that Ms. Truss’s policy choices are more likely to provide an unwelcome rise in demand during a period of high inflation than they are to increase the supply side of the economy.
Experience — including the “dash for growth” in 1972, the last time a British government cut taxes as steeply as Ms. Truss has proposed to do — suggests that the plan is “stoking up the boom that the Bank of England will have to deal with by having higher interest rates than otherwise,” said Mr. Chadha of the National Institute of Economic and Social Research. In the long run, that will be “more damaging to the economy,” he said.
The Bank of England’s chief economist said the government’s policies would be met with a “significant” response from monetary policymakers. Markets expect the central bank to raise its key rate to about 5 percent early next year, from the current 2.25 percent, increasing borrowing costs, roiling the mortgage market and blunting the chance of a short-term jolt to the economy.
“It’s a package that was relatively ill conceived in the first place,” Andrew Goodwin, the chief U.K. economist at Oxford Economics, said of the government’s policies. “And then I think they’ve compounded that by delivering it incredibly poorly.”
In an effort to calm markets, the government said that it would flesh out its policies, including changes to financial regulation, child care and immigration, and that it would publish “shortly” a “medium-term fiscal plan” that included an independent analysis of its impact on the economy and details about how the government intended to reduce the country’s debt burden.
This comes against a global slowdown in growth. The Organization for Economic Cooperation and Development recently said economies were slowing more than expected, slashing its forecasts for this year and next. The institution predicted that Britain’s economy would not grow next year.
“I think they would like to be radical,” Mr. Goodwin said of Ms. Truss and her government. But, he added, “they have to deal with the world they are living in, not the world they would like to be living in.”
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