The UK economy has long suffered from slow growth. Combined with a further slowdown in productivity growth, the standard of living for the average family has not improved substantially over the past decade.
Now, the new prime minister, Kwasi Kwarten, has unveiled a radical plan to return growth to its historic average annual rate of 2.5%. This is an increase of about 1 percentage point, resulting in better living standards and more funding for public services.
A central part of Kwarteng’s mini-budget includes tax cuts in hopes of providing greater incentives for individuals and businesses to work harder and invest more. This is the largest net tax cut by a prime minister since the early 1970s.
Much of this will benefit the wealthy more than the low-income, but the government has made high growth, not redistribution, a priority, and as the economic pie grows, this will benefit everyone. It claims to be profitable. So does this work?
UK Prime Minister’s Net Tax Cuts
Highlights first. National insurance premium increases were halted, the top income tax rate and cap on bankers’ bonuses were abolished, and the basic income tax rate was reduced from his 20% to 19% in April. Stamp duty on home purchases has also been reduced, especially for first-time buyers.
The planned corporate tax hike in April will not go into effect for now, but a range of other incentives will be put in place to stimulate investment and reduce the regulatory burden, including tax cuts for the self-employed. Taken together, these measures will cost £45bn a year.
In addition, governments are spending heavily to keep energy bills down. It will cost an estimated £60bn a year over the next two years to mitigate the planned increase in households, and around £30bn to support businesses over the next six months. Depends on gas price.
The evidence is inconclusive as to whether lower tax rates will always motivate individuals to work harder and unleash entrepreneurship. With the number of her over 50 employees down significantly in the UK, especially since the pandemic, she could use her surplus cash to enjoy more leisure time.
On the other hand, the fact that poorer people benefit relatively little from tax cuts explains why the government plans to sanction those who work less than 15 hours a week and are not actively looking for work. maybe.
Ironically, post-Brexit, the government sees increased immigration as a way to boost economic growth by adding more workers to the economy. However, increasing the size of the workforce does not necessarily lead to higher productivity (output per worker).
Therefore, corporate investment incentives, together with the previously announced upskilling plan, will be very important to achieve a step change in growth.
UK GDP Growth 1949-2021
Business investment in the UK has historically been much lower than its main competitors. However, a series of corporate tax cuts has had little impact.
The same is true of many previous schemes that encouraged certain investments, such as the Johnson administration’s “superdeductions” for investments in factories and machinery.
Kwarteng’s business incentives also include a new low-tax investment zone and planning reforms, but it remains to be seen if this will make a big difference. With the looming recession, high inflation, energy crisis, supply shortages and difficulty recruiting skilled workers, it is difficult to predict dramatic changes in the short term.
The government has suggested that £47bn in additional tax revenue could be generated if the target of a one percentage point increase in annual growth over 2026-27 is met. This is a preliminary forecast and has not yet been scrutinized by the Office of Budget Responsibility.
In the short term, however, public spending could be significantly squeezed. The Fiscal Institute estimates that the impact of inflation will effectively cut sector budgets by £18bn compared to what was planned in the last Expenditure Review. This was before public sector salaries increased.
The Treasury Department’s own 2022 Growth Plan says “keeping spending under control” is a key part of its commitment to fiscal responsibility.
Regardless, the planned £90bn energy subsidy and £45bn tax cuts will provide a huge stimulus to the economy. To contain the extra inflationary pressure this exerts, the government hopes the Bank of England will continue to raise interest rates sharply. However, it is not clear how the tension between these two objectives will play out.
Equally disturbing is the fact that steps are being taken to raise the government budget deficit from £100bn to nearly £200bn next year, or almost 10% of GDP. This increases the likelihood that UK government debt will continue to rise as a percentage of GDP over the medium term.
UK government debt as a percentage of GDP
The government says that if its strategy boosts growth, it will not only add billions of pounds of tax revenue over five years to pay off the debt, but also increase the size of the economy as a whole, thus lowering the debt-to-GDP ratio. Nonetheless, the market reacted to the concerns, selling off British government bonds and the pound after the announcement.
where does this lead
The government has made it clear that its reforms will only bring benefits in the medium term. But short-term economic troubles can derail plans and threaten their chances of winning the election. This is because it will most likely be contested in 2024.
Liz Truss’ new government model re-baked the strategy of the 1980s Thatcher administration, where tax cuts and deregulation no doubt helped boost growth. However, tax rates were much higher at the time, and the size of the state-owned industrial sector was much larger.
Read more: Why Liz Truss isn’t Margaret Thatcher when it comes to the economy
A more worrisome comparison if the ‘dash to growth’ fails on short-term economic problems may be the ‘barber boom’ introduced by the Conservative government in 1970-74. A massive economic stimulus set off a spike in inflation, public sector wage strikes, and a foreign exchange crisis that led to the government’s defeat in the 1974 elections.
This is a dramatic shift in government policy and faces many obstacles. It may have a rough road ahead before seeing if this growth bet delivers the results its backers have promised.