Reviews | UK tax cuts will have to be paid for one way or another


Not even Margaret Thatcher has overseen such a bold set of tax cuts and deregulation as the one just announced by the British Conservative government. The first major government initiative under Liz Truss, the new premier, is expected to cut personal and corporate income taxes by more … than 45 billion pounds a year, according to the British Institute of Tax Studies. That would make it the biggest tax cut Britons have received since 1972 – three years before Truss was born.

Tax cuts aren’t the only thing on the agenda; There is a massive subsidy already predicted for household energy prices that will offset the disruptions of the war in Ukraine, and Kwasi Kwarteng, Chancellor of the Exchequer, promised Friday to reform child care, immigration, agricultural productivity, business regulations, digital infrastructure and barriers to home building. But the tax cuts and subsidies are the most important in the short term – and the markets aren’t happy with them.

Shortly after the government’s announcement, yields on UK government bonds jumped, while the value of the pound dropped sharply in the currency markets. It’s an unusual combination in rich country financial markets, but it makes sense when you consider that UK inflation is running at 8.6% annualized.

Part of the market reaction may be due to market concern about the government’s fiscal situation: the more money you borrow, the harder it is to repay it and the higher your risk of default. But it’s still not so likely that Britain will pull an Argentina and tell its bondholders to go pound the sand. The biggest risk is that by injecting more money into the economy, the government will further fuel inflation.

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This inflation will erode the purchasing power of sterling (which is why the pound has fallen) and eat away at the face value of government bonds (which is one of the reasons bondholders are demanding be compensated for the risk by higher returns). These higher yields, in turn, will increase the total amount the government must borrow.

Advocates for the government might counter that they sure understand this somewhat basic economy, but they have other issues to deal with. Russia’s invasion of Ukraine means Britain, like the rest of Europe, faces a cold winter with brutally high energy prices. Economic growth has been slow — indeed, slightly negative in the last quarterly report. And while everyone is dealing with the upheaval of war and the pandemic, Britain is also grappling with the disruption of Brexit.

The country needs both government reforms and business-led investments to broker these adjustments and rebuild itself into an economic powerhouse that can go it alone. It must also help vulnerable households through what will likely be a dark winter. Arguably, the government can’t help worrying about transient inflation – and even if the inflation isn’t so transient, the government will just have to worry about it later.

But governments can’t afford to worry about inflation later; if they or they don’t worry, the central bank will do it for them. The Bank of England has just announced its seventh consecutive rate hikeeven as he said the economy could already be in a recession.

This is something policymakers on our side of the pond are still struggling to grasp: the era of cheap freebies is over, at least for now.

When inflation was at rest and real interest rates were close to zero, politicians could pursue their political goals, or heck, just solicit votes, by pumping in borrowed money. And, boy, did they! But when inflation is high, the central bank will move to undo those actions by tightening monetary policy, and the markets will make you pay with higher bond yields. Stimulate the economy with borrowed money, and you’ll see the gains clawed back by higher interest rates. The resulting economic contraction and inflation will wipe out political gains along with economic gains.

Obviously, that message still hasn’t got through yet. Whether it’s Britain’s tax cuts or President Biden’s half-trillion-dollar offer to forgive student loans, governments continue to spend like there’s no money. tomorrow, only yesterday’s golden age. And in all honesty, “the free lunch is over” is a particularly hard message to hear when your economy is facing so many heartbreaking adjustments and you desperately need a little help. But as unpleasant as the truth is, it’s still the truth: as long as inflation stays high, when governments spend money or cut taxes, they’ll have to pay for it, one way or another. other.

The last 15 years have convinced many people that they don’t have to face unpleasant truths, that harsh realities can still be magic with more government money. But the real economic constraints were still there, waiting to reassert themselves. Now they have, and if governments don’t face these realities, reality will treat them harshly.


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