For the first time since 1979, a Chancellor stood at the despatch box and took on the economic status quo. Since 1997, economic policy has been geared around short-termism and focus groups rather than coherent principles or long-run growth: Kwasi Kwarteng has demonstrated that he has no interest in perpetuating that state of affairs.
Kwarteng not only reversed Boris Johnson’s regressive National Insurance increase and his proposed 6 per cent rise in the job-killing corporation tax, but he went even further by slashing stamp duty, cutting the basic rate of income tax to 19p, and eliminating the 45p income tax band. The basic rate cut and National Insurance freeze will deliver further relief to those struggling this winter, while nixing the 45p rate and axing the Corporation Tax hike will ensure that Britain becomes a more attractive place to do business.
Centre-left commentators have generally judged the Chancellor’s tax cuts through two short-term lenses:
The first question is an important one, the new administration must balance the books, but the rates of taxation are not the only factor influencing government revenue. The Treasury estimates that a 0.25 per cent increase in trend growth will recoup £11bn in tax receipts over five years, covering the initial cost of eliminating the 45p rate during the same period. If the target of 2.5 per cent trend growth is met over five years, that number rises to £23bn. Focusing on tax rates assumes that the economy is frozen in state, that there is a fixed pie which ought to be distributed. This is exactly the opposite approach which this government is taking, they want to see the overall pie grow and with-it higher wages, more investment, and more economic activity which in turn means higher revenues for the Exchequer.
As the Cato Institute’s Ryan Bourne pointed out last week, tax policy should not serve only to maximise short-run revenues, but also to create the best possible incentive structure for private sector actors to increase economic activity. Exclusively focusing on the short-term impacts on the public finances overlooks this essential function of tax policy. Keeping Corporation Tax low and cutting the top rate of income tax may cost the Treasury, but it should make Britain a more attractive place to do business, one which encourages its own residents to make more money whilst attracting more investment from overseas.
That said, the decline of the Pound against the Dollar and increase in long-term UK bond yields demonstrates that these measures must be followed up with significant public sector reforms and spending cuts. Truss and Kwarteng understand that the stagnant statist consensus on tax must end, but they must also tackle the bloated public sector to adjust the state to its new funding regime. This means smaller measures like civil service reform, in addition to wholesale privatisation of industries that the state has no business being involved with. A first step on public sector reform would be to end government involvement in the railways by privatising Network Rail, ending subsidies to private operators, and allowing the market to set the price of tickets.
The second prevailing criticism is that the measures will benefit higher income households significantly more than those on low incomes. Shocking as it was to find out that those who pay more tax will benefit from tax cuts, it’s not as if the Government has been stingy on support for those on low incomes, having announced £60bn’s worth of support to keep energy bills low this winter. Cries of Tory hatred for the poor will undoubtedly abate if living standards increase across the income distribution, which is why the Government must follow this encouraging fiscal announcement up with more radical measures.
The most important of these is on housing and planning. Our burdensome planning system has held the entire economy back, with the effects disproportionately felt among the poor and the young. By locking up swathes of land around the productive centres of the British economy, housing supply has been restricted while putting downward pressure on labour mobility. Freeing up more land for housing supply would allow workers greater freedom to change employers, make the dream of home ownership a reality for more people on lower incomes, and ensure the most productive (and thus well compensated) use of workers’ labour.
Friday’s fiscal statement was a welcome first step from the new administration: they announced some important new policies and clearly demarcated themselves from the stagnant statist consensus of the last 25 years. Nonetheless, this package must be the first of many to address the obstacles to growth. There must be a consistently radical and growth-oriented approach to politically sensitive economic issues, from housing and childcare to transport and health.
Some optimism is warranted, but the Downing Street duo must demonstrate their willingness to power through short-term market setbacks if we are to believe that they can deliver the long-lasting economic reforms that they are promising.