Friday’s policy statement from Britain’s new chancellor was one of the most consequential fiscal events of recent decades. Here are eight observations on the package.
1. This is an audacious and radical departure from the previous 12 years of Conservative policy. £45bn of tax cuts, funded by borrowing, represent the biggest easing of UK fiscal policy since 1972. The government aims to roughly double the UK’s trend rate of growth to 2.5%, a hugely ambitious target given the UK’s poor productivity record.
2. Tax cuts will add to the boost to demand from the huge energy support package announced earlier this month. Monetary policy is pulling in the opposite direction, with the Bank of England raising interest rates to cool the economy. Although fiscal ease will bolster growth in the near term, it almost certainly means higher interest rates further out. Financial markets are pricing a peak in UK interest rates next summer of around 5.0%, more than twice today’s level of 2.25%.
3. Public sector debt will be far higher than previously expected. The Resolution Foundation estimates that the UK government will need to borrow more than £400bn extra over the next five years to fund tax cuts and support for energy bills. As a share of GDP, public debt will be almost 20% higher by 2025-26, according to the Resolution Foundation. Friday’s fiscal event and the energy support package will lead to the largest permanent increase in public borrowing since records began in the early 1970s.
4. Tax cuts and help with energy bills will not prevent a major squeeze on incomes. With inflation outstripping growth in earnings the Resolution Foundation estimates that the real value of non-pensioner incomes will be 8% lower by the end of 2023 than they were two years earlier. This is a significantly larger decline than was seen in an equivalent period in the financial crisis.
5. All taxpayers will gain from a lower basic rate of income tax and lower rates of National Insurance, but the gains will be greatest for higher income earners. According to the Resolution Foundation, two-thirds of the gains from the personal tax cuts will go to households in the top 20% of the income distribution and almost half go to the top 5%. The marginal effective rate of income tax and National Insurance for someone earning more than £150,000 will fall from 48.25% to 42%.
6. Even after Friday’s tax cuts the burden of tax will, by historic standards, remain high. The new government’s tax cuts only partially reverse increases announced previously by Rishi Sunak. Over the next few years taxes’ share of GDP is likely to remain at its highest level since the 1940s.
7. The initial verdict of financial markets to the fiscal statement was negative. Increased public spending has stoked expectations of higher interest rates to come. Together with a surge in government borrowing this led to a sell-off in UK government bonds and higher borrowing costs for the government. Last week the interest rate on 10-year UK gilts, or bonds, rose by 69bps, the largest increase in more than 30 years. Sterling also sold off on Friday, dropping 3.2% against the dollar to close at $1.09. The dollar has risen against almost all currencies this year, but the rise against sterling, some 20% since January, has been particularly pronounced.
8. Most commentators and economists see Friday’s package as a gamble. If tax cuts, allied to other pro-market policies, help boost trend growth they will have succeeded. That response is far from assured, even in the long term. Meanwhile, debt-financed fiscal easing creates new risks and points to even higher interest rates.
An immediate test comes when financial markets open this morning. A continued sell-off of UK government bonds and the pound would raise the pressure on the BoE to increase interest rates.
What is clear is that by setting its sights on increasing Britain’s growth rate, the government has set itself a hugely ambitious target.