The race for leadership of the Conservative Party, and indeed the next general election, will be decided by big economic ideas. In a country faced with a potential inflation rate of 15 percent (which could mean a real wage cut of more than 10 percent for everyone in the country) and the likelihood of a recession, voters want bold new ideas.
As she demonstrated in last night’s leadership debate, Liz Truss understands this very well, and is offering Conservative members tens of billions of dollars in tax cuts and “full-fat free ports,” which she claims will boost investment while lowering inflation. Trussonomics is a radical departure from current orthodoxy, an economic rethink that will have serious implications for businesses, consumers and institutions, most notably the Bank of England.
But critics warn that the assumptions Truss is making — that tax cuts will pay off, that there is capacity in the economy — are wrong and that continuing those assumptions could do even more damage to an ailing economy.
Do tax cuts help the economy?
Truss has said that not raising the corporate tax rate next April from 19 percent to 25 percent and reversing the increase in Social Security introduced in April this year will increase business investment and the “supply side” of the economy (productivity and efficiency).
Taxes are related to investments, Michael Devereux, director of the Oxford University Center for Business Taxation, told me. “In the context of a multinational company’s decision to establish a plant or invest in the UK rather than another country, there is ample evidence that the tax rate plays a role in that decision.”
As a former Secretary of Commerce, Truss may have a special interest in these foreign direct investment decisions and the policies that affect them. But for the rest of the economy, a corporate tax cut makes less sense. Devereux said domestic companies are more concerned about things like capital deductions and deductions (like Rishi Sunak’s super deduction) for investments. For most investments, “the calculation depends much more on how lax the tax system is in defining taxable profits” than the overall rate at which the profits are taxed.
While companies clearly consider tax costs when planning a new investment, Devereux said the link between social security or income tax and “any kind of growth is not at all clear”. In other words, people are not responding individually to lower personal taxes by staying at work an extra hour each day.
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Can tax cuts lower inflation?
Truss has also claimed that her tax cuts would help curb inflation by boosting businesses and stimulating the “supply side” of the economy. From a certain perspective, this makes sense: the inflation we are currently witnessing is being driven by tight supply (high energy costs, shortages, broken supply chains), so it can be argued that increasing supply would offset demand and thus counteract rising prices .
But even if companies were to reinvest the money saved by lower corporate taxes, it would only lead to more demand, because companies are consumers too: you can’t just whip up an offer out of thin air. So that would at least negate the effect of the tax cut and could only create more inflation.
For personal taxes, too, the effect of being able to keep more money is likely to mean higher spending and therefore higher demand, which could put more upward pressure on prices.
That’s not to say tax cuts can’t be disinflationary: Targeted tax cuts like fuel and sales tax directly lower the cost of items in the “shopping cart,” which the Office for National Statistics (ONS) uses to calculate how quickly prices are rising, which is reflected in can affect the price of goods and services that are linked to the inflation rate, such as B. Train tickets and mobile phone bills.
Are full-fat free ports as tasty as they sound?
Freeports – business zones where companies are encouraged to invest through lower taxes and regulations – are arguably Sunak’s preferred policy; he saw this as a major reason to evade EU state aid rules. Truss parks their tanks on Sunak’s lawn with an offer of “full fat” freeports that – thanks to as yet undisclosed details – will be even freer than his.
In practice, however, the key freedoms conferred by free ports include the freedom to launder money and evade taxes (as noted by the European Parliament in 2018). Deregulated zones can also give companies more latitude for workers’ rights; While this can benefit some businesses, as the rapid growth of the gig economy has shown, it also keeps productivity in check by depressing wages and preventing workers from investing in their own career development.
The headroom myth
Inflation is scary and needs to be fought – but for truss followers, it also has benefits. As prices and wages rise, so do government revenues, as higher taxes are levied on goods, and “fiscal strain” – one of the least fun types of strain – causes more workers to pay higher taxes. Meanwhile, the national debt is becoming cheaper to service, creating tens of billions of pounds worth of “wiggle room” that Truss said is now available to allow for tax cuts.
The problem with this is that it’s fairy gold, created by historically low interest rates (and therefore very cheap government debt). For every percentage point that interest rates go up, the $800 billion will increase by $20 billion over the long run, according to the National Institute of Economic and Social Research.
One economist cited by Truss as an influence is Margaret Thatcher’s former adviser Patrick Minford, who wants a 5 to 7 percent interest rate. That might be desirable in a healthy economy, but Britain has a long, long way to go before it can afford debt at these prices.
Return of the Iron Lady?
Truss may be perfectly reasonable to address older Conservative members as the second Thatcher they will remember beating inflation with policies like monetary targets for the Bank of England (Truss has said she wants to change the bank’s mandate and that “we weren’t tough enough on the money supply”). But you may also recall that Thatcher achieved this by creating a deep recession that left three million people unemployed.
There’s also the fact that you can’t use the policies that finally pulled Britain out of its recession in the early 1980s – sell-off of national industries, sell-off of council housing, deregulation of banks and other industries – because those cards have already been played. Most worryingly, Trussonomics is doing the damage Thatcher caused without the remedy that followed.
[See also: Sunak or Truss: Who won the Tory leadership debate?]