News

A clash over tax and economic policy has dominated the early tussles between former chancellor Rishi Sunak and foreign secretary Liz Truss in their bids to become Conservative leader and the next UK prime minister.

As the second phase of the leadership contest got under way this week, with two candidates facing a vote by party members, the dividing line between their campaigns has hardened around tax.

This is not surprising when the UK economy is suffering its worst bout of stagflation — low growth with high inflation — since the 1970s with a likelihood that this will descend into an inflationary recession, as tax levels rise to their highest level since the second world war.

Although Andrew Bailey, Bank of England governor, has been reluctant to spell out the implications of rising prices, he said this week that a 0.5 per cent interest rate increase was “on the table” to defeat inflation at the same time as the central bank is forecasting the economy will contract next year.

The choice of leader now falls to about 160,000 Tory members with the new prime minister declared on September 5. Here are six key questions to consider when assessing the economic policies of each finalist.

1. What are the candidates’ main economic proposals?

Truss, the frontrunner in the polls, wants to overturn what she sees as a cozy consensus, “peddling a particular type of economic policy for the past 20 years and it hasn’t delivered growth”.

She proposes immediate tax cuts as her big idea. Specifically, she wants to reverse the national insurance increases imposed in April, a plan to cancel the corporate tax rate rises next April and a temporary removal of green energy levies on electricity bills.

The cost of the package would be more than £30bn, Truss has said, but she insists this plan will not be inflationary, will prevent recession and ultimately boost tax revenues through higher growth.

Sunak also wants to cut taxes but only after inflation — which hit a 40-year high of 9.4 per cent in June — returns to more manageable levels. This, he said, was more responsible than “something-for-nothing” tax cuts funded by borrowing, which were more extreme than the policies proposed by former Labour leader Jeremy Corbyn.

2. Can the UK afford tax cuts?

Yes. Countries can always afford to cut taxes, but they have to accept the consequences. Unless the result is a large and permanent improvement in economic performance, lower headline tax rates have to be balanced either by lower public spending, higher public borrowing or stealthy tax rises elsewhere.

With historically poor levels of performance in the health service and strains in public sector pay, holding government departments to spending plans set last year will be difficult for both Truss and Sunak.

The next prime minister will face demands for further support for households struggling to pay soaring energy bills this winter.

3. Do tax cuts raise inflation?

With very few exceptions, tax cuts are inflationary but might not necessarily raise inflation.

Reducing tax rates puts more money in the pockets of households or companies, some of which is likely to be spent. This generates higher inflation than a world in which taxes had not been cut. The inflationary effect might not actually increase inflation, however, either because the effects are small, or because they will be offset by higher interest rates set by the central bank.

Jagjit Chadha, director of the National Institute of Economic and Social Research, has highlighted the importance of monetary policy to offset fiscal stimulus at times outside a period of depression. “Inflation is ultimately determined by the central bank,” he said.

The logic is awkward for both Truss and Sunak. It suggests Truss cannot simultaneously argue tax cuts do not increase inflation but prevent recession. For Sunak, the difficulty stems from saying his opponent’s plans are inflationary yet also praising the BoE for its ability to control inflation.

4. Will tax cuts avoid recession?

No. If you accept that the BoE is in charge of managing the economic cycle, then it will offset any effect of tax cuts on the UK’s immediate economic prospects.

Those advising Truss accept her suggestion that tax cuts both boost growth and reduce inflation is problematic. Julian Jessop, an independent economist, said: “You can’t believe all of these things at once for every tax change, but you can believe some of it for some of the tax changes.”

Sunak also has questions to answer on this score. Having been chancellor for more than two years, he will find it more difficult to avoid blame for the coming economic downturn that the BoE thinks is necessary to control inflation.

5. How will the candidates boost growth?

Sunak has promised a Thatcherite agenda of reforms, but has not mentioned any new specific policy reforms. Truss has pinned her hopes on her tax cuts having powerful effects on stimulating investment and labour supply.

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, was sceptical: “We’re not buying Truss’ argument that these tax cuts would trigger a big enough supply-side response to offset a decent chunk of their cost to the Treasury.”

Neither candidate has mentioned supply-side reforms on planning or improving trading relationships with the EU that could offer significant efficiency improvements but with potential political costs.

6. How plausible are the economic plans of each candidate?

Truss has an optimistic campaign that sees tax cuts as boosting growth, improving efficiency, saving money and reducing inflation. Her plans are highly unlikely to achieve all of these ambitions.

Sunak has talked of tax cuts while the tax burden is rising to its highest level since the late 1940s, and a Thatcherite agenda without spelling out his desired policies. His plans, therefore, are undermined by the appearance of style over substance.

The argument over tax cuts is fierce but peripheral to the bigger troubles of an energy crisis and low growth rates that plague the economy, said Simon French, chief economist of Panmure Gordon. “The turf war over inflationary impulse from tax cuts is a little like arguing over the curtains in the Colosseum as Rome burns,” he said.

Articles You May Like

Chicago preps deal amid heated budget debate
Tech stocks hit first all-time high since July
Tesla loses bid to restore Musk’s record $56bn pay package
Here’s what the rise of homeowners associations means for buyers
More conservative Texas Legislature tees up bills for 2025 session