A struggling economy. An unpopular Conservative government. A dramatic change of course. Britain has been here before. Just like Reginald Maudling in the early 1960s and Tony Barber in the early 1970s, Kwasi Kwarteng has gone for broke, with a massive package of tax cuts designed to put Britain on a higher growth path.
The chancellor will be crossing his fingers that his experiment has a happier ending than those of his predecessors, neither of which ended well. It is one huge gamble on supply-side reforms boosting enterprise, tax cuts paying for themselves, and the financial markets remaining onside. The initial reaction from the City was far from reassuring.
As was only too predictable, sterling took a thumping on the currency markets. City currency traders might well be among the big beneficiaries of Kwarteng’s tax cuts but that didn’t stop them selling the pound down through the $1.10 level against the US dollar. Parity against the US currency is not that far away.
No question, this was a big package, a full-scale budget in all but name. Kwarteng delivered on all the tax pledges made by Liz Truss during her leadership bid – and more. The 45% rate of income tax for the highest earners has been scrapped; a reduction in the basic rate from 20% to 19% pencilled in by the former chancellor Rishi Sunak for 2024 has been brought forward by a year.
Put together with the removal of the increase in national insurance contributions and the decision not to go ahead with next April’s increase in corporation tax and you get a £45bn giveaway, not quite as big as Barber’s in 1972 but hefty by historical standards.
As the Institute for Fiscal Studies pointed out, this was a deeply regressive mini-budget, with the biggest percentage gains going to the top 1% of earners. The much more modest help for those on the lowest incomes will be wiped out by the higher cost of imported fuel and food caused by a weaker pound.
Kwarteng’s insistence that the government was committed to fiscal responsibility was greeted with derision from Labour MPs, particularly given the lack of independent scrutiny of the chancellor’s arithmetic from the Office for Budget Responsibility. Such an exercise might have questioned the newfound belief in the Treasury that new investment zones, slashing red tape, tougher welfare rules and an end to the bankers’ bonus cap will raise the trend rate of growth to 2.5%.
In effect, the mini-budget was a triumph for free-market thinktanks, such as the Institute for Economic Affairs and the Adam Smith Institute, which are true believers in the idea that low-tax, light-touch regulation, small-state economies are not just good for the rich but good for everyone.
That conviction is going to be tested to the limits in the months ahead. Britain has inflation at close to 10% and to the extent it boosts demand, the mini-budget will add to inflationary pressure. It will do nothing to discourage the Bank of England from continuing to raise interest rates and if borrowing costs go as high as the markets are predicting the sugar rush will be short-lived.
What’s more, the main beneficiaries of the package will be the better off; the politics of the package depend heavily on less well-off voters being convinced of the theory of trickle-down economics. They might take some persuading.
But the biggest immediate threat to the chancellor comes from a crashing pound and soaring bond yields. No chancellor can avoid the scrutiny of the financial markets, which is why Kwarteng’s gamble has only two feasible outcomes: complete success or abject failure. History suggests it won’t be the former.