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The mini-budget: An Autopsy


I wrote two weeks ago that Boris Johnson will surely go down as the worst Prime Minister in modern British History. Last week, Kwasi Kwarteng made himself top contender for the worst Chancellor.

The “mini-budget” he announced to a startled Parliament last Friday is a major fiscal event. Passed without the OBR forecasts saved for full budgets, we can only estimate the full cost of his experiment, but it will be substantial.

Truss and Kwarteng campaigned on being “unashamedly” focused on “growth”. This is a flawed growth strategy based on complacency about the market appetite for government debt. 

This “mini-budget” is premised on the ideology known as trickle-down economics: that supply-side tax cuts and reforms that broadly benefit the wealthy drive economic growth and improve the financial situation of all. This theory has long been propped up by the near-religious adulation of Saint Reagan and Mother Thatcher. En bref: the rising tide lifts all boats. This theory has, however, been widely and devastatingly discredited. 

As Paul Krugman notes in his recent column for the New York Times, economic growth under Reagan actually fell below the pre-Reagan trend line and finished roughly where it was trended to be before he came to power. Moreover, Clinton’s tax increases led to faster average growth than under Reagan. 

The reasons for this are complex and historically nuanced but can be broadly surmised as follows: money given to the wealthy is not spent in a way that drives economic growth. The wealthy, with no pressing material needs, are likely to save or invest it. Conversely, the economically less well-off are likely to spend it on goods that they need, such as housing or other essential material goods. So, instead of being funnelled into non-productive financial markets, the money is spent in the real economy, enriching those who sell goods and precipitating around the economy.

It is also important to note that, even if we were to follow the logic of tax cuts (especially of corporation tax) making the economy more competitive, these cuts do not change the relative attractiveness of the UK as a place to invest. Reversing the proposed increase in corporation tax will not encourage businesses to rethink their focus on the UK. A 6% rise to 25% (as was proposed by Sunak) would only bring the UK in line with many of its European neighbours, and still below France and Germany. 

So, trickle-down economics is economically illiterate, but there is a further concern: this mini-budget is hugely inflationary. As pointed out by the IMF, “large and untargeted fiscal packages at this juncture” are not recommended. These inflation pressures will likely push the Bank of England to issue a greater than predicted rate rise. 

Financial markets, particularly in gilts, sterling, and other related assets, have reacted extremely negatively to what they view as ill-timed fiscal overextension. These markets are fundamentally confidence driven. They run on trust in the ability of the UK government to honour its debt commitments to its creditors. The size of this mini-budget took a sledgehammer to that trust. 

But, it is important to note here that financial markets are often generous to economically and politically prosperous countries like the UK. Indeed, the government’s most expensive commitment: its energy intervention, was not met with market turmoil. This is because this was seen as a necessary and sensible fiscal intervention. The reaction to this mini-budget however is a result of what Dario Perkins has labelled the “moronic risk premium”. In other words, that the UK government is perceived by markets to be moronic and there is a premium associated with that. Kwarteng’s budget is an indicator of a government that cannot be trusted. Aside from the budget itself, market actors have noted the lack of oversight from the OBR, and the sacking of Tom Scholar, the most senior civil servant at the Treasury, at the beginning of September. All of this gives the very strong impression of incompetence that is intolerable to lenders. 

Indeed, the U-Turn on the 45p rate announced at the beginning of the Conservative Party conference and the small market rally in response shows this. The cut on the top rate of tax was a relatively inexpensive part of the budget, but crucially also the most bizarre. Ditching the cut encouraged markets by signalling that the government may be willing to make some concessions, and might have some sense of humility. 

So, as markets have lost confidence in the UK government and its economy, gilts and sterling have tumbled in price, a reflection of struggling demand. The correlation between the health of financial markets and the health of their underlying economies is often overstated, but these market gyrations have extremely worrying complications. High inflation will inevitably force a higher than expected hike in interest rates from the (thankfully independent) Bank of England. This will push up the cost of debt on everything, but most concerningly on mortgages. More than 40% of buyers have had their offers pulled since the announcement over fears of unsustainable financing costs for banks. These offers will return at significantly higher, potentially unaffordable, rates. This could precipitate a collapse in demand as buyers will no longer be able to shoulder very expensive borrowing costs. It may also cause a crisis in the private rental market, on which many, especially young, people rely; many private landlords have significant mortgages on their rented properties.

There is also the question of fairness. Having covered the economic illiteracy of the budget, it would be remiss to not emphasise that this mini-budget is an extremely unfair way of allocating state resources. Almost two-thirds of planned tax cut gains would go to the richest fifth of the population, and almost half would go to the richest 5%. We should not forget that whilst the UK is an aggregately wealthy country, this wealth is spread extremely unequally. So whilst the wealthy in the UK enjoy high standards of living: last year the top-earning 3 per cent of UK households each took home about £84,000 after tax, narrowly behind the wealthiest Germans and Norwegians and comfortably among the global elite, these standards are not enjoyed by all: the average British household ranks 12th and the poorest 5% rank 15th. Far from simply losing touch with their western European peers, last year the lowest-earning bracket of British households had a standard of living that was 20 per cent weaker than their counterparts in Slovenia. 

It would be both fair and sensible to use fiscal policy to address this. Indeed, Britain’s public infrastructure is in dire need of investment. In this climate, in which the the worst off are suffering the most, it is grossly unfair to deliver a series of tax cuts that benefit the best off. The only fiscal expansion that would be justifiable at this stage would be one that addresses this. It would have the additional benefit of going some way toward combating The UK’s chronically low-productivity.  

It is perhaps true that this mini-budget represents the final crystallisation of what Brexit really was: a hard-right coup of the Conservative Party. Long the “natural party of government” the Conservative Party has gone rogue into the depths of ERG market fundamentalism.

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