Kwasi Kwarteng defended his controversial credit-and-tax-cut mini-budget on Sunday, invoking the ghost of Margaret Thatcher.
“I want to see . . . people keep more of their income because I believe it’s the British who are going to drive this economy,” Britain’s new chancellor told the ` as he promised more tax cuts.
However, Kwarteng’s words and sentiments were met with hostility from economists and financial market experts, who disputed the Thatcher parallels and said the policy had more obvious roots in US history and the events of the 1970s. Many warned that corrective action was needed to calm financial markets.
When Thatcher’s first government was elected in 1979, Britain was seen as the sick man of Europe, with a top tax rate of 83 percent, widespread restrictive industrial practices and terrible industrial relations.
In addition to a deregulation program, it cut the top tax rate to 60 percent in its first budget, along with a property tax cut from 33 percent to 30 percent. In 1988, the base rate dropped to 25 percent and the maximum rate to 40 percent.
But economists said that’s where the similarities ended with Kwarteng’s decision to abolish the top tax rate of 45 percent and lower the property tax rate to 19 percent.
Thatcher’s government raised the VAT rate from 8 percent to 15 percent in the 1979 budget to offset income tax cuts and ensure they were non-inflationary. It also raised the Social Security rate from 6 percent in 1979 to 9 percent in 1983, in stark contrast to the measures announced Friday.
Prime Minister Liz Truss has sought to cut taxes and relax regulation © Markus Schreiber-WPA Pool/Getty Images
In 1988, Nigel Lawson’s top-rate income tax cuts came only when the government had a budget surplus of 1.1 percent of GDP, not when it was running a large deficit as it is now. The difference has led to less flattering comparisons with Anthony Barber’s earlier budgets of the 1970s, which triggered a boom and high inflation followed by bust.
Mohamed El-Erian, an adviser at Allianz, said: “This is 1972 in the sense that the government is going for growth and it’s doing it through an unfunded stimulus.”
He added that the measures are also comparable to Reaganomics and “drive more deregulation, more tax cuts, drive growth and let the central bank deal with the inflation problem.”
Ronald Reagan, US President from 1981 to 1989, noted that his tax cuts in the late 1980s did not result in increased revenue, but in double fiscal and trade deficits.
Jason Furman, former economic adviser to Barack Obama, noted the similarity of Kwarteng’s measures to the 1981 US tax cuts, which he said were “partially reversed in 1982 in the face of high inflation and rising budget deficits.”
Academics disagree over whether Reagan’s tax measures spurred labor supply and entrepreneurship because it’s difficult to separate the pure impact of taxes on growth. A recent study by Princeton University Professor Owen Zidar found that “tax cuts for high-income taxpayers generate less growth than similarly large tax cuts for low- and middle-income taxpayers.”
Some economists have compared Kwarteng’s announcement to US President Ronald Reagan’s policies © Don Rypka/AFP via Getty Images
In the UK, studying the impact of introducing the top rate from 50 percent in 2010 and cutting it to 45 percent in 2013 has been complicated, said associate professor Andy Summers of the London School of Economics, because the main effect was not there changing work patterns, but “for rich people to change the tax year in which they receive income to maximize their profits”.
Torsten Bell, director of the Resolution Foundation, a think tank, said Prime Minister Liz Truss’ approach to tax cuts and deregulation might not have the same impact in the US or Britain today as it did in the 1980s anyway.
The top rate of income tax is already so much lower and the UK is less regulated than most advanced economies, he said. Instead, the most likely effect would be “worse public finances, higher borrowing costs and lower public spending”.
If the government wanted to keep spending on schools and hospitals while putting debt on a downward path in time for the next election, it could well result in public investment being cut – which “has more impact on growth pound for pound than it does.” Tax cuts,” he added.
Internationally, the budget was met with criticism, leading some to believe that the British government had lost the economic plot.
Olivier Blanchard, former chief economist at the IMF, also warned of the risks of a larger market reaction, saying the budget was a “textbook example of how not to design and not to sell fiscal expansion”. He added: “While we were worried about Italy, the UK crept in. We’re lucky the UK isn’t in the euro. . . Otherwise we would face another euro crisis.”
Adam Posen, president of the Peterson Institute for International Economics and a former member of the Bank of England’s Monetary Policy Committee, suggested that if the government does not change course, the central bank may need to intervene early to calm markets.
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“The only thing that will stabilize the UK economy is an about-face in fiscal policy. BoE rate hikes are a partial substitute but the second best result,” he said on Twitter.
Some of the biggest concerns came from people who work in the financial markets. Sushil Wadhwani, an asset manager and former BoE policymaker, said most market participants no longer believed that public finances were sustainable and that the government had been “cold” to market moves.
“It’s very easy to see how Truss-Kwarteng’s fiscal expansion leads to a slowdown in growth — a combination of interest rates having to rise sharply in response to a market crisis and falling confidence that’s then generated,” Wadhwani said . “This is in stark contrast to the positive confidence effects created by Reagan’s policies.”
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