First, steady the ship: re-framing the economic policy debate

A debate over fiscal strategy has featured prominently in the Conservative Party leadership contest, with foreign secretary Liz Truss arguing for immediate tax cuts and former Chancellor

Rishi Sunak arguing for tax cuts to be deferred until inflation and the budget deficit are brought under better control. The former approach has been criticised as irresponsible and likely

to worsen the inflationary outlook; the latter approach has been criticised as insensitive to the acute economic pressures facing households and small businesses.

Yet the framing of this debate is cock-eyed. Neither immediate nor deferred tax cuts will address the urgent challenge of economic stabilisation, which will require pragmatism and

flexibility. Unless the ship is first steadied, then arguments over the best way to stimulate economic growth are academic.

In common with many other large, advanced economies, UK output (see figures 1 and 2) has fluctuated sharply over the past two years: plunging, recovering, plunging again, recovering again,

and faltering once more. The consensus of professional forecasters for GDP growth in 2023 has been revised down to 0.5 per cent, with a few looking for a recession (figure 3). This is in

marked contrast to the forecasts used in the Spring Statement of 2022, issued in March, anticipating a robust recovery, extending out to 2026. The hasty repair of the public finances held

out in this document is no longer credible. The case for a more gradual withdrawal of the Covid-era support measures is overwhelming.

Sunak’s reluctance to compromise on the speedy reduction of the budget deficit – from a staggering £310bn (14.5 per cent of GDP) in 2020-21 – is understandable. Enormous strides were made

last year, shrinking the deficit to only 6 per cent of GDP, but the planned reductions to 3.9 per cent this year and 1.9 per cent next year are much too restrictive in the context of a

stagnating economy and a ballooning bill for inflation-linked debt interest payments. The cumulative budget deficit in 2022-23 (figure 4) is tracking higher than projected, month by month,

despite the helpful undershoot in public sector investment.

In his 2022 Mais lecture, Sunak highlighted the difficult decisions on taxation and spending taken by Margaret Thatcher and her Chancellor Sir Geoffrey Howe during the recession of 1980-82,

which laid the foundations for many years of prosperity and lower tax burdens. His readiness to contemplate another interval during which ambitions for lower taxes are pushed further into

the distance is commendable. However, a dogged determination to hold to a policy course, devised when Russia’s invasion of Ukraine had barely begun, may be the undoing of his leadership bid.

While Ms Truss’s instincts for a looser approach to the public finances are politically savvy, not to mention popular, the framing of her tax cutting proposals is unsound. By appealing to

some long-forsaken hypothesis of self-financing tax cuts as a route to faster economic growth, she has lashed herself to the wrong mast. If the economy were in calmer waters, with clearer

skies, then there would be a case to be made for selective tax cuts. Moreover, while the reversal of the NIC increase and the scrapping of the proposed rise in the rate of corporation tax

would help to soften the blow, they are unlikely to mitigate cost of living pressures in the lower reaches of the income distribution or move the growth needle in the face of great economic

uncertainty.

Real household disposable incomes could fall by 3 or 4 per cent over the next 12 months, with many households tempted to deplete meagre savings or take on expensive forms of debt. This, at a

time when a flustered Bank of England is trying to rescue its credibility by turning up the heat on interest rates, with the first 0.5 per cent hike for 27 years announced this week. The

form of fiscal relief best suited to address the coming storm is targeted cash payments to welfare recipients rather than tax cuts. Unless the Government recognises the deeply regressive

nature of the real income squeeze, then it faces protracted labour market tensions and further economic disruption. First, steady the ship, before seeking to embark on a new course.

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