
That’s an understatement. In reaction to his proposals to cut taxes and subsidize energy costs, the pound fell and gilt yields rose. Economists stated concerns about the UK’s debt sustainability. Some political commentators have called for an immediate end to his presidency.
But markets and commentators have grossly overreacted. Much of what Truss suggests makes perfect sense.
The prime minister is absolutely right to focus on economic growth. Britain is the only Group of Seven country with a smaller economy today than in the fourth quarter of 2019, before the coronavirus pandemic. In the 40 quarters before the pandemic, its economy grew at an annual rate of less than 2 percent more than half the time.
Many of the prime minister’s proposals are likely to boost economic growth by increasing private investment in Britain, which has been troubled for years and lags behind other countries. The government’s tax plan will cancel the scheduled increase in the corporate tax rate to 25 percent from 19 percent and make permanent a temporary increase in the annual investment allowance, allowing businesses to deduct the entire cost of eligible plant and machinery up to 1 million pounds in the first year.
These changes, by increasing after-tax returns, will strengthen investment in the longer term, which in turn will improve productivity. This is sorely needed, as weak productivity growth threatens wages, incomes and mobility. In addition, Truss’ plan calls for a review of ways to expand the tax on research and development expenses as a way to support basic research that encourages long-term prosperity.
The prime minister’s plan also includes deregulation. For example, Truss will speed up the completion of infrastructure projects by reducing the scope of environmental impact assessments. He will also reduce the tax on property transactions, create a more liquid housing market and increase economic efficiency and labor mobility.
The most questionable part of the plan is the income tax cuts. A reduction in the basic rate of income tax by one percentage point, to 19 percent, will increase fuel consumption at a time when the Bank of England is trying to control inflation. But after the rhetoric during the leadership election about the independence of the central bank, the prime minister was clear: “It is right that the interest rates are independently set by the Bank of England and that the politicians do not decide about it.”
The prime minister’s proposal to abolish the 45 percent tax bracket on incomes above 150,000 pounds a year – the top 1.1 percent – is also unwise in the current fiscal and economic environment, has been widely criticized and was finally scrapped. “I got it and I listened,” Truss said.
Energy subsidies are hard for an economist to swallow. By protecting the public from high prices, they reduce the incentive to change behavior: turning off the lights when you leave a room, wearing an extra sweater. But other European countries follow broadly similar policies, and there are no good solutions for the government when average household energy bills are set to rise due to Russia’s invasion of Ukraine. And these subsidies are not economic stimulus – they simply shift the responsibility for absorbing high energy costs from the private to the public sector.
So yes, there are legitimate grounds here for concern and criticism. But Britain did not collapse. In fact, there is a lot here to support.
Fortunately, the hyperbole seems to have died down, and the markets are recovering. After the Bank of England’s intervention to provide emergency liquidity to the financial system and the government’s decision not to scrap the 45 percent rate, the pound recovered its losses. Britain’s 10-year borrowing rate is less than half a percentage point above the US rate – a relatively small gap.
But strength is not enough. The launch of the plan failed and created a crisis in the government’s credibility. Truss and Kwasi Kwarteng, the chancellor of the exchequer, had to convince the markets and the public that their plan made sense. They need to explain why energy subsidies are the best of a bunch of bad options, and why their tax and regulatory changes will boost growth.
Credibility also requires them to clearly state where they plan to cut spending to move toward fiscal balance. And the government should flesh out plans for deregulation of childcare, agriculture, infrastructure, housing and land use.
In Birmingham, Truss removed the green eyeshades: “Low growth is not just numbers on a spreadsheet.” In fact, slower growth means fewer opportunities for economic growth. This implies a conflict over distribution. This means that the talents of the workers are underutilized and energy is not used. It means slower aspirations and more modest dreams for the future.
Truss’ economic agenda is a work in progress. It got off to a bad start. But by focusing on growth, the prime minister is clearly pushing Britain in the right direction.