26 September 2022

The pro-growth ‘gamble’ isn’t as big as you think


Friday’s de facto budget has thrown commentators on all sides into a tailspin.

On the left, people like Owen Jones – who debated the tax cuts with me on BBC 5 Live – described Kwasi Kwarteng’s Growth Plan as ‘class war’. On the right, Gavin Barwell described the tax cuts as fiscally ‘reckless’. And across the spectrum, people seemed uncomfortable with proposals that seem to give a lot to the rich, and not so much to the poor. That unease reached financial markets, with sterling plummeting first thing this morning, only for traders to calm down and realise that £45bn in tax cuts hadn’t suddenly turned Britain into Argentina.

As far as the ‘budget for the rich’ line goes, it’s worth taking a step back and looking at the overall package. For all the invective, Liz Truss isn’t gambling away the future of the British economy. Kwasi Kwarteng isn’t betting the house, the car, and the shirt on his back on tax cuts paying for themselves. We aren’t entering a currency crisis, and we certainly aren’t going bust.

While tax cuts certainly benefit the rich more in cash terms – because they pay more tax – they still work for poorer households too. Indeed, the case for cutting the basic rate of income tax is sufficiently compelling that even Labour is committing to keeping it. It’s also completely wrong to say the Government has abandoned the country to spiralling inflation when it’s biggest measure by far was dropping circa £60bn on the energy price cap.

The core message of the budget was not ‘class warfare’, but a fundamental change in emphasis: rather than worrying primarily about balancing the budget in the short run, the focus now is on getting the country growing.

Whether or not you think the budget was good for Britain should therefore depend entirely on whether you think this will happen. Whatever you care most about – the NHS, low-income households, the military, social care, or just your chance of owning a home – economic growth is the one actual miracle cure available. A larger economy supports more public spending, pays people better, funds higher investments.

Does this mean making the poor worse off? Of course it doesn’t. It might be a cliché that a rising tide lifts all boats, but everyone knows that it’s better to be lower class in a rich country than middle class in a poor one. Pakistan is fractionally less unequal than Britain, but the direction of migration is all one way.

The thing is, you do actually need that larger economy for this plan to work. And as positive as Friday’s measures were, they won’t get us there on their own. Each measure in isolation moves in the right direction: scrapping the 45p additional rate will cost the government £2 billion on one estimate, but might ‘plausibly cost nothing at all’ once the increased work incentive is taken into account. Cutting the basic rate of income tax, scrapping NI increases, and the increase in corporation tax – one of the most damaging taxes for investment – will also help to boost growth. But on their own, they won’t be enough to make up the lost revenue to the Exchequer.

That’s not the end of the world: we shouldn’t mistake what’s good for government revenue with what’s good for Britain. Generally speaking, the government taking money makes the country poorer, and the government taking less money makes the government poorer: there is a straight and uncontroversial trade-off between the size of your economy and the size of your government. And if you can create economic growth, you can grow both without raising tax rates.

It’s worth repeating, though, that tax cuts won’t create that growth on its own. But the other policies announced alongside them just might: rearranging IR35, letting loose fracking, building onshore wind, creating investment zones with clearer, simpler planning rules. These are exactly the sort of thing that might deliver the higher growth rates the Government wants. And if it gets it, then it won’t need to raise taxes.

When it comes to the public finances, only one thing really matters: g>r. In plain English, this says that so long as the growth rate of the economy is higher than the interest paid on the debt, then the government can run modestly sized deficits forever, without ever needing to run surpluses to pay them back. And Britain does have room to grow; our American cousins are around 40% richer than us on a per capita basis. It’s startling to note that if the UK were a US state, we would be the second poorest.

Right now, the signals from markets are concerning, but not altogether surprising. After all, successive governments have tried and failed to reform planning and boost growth, and this one has just slated big tax cuts on the basis that it will succeed where they failed. One reason for optimism is that by putting tax cuts first, Tory backbenchers have their red meat and will now have to vote through the reforms that underpin them. Otherwise, in a few years time they’ll need to either cut spending, or raise taxes again.

That is the ‘gamble’ here, but it’s nowhere near as dramatic as some commentators would have you believe. Describing it as some crazed roll of the dice seems unfair. Remember too that, in per capita terms, British GDP has grown just 0.6% per year since the financial crisis. Taxes, meanwhile, are still on course to reach their highest sustained level since the 1940s. With that grim record, surely it’s right that we try something different.

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Sam Ashworth-Hayes is a writer and economist.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.