The IMF is less than impressed with Liz Truss and Kwasi Kwarteng’s first mini-budget. In the kind of admonishment you’d normally expect them to make about an emerging economy, they said, ‘the nature of the UK measures will likely increase inequality… [the government might want to] reevaluate the tax measures, especially those that benefit high income earners’.
This is a bizarre statement to make. The UK is substantially less unequal than the USA, and the inequality/growth relationship is not particularly strong for developed economies. Should the IMF be expressing concern that the American economy will be undermined by its low top tax rates?
The cut in the highest rate of tax from 45% to 40% has driven a huge amount of media coverage, but is expected to cost around £2bn a year once behavioural responses are taken into account. As the IFS notes, it may very plausibly end up costing nothing.
It does, however, run contrary to an interesting strain of thought that has begun to predominate the IMF’s guidance to Britain. In this analysis, what really matters is how equal a country is, rather than how well off rich and poor are. But if this were true then why are so many people leaving countries like Pakistan – fractionally less unequal than Britain – in the belief that they will live better lives in the UK?j
To get a taste of how the Fund thinks Britain should be run, we can look at their country reports from earlier in this year. The UK needed a ‘revenue-based strategy’ for funding government spending, which meant tax rises. Among the suggested options were increasing income tax for the upper 50% of the population, applying a one-off wealth tax ‘payable on all individual wealth… above £2bn and charged at 1% a year for five years’, or raising dividend taxes for higher rate payers to 26%.
These suggestions are insane. Economists uniformly recommend against ‘one-off’ wealth taxes precisely because after a government’s done it once, nobody will ever believe that they won’t do it again. The damage this does to the incentive to invest or situate wealth in Britain would be huge, particularly as it probably wouldn’t actually raise very much: anyone with more than £2bn in assets is likely to simply leave the country rather than pay. Similarly, taxing dividends for the people most likely to invest in companies is a great way to shut off capital for British firms.
The March of the Sensibles
One explanation for this is that the IMF has been captured by a deep cover cabal of Soviet sleeper agents desperate to bring down the capitalist system and revert to communism. I am sympathetic to this argument, but think we can probably do better. Financial markets didn’t much like the Truss budget either, and while they may be many things they are rarely hotbeds of Trotskyism.
I’ve written about the market reaction on these pages, but to reiterate, my view is that they are understandably pessimistic about the ability of the UK government to produce the sort of growth it’s promising. They expect inflation to increase. Generally, this should drive a currency upwards (see my thread here). This means the drop signals either a sudden panic over the long-term fiscal sustainability of the UK, which would be entirely unwarranted, the competence of the government (which won’t affect the previous), or – most plausibly – Mike Bird’s suggestion that markets don’t think the Bank of England will do its job sufficiently well to mop up the inflation created by the tax cuts (although, again, it’s debatable just how much inflation will be caused).
The IMF’s reaction doesn’t fit neatly into these categories, and I think that’s because it’s driven by something else entirely. The IMF is staffed by a certain sort of person who is commonly found in the policy world, writing at papers like the Financial Times, working at think tanks like the IFS, or speaking soberly about fiscal sustainability in the Treasury. Let’s call them the Sensibles.
Sensibles pride themselves on being, above all else, sensible. Sensible means not doing anything that might rock the boat; like the apocryphal provincial official, their working orders are to ensure that nothing changes. In macroeconomic policy, that means making sure that governments don’t do anything unusual. If the country is on a long, slow path of decline – like the UK very much is – then that’s bad. But if an attempt to shake that up fails and drives up borrowing costs, that’s much worse: now you’re paying more on your debt, and still in decline. Much better to try the Approved Method again and see if it works this time.
The Sensibles hated the mini-budget. It put growth ahead of the deficit. It didn’t go out of its way to appease bond markets and keep borrowing rates ultra low – resulting in borrowing costs rising to a dizzying 0.2% real yield. It made lots of sweeping statements about planning reform and deregulation – risky! It wasn’t at all what British economic policy orthodoxy has preached for the last decade.
The Sensibles have quite a lot riding on this. If the mini-budget and the associated supply side reforms work in the long run, then everything we were repeatedly told was Sensible was not. This would be quite damaging if your career is based on sitting in an office and wisely telling people that changing anything is bad. Doubling down on Sensibleness is the only response open to the mini-budget: if you can bully Truss into changing course, then Sensibleness prevails. If Truss changes course after failing to get further supply-side reforms through, you are vindicated. And if the policies do work, well – you’ve lost anyway.
This is republished from Marginally Productive. Read the original article here.
Click here to subscribe to our daily briefing – the best pieces from CapX and across the web.
CapX depends on the generosity of its readers. If you value what we do, please consider making a donation.