New UK Prime Minister Liz Truss introduced a massive tax cut package — and triggered a currency crisis.
Editor’s note, October 3, 12:40 pm ET: Ten days after announcing a plan to cut taxes for top earners, UK Prime Minister Liz Truss’s government today reversed that plan. British markets initially rallied, but questions remain about the UK economy in the long term.
Last week, the UK had its most dramatic currency crisis in recent memory. That’s on top of staggering inflation that the Bank of England has yet to significantly curb and a cost-of-living crisis. The situation in the UK sent global financial markets into a tailspin. Though the present crisis has been driven by a combination of factors, including the economic fallout of Brexit, Prime Minister Liz Truss’s recent package of tax cuts has helped push the UK’s economy into chaos.
On September 23, Truss’s Chancellor of the Exchequer, Kwasi Kwarteng, introduced the UK’s biggest tax cuts in 50 years, estimated at about 45 billion pounds over five years. The so-called “mini-budget” proposed tax cuts for the UK’s highest earners, and announced a rollback of corporate tax hikes and a cost increase for national insurance, both intended to go into effect next year. Kwarteng and Truss’s plan also slashes the stamp tax, a duty on land sales in England and Northern Ireland, in a bid to increase home purchases.
By Monday, global markets responded by selling off UK-backed assets and pushing the UK’s currency, the pound, to a valuation of $1.03, its lowest-ever value against the dollar, before it inched up later in the week. Investors soundly rejected the new economic plan, dubbed “Trussonomics” in reference to Reaganomics, the supply-side economic policies passed under Ronald Reagan in the 1980s.
Truss and Kwarteng have stood by their decision to cut taxes for some of the wealthiest Britons and create special incentives for corporations, including tax cuts and rollbacks in regulations, insisting that the tax cuts will spur more investment in the economy. It’s a 21st-century take on trickle-down economics, one that’s happening in the midst of global inflation and skyrocketing energy costs.
Dylan Martinez/AFP via Getty Images Britain’s Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng chat during a visit to Berkeley Modular, in Northfleet, England, on September 23.The mini-budget was instituted against the accepted logic of most mainstream economists — and without typical political guardrails. Truss fired Tom Scholar, the permanent secretary to the Treasury and a longtime civil servant, on September 8, paving the way for Truss to combat what she called “Treasury orthodoxy” — the mainstream economic perspective that’s dominated the Treasury’s approach to taxes and government spending and which, according to Truss, contributed to sluggish economic growth.
Scholar’s firing was widely seen as a political stunt that not only deprived the government of a well-respected technocrat during a difficult economic period, but also eroded the neutrality of the UK’s civil service. The government also requested that the Office for Budget Responsibility (OBR) not provide any independent analysis of the plan, according to an analysis of the plan by the National Institute of Economic and Social Research.
The UK was already dealing with global inflation and stagnant wages, in addition to a weaker-than-expected economic recovery from the Covid-19 pandemic. Add to that the energy crisis amid one of the hottest summers on record, and a recession has seemed all but inevitable.
Although these and other compounding factors have contributed to the cost of living crisis in the UK, the currency crisis is certainly exacerbating it.
And the most recent dramatic fall in the pound’s value is a direct result of Kwarteng and Truss’s tax cuts and mini-budget, Nikhil Sanghani, managing director of research at the Official Monetary and Financial Institutions Forum (OMFIF), told Vox. “The pound sterling has done worse than any other currency in the world” against the dollar over the past week, he said.
The tax cuts are directed toward Britain’s top earners. Kwarteng’s new measure eliminates the 45 percent income tax bracket, previously the highest, on earnings more than 150,000 pounds. Now, the highest tax bracket is 40 percent, on incomes above 50,271 pounds, which will save the wealthiest households about 9,187 pounds per year, the Guardian reported. A planned corporate tax increase, from 19 percent to 25 percent, has also been reversed, putting about 19 billion pounds into the economy that Kwarteng said could be used to “reinvest, create jobs, raise wages, or pay dividends which support our pensions.”
In other words, the tax cuts put more money into an economy already reeling from inflation — for which the typical macroeconomic remedy is to get people to spend less, not more. Investors are seeing the tax cuts as so illogical and dangerous that they are rushing to sell off their British assets — whether it’s bonds or holdings in pounds — driving down the value of the currency.
“Most mainstream economists don’t think this is a good idea,” Sanghani said. “It’s a tough one to square.”
“The pound falling in value is the market’s response to realizing that the risk inherent in the asset is much higher than hitherto appreciated thanks to Trussonomics,” Mark Blyth, director of the William Rhodes Center for International Economics and Finance at Brown University, told Vox via email.
The announcement of Kwarteng and Truss’s new plan triggered a sell-off in government bonds — typically considered quite safe investments — which was so extreme that the Bank of England, the UK’s central bank, stepped in and purchased 65 billion pounds worth of bonds “to restore orderly market conditions” and float the country’s pension scheme.
One reason the tax cuts are so unnerving is that they’ll be financed by further borrowing. The UK already has a significant public debt burden — without new taxes, the UK’s Office for Budget Responsibility warned, public debt would balloon to 320 percent of Britain’s GDP in 50 years, up from 96 percent, or 2.4 trillion pounds, now. That could, in the future, lead to spending cuts for public services.
Although Truss instituted a price cap on energy costs earlier in September, as in other nations, real wages in the UK are not keeping up with inflation, Julian Jacobs, an economist at OMFIF, told Vox. “The UK has seen an influx of striking activity — tube strikes, train strikes — largely as a result of wage stagnation,” he said. When combined with high inflation, high energy costs, and more expensive borrowing, the people who stand to suffer the most are the ones who can least afford to.
Frank Augstein/AP Pedestrians pass by the Bank of England in London on September 28. The Bank of England launched a temporary bond-buying program as it took emergency action to prevent “material risk” to UK financial stability.The International Monetary Fund (IMF) agreed, issuing an astonishing and nearly unprecedented rebuke against the tax cuts Tuesday, which devalued the pound even further. “The nature of the UK measures will likely increase inequality,” the global lender said, urging the government to “consider ways to provide support that [are] more targeted and reevaluate the tax measures, especially those that benefit high-income earners.”
For the IMF to deliver such a strong admonishment to the fifth-largest economy in the world is particularly striking; typically the fund makes such statements about “emerging market countries with problematic policies but not often G7 countries,” Adnan Mazarei, a former deputy director at the IMF, told the BBC.
“There might never have been a good time to push through tax cuts,” Sanghani said, but right now is especially bad. On top of high inflation caused in part by the Covid-19 stimulus, interest rate increases to combat the inflation, and outrageous energy prices caused by Russia’s war in Ukraine, a tax plan that flouts conventional wisdom is, he said, “the nail in the coffin in terms of, ‘Will there be a recession?’’’
Kwarteng will present a new fiscal plan on November 23, but the Labour Party’s shadow chancellor of the exchequer Rachel Reeves urged the government not to wait that long. “This statement from the IMF should set alarm bells ringing in government and make it clear that they need to act now,” she said.
However, both Blyth and Sanghani say that the tax cuts were purely a political decision. “Forget Reaganomics. This is simply a ’smash and grab’ raid by the Tories for their backers as they get lobbed out of power for the next decade,” Blyth told Vox. YouGov polls over the past nine months have put Labour firmly in the lead for the next government. After a series of mishandled crises under Tory leadership — from Brexit, to former Prime Minister Boris Johnson’s Covid-19 scandals and ensuing resignation, to the cost-of-living and currency crises now — it seems that voters are ready to boot the Conservative Party.
Given that, the calculus behind the tax cuts is unlikely to change, and Truss has thus far stood by her plan. “We are facing very difficult economic times,” she said Thursday morning during interviews with local BBC radio stations. “We are facing that on a global level. We won’t see growth come through overnight. What is important is that we are putting this country on a better trajectory for the long term.”
But injecting more money into an economy already suffering from an inflation crisis is illogical and contrary to the efforts of the Bank of England, which has raised interest rates seven times since December to help reduce the rate of inflation, which is now around 10 percent.
Taxing income is another way to tackle inflation and also provides the government with revenue to fund its programs, like pensions for the aging population and Britain’s National Health Service. Instead, the government “decide[d] to do massive tax cuts that may not be even stimulatory given that the skew on who gets the money makes the Trump tax cuts look like socialism,” Blyth said. “The people who get all the money will not spend it because they are already rich, and the people who need money to spend will get next to nothing and will then get slammed with a doubling of energy bills and a huge rise in their mortgage costs.”
The new measures have proved unpopular with voters, too, according to the latest polling by YouGov; as of Thursday, the Labour Party had a 33-point lead over the Conservative Party, Reuters reported. That’s the highest polling the party has gotten since the 1990s, YouGov told Reuters, and it points to a possible chance to grab power from the Tory party when national elections take place in 2024.
Truss has affirmed her commitment to the economic plan, and whether the resounding criticism — from global markets, the central bank, the IMF, and even voters — will change her mind before too much damage is done remains to be seen. But Sanghani told Vox that “the only real way to turn this around is a policy U-turn.”
Blyth agreed, urging the government to “stop doing astonishing acts of self-harm, from Brexit — which lost the UK the export markets they might use to grow out of this crisis — to 1980s-style tax cuts and cuts in spending on a state that has already been cut to the bone. That would be a start.”