Will Sunak overcorrect Truss’ tax mistakes?
Sunak and his Chancellor of the Exchequer Jeremy Hunt are preparing the public for increased tax burdens and deep spending cuts. Sunak hopes first that his plan will restore the government’s reputation for fiscal probity. This in turn should reduce borrowing costs and make it easier to release the reins. But he probably also wants to give himself the opportunity to reduce the tax burden as the general election approaches.
Will all this contribute to creating conditions for growth? Bloomberg Opinion’s Therese Raphael talks to Bloomberg Economics’ Dan Hanson about what lies ahead.
Thérèse Raphaël: Whatever the Bank of England’s decision on Thursday — and the consensus is for a 75 basis point rate hike — it will be based on the assumption of fairly strong fiscal consolidation when the government announces its plan on November 17. level of spending cuts Hunt will need to find later this month to allow the BOE to ease monetary policy or at least prevent further hikes?
Dan Hanson: The figures in question, a consolidation of between £30bn ($34.8bn) and £50bn, make it likely the BOE will eventually pivot to cuts, but probably not until she sees inflation come down roughly. distance from its 2% target.
Remember that the decision to end the price cap on household energy bills early, which was part of Hunt’s strategy to boost market confidence, will mean inflation will be higher this year. next than it otherwise would have been. The annual CPI is now expected to average 9% instead of 5.5% in a world where the ceiling has been maintained for two years. This will limit the BOE’s room to maneuver, even if the economy is in the throes of a recession.
TR: Sunak says Truss was right to point out the UK’s poor growth record. It’s hard to disagree. But what does his plan, which looks a lot like Austerity 2.0, mean for the UK’s growth prospects?
DH: The impact on growth will very much depend on the profile of spending cuts and tax hikes. The greater the initial burden (ie the earlier the pain is caught rather than spread over time), the greater the likely economic impact. This is because monetary policy operates with a lag, so the BOE would not be able to offset the effects. I also doubt the BOE is willing to soften its stance on 2023 given the inflation outlook.
In our forecast, we have assumed that consolidation will accelerate over the next five years, depressing growth by about 0.2 percentage points in 2023 and 2024. Beyond 2024, we assume that the BOE maintains its monetary policy looser than it otherwise would, to keep the economy going trend.
TR: Instead of tax cuts with no spending cuts under Truss, we’re now ready to get tax increases along with major spending cuts. Is there a danger that this government will correct too much by pressing too hard on the budgetary brakes?
DH: Absolutely. Much of the hard work to restore confidence in Britain’s assets has been done, with Hunt canceling the majority of tax giveaways and announcing he will set out a plan to reduce the debt burden. The presence of Rishi Sunak as prime minister also appears to have bolstered sentiment.
Clearly the government needs to deliver on its commitment to fiscal sustainability, but I think the cost to the economy of overcooking consolidation outweighs the credibility dividend of rapidly reducing the burden debt. Remember that the economy is facing a recession, probably similar to that of the 1990s. Fiscal policy has a role to play in providing support during this difficult time.
TR: Sunak says his ultimate goal is to cut taxes. But due to both pandemic-era spending and the past six weeks, we are looking at falling GDP and a recession that will last at least through the end of 2023, according to Bloomberg Economics analysis. At this point, is there anything the government can do to shorten the recession and restore growth or is it more about laying the foundations for future growth?
DH: The government has a big decision to make about the level of energy support it wishes to provide beyond April – this is where it could have the most impact on the short-term outlook. Whatever is in mind will help to make a decision quickly so households and businesses can plan ahead.
Given the constraints it currently faces in terms of fiscal policy, the government should seek additional savings on the measures it has already announced. This could accelerate work to break the link between wholesale gas and electricity prices, which amplifies the pain for households and businesses and increases the cost of government interventions. Another option would be to plunder the profits of electricity generators that do not depend on fossil fuels, a measure in a new law allowing the government to impose a cap on revenues.
The big picture here is that the economy is currently overheating, so unless measures are effective and well-targeted, intensified support will lead to a more aggressive response from the BOE.
TR: France imposed energy price controls and managed to bring headline inflation down to 7.1%, the lowest in the euro zone. Markets did not panic and growth should be faster than in the UK and Germany next year. Is there a lesson here for Hunt and Sunak on how best to fight the inflation that stems from energy prices? Or is it France sui generis here?
DH: Price caps certainly tackle short-term inflation, but they are poorly targeted. In a tight labor market, excessive support exacerbates domestically generated inflation, which will likely require a relatively large monetary policy response to keep supply and demand in balance. Given the context, the best thing the UK government can do is opt for more targeted support after the cap ends.
TR: The focus has been on getting the government’s fiscal policy rating from the Office for Budget Responsibility. How important is OBR here and are there any limitations to their rating that we should keep in mind?
DH: If the past month has done nothing else, it has highlighted the importance of independent institutions. The forecasts published by the OBR will be thorough, but it is important to remember that they are highly uncertain and, like any point projection, will almost certainly be wrong.
Ahead of what is undoubtedly a dark winter, I just hope the budget watchdog isn’t overly pessimistic about the outlook for the economy. Government will have to make decisions within the parameters set by the OBR and those policy choices will have real consequences. A forecast of significantly slower trend growth, for example, would force the government to find more savings to plug the hole in public finances, leaving the economy to risk a prolonged period of weak growth while repair work is carried out. ended.
TR: We’ve heard a lot about rising national debt levels. How important is a decline in the national debt burden and what is the right target here to keep markets together and show fiscal responsibility? Is it worth increasing the tax burden to ensure debt is trending down as a percentage of GDP?
DH: I don’t think there is a magic target. Markets accept that changes in the level of the debt-to-GDP ratio are sometimes necessary to support the economy during a difficult period. Once this period has passed, the key is to show that you are taking steps to put the debt burden on a sustainable path.
As to whether this should be achieved through higher taxes or lower spending, I think in the case of the UK it will take a combination of the two. Following the austerity of the 2010s – when there were deep cuts in investment spending in the UK – and against a backdrop of high inflation and growing demand for public services, there is simply no not possible to expect that the money will be found in the departmental budgets. Lower capital spending will help in the short term, but that budget isn’t huge anyway. Meanwhile, cutting benefits when inflation is in double digits is politically difficult.
That leaves taxation to fill the void. Sunak has a background on this, too: when he was chancellor, he was willing to raise the tax burden to its highest level since the late 1940s. He and Hunt appear to be laying the groundwork for a return to that approach the November 17. This bad news will probably be accompanied by a promise of reduction if the outlook allows it.
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Therese Raphael is a columnist for Bloomberg Opinion covering health care and British politics. Previously, she was the editorial page editor of The Wall Street Journal Europe.
Dan Hanson covers the UK for Bloomberg Economics in London. Previously, he spent seven years at HM Treasury working on a variety of UK macroeconomic issues.
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