Towards Austerity 2.0?

New Chancellor, new fiscal plan. This week began with the new Chancellor Jeremy Hunt announcing further U-turns on the government’s ‘mini-budget’, after Kwasi Kwarteng was sacked late last week. All of the tax cuts announced in the government’s Plan for Growth have been reversed, however the government still plans to abolish the Health and Social Care Levy and keep the cut to Stamp Duty. (HMT has listed the U-turns here.) 

• Financial markets dominated fiscal policy. In the words of Martin Lewis “Trussenomics totally hunted down and gone.” But, as IIPP’s Josh Ryan-Collins explains, “The defeat of free market ideology will be worthless if it results in a fear of public spending and an unquestioning faith in the markets.” Hunt justified the U-turns on tax cuts in an attempt to “reduce unhelpful speculation” ahead of the medium-term fiscal plan. The IFS has calculated the ‘credibility cost’ of the mini-budget was ~£10bn in extra debt payments each year as investors charged higher rates on government debt. 
• But what did bond markets actually fear? IIPP’s Josh Ryan-Collins makes the important point that “investors lost confidence in the government’s ability to bring down prices”, not expansionary fiscal policy in general: “High inflation reduces the real value of government debt and will lead to higher interest rates that will push down their price. This is bad news for the investors who hold such debt, hence the sell-off of bonds…it was the £45bn of tax cuts on top of already rising inflation that the market didn’t like. Even bond traders understand that making rich people richer is likely to stoke inflation and won’t on its own increase growth.”
• New advisory council to calm markets? The Chancellor also announced a new board of economic advisors at the Treasury. Four have been announced at the time of writing; economist and former MPC member Andrew Sentance notes that the “problem is all members are from the financial sector” One advisor, Rupert Harrison, was George Osbourne’s Chief of Staff at the height of the austerity years, who is now working for the US investment management firm, Blackrock. (IIPP’s Josh Ryan-Collins also notes that Blackrock “are designers of the LDI schemes that created financial chaos over the last two weeks and required BoE bailouts.” Economist Carolyn Sissoko has a timely paper out on Financial Dominance: Why the ‘Market Maker of Last Resort’ Is a Bad Idea and What to Do About It.)

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Risk of reverting to austerity. The episode of ‘financial dominance’ over the government's fiscal policy has sparked renewed fears of spending cuts. The BBC reported that yesterday the Chancellor warned the Cabinet of “the extent of the black hole in government finances means he needs to find tens of billions to balance the books”, which may force some ministers to resign. Polling from Ipsos Mori has found ‘The level of the deficit’ is now 8th in the list of important economic indicators for the public. (A recent study published in the Journal of Epidemiology and Community Health found there were 334,327 excess deaths in England linked to austerity from 2010-2018.)

• “Black holes'' and fiscal rules. BBC Newsnight’s Ben Chu calculates that a £38bn shortfall remains in the public finances to meet the government's fiscal rules - to have the government’s debt-to-GDP ratio falling at the end of three years. Hunt suggested that the measures will ‘raise’ £32bn every year but warned of more “difficult decisions” to come as the government tries to reduce its debt to GDP ratio through cutting spending. It is now widely acknowledged that Osborne-era experiment to  reduce UK’s debt-to-GDP ratio through austerity failed.
• You can’t cut your way to growth. Finance Watch’s report Fiscal Mythology Unmasked explains why debt-to-GDP ratios are poor arbitrary indicators for debt sustainability. For a modern explanation of fiscal responsibility, read Lord Nicholas Stern and Dimitri Zenghelis paper explaining why public investment in economic growth is key to debt sustainability: “G7 countries should increase post-pandemic public investment...recognise the potential economic and social returns to increasing public debt for the purpose of investment…[and wait] to pay off the public debt until the economy is undergoing robust growth.”

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Renewed call for wealth taxes to raise revenue. The Telegraph’s Tony Diver reports that “Labour is looking seriously at reform to capital gains tax – better balancing it with income tax – but rule out more radical measures that would tax assets directly.” Church Action for Tax Justice and several prominent UK Christian leaders have written to the Chancellor urging him to “introduce wealth taxes to reduce inequality, instead of cutting public services and benefits.” Tax Justice UK’s response to his announcement argued that “to avoid further austerity we need to tax wealth more. Capital gains taxes should be aligned with income tax rates. We should end inheritance tax loopholes open to the wealthy. And we need to tax the wealth of anyone with £10 million of assets.” 

• They can reduce inflation. The International Monetary Fund has urged the UK government to consider ‘raising windfall or wealth taxes’ to reduce inflationary pressure. This would be preferable, it argued, to the sole use of higher interest rates to tackle inflation. 
• And don’t have to compromise economic growth. Economists Linus Mattauch, David Klenert, Joseph Stiglitz and Ottmar Edenhofer have published a paper showing how governments can tax wealth to fund public investment and reduce wealth inequality, without compromising economic growth.

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Political flashpoint for energy bills in April 2023. Hunt announced the Energy Price Guarantee will now only remain in place until April, in order to avoid long-term exposure of the public finances to volatility in international gas prices. The Treasury is launching a review into how to support energy bills beyond April in ways that will lower cost to taxpayers whilst remaining supporting household needs. Sky’s Rob Powell’s analysis of leaked photos also suggest the Treasury is looking at a targeted grant scheme for vulnerable businesses, such as the hospitality and the most energy intensive sectors.

• Macroeconomic impacts of unfreezing the Energy Price Cap. Economist Samuel Tombs calculates that “current wholesale prices point to a 73% jump in energy bills, to £4334…That's a big change in the outlook for CPI inflation (↑) and GDP (↓).” (For an explanation of how freezing (or lowering) the Energy Price Cap has deflationary effects, read our previous digest covering research from IPPR.)
• A package to fix the UK's energy price crisis. NEF proposes to replace the Energy Price Cap with a new system for ‘free basic energy’ as part of a rising block tariff, so that all households receive the same amount of energy for free, and everyone pays the same premium price or further energy above this. They also argue that the government should create a new permanent energy element in all means-tested benefits – similar to housing or child benefit – to help the poorest families cover their remaining energy bill, paid for by increasing capital gains tax. Finally, the package includes a £750 “cost of living allowance" for all households funded through a reformed windfall tax on oil & gas.the package would  The package costs half that of freezing the price cap for 12 months, increases incentives to improve home energy efficiency and increases disposable incomes for 80% of families on average (for the poorest 50% it would be enough to fully reverse the squeeze since April 2021). Fuel Poverty Action is handing in a petition with nearly 650,000 signatures to 10 Downing St. today calling for a universal band of free energy, paid for by ending fossil fuel subsidies, windfall taxes on excess profits and higher tariffs on excessive energy use.