The writer is chief executive of the Resolution Foundation think-tank
We all make mistakes, it’s their scale that matters. Britain is engaged in by far the worst unforced economic policy error of my lifetime. Large, unfunded tax cuts the government claimed would boost growth have instead convinced markets the UK’s entire macroeconomic framework is under threat.
Turmoil has been the short-term result, with borrowing costs surging and pension funds floundering. Forcing the Bank of England into restarting gilt purchases the week before it was due to begin gilt sales is not what success for a new chancellor looks like. But it’s important to step back from the hour-to-hour noise of markets, because the effects of this abrupt shift in economic policy will be felt far beyond the trading floors.
The short-term impact of lower taxes is higher interest rates, which matter for family finances, not just financial markets. With 1.8mn households — including mine — due to flow off fixed-term mortgages next year, the pain is very much ahead rather than behind us.
Policymakers also face tougher trade-offs after last week’s shambles. The immediate focus has been on the Bank of England, but they in practice know what levers to pull. Markets are spelling out the scale of action required. Sterling’s recovery in recent days reflects increased confidence that it will follow: a large interest rate rise is coming on November 3.
Who has in fact been handed the most difficult policy task by Kwasi Kwarteng’s “mini” Budget? The chancellor himself. He now has at most eight weeks to fill a massive fiscal hole.
The deteriorating economic outlook (especially rising debt interest costs) meant that, even before the tax-cutting splurge, any fiscal headroom was largely gone. But the new government has turbocharged the problem. The largest tax cuts in five decades need funding, while spooking the markets means another £12.5bn a year added to the debt interest bill.
Kwarteng says he remains committed to debt falling eventually. In the absence of the Office for Budget Responsibility believing the new government miraculously means higher growth, that requires fiscal tightening of around £37-£47bn by 2026-27. More could well be required to ensure that tax revenues cover day to day spending or for even a small margin for error.
Performing a U-turn on some tax cuts would make this much more achievable. Yes, it’s politically painful, but so is the alternative: announcing huge spending cuts. Kwarteng is on course to be announcing cuts as big as those set out by George Osborne in 2010.
The Treasury is now desperately trying to work out what those will include, but history offers clues of what is to come. The experience of fiscal consolidation in the 1990s and 2010s points to it being easier to build fewer roads in future than fire nurses or teachers today. Cutting public investment back to its 1996-2016 average would undermine our growth prospects, but save £25bn.
Slowing increases in benefits so that inflation erodes their real value is also a Treasury staple. We look to be on course to uprate working-age benefits by earnings instead of inflation next year — a 4 percentage point real-terms cut that would net the Treasury £5bn, while costing a typical low-income working family with two children over £500 a year. We should be clear what this means: permanently cutting benefits to fund tax cuts for the top earners in the most unequal large country in Europe.
Much lower taxes will mean less public spending. That trade-off was ignored when those tax cuts were announced, but market pressure has now put it centre stage. The new government may have dreamt of emulating Margaret Thatcher, but the reality may involve looking a lot more like Osborne in the years ahead.