That’s an understatement. In reaction to his proposals to cut taxes and subsidize energy costs, the pound plunged and gilt yields soared. Economists Express concern about the sustainability of UK debt. Some political commentators have called for an early end to his term as prime minister.
But markets and commentators overreacted. Much of what Truss has proposed makes perfect sense.
The Prime Minister is absolutely right to focus on economic growth. Britain is the only Group of Seven country with a smaller economy today than in the fourth quarter of 2019, before the coronavirus pandemic. In the 40 quarters before the pandemic, its economy grew at an annual rate of less than 2% more than half the time.
Several of the Prime Minister’s proposals would likely boost economic growth by increasing private investment in Britain, which has been worryingly low for years and lags behind other countries. The government’s tax plan would reverse a planned increase in the corporate tax rate to 25% from 19% and make permanent a temporary increase in the annual investment allowance, allowing businesses to deduct the full cost of plant and machinery eligible up to £1 million in the first year.
These changes, by increasing after-tax returns, would strengthen longer-term investment, which, in turn, would boost productivity. This is absolutely necessary, as low productivity growth threatens wages, incomes and mobility. In addition, Truss’ plan calls for examining ways to expand tax breaks for research and development spending to support basic research that fuels long-term prosperity.
The Prime Minister’s plan also calls for deregulation. For example, Truss would speed the completion of infrastructure projects by reducing the scope of environmental impact assessments. It would also reduce the property transaction tax, creating a more fluid housing market and increasing economic efficiency and labor mobility.
The most questionable elements of the plan are the income tax cuts. Reducing the basic income tax rate by one percentage point to 19% will fuel consumption at a time when the Bank of England is trying to rein in inflation. But after worrying rhetoric in the leadership election on central bank independence, the Prime Minister was clear: ‘It is right that interest rates are set independently by the Bank of England and politicians don’t decide that.”
The Prime Minister’s proposal to scrap the 45% tax bracket on incomes above £150,000 a year – the wealthiest 1.1% – was also unwise in the current tax and economic environment, coming under heavy criticism and eventually abandoned. “I understand and I listened,” Truss said.
Energy subsidies are hard for an economist to swallow. By protecting the public from high prices, they would reduce the incentive to change behavior: turn off the lights when leaving a room, put on an extra sweater. But other European countries are pursuing broadly similar policies, and there are simply no good solutions for the government when average household energy bills are set to soar due to Russia’s invasion of Ukraine. And these subsidies are not economic stimulus – they simply shift the responsibility of absorbing high energy costs from the private sector to the public sector.
So yes, there are legitimate grounds for concern and criticism here. But Britain is not collapsing. In fact, there’s a lot here to back up.
Fortunately, the hyperbole seems to have died down and the markets have stabilized. Following an intervention by the Bank of England to provide emergency liquidity to the financial system and the government’s decision not to remove the 45% rate, the pound recouped its losses. Britain’s 10-year borrowing rate is half a percentage point below the US rate – a relatively small spread.
But stability is not enough. The deployment of the plan was botched and created a credibility crisis for the government. Truss and Kwasi Kwarteng, the Chancellor of the Exchequer, must convince the markets and the public that their plan is reasonable. They need to explain why energy subsidies are the best of a bunch of bad options, and why their tax and regulatory changes will spur growth.
Credibility also demands that they clearly state where they plan to cut spending to get closer to a balanced budget. And the government must flesh out its plans to deregulate child care, agriculture, infrastructure, housing and land use.
In Birmingham, Truss took off the green visors: “Low growth isn’t just numbers on a spreadsheet.” Indeed, slow growth means fewer opportunities for economic progress. This means a dispute over distribution. This means that workers’ talents are underutilized and their energy untapped. It means obscured aspirations and more modest dreams for the future.
Truss’ economic program is a work in progress. It started badly. But by focusing on growth, the Prime Minister is clearly pushing Britain in the right direction.