Our investment partners, Asset Intelligence Research, comment on last week's 'mini-budget' and look at how it may impact investors.
‘A NEW APPROACH FOR A NEW ERA.’
By Kel Nwanuforo
The new Chancellor of the Exchequer, Kwasi Kwarteng, made quite a number of bold statements in his ‘Growth Plan Statement’ – clearly a Budget in all but name. But this was perhaps the starkest of them all.
This phrase can be deconstructed and examined through quite a few different lenses. A ‘new era’? Mr Kwarteng may have been referring to the recent renewal in government – which would be contentious, given we are now more than twelve years into Conservative-led administration. It is literally true however, as the nation mournfully turns away from the long Elizabethan age and towards the new Carolean reign.
What about the ‘new approach’? Again there are different ways of reading and thinking about this. During the Conservative leadership contest Liz Truss derided the long-standing “Treasury orthodoxy” of “abacus economics”, which does indeed often see Chancellors at least attempt to demonstrate they are offsetting tax cuts or spending increases with equivalent spending reductions or tax rises.
So it is fair to say that the central approach that Mr Kwarteng has taken with this Statement – a sizeable package of permanent tax cuts funded by structurally higher borrowing – does represent a meaningful change in direction. The Chancellor has certainly taken advantage of the fact the UK is now free of the stultifying deficit and debt targets of the European Union’s Stability and Growth Pact, which were unnecessary for a country such as us outside of the Euro.
But is cutting taxes first and worrying about the deficit later truly a new approach? Right-wing politicians in America would certainly recognise the playbook of Ronald Reagan, George W Bush and Donald Trump at work.
Whether this government’s method is something new under the sun or not, there certainly is justification for being critical of the conventional Treasury view. It is true that the finances of the nation do not work in the same way as those of a household or business, where incomings and outgoings do have to remain in some semblance of balance most of the time. This has been poorly understood by much of the political class in recent years.
The key question however is the wisdom of embarking on this course at a time of sky-high inflation. The danger is that by putting more money into our pockets and into corporate bank accounts now, overall demand within the economy will rise and therefore, especially given we are in a time of constrained supply of goods and energy, the pressure on prices will be driven even higher. The likely upshot would of course be even higher borrowing costs, driven by the markets and the Bank of England. Potentially then we may face the government’s foot on the accelerator offset by the central bank’s foot on the brake.
This is a real risk. The early market response to the Chancellor’s statement has been to see government borrowing costs rise even further than they already have in recent weeks. Meanwhile, Sterling has fallen to the lowest level against the US dollar since 1985.
Yet there would also have been risk in taking the opposite approach and simply accepting economic stagnation. This illustrates the central challenge facing policymakers at the moment: what makes ‘stagflation’ so nightmarishly difficult to tackle is that the optimal policy solutions for the ‘stag’ and the ‘flation’ parts of that construction are diametric opposites.
The conventional solution to inflation? Raise taxes and cut government spending. The typical playbook for stagnation? Cut taxes and increase spending.
The new Prime Minister and Chancellor have very clearly planted their flag on fixing the latter. Their focus is now on boosting economic growth to a trend rate of 2.5% over all other priorities, while hoping that the Energy Price Guarantee will be enough to see a peak in inflation shortly.
But beyond higher rates, this position faces another key risk: time. The extra issuance of government bonds necessitated by these tax cuts will be required on an ongoing basis as soon as each is cut. Yet the incentive effect of lower taxation on which the Chancellor is banking will take time to work in itself – especially given the broadly gloomy economic picture globally – but also certainly to feed through into higher economic growth. Deciding to build a new factory, for example, does not happen overnight.
Of course, that is assuming that lower taxes will boost growth by a meaningful amount anyway. As the Shadow Chancellor pointed out in her response, the UK already has the lowest rate of corporation tax among the G7 nations but also has the lowest rate of business investment. When deciding where to invest, other factors such as skills, productivity and trade links are also vital for businesses and entrepreneurs. Low taxes might arguably be a necessary precondition – but are unlikely to be sufficient.
Risks, uncertainties and challenges abound, although the new government has at least acted quickly and decisively in moving forward with their plan. We must hope that their big gamble pays off – or this new era may well see the new approach of a yet another new face at the Treasury in short order.
Key measures announced for England (national variations for Scotland, Wales and Northern Ireland may apply)
- Basic rate of income tax to be cut from 20% to 19% in April 2023
- 45% additional rate of income tax, levied on earnings above £150,000, to be abolished in April 2023
- National Insurance rate increases introduced in April this year to be reversed from November 2022, with the planned Health and Social Care Levy due to be introduced next year abandoned
- Threshold for nil-rate stamp duty doubled to £250,000 immediately, with the first-time buyers’ nil-rate threshold up from £300,000 to £425,000
- Next year’s planned rise in corporation tax, from 19% to 25%, abandoned
- Temporary £1m annual investment allowance for businesses to be made permanent
Source: Asset Intelligence 23/09/2022
Production
