Past chancellors and experts attack Tory leadership challengers’ race to slash taxes
It is rather reassuring that Conservative MPs are putting the economy at the forefront of their leadership campaigns. Jostling to succeed a Prime Minister alleged to have uttered “f*ck business” in response to their Brexit concerns, UK businesses are looking for candidates offering stability, and rather less open hostility. Workers are looking for credible policies to address the cost-of-living squeeze. How much of what we have heard so far passes these tests? And what is the likely economic impact if some of these ideas are implemented?
The case for tax cuts
Almost all the candidates are offering some form of tax cuts. The backdrop to this is a UK tax burden that is expected to reach more than 36% of GDP by 2024. This is a level unseen for seventy years. The various pitches include cuts to Corporation Tax, Fuel Duty, Income Tax and reversing recent increases to National Insurance levies. Soundbite achieved – each tax-cutting leadership candidate will need to build these headlines out in three ways if they are to also be credible.
First up, what is the broader economic strategy that justifies these tax cuts? If the economy enters a deep recession this winter, there is a respectable case for a pre-emptive emergency cut to taxes to stimulate activity. But such a recession would also destroy any headroom against existing borrowing targets. So credibility requires making the case for further public sector borrowing – and its implications for future generations – not shying away from it.
Secondly, if we reject – as I believe we should – the largely fantasy economics of tax cuts generating more tax revenue, what activity will the government cease doing? Kemi Badenoch – at this stage one of the fringe candidates – made an impressive pitch over the weekend for limiting the scale of what activity the government undertakes. But reducing quangos, red tape and targeting efficiencies quickly morph into public sector pay restraint and mothballing levelling up funds if big savings are to be realised. Candidates that talk about savings in generalities are the easiest to dismiss.
Thirdly, there is a risk – albeit one that remains modest – that tax cuts act to generate higher inflation. This risk is higher for wide-ranging payroll and consumption taxes than for fuel levies and company taxation. There has been more than a whiff of trying to scapegoat the Bank of England for their failure to control inflation – most vocally from Tom Tugendhat – but this hawkishness on monetary policy is rather difficult to square with demands for tax cuts.
So, what about Spending?
Alongside Badenoch, Nadhim Zahawi and Liz Truss have emerged as the candidates most vocally targeting the funds for tax cuts by clamping down on public sector spending. This rhetoric will play well at hustings but as Truss was recently reported as requesting additional staff at the Foreign Office, and Zahawi more recently seeking an inflation target-busting pay increase for teachers, talking about spending restraint is the easy part. It struggles to survive contact with the reality of the post-COVID, post-Brexit economy.
How does this fit into an economic growth story?
These tax and spending gyrations from all the candidates become rather less strenuous if there is a strong story to tell on economic growth. Shadow Chancellor, Rachel Reeves, is already positioning the Labour Party to argue that the Conservatives are the party of low growth, and that the Labour Party’s spending ambitions can be assuaged by a faster-growing economy. Whilst details are sketchy on the Labour Party’s plans, it represents a potential Achilles Heel for any Conservative government heading into a likely 2024 election. Jeremy Hunt and Sajid Javid have floated a reduction in the headline rate of Corporation Tax from 25% to 15%. This type of tax arbitrage with other major economies comes at a difficult time when the Biden administration in the US have recently brokered a minimum Corporation Tax rate. However, this proposal from Hunt and Javid does at least acknowledge that an ageing society’s pensions and care requirements are rather more affordable if productivity and growth can be increased. One must hope that beyond the tax changes there are stable and consistent plans for higher economic growth. Recent years have seen a Productivity Plan in 2015 become an Industrial Strategy in 2018, a Plan for Jobs in 2020 and most recently a Levelling Up Plan in 2022. Fewer announcements, more delivery will be a key test of the new Conservative leader.
And what about Rishi?
The former Chancellor, Rishi Sunak, is currently the front runner with both bookmakers and in Conservative MP endorsements. He has largely eschewed the rhetorical race to lower taxes. Uncharitably some have seen this as him defending his own record in the Treasury. However, he has consistently acknowledged that the economic circumstances are what they are, not what he would wish for. The 1980s Thatcherite economy with its more favourable demographics and North Sea windfalls was able to backstop a smaller state. This is either myopically defeatist, or refreshingly honest. The next few weeks will establish which of these policies carries sway with Conservative MPs, and party members.
Managing Director, Head of Research