🕑 4 min By Leo Paggen
1. Background Information
Following the resignation of former United Kingdom prime minister Boris Johnson due to what members of his own party believe was a “lack of integrity, competence and vision”, a new prime minister has been appointed. Liz Truss has only been prime minister for just under a month, and her name is already a synonym for a lack of trust for the citizens of the United Kingdom. Though she has taken the position of prime minister in times that are very difficult and uncertain for the United Kingdom’s economy, some of her and Chancellor of the Exchequer (or simply “Chancellor”) Kwasi Kwarteng’s decisions are so controversial they managed to get negative reactions from even the IMF.
2. A Controversial Set of Economic Policies, the “Mini-Budget”
The most talked-about announcement from the prime minister and the Chancellor is what is known as the “mini budget”, in other words an unofficial budget statement that was announced just last month. The so-called “mini budget” consists of important economic policies, namely the infamous income tax cut. Although the tax cut is not a brand-new idea, it has been implemented earlier than expected. While the implementation of the changes made to the basic income tax rate may look very good for the United Kingdom’s citizens, a decrease from 20% to 19% in tax rates could potentially cause the United Kingdom to temporarily forgo substantial tax revenue. The illusory good news about the tax cut for people also comes bundled with what many refer to as unfair and disproportionate tax cuts; namely keeping the corporation tax rate the same, but decreasing the highest income bracket tax rate by a much bigger margin than 1%.
While the plan was to raise corporate tax rate to 25%, Kwarteng’s mini budget aims to keep the corporation tax rate at 19%, which also will inevitably cause the government to temporarily give up on immense potential tax revenues. Cutting tax rates on the incomes of those who are struggling the most is one thing, but not raising income taxes for entities such as corporations is something many claim to be unfair. What is more unexpected and talked about is that as previously mentioned, the highest income tax rates in the United Kingdom have also been cut, by a very large margin, from 45% to 40%. These new unfunded tax cuts are not going to pay for themselves, and many sources place the estimated cost of such policies at 45 billion pounds.
3. Actual and Potential Consequences of the Mini-Budget
The International Money Fund (IMF) has warned the United Kingdom’s government against the implementation of such economic policies, claiming they will increase inequality in the country. After all, people at the bottom of the income distribution gain much less from a 1% income tax rate decrease than do people at the top of the income distribution from a 5% income tax rate decrease. In addition to this issue, Moody’s, a credit rating agency, qualified the tax cuts as “credit negative”, a claim that will certainly deteriorate the already low trust people have in the government’s ability to carry and sustain such policies. The policies announced by the government are also part of the reason why the pound’s value against the US dollar fell drastically, experiencing the same fate as the euro, and further deteriorating international trust in the United Kingdom’s government. Concerns the pound or even hit parity with the US dollar are arising because investors do not feel like the United Kingdom is worth investing in right now due to the announcement of the mini-budget.
That and economic volatility, which the Eurozone is also facing, make investors reluctant to invest in the United Kingdom. Another important consequence of the policies deals with mortgages in the United Kingdom. Because of the unfunded tax cuts, the United Kingdom is more than likely going to have to borrow from foreign countries, at a higher rate than before. Increased borrowing costs have contributed to a rise in mortgage prices, which would explain why more than 40% of available mortgages on the market were removed over the next few days following the mini-budget announcement; uncertainty in markets is causing mortgage issuers to have to review their offerings, with some even removing their offers until the financial turmoil comes to an end. This of course affects not only mortgage issuers in a negative way, but also prospective homeowners, who see the cost of their mortgages go up drastically.
4. The Government is not Backing Off
In spite of all the apparent problems their new policies may bring to the country, the Prime Minister and the Chancellor of the United Kingdom insist on implementing their policies. After all, it is too late to back off now, trust in the government has already been almost irreversibly damaged, Truss and Kwarteng have little choice but to persuade people that their policies will decrease the costs of living for everyone, and foster economic growth, which the United Kingdom has been lacking for a couple of years now. Truss insists that the economic problems the United Kingdom is facing are only due to the international turmoil caused by events like the COVID-19 pandemic and Putin’s war on Ukraine, but many also say the mini-budget is also partly to blame. As for Kwarteng, he insists on sticking to his growth plan, hence refusing to shelf the mini-budget.
Lizz Truss and the Chancellor have only been in power for a few weeks, yet some of their moves have already caused major damage to the United Kingdom’s economy. Concerns of potential rising inequality and rising debt in the country are causing people to lose trust in their government’s ability to sustain the policies they announced. Whether the government is right or wrong about their policies and their implementation remains a question that cannot be answered now. The answer will be found by staying vigilant and closely following the development of the United Kingdom’s economy over an extended horizon. Only then will the potential past mistakes appear to the eyes of the population.
Sources: The Guardian, The Economist, The New York Times
Written by Leo Paggen