Sensemaker: Tax and growth in the UK

Long stories short

• An aide to Viktor Orbán resigned and likened him to Goebbels after the Hungarian prime minister said he didn’t want his country to become “mixed race”.
• McDonald’s increased the price of its 99p cheeseburger in the UK for the first time in 14 years, to £1.19. 
• Accountants estimated the value of Rome’s Flavian Amphitheatre, better known as the Colosseum, to be €77 billion.
• Boris Johnson said “as far as I’m aware” he didn’t discuss government business with former KGB officer Alexander Lebedev during the Salisbury poisonings affair (more below).

Tax and growth in the UK

Both contenders to be the UK’s next prime minister want to cut taxes to drive economic growth. The first goal is a requirement for Conservatives appealing to their base. The second is a requirement for the country, especially post Brexit. But there’s an obstacle:

Inflation. This generally rises with tax cuts because they allow more spending, which pushes prices up. Inflation is already running at 8.2 per cent. It’s one of the biggest risks facing the economy and policy should be focused on controlling, not worsening, it.

The Bank of England has stressed the need to bring prices down. It would likely respond to inflationary tax cuts with higher interest rates, which are currently at 1.25 per cent.

• Liz Truss wants immediate tax cuts despite inflation. The only economist she could name in support of her plans, Patrick Minford, said rates could rise to 7 per cent. Rates at that level would hit disposable incomes. 

• Rishi Sunak says he would act “once we have gripped inflation”. His team claims rate rises under Truss would add almost £600 to the average monthly mortgage payment. So the Sunak plan is to wait for inflation to slow down and then cut taxes.

The trouble for both candidates is that a more fundamental problem remains:

Higher taxes aren’t the reason for weak growth, which has been slow for the past 15 years. The UK’s growth has underperformed most European countries, including France, Germany, and the Netherlands. Its tax burden, measured as government revenue relative to GDP, was 38.8 per cent before the pandemic – compared to 43.7 per cent in the Netherlands, 46.7 per cent in Germany, and 52.5 per cent in France. 

The UK is at full employment, so it needs productivity improvements for sustainable economic growth. Lowering taxes doesn’t necessarily make workers or companies more efficient. Yet this is what both candidates are proposing:

Personal tax

• Sunak promised a 1p cut in the headline income tax rate by 2024 in his last budget as chancellor, but he plans to keep National Insurance contributions at the increased level announced in April, which is an effective tax rise. 
• Truss said she would reverse the increase in NI rates at a cost of £13 billion a year to boost growth. While it would strengthen the incentives to enter work and earn more, these effects wouldn’t be anywhere near strong enough to cover the cost of her plan.

Corporate tax

• Sunak. The March 2021 budget announced an increase in corporation tax from 19 to 25 per cent from April 2023 for big companies. Sunak wants to go ahead with it.
• Truss wants to cancel it. The UK’s current rate is one of the lowest headline rates in the developed world. Cancelling it would cost £17 billion a year, but Truss argued it would attract investment that generates growth. It might, but the effect, again, wouldn’t be large enough to offset all of the lost revenue.

The cost of tax cuts suggests the candidates are planning cuts to public spending to pay for them. But neither has been clear on where those cuts would fall, and public services are already stretched. 

High inflation is eating away at departmental budgets. It’s also leading to demands for higher wages. Giving pay raises without the requisite funding – that is, in the face of tax cuts – would necessitate cuts in headcount, cuts to public services – or more borrowing.

Borrowing

• Sunak. Under plans he made as Chancellor, the government is committed to having public sector net debt falling as a fraction of national income by 2024/5. It’s also committed to covering all day-to-day spending out of tax revenue – borrowing only to invest – by the same year.
• Truss. Her borrowing plans are unclear. She’s said she wants to put debt on a “longer-term footing”, by which she may mean locking in long-term interest rates and increasing government debt maturity. The UK already has a longer public debt maturity than any other OECD country. Extending it wouldn’t cover the cost of her proposed tax cuts.

The next prime minister would be right to focus on generating economic growth. And changes to tax policy can help support that aim. But they’ll only be effective in conjunction with changes that boost productivity: better schools and vocational training, planning and competition policy reform, investment in infrastructure, and reformed trade policies. It’s this last point that is the most important.

The UK has made trade with the EU – its nearest and richest partner – more difficult and, in the case of many export markets, almost prohibitively expensive. Sunak and Truss are competing to be seen as the Brexit candidate. It’s an unfortunate state of affairs. Rejoining the single market would generate more growth faster than any other policy.

Must watch: this animation for UK exporters to the EU under current rules, which appeared briefly on the UK government website earlier this month but has since been taken down.

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CAPITAL ECONOMY, BUSINESS AND FINANCE

Slow global growth
The IMF warned that the global economy will grow at a slower rate than predicted, with the UK set to underperform the world’s richest economies. In April the fund estimated a global growth rate for the year of 3.6 per cent in April, but it’s now lowered that to 3.2 per cent. It blamed the downgrade on central banks raising interest rates to control inflation, the war in Ukraine, and a slowdown of China’s growth because of the country’s severe Covid restrictions.

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TECHNOLOGY AI, SCIENCE AND NEW THINGS

America chip bill
The US Senate voted to proceed with a $280 billion package to fund domestic microchip production. The bill is designed to reduce the risk of supply chain disruptions, which have slowed the manufacture of a range of products from cars to appliances; to reduce the country’s reliance on foreign manufacturers; and to help it compete with China. About $50 billion will go to conventional chip production to ease US dependence on factories in Taiwan, but most of the money – $200 billion – will go towards scientific research. The bill will now head to the House of Representatives for a vote before the August recess.

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The 100-year life health, education AND GOVERNMENT

Ketamine on the NHS 
Regular readers may remember our Sensemaker on the potential for psychedelics being provided on the NHS as a therapy for mental health disorders. It now looks likely that Ketamine assisted-therapy for alcohol use disorder will be one of the first treatments to be approved. The UK government’s National Institute for Health Research has agreed to put up 66 per cent of the funds (roughly £1.6 million) for a Phase III trial run by a Canadian biotech company to be administered across the health service. The trial will be one of the biggest of its kind to date and is the only Phase III clinical trial of psychedelics to receive government funding so far. If its results compare with those of an earlier Phase II trial which showed 86 per cent abstinence at six-months post-treatment versus 2 per cent pre-trial, the chances of quick adoption by the NHS are “very high”, according to trial leader Professor Celia Morgan. Prescription drugs for alcohol dependency cost the NHS £4.5 million in 2020/21 and alcohol-related harm is estimated to cost £3.5 billion every year in England.

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Our planet CLIMATE AND geopolitics

Dry England
The UK’s Met Office said the January to June period was the driest in England since 1976. Months of below-average rainfall have led to low groundwater levels, dry soil, and low reservoir levels. Nowhere is considered to be “in drought”, but if dry conditions continue, the National Drought Group will impose restrictions on non-essential water use that may include hosepipe bans. The last time the group declared a drought was in 2018.

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CULTURE soCIETY, IDENTITY AND BELONGING

Boris Johnson letter
Boris Johnson wrote to parliament’s Liaison Committee confirming he attended a “social event” in April 2018, at the height of the Salisbury poisoning crisis when he was Foreign Secretary, at the Italian villa of Evgeny Lebedev. Lebedev’s father, KGB-officer-turned-oligarch Alexander Lebedev, also attended. Johnson wrote: “As far as I am aware, no Government business was discussed.” He claimed the meeting with Alexander wasn’t “pre-arranged”. He also claimed it was all in line with established security protocols and that there was no need to inform his officials of the meeting afterwards. Tortoise has been reporting on this story for months, and the findings do not match Johnson’s claims. For one thing, we heard that Johnson and Alexander discussed the Skripal case.

Thanks for reading. Please share this around and tell us what you think. Send an email to sensemaker@tortoisemedia.com.

Paul Caruana Galizia
@pcaruanagalizia

Additional reporting by Phoebe Davis.

Photographs Getty Images, PA images/Alamy

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