LONDON — Britain’s new prime minister, Liz Truss, bet on Friday that a heavy dose of tax cuts, deregulation and free-market economics would revive her country’s growth — a sea change in policy that has unnerved investors. already rocked by an energy crisis, soaring inflation and the specter of widespread recessions.
Britain’s announcement came as markets around the world had slumped for weeks in response to rising interest rates and recession fears. The slide continued on Friday, with the S&P 500 index falling near its lowest point of the year and European markets falling.
The move by Ms Truss’ government signaled a clean break with former Prime Minister Boris Johnson and with a generation of more tax-conscious Conservative governments.
For Ms Truss, the measures – which critics liken to the ‘trickle down economy’ of the 1980s – amounted to a jaw-dropping bet that Britain’s economy would return to robust growth before it faced voters in two years. But the tax cuts, in addition to extensive state intervention to limit soaring household energy bills linked to Russia’s war in Ukraine, will likely require tens of billions of pounds of new government borrowing, which will aggravate concerns about British public finances.
UK stocks and bonds and the pound all fell after the news, with the currency falling to new lows against the dollar, levels not seen in nearly four decades. Nervousness spread to the United States and Europe, where stocks fell sharply amid fears that more aggressive interest rate hikes would be needed to stifle inflation and that economies could slide into painful recessions this winter.
These fears are even more acute in Britain, where economic growth has stalled, inflation is at its fastest pace since the early 1980s and the Bank of England has already hiked rates seven times to curb the rise in prices.
In this difficult environment, the new Chancellor of the Exchequer, Kwasi Kwarteng, abandoned a proposal to increase corporation tax and, in a surprise move, also abolished the maximum rate of 45% of the tax on income applied to those earning more than 150,000 pounds, or about $164,000 a year. It also cut the base rate for low-income earners and lowered taxes on home purchases.
“We will focus on growth, even if that means making tough decisions,” Mr Kwarteng told a packed House of Commons. He acknowledged that “none of this will happen overnight”, but said the focus on tax cuts “is how we will turn this vicious cycle of stagnation into a virtuous cycle of growth. “.
It is hard to overstate the magnitude of the change in policy by Mr Johnson’s government, which just a year ago announced targeted tax increases to offset increased public spending due to the pandemic.
While Ms Truss ran for leader of the Conservative Party as a tax cut, the scale of the cuts announced on Friday surprised markets. They will cost £45billion, or around $49billion, over the next five years – the biggest tax cuts from any budget since 1972, according to the Institute for Fiscal Studies, a London-based think tank.
The government argues that lowering taxes will encourage more investment and the benefits will trickle down to the economy. But the risk is that the measures will be insufficient to reverse years of lackluster productivity and business investment.
The tax cuts follow promises already made to protect households and businesses from soaring energy prices, which have tempered both the expected increases in inflation and the expected decline in economic growth. But together they will mean more government borrowing, and one of the biggest dangers is that investors will doubt that the government’s new policy is working. This could push the cost of borrowing to painful heights and make debt levels unsustainable.
These fears led to the massive sell-off of UK assets on Friday. Some analysts said the risk that the pound and dollar could soon reach parity had increased, reflecting both the pound’s fall and the dollar’s role as a safe haven during global economic storms.
Beyond fears of unsustainable government borrowing, critics said Britain’s fiscal and monetary policies were dangerously contrarian.
The Bank of England is trying to curb inflation by using one of the few tools at its disposal: interest rate hikes that dampen economic activity. Still, the government is trying to revive the economy, for example by fueling the housing market and cutting taxes broadly, a combination that could fuel higher inflation.
On Thursday, a former deputy governor of the Bank of England, John Gieve, told the BBC that the central bank and the government were “pushing in different directions”.
The Chancellor’s statement to Parliament on Friday underscored the free-market, small-state and tax-cutting instincts of Ms Truss, who drew inspiration from Margaret Thatcher, who served as Prime Minister from 1979 to 1990. The economic revolution in Thatcher in the 1980s turned the economy around, albeit at great cost to many, with rising unemployment and labor unrest.
Some dispute the comparison with Thatcher. The plans announced on Friday mean a sharp increase in government borrowing at a time of rising interest rates, and so far there have been no indications of corresponding spending cuts. While Thatcher was a committed tax cutter, she first believed in balanced budgets.
Ms. Truss’s tax cuts, which disproportionately favor high earners, instead drew comparisons to the tax policies of Ronald Reagan, the US president who argued that tax benefits for corporations and the wealthy would benefit the low income people.
Nonetheless, Mr Kwarteng’s plans – and the ideology behind them – will likely set the stage for the campaign ahead of the next general election, due to be held by January 2025.
Ms Truss hopes that over the next two years policies she calls ‘shameless pro-growth’ can at least spark a strong economic recovery, allowing her to call on voters to stick with the Tories – rather than to risk tipping over to the opposition Labor Party.
By describing his announcement as a “fiscal event” rather than a budget, Mr Kwarteng avoided the need for an in-depth assessment by a government watchdog of the economic and fiscal impact of his plans.
The government gave a first look at the cost of caps on energy bills on Friday, estimating the price tag would be £60billion in the first six months alone. Mr. Kwarteng also gave estimates of the cost of the tax cuts.
Even as Mr Kwarteng answered questions from his fellow lawmakers in Parliament, UK assets began to fall in financial markets. He responded to the news by saying: “The markets are reacting as they will, but the growth plan will show very soon that we are on the right track and heading towards a more prosperous future.”
The pound has weakened against most major currencies this year, but those losses intensified on Friday. The pound fell more than 2% against the euro and 3.5% against the US dollar to under $1.09. The FTSE 100, the benchmark UK stock market index, lost around 2%.
The yield on government bonds, a measure of borrowing costs, has jumped as investors digest tax cuts and policies that will require £72bn of bond sales more than expected.
Mrs. Truss’ government now says stimulating growth by lowering taxes and reducing regulation is its central mission, even if that means courting unpopularity; it will also make it possible, for example, to lift the ceiling on bonuses that can be offered to bankers.
Scottish First Minister Nicola Sturgeon said the Twitter that the ad would send “the super-rich laughing all the way to the real bank” while increasing the number of people dependent on food banks, which help those unable to pay for essentials.
Mr Kwarteng also presented plans to create “investment zones”, with liberalized planning rules, where targeted and time-limited tax cuts will be offered to encourage the construction of shopping malls, restaurants , apartments and offices.
Mr Kwarteng also said he aimed to speed up infrastructure projects, including new roads and railways, by reducing the burden of environmental assessments required before work begins.
Rachel Reeves, the opposition Labor Party’s economics spokeswoman, described the announcement as ‘a budget without numbers, a menu without prices’ and ‘an admission of 12 years of economic failures’ from a party conservative in power since 2010.