Liz Truss’s tax-and-spend plans remain “unsustainable” following her U-turn on the 45p tax rate for high-earners, a leading economic expert has said.
The humiliating climbdown, announced this morning by Kwasi Kwarteng, will reduce the unfunded tax cuts in the chancellor’s mini-Budget by just £2bn, from £45bn to £43bn, said Paul Johnson, the director of the Institute for Fiscal Studies.
This difference is “trivial” in economic terms and is unlikely to have much effect on the view of financial markets or the Bank of England on the overall package, Mr Johnson told the BBC News Channel.
In terms of its judgement on inflation and the knock-on decisions on raising interest rates “the Bank will be just as concerned that £43bn is being pumped into the economy as it would have been with £45bn”, he said.
And he said it sets the scene for “dramatic” cuts to public spending in Mr Kwarteng’s 23 November fiscal statement, unless the chancellor is prepared to back down on further Budget measures, raise taxes elsewhere or face down the markets over his failure to rein in debt.
“This was the smallest fiscal measure in the mini-Budget,” said Mr Johnson. “To the extent that what we saw a couple of weeks ago was leading to fiscal unsustainability, it still is.
“Nothing really has changed. What has changed, perhaps, is a sense that this is a government that will back down, that will listen and will take opinion seriously.”
Mr Johnson said that the “big story” from the mini-Budget remained that it delivered an unfunded package of tax cuts totalling more than £40bn without the backing of an independent assessment by the Office for Budget Responsibility spending watchdog.
“We’re pretty confident that on current tax and spending plans, the government is on course to have an unsustainable fiscal policy – in other words, debt rising over time,” he said. “So from that point of view, it is pretty much as we were.”
Mr Johnson said that the U-turn could provide the government with “a bit of breathing space” with the markets.
But he said: “The difference it’s made really is trivial. There’s a lot of credibility issues, a lot of sense-of-direction issues here, rather than real change.”
If markets respond positively to the change, it may take “some of the pressure” off the Bank’s Monetary Policy Committee to hike interest rates, said the IFS chief.
But he added: “We can still expect interest rates to rise significantly and it will remain the case that for anyone with much of a mortgage at all, those increases in interest rates will wipe out the tax cuts that have been introduced.”
In the fiscal statement which he has promised for 23 November, Mr Kwarteng will have to deliver “something convincing about how he is going to get the public finances onto a sustainable footing – whether that involves undoing some more of those tax cuts or some additional tax rises or something fairly dramatic on the spending side”, said Mr Johnson.
If he was unwilling to do any of these things, Kwarteng would have to “brazen it out” and declare that the OBR had found he would not meet his fiscal target to have debt falling as a share of GDP within three years, but believed he could do it in five or seven.
The markets “might not react well” to such a statement, said Mr Johnson.
The head of the Resolution Foundation low-pay thinktank, Torsten Bell, agreed: “U-turning on 45p doesn’t change the big picture of a £40bn package of unfunded tax cuts which drove the market reaction (and doesn’t) avoid the big spending cuts that will follow.
“ U-turning on 45p does help the internal politics (Tory MPs won’t vote down finance bill), help wider politics (Labour wants to attack 45p not other tax cuts) and make the overall tax cut package less regressive (moves it from big giveaway for very top to the top half).”
