In keeping with the tradition of his predecessor, Chancellor Kwasi Kwarteng made a U-turn on Monday on his plans to scrap the 45p rate of income tax for top earners. His mini-budget announcement last week, which included the 45p scrap, was a tax-cutting package that would have left a £45 billion gap in the budget, causing markets to lose faith in the government’s ability to repay its debt. Gilt markets went into a death spiral and the pound went crashing.
Pension funds use government debt as collateral to pay for their ‘interest-rate swaps’—a financial instrument designed to protect them from changes in interest rates. On the other side of this risk-hedge are banks. So to prevent a meltdown in the banking sector, the Bank of England could issue up to £65 billion of quantitative easing (QE), buying long term government debt, bringing the price of bonds back up, and stabilising yields.
The Chancellor’s tax-cutting mini-budget was perceived as inflationary, causing markets to price in further rate hikes by the BoE. As a result, pension funds began selling gilts to get the cash needed to pay for their interest rate swaps. The increased supply of gilts on the market caused their price to fall, meaning they became harder to sell, and their increasing illiquidity meant that pension funds would not have been able to make payments to the banks. Had the BoE not intervened to stabilise gilt prices, ‘re-liquidating’ pension funds, banks would have faced substantial losses from the swaps, leading to a contraction of credit and potentially another financial crash like 2008.
By forcing the BoE to issue billions in QE, while simultaneously demanding counter-intuitive hawkishness with higher interest rates, the government is creating a huge amount of uncertainty and confusion about the UK economy—partly attributable to the sell-off of the Pound. Governor Andrew Bailey remains hesitant to take a strong position on the Bank’s response to the collapsing exchange rate, but the market is expecting a 0.75 percent increase in the base rate come the next Monetary Policy Committee meeting in November, and is predicting interest rates will rise as high as six percent by next year.
Such high interest rates will have devastating impacts for households. With around 300,000 fixed rate mortgages ending per quarter, the cost of monthly repayments for many households is set to increase by hundreds of pounds—as well as raising rents due to buy-to-let landlords passing on higher monthly repayments to tenants. It will also mean higher borrowing costs at a time when incomes are being squeezed and wages lag behind inflation—credit card borrowing is now growing faster than at any time in the past ten years.
So is this economic mismanagement brazen stupidity, misguided ideology, or sinister strategy? The answer is a bit of each. But one thing is clear: the direction of travel urgently needs to change.
Stupidity, Ideology, Strategy
It seems clear from the reaction yesterday morning that the Prime Minister and Chancellor were unaware of the ramifications their policies would have for the banking sector. The unfunded proposal to scrap the 45% rate on earnings over £150,000 would have seen the incomes of the richest 5% increase by 5.5%, with over half the total tax savings going to those with incomes of over £1 million. The supposed reasoning behind this giveaway to the rich is that the highest income earners earn the most because they are the ‘most productive’. Decreasing their tax liability, the notion goes, would incentivise them to ‘work harder’ and increase the UK’s lagging productivity. Supposedly, this should stimulate growth, leading to more tax revenue in the long run despite lower top rates. Clearly, the markets weren’t convinced by this gamble.
On the other hand, Kwarteng is an economic historian and notorious gold bug—well known for his disdain of ‘fiat currencies’, going so far as to write a book on the topic entitled War and Gold. As such, it seems unlikely that someone with his ideological disposition would be unaware of the risks posed to currency depreciation following large unfunded tax-cuts. As another economic historian, Adam Tooze, suggests in his recent Guardian article, crashing the pound could be part of an ideological plot by Kwarteng and Truss to shrink the state.
And despite backing off from the 45p rate cut on income tax, Kwarteng is continuing with the lifting of the bankers’ bonus cap and the reversal of the corporation tax rate increase, meaning it will remain at 19% instead of increasing to 25%. Again, the justification for this is encouraging investment and growth—but evidence suggests it won’t have that effect. The rate of corporation tax was reduced from 20% to 19% in 2017, and the rate of fixed capital formation fell by around half a percent by 2019—with a further significant fall in 2020 following the outbreak of the pandemic.
Scrapping the rise in corporation tax will cost over £18 billion—which will be paid for by cuts to government spending. As a cost saving measure, the government has decided to raise benefits payments by earnings instead of inflation, a policy that will see the poorest fifth lose around 2% of their income. The decision represents the biggest permanent real-terms cut to benefits ever made in a single year. As pressure mounts on Truss and Kwarteng to effectively cost their budget, more cuts like this are sure to follow. As Sean Irving has suggested in Tribune, this, too may have been part of the plan all along.
Squeezing benefits in this way is also part of a perverse scheme to force some of the 1.7 million people who are not looking for work due to long-term illness back into the labour force. Despite UK unemployment being at a record low of around 3.8% and Brits on average working longer hours than many of our EU peers, Truss is thinks Brits need ‘more graft’ to address the UK’s lagging productivity.
But decades of hard graft by UK workers hasn’t paid off. There has been a gross decoupling of wages from productivity over the past 30 years, representing a transfer of wealth from workers to the rich, as wages stagnate and profits margins soar. Put simply, in the current climate, funding tax cuts with the promise of growth is little more than a fantasy.
What We Need Instead
There is little sign that energy prices will come down in the near future. The forecast of a cold winter ahead will likely necessitate rationing in order to ensure energy is available for homes, hospitals, and schools, while excess winter deaths are likely to go through the roof. What we actually need to get through this crisis is redistributive taxation to fund government spending and support households. We need to bring energy bills well below the new £2,500 figure, a proper rise in wages and social security, action on rental costs spiralling out of control.
There are many ways the government could fund these kinds of measures, whether through a windfall tax on the huge gains hedge funds made shorting the pound, increasing the windfall tax on energy companies that are making record profits, taxing non-domiciles on their worldwide income, or increasing the rates of tax on passive incomes like capital gains and dividends. But granting corporations a lower tax bill paid for with cuts to public spending and letting bankers gift themselves higher bonuses isn’t going to cut it.
This Conservative government is risking people’s lives with their reckless economic experiment. Thousands took to the streets this weekend as part of the Enough is Enough campaign’s day of action, demanding a change to the road our leaders keep insisting on driving us down. Many more demonstrations of action like this will be needed if we are going to fight back against the open class war the Tories are waging on us all.