Possible replacement for Boris Johnson has risky economic plan, analysts say

The favorite to replace Boris Johnson as the UK’s next prime minister has a plan to rescue the country from recession – but many economists are not happy about it.

The polls put Liz Truss, the UK foreign minister, well ahead of former finance minister Rishi Sunak in a race that will be decided in early September by members of the Conservative Party.

If elected, Truss faces a number of daunting problems. Millions of Britons are struggling to make ends meet as inflation hits a four-decade high, driven by rising household energy bills expected to reach 300 euros ($365) a month in January.

On Thursday, the Bank of England raised interest rates by 50 basis points to 1.75% – the biggest increase in 27 years – and said it expects the UK economy to slip into recession by the end of the year. .

But Truss, in a debate the same day hosted by Sky News, struck an optimistic note, saying a recession was “not inevitable”.

“We can change the outcome and we can make the economy more likely to grow,” she said.

What is her medicine? A set of personal and business income tax cuts worth more than 30 billion euros ($37 billion), according to estimates by the Institute for Fiscal Studies.

Tax cuts, Truss said, will help curb runaway prices and spur growth — a claim that has left many economists baffled.

Inflation pressure

Truss has pledged to reverse an income tax increase introduced in April and abandon a planned increase in business taxes next year from 19% to 25%, designed to help pay the costs of pandemic relief.

It is counting on these cuts to spur growth, encourage companies to invest and ultimately help reduce inflation – which the Bank of England expects to exceed 13% by the end of this year.

But without a significant reduction in government spending — which Truss did not present in detail — “most of the economic theory that we have built up over the last 100 years would claim the opposite,” Grégory Claeys, a senior fellow at Bruegel, a think tank, told CNN Business .

Truss cited Patrick Minford, a pro-Brexit economist at Cardiff University whose research influenced Margaret Thatcher’s government in the 1980s, to support his view.

And in a letter to The Telegraph last month, a group of economists praised his plans, arguing that his tax cuts would “not be inflationary” and were necessary due to the “unbearable strain” that historically high taxes were putting on families in the Kingdom. United.

But John Van Reenen, a professor at the London School of Economics, among others, disagrees.

“[Ela está] wrong. It’s not going to decrease inflation, it’s going to increase it,” he told CNN Business .

Tax cuts put more money in people’s pockets, increasing demand for goods and services. In the context of an “extremely tight” labor market, Van Reenen said, fueling more demand will worsen inflation.

A spokesperson for Liz Truss told CNN Business that the country’s tax burden will soon be the highest since the 1940s, stifling business, innovation and growth.

“Liz’s tax cuts are necessary, affordable and non-inflationary. Cutting taxes, encouraging business investment will increase productivity, create new jobs and ensure people can keep more of their hard earned money,” the spokesperson said.

Any further rises in consumer prices could cause more pain to households and spur the Bank of England to raise interest rates again, particularly hitting those without a fixed rate mortgage.

UK shoppers have already slashed spending on groceries and ditched streaming subscriptions as the cost of living soared in recent months.

Eye-watering energy prices, exacerbated by Russia’s invasion of Ukraine, pushed consumer prices up by 9.4% year-over-year.

But on Thursday, Truss reiterated her opposition to raising an unexpected €5 billion ($6 billion) tax on oil and gas company profits to fund more aid to consumers, arguing that it would discourage investment in the UK.

“If we also have a reputation for levying a surprise tax on any industry that makes a profit, that’s a big problem for our country,” she told Sky News.

accumulating debts

Economists point to other obstacles to Truss’ plans, which include a pledge to increase military spending: rising government debt.

“What effect would you have on growing [de cortes de impostos] is far from enough for them to pay for themselves,” Stuart Adam, senior economist at IFS, told CNN Business .

Truss previously served as a high-ranking minister in the country’s Treasury department, a role that has responsibility for managing public spending.

Now, instead of major spending cuts, Truss has promised to find savings through reducing waste and inefficiency in the public sector, although some of his plans have already gone awry.

Earlier this week, Truss withdrew a proposal to link the salaries of government workers to the local cost of living, which she claimed saved 8.8 billion euros ($11 billion).

Critics argued that the plans would result in an effective pay cut for millions of nurses and teachers.

Truss cannot afford to piss off public sector employees, thousands of whom went on strike this summer – or threatened to do so – to demand pay increases.

In the long run, Adam said, the government would need to cut its spending or raise taxes again to pay any tax cuts introduced by Truss.

“At some point it has to come home to roost,” he said.

Towards growth

Truss’ plans to grow the UK economy are ambitious, given the central bank’s own forecast that the economy will reverse in the fourth quarter, a situation that could last all of next year.

Van Reenen said the “temporary sugar rush” brought on by the tax cuts would do little to prevent an economic slowdown, which is being driven by supply shocks rather than a lack of demand.

“Only stimulating demand [por meio de cortes de impostos] not a great tool to go out [de uma recessão]” said Adam.

Further interest rate hikes resulting from higher inflation would likely reduce demand anyway, he added.

For Van Reenen, the focus on tax cuts to boost growth is misguided. Deeper problems in the economy, including more than a decade of stagnant productivity and real wage growth, must be a priority for the new prime minister.

“It’s a little depressing the lack of meaningful engagement with serious issues,” he said, referring to Truss and Sunak’s plans for the future.