After a disastrous two weeks and a dreadful party conference, both the Prime Minister and the Conservative Party are trapped with nowhere to go. The only difference is that the Conservative Party knows it.
Liz Truss’s predicament flows from her successful leadership campaign – the pledge to reverse Rishi Sunak’s tax increases. Cancelling the rise in corporation tax and reversing the National Insurance increase, combined with an expensive energy price cap freeze and yet further tax cuts (most prominently, scrapping the 45p income tax rate) spooked the markets.
The energy price cap freeze is a temporary policy (so should not cause long-term damage to the public finances) and the abolition of the 45p income tax rate has been abandoned, but £43bn of unfunded tax cuts remain. The markets are watchful and a failure to address this runs the risk of further turbulence, with interest rates forced to go higher than they otherwise would.
How to solve this problem? Increasing taxes would go against everything Truss stands for and leave her politically broken. Spending cuts, at least on the scale required to fill in the hole created, look untenable. Conservative MPs who forced a reversal of the top-rate tax cut will, for example, thwart a real-terms cut in benefits.
Truss had two hopes when she set out her tax plans over the summer. The first was that the markets would take it in their stride. They did not. The second was that higher levels of growth as a consequence of ambitious supply-side reforms will mean that the tax cuts are affordable. There are a small number of economists who believe this but the problem for Truss is that these are not the economists of whom the markets or the public will take much notice.
The exclusion of the Office for Budget Responsibility (OBR) from the original mini-Budget was a contributing factor to the subsequent market turmoil, suggesting an undermining of important institutions. The Prime Minister and the Chancellor, Kwasi Kwarteng, now recognise that the OBR cannot be ignored but when the next economic statement is delivered, it will likely give its opinion on the growth-enhancing impact of the policies announced so far and conclude that it amounts to very little. Awkward for a government emphasising growth.
This is not to say that there is nothing of any value in the government’s proposals but the OBR will not place much store on high-level proposals that have yet to be implemented. This is not new; it has frustrated previous Treasury teams. It is, however, a reasonable assessment, especially since the chances of the government being able to deliver on some of its more controversial plans look increasingly slim.
If anything, the OBR will revise down growth and revise up the deficit because of the actions the government has taken. Higher interest rates will both slow the economy (thus reducing tax receipts) and increase the UK’s debt interest costs.
In summary, the Prime Minister has a budget deficit that she has to cut and that won’t be reduced by higher growth (at least, not according to the OBR numbers), but she is incapable of either raising taxes or cutting spending. She is trapped. All that she can do is try to muddle through and hope the markets treat her kindly.
The Conservative Party is similarly left with an array of impossible choices. It could keep Truss as prime minister but she has made a terrible first impression, shown an absence of judgement and communication skills, and, as discussed, cannot resolve the fiscal problem she has created for herself. A general election catastrophe appears inevitable.
There is an obvious response. Truss should go and be replaced immediately by someone who has the confidence of the markets. As luck would have it, such a candidate is available in Rishi Sunak. His criticisms of Truss’s fiscal plans have been vindicated and he would be able to address the fiscal issue simply enough, by sticking with the tax increases he had already announced as chancellor. The markets would be calmed and the “Kwarteng premium” that is pushing up interest rates would be removed.
The problem with this is that it only works if Conservative MPs overwhelmingly support the move. In those circumstances, it may be possible to exclude the party members – and a lengthy leadership campaign – as happened when Michael Howard succeeded Iain Duncan Smith in 2003. It is hard to see this happening today. The parliamentary party may have reached an overwhelming conclusion that Truss is not up to it, but that does not mean there is a consensus as to who should succeed her. There is, after all, an alternative to Sunak.
It is surely no coincidence that three of Boris Johnson’s most loyal supporters – Nadine Dorries, Priti Patel and Conor Burns – have criticised or mocked his successor as prime minister. None will have done so with the intention of putting Sunak in Downing Street.
A vacancy in No 10 means an opportunity for a restoration. Johnson will not forego that opportunity, especially if his doing so benefits the man he blames for his downfall. And if Johnson’s name goes forward to the members, he has every chance of succeeding. Most Conservative MPs would be reluctant to run this risk.
All options for change look impossible but the status quo is untenable. Something will have to give.