Sometimes policy is about making choices. On other occasions, the reality is that there is only one choice available. This is where the government is getting to on fiscal policy, although the Prime Minister and Chancellor might not realise this yet.
Plan A – way back on 23 September – was to borrow to fund tax cuts. This was as part of a package of supply-side reforms, and the hope was that the markets would be relaxed because, although borrowing was rising, it would be in the cause of economic dynamism. If the UK was no longer held back by high taxes on business profits or entrepreneurs, all would be well.
It did not work out like that. The markets reacted very negatively, believing that the mini-Budget represented wishful thinking, ideological zealotry and a lack of seriousness. Matters were not helped when the government briefed over the subsequent weekend – after early market turbulence – that there were more tax cuts to come. The Chancellor of the Exchequer, Kwasi Kwarteng, essentially confirmed that in his interview with Laura Kuenssberg on 25 September.
A variation of Plan A was that the Office for Budget Responsibility (OBR) might give the government some credit for its growth plans and revise upwards its economic forecasts. This was always a long shot (if that had been likely, the OBR would presumably have been invited to opine on the mini-Budget). Some Conservatives are complaining that the OBR is insufficiently “dynamic” in its forecasting because it does not assume tax cuts and deregulation bring immediate and substantial benefits. But the OBR works on evidence, not leaps of faith, and the evidence rarely points to tax cuts paying for themselves.
The government now had a problem. The markets were jittery and interest rates were rising. The government’s debt interest bill increased – by £10bn a year, according to the Institute for Fiscal Studies (IFS) – so the public finances were deteriorating while households faced much higher mortgage bills. Sticking with Plan A while the markets were so negative was no longer an option.
[See also: Kwasi Kwarteng’s Budget is being rewritten while he’s across the Atlantic]
The objective now became restoring economic credibility by devising a plan to restore the public finances to sustainability. Given that Liz Truss had won the Conservative Party leadership by opposing tax increases – and promising “no new taxes” – Plan B was to find savings in public spending.
The challenge was not just to come up with a plan but a credible plan. It needed to be acceptable to Conservative MPs, acceptable to the public and acceptable to the markets. Even making a start on this is proving to be impossible. The first idea to emerge was reducing benefits in real terms, but it was quickly apparent that this was politically toxic, and the government did not have the votes. The list of other options to cut spending is not a long or attractive one.
At yesterday’s Prime Minister’s Questions, Truss appeared to rule out spending cuts, although subsequent briefing suggested that she was referring to spending in aggregate, which has been boosted by the energy price freeze. But when the IFS is warning that £62bn of cuts would be needed to stabilise debt as a share of GDP, it should be obvious that Plan B is a non-runner.
By a process of elimination, we are left with Plan C. Plan C is for a substantial proportion of the black hole to be filled by tax rises. The simplest way of doing this is not to proceed with the policies announced on 23 September. This has the advantage of raising a lot of money, but will also be interpreted by the markets as an act of penitence by a government that has learnt the lessons of the past three weeks. Credibility may be partially restored.
It is not yet obvious that ministers have got there but the logic of the situation is irresistible. It would, of course, involve a spectacular political humiliation. At best, Truss would be left in office but not in power. It is hard to see how Kwarteng could remain either. But in the end, the government cannot buck the market, and the longer resistance lasts the more painful it will be for the Tory party, the public and the UK’s international reputation.
Even now, ministers are only slowly edging towards an understanding of the crisis they have created. The Business Secretary Jacob Rees-Mogg is still arguing that recent market issues stem from the Bank of England’s interest rate decision of 22 September, not the Chancellor’s tax announcements the following day. This is preposterous and damages the government and the country’s credibility. More encouragingly, the appointment of a Treasury old hand, James Bowler, as permanent secretary to the department (briefed by No 10 as the Prime Minister overruling the Chancellor, which sounds ominous for Kwarteng) suggests greater sensitivity to market sentiment. Bowler is also very capable. “He is a joy to watch telling people what they need to hear in a way in which they can hear it,” says a former colleague. He will need to do plenty of that.
The economics moved swiftly after Kwarteng’s 23 September statement. The politics has yet to catch up fully, but it must. The question now is how much economic damage is done before the Prime Minister succumbs to the inevitable.
[See also: Liz Truss sacks Kwasi Kwarteng amid market turmoil]
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