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15 September 2022

The government is setting itself up to fail on the economy

Liz Truss and Kwasi Kwarteng's debt-led approach is not the best way to achieve growth, says Paul Johnson of the IFS.

By Freddie Hayward

The Queen’s body was placed in Westminster Hall yesterday and people started filing past at 5pm. The queue is now 2.6 miles long. Rory Scothorne captures the paradox between the ordinariness that the public project onto the monarchy (“they are just like us”) with the extraordinary treatment they receive.

On the surface, politics is paused. Parliament is suspended. Many MPs have returned home. Pushy journalists are denied interviews with a curt reminder that the nation is in mourning. But, behind the solemnity, government rumbles on. Preparations are underway for the Chancellor’s mini Budget next week. The announcement will (hopefully) include costings for the huge energy package. The Chancellor is also planning to lift the cap on banker’s bonuses, according to the FT. The cap was imposed by a 2014 EU rule that states banks could only set bonuses at twice the level of fixed pay.

The Conservatives have long opposed the limit. In 2014, George Osborne tried to overturn the directive in the European Court of Justice. Back in June, Boris Johnson explored the idea of reversing the cap, but backed off once he realised the public might not appreciate the policy during a cost-of-living crisis.

No such concerns seem to animate Truss’s government. The justification for the policy runs along the lines: lower taxes and less regulation will lead to higher growth. Scrapping the limit will also be heralded as a victory for post-Brexit Britain. But the plans are worrying as they suggest the government thinks the problem with the economy is that bankers aren’t paid enough.

Once combined with the halt in the rise of corporation tax, the cut to National Insurance and the refusal to impose a tougher windfall tax, the economic raison d’être of a Truss government becomes clear: fund tax cuts for corporations and the rich through debt in the hope of stimulating economic growth.

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Kwasi Kwarteng has set a target of 2.5 per cent of GDP growth – a level not seen since the early 2000s. The unspoken problem with such an approach, as Harry has pointed out, is that Brexit will cut GDP by 4 per cent in the long term. Even with Brexit accounted for, it seems unlikely that tax cuts are what the economy needs.

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Paul Johnson of the Institute for Fiscal Studies argues that education spending, planning reforms and investment would be better for growth. The debt-led approach means the government’s fiscal rules (debt to be falling as a share of GDP in 2024-25) might be missed. And the 2.5 per cent target seems difficult to achieve with their chosen policies. The government risks setting itself up to fail.

[See also: Could an extra bank holiday push the UK into recession?]

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