Kwarteng invokes Thatcher but UK faces very different times

Defending his controversial borrow-and-tax-cut mini-Budget on Sunday, Kwasi Kwarteng invoked the spirit of Margaret Thatcher.

“I want to see . . . people retain more of their income, because I believe that it’s the British people that are going to drive this economy,” the new UK chancellor told the BBC as he promised more tax reductions to come.

Kwarteng’s words and sentiment, however, received a hostile reception from economists and financial market experts who disputed the Thatcherite parallels, saying the policies had more obvious roots in US history and the events of the 1970s. Many warned that rectifying action would be required to calm financial markets.

When Thatcher’s first government was elected in 1979, Britain was seen as the sick man of Europe with a top income tax rate of 83 per cent, widespread restrictive practices in industry and terrible labour relations.

Alongside a programme of deregulation, she cut the top rate to 60 per cent in her first Budget alongside a basic rate income tax cut from 33 per cent to 30 per cent. In 1988 the basic rate went down to 25 per cent and the highest rate down to 40 per cent.

However, economists said this was where the similarities with Kwarteng’s decision to abolish the top 45 per cent rate and cut the basic rate to 19 per cent ended.

Thatcher’s government raised the value added tax rate from 8 per cent to 15 per cent in the 1979 Budget to offset the income tax reductions and ensure they were not inflationary. It also raised the national insurance employee rate from 6 per cent in 1979 to 9 per cent by 1983, in sharp contrast with measures announced on Friday.

In 1988 Nigel Lawson’s cuts to the top rate of income tax only came when the government had a budget surplus of 1.1 per cent of gross domestic product, not when it was running a large deficit as now. The difference has led to less flattering comparisons with the earlier 1970s Budgets of Anthony Barber, which created a boom and high inflation followed by a bust.

Mohamed El-Erian, adviser at Allianz, said: “This is 1972, in the sense of the government going for growth and doing it via an unfunded stimulus.”

He added that the measures also bore comparison to Reaganomics, amounting to “more deregulation, more tax cuts, go for growth and let the central bank deal with the inflation problem”.

Ronald Reagan, US president from 1981 to 1989, found that rather than increasing revenues, his tax cuts led to twin budget and trade deficits by the end of the 1980s.

Jason Furman, former economic adviser to Barack Obama, noted the similarity of Kwarteng’s measures to the US 1981 tax cuts, which, he said, “were partially undone in 1982 in the face of high inflation and rising budget deficits”.

Academics disagree about whether Reagan’s tax measures spurred higher labour supply and entrepreneurialism as a result of the difficulty of separating out the pure effects of tax on growth. One recent paper by Professor Owen Zidar of Princeton University found that “tax cuts that go to high-income taxpayers generate less growth than similarly sized tax cuts for low- and moderate-income taxpayers”.

In the UK, examinations of the effect of introducing the 50 per cent top rate in 2010 and reducing it to 45 per cent in 2013 were complicated, said associate professor Andy Summers of the London School of Economics, because the main effect had not been in changing working patterns, but “for rich people to change the tax year they received income to maximise their gains”.

Torsten Bell, director of the Resolution Foundation, a think-tank, said prime minister Liz Truss’s approach to tax cuts and deregulation might in any case not have the same effect now as in the 1980s in the US or UK.

The top rate of income tax was already so much lower and Britain was more lightly regulated than most advanced economies, he said. Instead, the most likely effect would be “worse public finances, a higher cost of borrowing and lower public spending”.

If the government wanted to maintain spending on schools and hospitals, while still putting debt on a downward path by the next election, it might well end up cutting public investment — which “pound for pound has more impact on growth than tax cuts”, he added.

Internationally, the Budget received a critical reception, generating a view in some quarters that the UK government had lost the economic plot.

Olivier Blanchard, former chief economist at the IMF, also warned of the risks of a bigger market reaction, saying the Budget had been a “textbook example of how not to design and not to sell a fiscal expansion”. He added: “While we were worried about Italy, the UK sneaked in. We are lucky that the UK is not in the euro . . . Otherwise we would be facing another euro crisis.”

Adam Posen, president of the Peterson Institute for International Economics and a former member of the Bank of England’s Monetary Policy Committee, suggested that the central bank might need to step in early to calm markets, if the government did not change course.

“The only thing that will stabilise the UK economy is fiscal policy reversal. BoE rate hikes are a partial substitute but a second-best outcome,” he said on Twitter.

Some of the greatest concerns came from people who worked in financial markets. Sushil Wadhwani, an asset manager and former BoE policymaker, said most market participants no longer believed the public finances were sustainable and the government had appeared “dismissive” of market movements.

“It is very easy to see how the Truss-Kwarteng fiscal expansion leads to growth falling — a combination of interest rates having to go up a lot in response to a markets crisis and falling confidence that is then engendered,” Wadhwani said. “That is in sharp contrast to the positive confidence effects created by Reagan’s policies.”