Kwasi Kwarteng reverses course on the top rate of tax

KWASI KWARTENG, the chancellor of the exchequer, has given two big speeches in his short time in the job. In the first, the infamous fiscal statement that he delivered to Parliament on September 23rd, he was visibly high on adrenaline. Tax cuts delivered, growth assured, so many rabbits pulled from his hat that it felt like Watership Down. Britannia finally unchained.

On October 3rd Mr Kwarteng addressed the Tory party conference in Birmingham. The tone was not exactly contrite, but it was markedly less triumphalist. That morning he had announced a big U-turn, reversing the decision he and Liz Truss, the prime minister, had made to abolish the top rate of tax. His earlier cocktail of huge tax cuts and minimal independent scrutiny had caused markets to take fright and the Bank of England to intervene on grounds of financial stability; the Conservative Party’s poll numbers had crashed; Tory MPs were lining up to denounce the decision to give richer people a tax break during a cost-of-living crisis. There had been “a little turbulence”, acknowledged the chancellor in his address to the party conference. “We are listening and have listened.”

The U-turn has defused an immediate political implosion, but not done much more than that. Abolishing the top rate of tax accounted for only about 5% of the £45bn ($51bn) of tax cuts announced last month. To reassure markets, the government is working on a new medium-term fiscal plan, which had been due on November 23rd but may now be accelerated; and to ensure its credibility, it is now shackling itself again to institutions that it has previously criticised or ignored. It is relying on the Bank of England to keep markets under control. The Office for Budget Responsibility (OBR), a fiscal watchdog whose views the government had shown little interest in before, will provide an independent assessment of its plans. “There is no path to higher sustainable growth without fiscal responsibility,” said Mr Kwarteng, a tad late.

The government hopes this will be enough to get on with its growth agenda. On this view, the U-turn on the top rate of tax signals pragmatism and flexibility to the markets, and it buys it political room to make whatever spending cuts are necessary to make the sums add up. The OBR will see the detail of supply-side reforms that are going to be unveiled in the coming weeks, goes this argument, and will concur that a big boost to economic growth is on its way. Inflation will add to government tax receipts, helping the books look better. The markets will settle; the pound and gilts gained ground after Mr Kwarteng reversed course.

So much for the fantasy. The government has bought itself a bit of time but still faces a succession of hard choices. The OBR is likely to be sceptical that tax cuts do a great deal on their own for long-run economic growth. Having suddenly got religion about the importance of Britain’s institutions, the government cannot lean on them too hard to come round to its point of view.

It is possible that the coming supply-side reforms will be superbly crafted; much the greater risk is that they will be rushed out. Many of them will also collide with political reality. A sensible sequencing of the growth plan would have kept tax cuts back as the reward for pushing through unpopular but growth-enhancing measures like planning reform and big infrastructure projects. Instead, the tax cuts have been bodged, mortgage bills are a lot higher than they were before the fiscal statement and the prime minister is weakened. With an election looming in the next two years or so, few Tory MPs will want to pick a fight with their constituents over building lots of homes or liberalising immigration.

If the OBR does not buy the government’s promises on growth, Mr Kwarteng’s new embrace of fiscal restraint points to one of two things: roll back more of the tax cuts announced on September 23rd, something Ms Truss will not want to contemplate, or try to spend less. But spending less is much harder than it sounds. Inflation is already eating into departmental budgets agreed in 2021. Tory MPs who opposed tax cuts for the rich are gearing up to oppose benefits cuts for the poor. Reductions to capital spending make no sense at all for an administration that bangs on about infrastructure.

Mr Kwarteng’s original sin was to bring the government’s commitment to fiscal sustainability into question by relying heavily on unfunded tax cuts to ignite growth. Today’s U-turn has not washed that sin away. Mr Kwarteng and Ms Truss have acknowledged that the fiscal statement did not go down well. They have not cleaned up the mess they have made. ■