Tuesday, March 21

Two sides of Trussonomics: tax cuts and higher interest rates | economic policy

Liz Truss is short of heavyweight support for her plan to cut taxes immediately if she succeeds Boris Johnson as prime minister. Last week, when questioned on the Radio 4 Today programme, she came up with only one name: Professor Patrick Minford.

So it came as little surprise to find a letter appearing in the Daily Telegraph signed by a group of economists endorsing Truss’s proposal.

A letter to the editor has been a long-established feature of UK politics since 364 economists wrote to the Times in 1981 taking issue with Geoffrey Howe’s decision to raise taxes when the economy was in recession.

The Daily Telegraph letter supporting Truss’s tax plan has fewer signatories – just seven – and includes veterans of the Brexit campaign in 2016.

Graham Gudgin co-authored papers criticizing the Treasury’s assessment of the economic costs of leaving the European Union, while other signatories include Gerard Lyons, economic adviser to Boris Johnson when he was London’s mayor, and Shanker Singham, of the Institute of Economic Affairs, a free market thinktank.

While not mentioning Truss by name, the letter makes the case for the immediate tax cuts being proposed by the foreign secretary.

But it also spells out a feature of Trussonomics the Tory frontrunner has kept quiet about until now: that the increase to demand from scrapping April’s rise in national insurance contributions would be offset by higher interest rates from the Bank of England.

“The policy solution necessitates a tighter monetary policy from the Bank of England to control inflation and a looser fiscal stance, focused on targeted tax cuts, to address weakening growth,” the letter says.

This would be the mirror image of what happened in 1981, when the higher taxes in the budget were the trigger for interest rate cuts. Now the argument is that interest rates would rise to allow taxes to come down.

There is a case to be made for a change in the mix of policy. Interest rates have been kept low since the global financial crisis of 2008-09 and the Bank has also pumped almost £900bn into the economy through its bond-buying quantitative easing programme.

Fiscal policy – ​​the tax and spending decisions taken by the Treasury – has been kept relatively tight. Whitehall departments have been squeezed, the welfare system has been made less generous, and taxes as a share of national output is due to rise to its highest level in 70 years.

The letter from the seven economists does not specify how much higher official interest rates – currently 1.25% – would need to rise. It implies, however, that the Bank need not be too aggressive.

“Given the nature of our inflation shock – driven by global supply-side measures and previously lax monetary policy – ​​targeted tax cuts will not be inflationary. The domestic economy is not overheating.”

Minford has been more specific, saying borrowing costs could rise to 3% and perhaps higher.

“Yes, interest rates have to go up and it’s a good thing,” he told the Times. “A normal level is more like 5%-7% and I don’t think it will be any bad thing if we got back to that level.”

Sunak, who is the underdog in the leadership race, has seized on Minford’s comments, saying interest rates of 7% would add almost £600 to the average monthly mortgage payment. On balance, homeowners would be £6,600 worse off even after Truss’s tax cuts, Sunak’s team said.


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