Home / Opinion / Views /  After tax cuts, will Truss make a U-turn on ideology too?

Just over a week after his mini-budget sank the pound, crashed bonds, which sent the UK government’s borrowing costs spiraling, and spooked markets, ultimately forcing the Bank of England to step in with a £65 billion temporary support involving printing pounds, Chancellor Kwasi Kwarteng has made a humbling retreat.

Kwarteng axed his controversial unfunded tax cuts on Monday and brought forward the publication of his strategy for cutting the country’s debt. As also the UK’s Office for Budget Responsibility (OBR) forecasts. He will now publish his medium-term fiscal plan and the OBR forecasts this month itself rather than on November 23.

The tax cuts, the most generous in the last 50 years, were announced without consultation with Cabinet and bypassing assessment by the OBR that last published the country’s growth forecast in March. As a result, investors had no way of knowing how much, if at all, the chancellor’s fiscal plan would stimulate growth or how it would burden fiscal sustainability. Kwarteng had relied on the hope that faster economic growth will cover for the revenue lost to the tax cuts.

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The mini-budget had drawn scathing criticism from the International Monetary Fund. The markets had reacted nervously and the UK’s top corporate leaders had openly, publicly and unequivocally expressed anxiety over the affordability of the chancellor’s fiscal package, the country’s debt sustainability and the new government’s commitment to ideology rather than sound policymaking. Financial stability came under threat. The mass sell-off in bonds put pension funds at risk of insolvency and raised mortgage costs, pinching household budgets.

Monday’s U-turn came after threats from rebel Conservative MPs that they would not vote in the House of Commons for Kwarteng’s plan to scrap the top income tax bracket, which would have benefitted those earning more than £150,000 and cost the exchequer up to £3 billion a year.

The immediate political crisis has been averted, but the real damage is that Prime Minister Liz Truss, who is widely believed to have been a co-author of the tax proposal that made little political or economic sense, looks vulnerable already. She and the chancellor look like they can be pushed around by their foes in the Conservative Party, a Financial Times commentator wrote, cautioning that the mini-budget contains more proposals prone to pressures from the rebels, such as the decision to scrap the cap on bankers’ bonuses.

Of the more important implication of the developments, the commentator wrote, “The retreat signals less a recognition of the economic realities than the political ones".

After Kwarteng abandoned the unfunded tax cuts, bonds recovered and the pound returned to the level before the fiscal package was announced last month.

But the chancellor still has a fiscal hole to fill. Welfare spending cuts by not topping up allocations to cover for inflation is an option under discussion but one that could prove imprudent amid a cost-of-living crisis.

The UK has a lower debt burden than most other G7 countries, but Kwarteng put the new government’s fiscal credibility at risk by bypassing the OBR assessment of the growth and debt sustainability implications of his tax cuts, showing lack of regard for institutions and processes of the sort seen in developing countries, including India, but not expected in mature economies. And he didn’t cover himself with glory by firing a top official of the Treasury and overoptimistically targeting 2.5 per cent growth in his fiscal statement, without giving credible evidence to back up the claims.

Political commentary in India defended Kwarteng’s fiscal package, arguing that the opposition to it was purely ideological. This is misleading. The tax cut was a policy error because the fiscal statement accompanying it contained no measure for making good the revenue loss that would have to be incurred. Plus, he gave no plan for tackling debt. The chancellor was relying solely on the hope that the cut would spur growth. This when the global economy is staring at recession, and the UK government’s borrowing costs are set to rise, given the central bank is going to have to hike rates to control decades-high inflation. Second, and more importantly, the biggest thumbs-down for Kwarteng came from the markets. Those aren’t ideological adversaries.

Prime Minister Truss has pledged to boost the UK’s economic growth through supply-side reforms that typically take years to deliver results. It remains to be seen whether the debacle will force her to return to the drawing board and re-examine blind faith in ideology.

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