Tom Cloughterty is Head of Tax at the Centre for Policy Studies.
It doesn’t take great psychic power to know what economic challenges a new government led by Liz Truss will face. In the short term, it must confront inflation, an acute cost of living crisis, and the possibility of a nasty recession. Looking further ahead, the key task is to boost investment and productivity, so that real wages and the economy grow faster. All of which, of course, is far easier said than done.
We also know a fair bit about how a Truss government is likely to approach these economic challenges, because she herself has an unusually clear and well-established ideological worldview – something that is vanishingly rare among contemporary politicians.
Truss is a supply-sider in the Ronald Reagan mould. She believes that freeing trade, liberalising regulations, and reforming taxes will boost the economy and raise living standards. That’s why she has talked more about growth in the last few weeks than any other Conservative has over the last decade (and more).
It’s also why her premiership could mark a break from the narrower fiscal conservatism that has dominated party thinking since the financial crisis. This‘Treasury orthodoxy’ takes the state of the economy as a given and prioritises careful management of the public finances. At its best, this approach ensures prudent stewardship of taxpayers’ money. But at its worst, it can be a recipe for economic defeatism and managed decline.
Truss is plainly no spendthrift. But she will want her government to make its own economic weather, by pursuing ambitious reforms designed to deliver rising prosperity. Doubters should remember that, on a per capita basis, we’re almost a third poorer than the United States and a fifth poorer than Germany. So we don’t need to reinvent the wheel; we just need to catch up – and the faster the better.
Pro-growth reform, however, will take time to deliver, and more time to show results. And in the weeks immediately after her move to Downing Street, there will be several urgent tasks in the new prime minister’s in-tray. An emergency budget in September may serve two purposes: first, to deliver key campaign promises on National Insurance and Corporation Tax; second, to get to grips with the energy crisis that is causing so much uncertainty – and, indeed, downright panic – as we drift towards winter.
On tax, Truss has promised to cancel the rise in National Insurance Contribution rates, with as close to immediate effect as tax administration will allow. Corporation tax will stay at 19 per cent, rather than rising to 25 per cent next year – something we at the Centre for Policy Studies have led the charge on.
While these moves are welcome, I hope Truss’s new Chancellor will not forget about this summer’s capital allowances consultation: any move towards ‘full expensing’ on business investment, even an incremental one, would be a powerful statement of pro-growth intent.
Yet for all that tax has dominated the leadership debate, a Truss government’s initial fortunes will be defined by its response to spiralling energy bills. Removing green levies is a good start, but there is no escaping the need for more comprehensive action. Without significant help, many households will face severe hardship, countless businesses will go bust, and the economy will likely crater as spending on everything except life’s essentials plummets.
Meaningful action on energy bills may not sit easily with Truss’s free market principles. But effectively handling this problem – while also staving off disaster in the NHS – is an essential precursor to anything else that a Truss government might want to do.
The goal should be to couple a big, short-term intervention designed to take the sting out of energy price rises now with more free market measures to boost domestic energy supply in the long run. Access to abundant clean energy is vital to our future prosperity, and can help insulate us from the vicissitudes of geopolitics.
Looking beyond Truss’s first weeks and months in office, there are plenty of other areas where her reformist zeal could make a big difference on the economic front. The pledge to remove all retained EU law from the statute books by the end of 2023 is an ambitious one, and will require focus and prioritisation across Whitehall. But delivering on that promise is central to realising any economic benefits from Brexit. A sharp break from Brussels bureaucracy offers a chance to free up capital for investment and liberate the industries of the future from prohibitive red tape.
We mustn’t forget, though, that the regulations which most damage our economic performance – not to mention our cost of living – are homegrown. Take housing: through the combination of a nightmarish planning system and heavy stamp duty, we have condemned generations of Britons to live in expensive and low quality homes. Young people are locked out of ownership, unless the Bank of Mum & Dad is feeling generous, and workers are kept away from productive job markets. It’s a slow-motion social and economic catastrophe that any ‘supply sider’ government must address.
What about tax? Neither Truss nor her supporters will want axing the Corporation Tax increase and reversing the National Insurance hike to be the end of the story. I’ve mentioned capital allowances and stamp duty already. Along with business rates, these are the obvious targets for a pro-growth Chancellor to reform. Truss’s government should also look to eliminate the unfairnesses that litter the personal tax system – chief among them the way we tax families. Households with the same income can pay wildly different amounts of tax depending on how that income is distributed. This is wrong, and fixing it would be popular.
The other side of the ledger is, inevitably, harder. There’s nothing like a fast-growing economy to make your fiscal worries go away, but growth policy takes time to have an impact, and in the short term sticking to any reasonable fiscal framework will require spending restraint. Austerity is the wrong word – at this point, if you’re simply starving the public sector of resources, you’re doing it wrong. But the whole of Whitehall must be on a mission to cut waste, seek greater value for money, and boost public sector productivity.
The existing set of fiscal rules should not be sacrosanct: the current budget ought to trend towards balance, but it is right to borrow to invest when capital expenditure can deliver good returns (we must be strict on this). Pandemic debt, moreover, can and should be put on a separate, longer-term footing.
It is worth saying something about the Bank of England. As the government tries to spark growth by liberating the supply side of the economy, the independent Bank’s job is to keep demand on a stable path. There’s nothing remotely revolutionary about that mandate – but Truss is right to wonder, as she has during the campaign, whether the current monetary framework is really up to the task.
Flexible inflation targeting has had its successes, but its failures – like letting money growth get out of control even as the economy was bouncing back from Covid – are becoming increasingly obvious. It is possible that a shift to targeting the level of nominal GDP (or even nominal wages) would yield better macroeconomic results.
I’ve covered a lot of ground, and I’ve tried to be optimistic. But I don’t want to sound Panglossian. If ‘unleashing investment and growth’ was easy, we would have done it already. And Truss’s government will face significant economic headwinds. They are starting with a handicap.
Perhaps the biggest challenge, though, is political: growth is popular, but the policies that deliver it sometimes aren’t. As the great Kiwi reformer Roger Douglas put it, you have to ‘let the dog see the rabbit’. But with at most two years before thoughts turn to an election, the new Government will need to get cracking at once.