Will “Trusonomics” work? – New Statesman

The Conservative Party leadership race, and indeed the next general election, will be decided by big economic ideas. In a country facing a potential inflation rate of 15% (which could represent a wage cut in real terms of more than 10% for everyone in the country) and the likelihood of a recession, voters want bold new ideas.

As she demonstrated in last night’s leadership debate, Liz Truss understands this well and is offering Conservative MPs tens of billions of dollars in tax cuts and “full free ports”, which she says , will stimulate investment while reducing inflation. Trussonomics is a radical departure from current orthodoxy, an economic overhaul that will have serious implications for businesses, consumers and institutions, especially the Bank of England.

Critics, however, warn that the assumptions made by Truss — that tax cuts pay off, that there is capacity in the economy — are incorrect, and pursuing them could do even more harm to a struggling economy. difficulty.

Does lowering taxes help the economy?

Truss said scrapping the corporate tax hike from 19% to 25% next April and reversing the National Insurance hike, introduced in April this year, would boost investment by businesses and stimulate the “supply side” of the economy (which covers productivity and efficiency).

Tax has to do with investing, director of the University of Oxford’s Center for Business Taxation, Michael Devereux, told me. “In the context of a multinational deciding to set up a factory or invest in the UK rather than another country, there is ample evidence that the rate of tax plays a role in this decision.”

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As a former Secretary of Commerce, Truss may have a particular interest in these foreign direct investment decisions and the policy that affects them. But for the rest of the economy, reducing corporate tax is less helpful. Devereux said domestic businesses are most concerned about things like capital cost allowances and deductions (such as the Rishi Sunak super-deduction) for investment. For most investments, the calculation “depends much more on the generosity of the tax system in defining taxable profit” than on the overall rate at which profits are taxed.

While companies clearly consider the cost of tax when planning a new investment, Devereux said the link between national insurance or income tax and “any kind of growth is not not at all clear”. In other words, people do not individually respond to personal tax cuts by staying an extra hour at work each day.

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Can tax cuts reduce inflation?

Truss also claimed his tax cuts would help curb inflation by stimulating business and boosting the “supply side” of the economy. From a certain point of view, this makes sense: the inflation we are currently experiencing is due to a tight supply (high energy costs, shortages, disrupted supply chains), so it can be argued that the increase in supply would balance out demand, which would resolve the rise in prices.

However, even if companies decide to reinvest the money they have saved from lowering corporate taxes, this will only create more demand, because companies are also consumers: they cannot just creating the offer out of nowhere. So that would at least negate the effect of the tax cut and might just create more inflation.

With personal taxes as well, the effect of being able to keep more money likely means increased spending, and therefore demand, which could put upward pressure on prices.

This is not to say that tax cuts cannot be disinflationary: targeted tax cuts, such as fuel and VAT, directly reduce the cost of items in the “goods basket” that the Office of National Statistics (ONS) uses to calculate how quickly prices are rising, which can have a ripple effect on the price of goods and services linked to the rate of inflation, such as train tickets and phone bills mobile.

Are fat-free ports as delicious as they look?

Free ports – business zones in which companies are encouraged to invest by lower taxes and regulations – are arguably Sunak’s favorite policy; he saw them as a key reason to evade EU state aid rules. Truss is parking his tanks on Sunak’s lawn with a “full-fat” freeport offer that, thanks to details yet to be revealed, will be even freer than his own.

In practice, however, the main freedoms conferred by free ports include the freedom to launder money and to evade taxes (as noted by the European Parliament in 2018). Deregulated zones can also provide companies with greater latitude when it comes to workers’ rights; as the rapid growth of the gig economy has shown, this may indeed benefit a few firms, but it also limits productivity by suppressing wages and preventing workers from investing in their own career development.

The Myth of the Margin

Inflation is scary and must be killed – but it has an upside for Truss supporters. As prices and wages rise, government revenue also rises, as higher taxes are levied on goods and the “fiscal brake” – one of the least fun types of brake – causes more workers to pay higher taxes. Meanwhile, public debt service is becoming cheaper, creating tens of billions of pounds of “headroom”, which Truss says is now available to make tax cuts possible.

The problem with that is that it’s fairy gold, created by historically low interest rates (and therefore very cheap government debt). For every percentage point increase in interest rates, according to the National Institute for Economic and Social Research, the £800bn of public debt that is being repaid at the Bank of England base rate will immediately cost around £10bn more, and could end up costing £20bn more in the long run.

One economist cited by Truss as an influence is former Margaret Thatcher adviser Patrick Minford, who wants a bank rate of 5-7%. In a healthy economy this might be desirable, but the UK still has a long way to go before it can go into debt at these prices.

Return of the Iron Lady?

Truss may well be wise to bring in older Tory members as a second Thatcher, who they will remember as beating inflation with policies such as money supply targets for the Bank of England (Truss said that she wanted to change the Bank’s mandate and that ‘we haven’t been tough enough on the money supply’. But they may also remember that Thatcher achieved this by causing a deep recession in which three million people were left unemployed.

There’s also the fact that you can’t use the policies that finally pulled Britain out of recession in the early 1980s – selling off national industries, selling off council housing, deregulating banks and other industries – because these cards have already been played. In its most ominous form, Trusonomics amounts to doing the damage done by Thatcher without the remedy that followed.

[See also: Sunak or Truss: Who won the Tory leadership debate?]

Maria D. Ervin