Jeremy Hunt is preparing to take control of public spending this week and raise taxes on everyone in a fall statement that will be long under pain and short in good news. After Liz Truss’s short and disastrous premiership, the “counter economics” she despised is back on the rise under Rishi Sunak.
The message from the government is that Britain must live within its means, which Hunt and Snack say requires action to reduce government borrowing and to ensure that the national debt begins to decline as a share of national income.
They say failure to do so would lead to a fiscal “black hole” that would scare financial markets and lead to higher borrowing costs for businesses and households.
However, some experts have warned that nothing is inevitable about the new era of austerity Hunt appears to be poised to enter, and that there are other ways to raise money and keep the markets at bay at the same time.
Is there a black hole?
Many center-left economists challenge the idea of a measurable “black hole” in public finance, pointing out that its existence is only created by any fiscal rules the government has set for itself—and that estimates of its size are highly sensitive to economic expectations.
Economist Joe Michel, co-author of a research paper for the Forum for Progressive Economics highlighting the “dangerous fantasy” of the financial black hole, says the economic background is highly uncertain, making this a wrong moment for concrete plans to cut spending.
“The reasonable thing is to wait and see,” he says. “Things are changing very quickly: we are heading into a recession, it appears that US inflation may be on a slope, gold yields have fallen significantly since the mini-budget and may continue to decline. These are all signs of a turning point.”
“What we’re seeing is a rush from £45 billion fiscal relief, with a gear budget, to a £60 billion tightening being floated with the current government,” he adds. “You’re talking about a £100 billion swing in fiscal policy, in response to a bunch of bond market moves that we don’t fully understand.”
Didn’t you make the experience of austerity gears inevitable?
Austerity proponents point to the massive sell-off in sterling and government bonds, in the wake of the Kwasi Quarting’s tax cut mini-budget, as evidence that financial markets are already calling for deep spending cuts.
But Michel highlights technical problems in pension portfolios that compounded the government bond sell-off (leading the Bank of England to intervene).
Other economists pointed to the broader context of Quarting’s statement, including the dismissal of Treasury Secretary Tom Scholar as permanent minister, and Curting’s impromptu promise of more tax cuts in the future.
Karsten Young, chief economist at the Institute for Public Policy Research (IPPR), also cautioned against learning the wrong lesson from Truss’s blows at the hands of markets.
He argues that fears of rising inflation, as higher government spending drives up demand, really spooked investors, driving up bond yields, and thus mortgage rates.
It has been portrayed as a crisis of financial credibility; While in fact he was expecting inflation to be higher, he says, adding that Germany announced a generous energy support package without being penalized by investors.
Is the government attacking the right target?
Jung is co-author of the IPPR report outlining a thoughtful alternative to renewed austerity. Conditional on avoiding skyrocketing inflation, rather than closing the “black hole,” the plan includes generous spending to help families through the cost-of-living crisis, and to protect public services from rapid cost increases.
IPPR notes that these and other urgent priorities could entail spending an additional £120 billion, most of which is temporary. To avoid this short-term bragging that exacerbates inflation, they are recommending £40bn tax increases – which could include reversing the recent cut in National Insurance contributions, for example.
Is a death ring looming?
Former shadow minister John McDonnell warns that the current policy mix – with the Bank of England raising interest rates and the government preparing to cut spending – threatens to exacerbate the economic downturn and lead to a cycle of cuts, weaker growth, larger than-planned deficits, and further cuts.
“The Bank of England raised interest rates, the government introduced austerity – and the result inevitably is recession. In technical language, I think it’s gritty,” says McDonnell.
“Even if you accept that there is a gap to fill, all you need is a relatively moderate plan for redistribution, in order to avoid austerity,” he adds. “I think the problem that Sunak and the others have is that they have put themselves in an ideological trench, fighting ancient wars.”
What about taxing wealth?
Tax Justice UK recently put forward proposals of up to £37 billion a year for tax increases, as an alternative to what it called “austerity 2.0”.
This included taxing the wealth of the super-rich – anyone with assets over £10m – at 1% per year; Alignment of capital gains tax with income tax, so that unearned income is taxed in the same way as income tax; And the application of national insurance on investment income.
Or borrow more?
Political economist and chartered accountant Richard Murphy agrees that a wealth tax should be considered, arguing that the rich have the ability to pay more.
Alternatively, the government can borrow more. The best way to do this is to dispense with the financial markets as a middleman. The National Savings and Investments Corporation is already providing the government with £210 billion. If the interest rates on their products were more competitive, they could raise much more and reduce the overall cost of government borrowing.
Or, since austerity is apparently needed to keep financial markets happy, the advisor could call those markets bluff and simply say he would buy back bond holdings for anyone who is not satisfied with the extra spending program and investment we need right now with QE. That keeps interest rates low.”