The UK economy is spiraling. The pound is falling. Here’s why. | Daily News Byte

Editor’s note, October 3, 12:40 pm ET: Ten days after announcing plans to cut taxes for top earners, UK Prime Minister Liz Truce’s government today That plan reversed. British markets At the beginning the rally took placeBut questions remain about the UK economy in the longer term.

Last week, the UK had its most dramatic currency crisis in recent memory. That’s on top of staggering inflation that the Bank of England has yet to significantly curb and a cost-of-living crisis. The UK situation sent global financial markets into a tailspin. Although the current crisis has been driven by a combination of factors, including the economic collapse of Brexit, Prime Minister Liz Truss’ latest package of tax cuts has helped push through. UK economy in chaos.

On 23 September, Truss Chancellor of the Exchequer, Kwasi Kwarteng, introduced the UK’s biggest tax cuts in 50 years, estimated at around £45 billion over five years. The so-called “mini-budget” proposed tax cuts for the UK’s highest earners, and announced a rise in corporate tax and an increase in spending on national insurance, both intended to come into effect next year. The Quarantine and Truss scheme also reduces stamp tax, duty on land sales in England and Northern Ireland to boost home buying.

By Monday, global markets had responded by selling UK-backed assets and pushing the UK currency, the pound, to a valuation of $1.03, its lowest value against the dollar before rising at the end of the week. Investors rejected the new economic plan, known as “trusonomics”, a reference to Reaganomics, the supply-side economic policies passed under Ronald Reagan in the 1980s.

Truss and Quartet have stood by their decision to cut taxes for some of the wealthiest Britons and create special incentives for corporations, including tax cuts and rollbacks in regulations, insisting that the tax cuts will encourage more investment in the economy. It belongs to trickle-down economics in the 21st century, amid global inflation and skyrocketing energy costs.

Dylan Martinez/AFP via Getty Images

The mini-budget was established against the accepted logic of most mainstream economists – and without typical Political Outposts. Truss sacked Tom Scholar, the permanent secretary to the Treasury and long-time civil secretary, on 8 September, paving the way for Truss to confront what he called “Treasury orthodoxy” – the mainstream economic perspective that dominates the Treasury’s approach to taxes and government spending. And which, according to Truss, contributed to slow economic growth.

The academic’s firing was widely seen as a political stunt that not only deprived the government of a respected technocrat during a difficult economic period, but also undermined the neutrality of the UK’s civil service. The government also requested that the Office for Budget Responsibility (OBR) not provide an independent analysis of the plan, according to an analysis of the plan by the National Institute of Economic and Social Research.

Tax cuts could hardly have come at a worse time

The UK was already dealing with global inflation and stagnant wages, in addition to a weaker-than-expected economic recovery from the Covid-19 pandemic. Add an energy crisis amid one of the hottest summers on record, and a recession seemed inevitable.

Although these and other compounding factors have contributed to the cost of living crisis in the UK, the currency crisis certainly exacerbated it.

and the most recent dramatic fall in the value of the pound This is a direct result of tax cuts and mini-budgets by Kwartang and Truss, Nikhil Sanghani, managing director of research at the Official Financial and Financial Institutions Forum (OMFIF), told Vox. “The pound sterling has performed worse against the dollar than any other world currency in the past week”, he said.

The tax cuts are aimed at Britain’s highest earners. Kwarteng’s new measure removes the 45 percent income tax bracket on earnings above 150,000 pounds, which was previously the highest. Now, the highest tax bracket is 40 percent on incomes above 50,271 pounds, which would save the wealthiest families about 9,187 pounds a year, the Guardian reports. A planned corporate tax rise, from 19 per cent to 25 per cent, has also been reversed, putting around £19 billion into the economy which Kwarteng said could be used “for reinvestment, creating jobs, raising wages or paying dividends that will fund our pensions”. supports.”

In other words, tax cuts put more money into an economy already suffering from inflation – The typical macroeconomic solution to this is for people to spend less, not more. Investors are seeing the tax cuts as so irrational and dangerous that they are rushing to sell their British assets – whether bonds or holdings in the pound – driving down the value of the currency.

“Most mainstream economists don’t think this is a good idea,” Sanghani said. “It’s tough to square.”

Mark Blythe, director of the William Rhodes Center for International Economics and Finance at Brown University, told Vox, “The decline in value is the market’s response to the fact that the risk inherent in the asset is much higher than expected thanks to Trusonomics.” by email.

The announcement of Quartet and Truce’s new plan triggered a sell-off in government bonds – normally considered a fairly safe investment – ​​that was so extreme that the UK’s central bank, the Bank of England, stepped in and bought 65 billion pounds worth of bonds. Restore orderly market conditions” and start a country pension scheme.

One reason the tax cuts are so unsettling is that they will be financed by more borrowing. The UK already has a significant public debt burden — without new taxes, the UK’s Office for Budget Responsibility has warned, public debt will reach 320 per cent of Britain’s GDP in 50 years, up from 96 per cent or £2.4 trillion now. It may, in the future, lead to reduced spending for public services.

Although the Truss established a price cap on energy costs at the start of September, like other countries, real wages in the UK have not kept pace with inflation, Julian Jacobs, economist at OMFIF, told Vox. “The UK has seen an influx of strike activity – tube strikes, train strikes – largely as a result of wage stagnation,” he said. When combined with higher inflation, higher energy costs and more expensive borrowing, the people who suffer the most are those who can least afford it.

Frank Augustine/AP

The International Monetary Fund (IMF) agreed, issuing a surprise and almost unprecedented rebuke on Tuesday against the tax cuts, which further devalued the pound. “The nature of the UK’s measures will increase inequality,” the global lender said. [are] Reassess more targeted and tax measures, especially those that benefit higher income earners.”

For the IMF to issue such a stern directive to the world’s fifth largest economy is particularly surprising; Adnan Mazarei, a former deputy director of the IMF, told the BBC that the fund usually “makes such statements about emerging market countries with problematic policies but often not in the G7 countries.”

The Tories’ tax cuts are deeply cynical and at odds with fiscal policy

“There’s probably never been a better time to push a tax cut,” Sanghani said, “but now is especially bad.” On top of high inflation fueled by the Covid-19 stimulus, interest rate hikes to combat inflation and outrageous energy prices fueled by Russia’s war in Ukraine, a tax plan defies conventional wisdom, he said, adding, “The coffin is, ‘Will there be a recession?'”

Kwarteng will present the new financial plan on November 23, but Labour’s shadow chancellor of the exchequer Rachel Reeves urged the government not to wait that long. “This statement by the IMF has set alarm bells ringing in the government and should make it clear that they need to act now,” she said.

However, both Blyth and Sanghani say the tax cut was purely a political decision. “Forget Reaganomics. This is just a ‘smash and grab’ raid by the Tories for their supporters as they are out of power for the next decade,” Blythe told Vox. YouGov polls over the past nine months have put Labor firmly in the lead for the next government. From Brexit to former Prime Minister From Boris Johnson’s Covid-19 scandals and subsequent resignation, after a series of mismanagement of the cost of living and currency crises – it seems voters are ready to boot the Conservative Party.

Given that, the calculus behind the tax cuts is unlikely to change, and Truss has so far stuck to its plan. “We are facing very difficult economic times,” she said during an interview with local BBC radio stations on Thursday morning. “We are facing it globally. We don’t see growth overnight. What matters is that we are putting this country on a better path for the long term.”

But injecting more money into an economy already suffering from an inflationary crisis is illogical and at odds with efforts by the Bank of England, which has raised interest rates seven times since December to help reduce inflation, which is now around 10 percent.

Taxing income is another way to tackle inflation and also provides revenue for the government to fund its programs, such as pensions for the aging population and Britain’s National Health Service. Instead, the government “decides[d] The slant on who gets the money makes Trump’s tax cuts look like socialism, given that it might not even be exciting to make massive tax cuts,” Blythe said. “The people who get all the money won’t spend it because they already have it. The rich, and people who need spending money, will get nothing and then be condemned with a doubling of energy bills and a huge increase in their mortgage costs. “

The new measures have also proved unpopular with voters, according to a recent poll by YouGov; As of Thursday, the Labor Party held a 33-point lead over the Conservative Party, Reuters reported. The turnout is the highest the party has achieved since 1990, YouGov told Reuters, and points to a possible chance for the Tories to take power when national elections are held in 2024.

Truss has confirmed her commitment to the economic plan, and it remains to be seen whether strong criticism – from global markets, the central bank, the IMF and even voters – will change her mind before more damage is done. But Sanghani told Vox that “the only real way to turn this around is a policy U-turn.”

Blyth agreed, urging the government to “stop the astonishing acts of self-harm from Brexit – which has deprived the UK of export markets it could use to grow from this crisis – with 1980s-style tax cuts and cuts to state spending that have already has been cut to the bone. That would be a start.”