Economist Anthony Yates looks at the different tax proposals of the two candidates vying to become Prime Minister and finds a common thread of fiscal fantasy and Brexit denial
The debates between the remaining candidates for the Conservative Party leadership have focused on whether the Party wants to implement and campaign on a platform of tax cuts, or on what Sunak called ‘sound money’.
With great pressure on public services, permanent tax cuts are going to be a hard thing to sustain and take to the next election.
The NHS is in a state of crisis, fighting the backlog of work that built up during the worst part of the COVID pandemic, still dealing with large flows of cases through its hospitals and the interference with working methods that COVID protocols imply.
Schools face a widening gap between state and private sector funding per head.
Sunak learned to his cost that the trouble with assisting a post-rational movement is that...- there is always going to be someone who will out-flank you
Local authority funding is already meagre after the early 2010s austerity and struggling to manage the burden of providing social care.
With the new threat from Russia and a more belligerent China, the Conservatives will find it awkward to cut funding for the armed services.
Money is going to have to be found to support poorer families through further energy price increases. And the transition to net zero has to be subsidized. And the list goes on.
A Laffer Minute
The Liz Truss response to this is to invoke the classic hope of the right that cutting taxes unleashes incentives for business owners and workers so much that economic activity expands to the point where revenues grow even though the percentage of those revenues taken in tax is lower.
The idea seems, at first sight, to be dignified by having behind it a curve invented by an economist behind it. But this curve - the Laffer Curve - was simply invented, by former Reagan advisor Art Laffer. It is not a reliable feature of actual economies that we can find in the data.
Sunak was visibly frustrated in Monday evening’s BBC debate, perhaps because he could see how appealing the tax cut promise was to Tory members, and knew that he was facing an uphill task to overturn the reported majority who preferred Truss for Prime Minister.
He tried to paint himself as the man rejecting ‘something for nothing economics’ [his words for Truss’ credo] and defended ‘bean counting’ [her words for his].
Economists watching Sunak find himself in this position will not miss the irony.
As Sunak reminds us often, keen to stress his tribal credentials, he campaigned for Brexit from the start. This was a fundamental rejection of the overwhelming economic consensus at the time that it was a bad idea because of how it would impede trade with Europe. And it was a rejection reaffirmed when he [and Truss, of course] fibbed reflexively that Brexit had anything to do with the chaos at the Dover border crossing.
Brexit abrogated bean-counting in place of faith. Facing Truss, he now wanted to complain that she was losing touch with bean counting in urging a tax cut.
Sunak learned to his cost that the trouble with assisting a post-rational movement is that, once it becomes accepted that arguments are not disciplined by reason and evidence - here manifest in the economics and trade literatures - there is always going to be someone who will out-flank you with even more radical and attractive sounding departures from it.
Any appeal to reason at this point is going to go unheard.
Thus out-flanked, Sunak was forced into his own fantasies, arguing that Truss’ tax cut was likely to prompt a disastrous surge in inflation and a hike in interest rates by the Bank of England that would then cause a recession.
Sunak gets the direction of the changes right in this warning but exaggerates greatly. Rates would rise somewhat to stem the increase in demand from the tax cut and their effect on inflation. But there is no real risk of a boom or a bust. Just a question mark about when taxes would rise again, or public services shrunk to make good the hole in government finances.
The final ignominy for Sunak was having his warnings dubbed ‘Project Fear’. First used privately by Better Together to describe their campaign to explain the unpalatable economics of Scottish Independence, it was thrown back at them by the SNP to mean ‘exaggeration and misinformation’. It was then picked up by Brexiteers who used it to great effect in the 2016 Referendum. Finally, Sunak, having been on the team that profited from it before, now had the ‘Project Fear’ label affixed to him by a former Remainer turned hard-Brexiteer, reaching for the high ground of optimism and faith.
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Whoever wins the contest for the leadership of the Party, their boosterism about Brexit or taxes is going to have to deal with the harsh realities of a weak economy, an electorate needing help with the cost of living, and Brexit depressing revenues that would pay for it.
Much of the current difficulties are global. The energy and food price rises are caused by shortages stemming from the war in Ukraine and the effect of Covid on the global supply chain, things the Conservatives are not responsible for, but will take a lot of the blame as the incumbent government.
They may well lose the next election as a result. However, having brought us into the post-rational world that sets economics aside, they will know that their legacy lives on in the form of Labour commitments to the hard Brexit written into the Trade and Cooperation Agreement. These commitments are made in order to avoid the risk of fusing together again g the electoral coalition which lost them the December 2019 General Election – a coalition that it is feared still holds true to the post-rational view of Brexit.
Labour has been forced to pick up the post-economics/post-rational baton, explaining that it can 'Make Brexit Work', and that there is ‘no case’ for rejoining the Single Market.
Such promises perpetuate this post-economics discourse even further out into the future. Because having dissembled that it could Make Brexit Work it is going to have to double down on the rhetoric and declare that it succeeded.
Quite where this ends, or if there is a way back to anchoring ourselves on data, bean-counting and economics, is hard to say.
Anthony Yates is the former Professor of Economics and Senior Advisor at the Bank of England
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