Kwasi Kwarteng’s statement was a borrow and hope Budget on a scale not seen since 1972.
Ditching the Conservatives’ carefully crafted reputation for prudence with the public finances, the new chancellor sought to borrow to cut taxes, increase growth rates and improve the underlying performance of the UK economy.
In what he termed “a new era” that “prioritises growth”, Kwarteng promised the additional borrowing would “release the enormous potential of this country”.
Economists were in no doubt about the importance of the statement, noting that the permanent cuts in taxes were the largest in a Budget since Anthony Barber’s in 1972. Torsten Bell, director of the Resolution Foundation think-tank, described himself as “awed” that Kwarteng was “totally rejecting not just Treasury orthodoxy, but Boris Johnson too”.
But most worried that additional growth might be temporary and inflationary, and lead to unsustainable public finances.
There is no doubt about the scale of additional borrowing required. The government’s Debt Management Office immediately set out new plans to borrow an additional £72bn before next April, raising the financing remit in 2022-23 to £234bn.
This will cover the energy price guarantee for both households and business this winter alongside the additional cost of government debt, which rose sharply on Wednesday. The permanent tax cuts, mostly coming in next April, will need additional financing, which the Institute for Fiscal Studies estimated would result in public borrowing remaining above £100bn a year into the medium term.
In these circumstances, public debt would keep rising as a share of national income, despite Kwarteng’s pledge that “in due course” he would show it coming down.
There are many big gambles being made by the chancellor’s new team at the Treasury. It hopes that borrowing to allow the UK to buy gas at inflated prices has little effect other than to reduce the risk of recession.
It hopes the fiscal stimulus will not increase inflationary pressure at a time of full employment. And it is putting its faith in a boost to the supply side of the UK economy that will raise the underlying rate of growth to 2.5 per cent a year and thereby collect more tax revenues.
The additional borrowing will also significantly worsen the UK’s trade deficit, already at historic highs, and the government is counting on this not pulling the rug from under sterling.
Kwarteng’s team included an “illustrative” table in the Budget documents showing that if the trend growth rate was raised 1 percentage point a year, after five years tax revenues would be £47bn higher than before.
While business groups and many taxpayers cheered the reduction in taxes, the Treasury did not provide any evidence that such a boost in the growth rate could be achieved by the measures announced.
Economists were sceptical. Richard Hyde, senior researcher at the Social Market Foundation, said the aim of increasing growth rates was welcome, but “it’s not clear that tax cuts are the best way to deliver it. The evidence of previous cuts in corporation tax is that they don’t reliably lead to increases in business investment.”
Since the 2008-09 financial crisis multiple different growth strategies, involving higher and lower taxes, have failed to boost Britain’s underlying rate of productivity growth, which has remained low.
The bigger immediate worry in financial markets and the Bank of England was that the enormous amounts of borrowing for spending and tax cuts would provide a sugar rush for growth, creating inflationary pressure, higher interest rates and unsustainable public finances.
Jonathan Haskel, one of the members of the BoE’s Monetary Policy Committee, said on Thursday night that, “the difficulty with the fiscal expansion is we’re doing it in the context of a very tight labour market and difficulties in China, which mean that our supply chains are rather compromised”.
With the BoE already having raised interest rates to 2.25 per cent on Thursday, Haskel’s comments confirmed that policymakers at the central bank would want at least partially to offset Kwarteng’s support for business and households with higher interest rates.
The concern is that the UK economy simply cannot take the high-pressure boost to demand without generating inflation. Kwarteng and the Treasury documents made no mention of the possibility that the tax cuts would raise inflationary pressure.
But financial markets took fright and quickly priced in higher borrowing costs to finance the UK government. The cost of government borrowing over two years hit 3.9 per cent shortly after the chancellor finished speaking, up from 0.4 per cent a year ago. There were similar rises across the spectrum of government borrowing.
Most economists said the Budget was therefore highly risky and — due to the higher borrowing costs — unlikely to encourage companies to borrow and invest.
Ruth Gregory, senior UK economist at Capital Economics, said that unless the gamble to boost the underlying growth rate works, “today’s fiscal package just means more inflation, higher interest rates and a higher debt ratio in the future”.