Why everyone is over-reacting to the mini-Budget

Most analyses of the chancellor’s mini-Budget speech have failed to grasp its purpose and significance, says Max King

John Major
John Major fixed the public finances – but still got voted out
(Image credit: © JOHNNY EGGITT/AFP via Getty Images)

In the rush to publish and pontificate, media analyses of Budgets are, inevitably, simplistic, shallow and populist. They are often governed by consensus group-think and politically influenced. The interviews with “ordinary people” are designed to support the narrative. Some economists may try to counter misconceptions, but their points are usually ignored and forgotten.

Commentary on last week’s “mini-Budget” contained more misconceptions than most, which may be a positive sign. One former chancellor observed that Budgets which look good on Budget day quickly unravel, while those that attract the most opprobrium stand the test of time.

Criticism from the standpoint of fiscal rectitude focuses on the strategy of borrowing for the purpose of cutting taxes when government debt is so high. In truth, however, debt isn’t especially high: 45% of the national debt – which is now nominally 88% of GDP – has been bought back by the Bank of England, net of which the national debt is below 50% of GDP.

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Unless banks go on a pre-2008 style lending spree, and are allowed to do so by the regulators, the Bank will not need to resell that debt and it will be redeemed over time.

Won’t the tax cuts stimulate consumer demand and increase inflationary pressures? Not if the Bank of England responds by stepping up interest-rate increases and so encourages saving. That is an obvious but unspoken objective of the Budget – to achieve tighter monetary policy at the same time as looser fiscal policy.

Bond yields are rising all over the world

The view that the reaction of sterling and the gilt market reflects badly on the Budget in the eyes of financial markets is highly questionable. Bond yields are rising around the world and the UK has had some catching up to do.

Investors believe that while the US Federal Reserve, led by Jerome Powell, takes inflation seriously and is therefore hiking rates aggressively, the Bank of England doesn’t and is not going far or fast enough.

As a result, the dollar is strengthening and partly in consequence, sterling is weakening. A reluctance to tackle inflation is viewed negatively by investors in gilts, so yields have risen, discounting higher inflation in the long term. The Bank of England is probably the cause of sterling and gilt weakness, not the Budget.

Commentators also need to face an electoral reality. John Major’s government in the 1990s focused on getting the public finances back into a strong position. It got no thanks from the electorate and was crushed in the 1997 election.

It handed the Blair government a growing economy and rapidly improving fiscal position, enabling an acceleration in public spending that helped Blair get re-elected twice. Conservatives will not make that mistake again, even if it is the responsible thing to do.

Criticism of the Budget’s measures is also off the mark. Of course tax cuts favour the well-off most: those who pay the most tax will see the biggest monetary (but not necessarily relative) gain. The purpose of cutting the top rate from 45% to 40% is not to favour those who are already well paid, but to raise revenue.

Attracting high earners

The expectation is that the reduction will encourage those the highly paid to come here from Europe and North America; while high earners in Scotland, where taxes remain higher, will also have an incentive to move. The reduction in the top rate should also encourage those in England who are highly paid to take on more employment. If so, the tax take from this cohort will increase, just as it did after George Osborne’s reduction of the top rate from 50% to 45% in 2011. The ultra-rich, meanwhile, will continue to benefit from lower-rate tax contracts struck with HMRC to persuade them to base themselves in the UK. There is one law for the international jet set and one for the hoi polloi, including the merely highly paid.

The removal of the cap on bankers’ bonuses does not necessarily raise their earnings, but returns them to a more sensible pay system of fairly moderate fixed salaries topped up with big bonuses in the good years.

In the bad years, they can be fired more cheaply and their held-over bonuses cancelled, if generated from false profits. The cap has forced banks to raise salaries, made it expensive to fire them and encouraged bankers to work overseas. The decline of the British banking sector in recent years may not be a coincidence.

The cancellation of the increase in employees’ National Insurance from 12% to 13.25% and from 2% to 3.25% for earnings above £50,000 favours the well paid monetarily, but not relatively. That the top rate of taxation was to be 48.25%, not 45%, is universally ignored.

The increase in the threshold at which National Insurance has to be paid from £9,568 to £12,584, announced in June, benefits the low paid. The elderly, even if still working, do not benefit from the cancellation as national insurance is not paid above the state retirement age of 66.

The 1.25% increase in employers’ contributions is also cancelled. This is generally described as a tax on business, but in reality, it is another tax on employees. Its rise would have increased employment costs, which for many organisations, particularly in the public sector, would have fed through into lower pay rises. The cancellation of the increase will reduce the funding pressure on the public sector, notably the NHS, which is by far the UK’s biggest payer of National Insurance.

The effect on investment of keeping corporation tax at 19% rather than increasing it to 25% is hard to gauge, but it certainly won’t reduce it. Logically, the consequent increase in the return on capital should encourage businesses to invest in the UK rather than elsewhere, but there are many other factors influencing investment. Lovers of round numbers, like me, will regret the missed opportunity of standardising the rate of VAT, income tax and corporation tax at 20%.

It was left to the Institute for Fiscal Studies to point out what was not in the Budget: the raising of tax thresholds. These – both the personal allowance and the higher-rate threshold – were frozen for four years in the 2021 Budget.

Given the subsequent acceleration of inflation, this is a far more swingeing increase in taxation than was ever expected. In addition, the withdrawal of the personal allowance between earnings of £100,000 and £125,400 continues to mean a marginal rate of tax of 60%, plus 2% national insurance.

The cancellation of previously announced tax increases is not really a tax cut, and the freezing of thresholds still means a big increase in personal taxation.

Arguably, the effect of the acceleration in inflation makes Rishi Sunak’s tax increases unnecessary anyway. Inflation may also be helpful to the government in reducing government spending in real terms to the extent that departmental Budgets are set in nominal terms. So the Budget deficit should continue to turn out better than expected.

Whether the measures will lead to a significant increase in growth is a moot point. Lower taxes and a squeeze on the public sector probably more than balance out the negative impact of higher interest rates. In any case, ultra-low rates encourage the wrong sort of growth. There is much talk of the need to increase stagnating productivity in the UK, but productivity in a service-orientated economy is very hard to measure. The data could be significantly understated.

Raising productivity

The area where there is significant scope to raise productivity is in the public sector, notably in the NHS. Productivity growth (better healthcare for the same money in real terms, in other words) was achieved in the 1990s, but subsequently went into reverse. An increase in real resources no longer results in better outcomes overall. Reforming the NHS will be a major – and probably – impossible challenge.

The good news for the government is that natural-gas prices are falling, so the cost of the energy price cap, feared to be at least £100bn just a few weeks ago, may turn out to be much less and maybe nothing at all. If so, further tax cuts, including a raising of tax thresholds, will be on the cards. Will this save the government’s re-election prospects? That is a matter of opinion. I suspect that voters distrust governments that pledge to raise taxes only on the rich, knowing that when that fails to raise revenue, they too will have to cough up.

Tax cuts are popular because £1 in your pocket is worth more than money spent invisibly on public services. But these are not tax cuts. Sunak’s tax increases constituted political suicide; this Budget means the government is now in with a chance – energy prices, the economy and much else permitting.

Max King
Investment Writer

Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.

After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.