Our Response to the Chancellor's Growth Plan

The chancellor’s Growth Plan revolved around a £45bn permanent tax giveaway amounting to around 1.5% of GDP by 2026. But with the economy reeling from an energy price shock, this fiscal boost will now draw a stronger monetary policy response from the Bank of England pushing interest rates further and faster and all but offsetting any immediate growth impact from this plan.

Studies suggest that a permanent increase in the fiscal deficit of this scale can be expected to raise interest rates by around 0.6 percentage points higher than they would have been in the long term. That’s not far off the increase we’ve seen in 10-year Gilt yields over the past four weeks and the situation can only be exacerbated by the government’s apparent disregard for institutional constraints like Office for Budget Responsibility (OBR) forecasts and the decision to abolish the Office for Tax Simplification.

Politically too this is risky. Homeowners, already suffering from mortgage rate whiplash, won’t thank the chancellor if his unfunded giveaways now precipitate a house price crash at a moment when the market already looks vulnerable.

In the longer term it’s hard to see how returning the tax system broadly to where it was in 2021 is now going to stimulate long-term growth if it wasn’t succeeding before. Indeed past utterances from the OBR have given clues as to how it would have assessed the long-term growth benefits of today’s decision not to raise corporation tax back to 25%. Those suggest that without any monetary policy response, today’s effective tax cut might raise the size of the economy by around half a percentage point by the late 2020s. But we’re in a very different economic climate today. And with the Governor telegraphing the Bank’s intention to offset the government’s fiscal loosening with higher interest rates, the growth effect of this centrepiece measure of the Growth Plan is unlikely even to achieve that scale.

To reassure jittery markets, the chancellor also committed to getting debt falling within the medium term. But today’s measures will not move the dial on economic growth to achieve that goal without a further squeeze on public spending.

In that sense the new government is taking a starkly different approach to dealing with the fiscal fallout from Brexit. Johnson and Sunak raised taxes to fill the £30bn fiscal hole created by leaving the EU, marking an end to cakeism. But Truss and Kwarteng look set to make public spending take the strain. As we head into what looks set to be a particularly grim winter crisis in the NHS, it may not be long before we find out whether voters are on board with that bold choice.

As had widely been previewed, the Chancellor confirmed the cancellation of the Health and Social Care Levy set to be introduced next year, and the equivalent increases in National Insurance Contributions that have been in place since April. He also brought forward the 1p cut in the basic rate of income tax Rishi Sunak announced in March from 2024–25 to 2023–24, and in a surprise move abolished the ‘additional’ 45% rate of income tax, bringing the top income tax rate back down to 40%. These direct tax cuts will benefit all income tax payers – who, we should remember, are only 60% of adults – but the better off will be the biggest winners, especially the very richest with incomes above £150,000.

With earnings falling behind inflation, the prospect for living standards next year looked bleak before the announcement of the Energy Price Cap earlier in September. But with other supports announced in May – the £400 universal energy bill support and temporary increases in benefits – falling away from next April, poorer households still looked set to be worse off in the next financial year than they are today.

Today’s announcements do little to change this picture for lower income households. But the biggest beneficiaries from cuts in income tax and National Insurance Contributions (due to be renamed the Health and Social Care Levy) will be the better-off. The richest tenth of households can now expect to be more than £2,000 a year better off next year from a combination of earnings growth and tax cuts.

The £60 billion price tag attached to the government’s energy bill support schemes is not only highly uncertain, but only covers six months of support. This is an essential expenditure and will help avoid a severe recession over the coming winter. But it is also fiscally unsustainable if energy prices remain high for some time. Nevertheless, while business support is set to be cut back after six months, household support will need to remain for as long as prices stay high.

Today’s statement brought some promising signals on boosting energy supply in the long run – including the unexpected promise to reduce planning constraints on onshore wind and a general insistence on cutting red tape on critical infrastructure. This is welcome news and will help spur the transition to net zero, but will do little to bring down energy prices in the coming years. Meanwhile the £1 billion committed to energy efficiency over three years is orders of magnitude below what is needed to keep households warm while reducing the national energy bill.

Bringing down prices through negotiating contracts with gas and low carbon suppliers is fanciful thinking. At best it is likely to smooth costs over time.

The truth is, the government currently has no exit strategy from energy bill support, except to hope prices fall of their own accord. They might get lucky, but attention must quickly turn from hoping for the best, to planning for the worst. A plan to properly tackle windfall profits, reduce energy consumption, and target support where possible will be essential if prices stay high. The clock is ticking, and markets are watching. The planning needs to happen now.

For all the noise around it, the centrepiece of the chancellor’s Growth Plan – corporate tax reforms – simply wind the clock back to 2019 when the UK’s pre-headline rate was 19% and the Annual Investment Allowance was £1m. But back then, business investment was stagnant so it’s far from clear why the results will be different this time. The chancellor is pulling levers that are unconnected to anything that will actually boost productivity or prosperity. A bit like the Wizard of Oz, he’s hoping we don’t look behind the curtain.

A key supply-side plank of the mini-budget are new low-tax ‘investment zones’ that will allow planning rules to be relaxed and will reduce business taxes to encourage investment.

They are the latest iteration of the earlier Freeports policy, as well as the 24 Enterprise Zones created in 2011. And they will suffer from the same drawbacks – as the OBR has previously argued and would have done again if it had been allowed to comment.

Academic evidence suggests there are three main problems with the policy. First, the zones won’t create new economic activity so much as displace it from areas outside the zone, representing a pointless, zero-sum game.

Second, there are often large deadweight costs, as firms already inside the zones simply bank the tax breaks and regulatory flexibilities but without making additional investments. A House of Commons inquiry found that the Enterprise Zones had created only 4,649 jobs by 2013-14, compared with the 54,000 originally forecast. A 2014 National Audit Office study warned that job creation in the Zones was very limited and well below forecast.

Third, the small number of new jobs created in the Zones tend to be low-wage and low-skilled. This is unsurprising as firms attracted by tax breaks to invest in the zones are likely to do so based on the prospect of lower costs. But it underlines the point that the measure is unlikely to attract high productivity businesses, the essence of ‘Levelling Up’. Rather it risks entrenching local disadvantage by encouraging local economies to double-down on their cost advantages.

International evidence, for example from the EU’s experience with Cohesion Policy, suggests Investment/Enterprise Zones can work. But they are only likely to succeed as part of an integrated plan to raise productivity, improve infrastructure and raise the rate of knowledge diffusion among firms. But there is little evidence of this kind of long-term thinking here.