On Truss’s Controversial ‘Growth Plan’

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Global stocks fell again Monday, extending another trying week for investors.^[i] Many financial commentators we follow attributed the drop to the Truss government’s “Growth Plan” announcement, which includes tax cuts, the reversal of planned tax hikes, select deregulatory moves and relatively large subsidies designed to offset rising energy prices. UK stocks sold off, Gilt yields rose and the pound fell sharply, briefly touching record lows against the US dollar before rebounding on Tuesday.^[ii] Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng argue this plan, which we will highlight below, will boost long-term UK GDP growth to 2.5% annually, up from the 1.8% average in the 20 years before the pandemic.^[iii] Yet commentators we follow fear the plan will fail to spur growth, risk stoking further inflation and, worse still, put British public finances on an unsustainable path.^[iv] Theatrically, some claimed it puts the UK on a path to become an unstable Emerging Market, with wild policymaking risking economic institutions and financial health.^[v] Whilst the plan may not deliver the faster growth targeted—if it becomes law as-is later this autumn—fears tied to it are far overstated, in our view.

We think the motivation for the plan is straightforward enough, and at root, it seems largely like a traditional economic proposal from Truss’s Conservatives. It lays much of the blame for the growth slowdown in the 20 years pre-pandemic on lower private investment than many peer nations.^[vi] In our experience, these factoids are nothing new, having circulated in many discussions of “structural challenges” facing the UK economy for years and years.

To confront them, Truss’s government proposes the following actions^[vii]:

• Eliminate the top tax bracket, reducing the rate from 45% to 40% for earnings above £150,000
• Bring forward a planned cut to the basic income tax rate from 20% to 19% to be effective a year early, in April 2023
• Eliminate a planned corporate tax hike from 19% to 25%
• Reverse the NHS-related tax hike of 1.25 ppt
• Reverse the planned 1.25 ppt dividend tax hike
• Amounts exempted from the stamp tax on home purchases will double from £125,000 to £250,000
  • For first-time homebuyers, the exempted amount will rise from £300,000 to £425,000
• The government’s previously announced plan to cap household energy prices
• Eliminate the government’s ban on hydraulic fracturing, or using injected sand and water to unlock underground deposits of oil and gas
• Strike down banker bonus caps and eliminate a tax surcharge levied on banks (although a higher corporate tax rate will remain in effect for them)

Whatever you think of the merits or timing of such measures, we don’t see them as giant. They are far from big enough to spur inflation materially, in our view. Perhaps exempting a greater portion of home purchases from stamp taxes would buoy home prices by spurring demand and keep shelter costs elevated. But whatever the inflationary effects of cutting it are, they could be offset by rising mortgage rates, an ongoing expense.

Some other measures, like the corporate tax move, simply forestall changes that haven’t even hit yet! Cutting the top tax rate would change the existing code, but it would have only affected approximately 440,000 UK taxpayers in fiscal 2021/2022, or 1.4% of all taxpayers.^[viii] In our view, the effects of cutting this rate, for better or worse, are likely small.

As to the national debt, the government estimates it would have to borrow £72.4 billion extra to fund the plan.^[ix] That is spurring a whole lot of handwringing over British debt, and stoking market volatility accordingly. For example, 10-year Gilt yields rose by 0.34 percentage point to 3.82% on Friday whilst the pound plunged.^[x] This sentiment reaction might be enflamed by the fact the government didn’t include an Office for Budget Responsibility assessment of the plan. Commentators we follow touted the omission as irresponsible, even though Kwarteng says the government will seek one before the full budget is unveiled later this fall. Hence, some of those Emerging Market claims.

But here is the thing: We don’t think the UK was over-indebted before this plan and, even if it is enacted in its present form, that won’t change much, in our view. According to the International Monetary Fund (IMF), the UK finished 2021 with lower debt as a percentage of GDP (gross domestic product, a government-produced estimate of national economic output) ratio than Japan, Italy, Portugal, Spain, the US, France and Belgium.^[xi] The ONS, which tabulates this figure a bit differently than the IMF, says its net debt was 96.6% of GDP in August.^[xii] That seems set to fall looking forward, tied in part to inflation. Whilst GDP growth is floundering on an inflation-adjusted basis, you repay debt with nominal pounds. And on a nominal basis, UK GDP grew 9.1% y/y in Q2 2022.^[xiii] Public-sector debt didn’t come close to keeping pace, resulting in a decline in the UK’s debt-to-GDP ratio. If the UK estimates are correct and the government borrows £72 billion to fund the plan, that could amount to another couple percentage points of GDP.^[xiv] But that is about it, and even this increase could be offset by growth, inflation or spending cuts elsewhere, which the Growth Plan hints at.

Then again, you don’t repay debt with GDP, either. You repay it with tax revenue and, as we wrote here recently, UK interest payments were just 12.1% of total tax revenue in fiscal 2021/2022—less than half their share from the 1960s – 1980s, which the UK navigated without a default crisis.

Furthermore, all this presumes the plan passes as-is. It may not. The Conservative Party is pretty far from united on many things, as all the turmoil before Truss’s government took the reins illustrates.

So whatever you think of this package of cuts, deregulation and energy-price cushioning, we don’t think it spells default, currency crisis or a fast track to the UK becoming a submerging market like Argentina. Those claims seem highly politicised to us—and fairly detached from economic reality. We think setting them aside will make the fiscal and market impact here more clear.