Sunday’s Observer led with the dramatic headline ‘Revealed: the £30bn cost of Liz Truss’s disastrous mini-budget’. Apparently, the former PM is responsible for half of the estimated £60bn fiscal hole that Jeremy Hunt intends to fill on Thursday with tax increases and spending cuts. But if you are suspicious about this claim, then you are right to be.
The £30bn figure comes from analysis by the Resolution Foundation (RF). In reality, there is not much analysis here, and little new.
Some £20bn of the £30bn is simply a (high) estimate of the direct cost to the Treasury of those tax cuts in Kwasi Kwarteng’s mini-budget that have survived. This £20bn is mainly accounted for by the reversal of the increases in National Insurance (NI) contributions, and partly by the reductions in Stamp Duty.
However, these measures were widely welcomed at the time, in part because they made a deep recession less likely. To be fair, the RF was concerned that most of the benefit of the NI reversal would go to higher earners. But at the very least, it is odd to characterise £20bn of tax cuts as a cost to taxpayers.
The remaining £10bn is a RF estimate of the annual increase in the government’s cost of borrowing that can be attributed to the fallout from the Truss premiership. This is just speculation.
The main difficulty here is deciding how much of the recent rise in interest rates and borrowing costs is due to global factors and how much is due to factors that are specific to the UK. Even then, the UK-specific elements cannot simply be blamed on Truss and Kwarteng.
The timing is also important. The OBR’s forecasts for the public finances will be based on market interest rates and other market prices between 24 October and 4 November. Since then, government bond yields and market expectations for official interest rates have fallen further. But if fiscal policy is about to be mechanically tightened on the basis of estimates that are already out of date, then surely that is a failure of the budget process, not the previous administration.
Of course, investors did react badly to the mini-budget on 23 September. This contributed to a jump both in bond yields and in expectations for official rates. However, as the RF itself acknowledged earlier this month, the UK-specific increases have since largely unwound.
Instead, the £10bn figure appears to refer to the widening in the gap between bond yields in the UK and Germany over the summer, before Liz Truss actually became Prime Minister! According to the RF, ‘this lasting hit to UK credibility means £10bn a year of additional cost by 2026-27’.
This claim is, at best, an almighty stretch. The UK-Germany spread has only widened by about a quarter of a point since the middle of the year. Over the past 12 months, data from Bloomberg show that 10-year government bond yields in the UK, Germany, France and the Netherlands have all risen by about two and a half percentage points. Clearly, global factors are by far the most important.
There are also several reasons why the UK-Germany spread might widen without this reflecting badly on the credibility of the UK government. For a start, it is normal for bond spreads to increase when yields are rising globally. Many would agree that UK interest rates in particular had been kept too low for too long (blame the Bank of England for that).
Structural problems in the euro area and in the German economy are likely to keep German yields relatively low. Indeed, if Trussonomics had succeeded in boosting UK growth, you might have expected UK interest rates to rise by more than those in the euro area anyway.
Unfortunately, the media like a headline number they can focus on, and the £30bn figure also suits two popular narratives.
The first is the idea that Sunak and Hunt must be even more ‘austere’ in order to restore credibility lost under the previous administration. But it should be sufficient to cancel or scale back the measures that the markets were least comfortable with, rather than double-down. After all, no UK politician will be in any hurry to face the same fate as Truss or Kwarteng. I have yet to meet any investors who are screaming for taxes to be hiked and spending slashed as the UK economy slides into recession.
The second is that the fallout from the Truss premiership has discredited ‘free-market economics’ generally (catnip to many readers of the Observer). This is a red herring. Free-market think tanks (including the IEA) were critical of the Energy Price Guarantee and the announcement of large tax cuts without at least some matching savings on public spending.
It was not good free-market economics either to ignore the concerns of financial markets, or institutions such as the OBR which are intended to hold governments in check. Above all, the most ‘free-market’ parts of Trussonomics – the supply-side reforms – were never actually implemented.
In short, whatever measures Jeremy Hunt unveils on Thursday will be his own policy choices. Blaming them on the previous administration would make little sense. My fear is that the pendulum is swinging too far from a decent but botched pro-growth strategy back to abacus economics, with the ‘beancounters’ at the Treasury firmly in charge again.
This article was first published by CapX on 14th November 2022