Five ways Kwarteng can reduce UK debt

Kwasi Kwarteng is drawing up a debt reduction plan to reassure the feverish financial markets that the government of Liz Truss can trust the public finances of the United Kingdom. Scheduled for November 23, the Chancellor wants to bring it forward to this month if possible, according to her staff.

The Chancellor’s ‘mini’ tax cut budget left investors demanding higher interest payments on UK assets, both because they expected the Bank of England to raise borrowing costs to control inflation – and because they had lost faith in the Chancellor’s ability to reduce the UK’s budget deficit and public debt.

Getting the government’s books to add up and reduce medium-term debt will be difficult for the Chancellor, who will have to choose one or more of the following five paths to fiscal discipline.

Cancel more tax cuts

After two U-turns in two days, it is no longer impossible to believe that Kwarteng could undo some of the other permanent tax cuts to bring the books closer to balance. It would really be a last resort.

With Labor backing the cut in the basic income tax rate and the reversal of the National Insurance hike in April, the most likely action here would be to reinstate the previously planned increase in the rate of income tax. corporate tax rate from 19% to 25% in 2023-24. This would bring in £17 billion a year.

However, it would undermine Kwarteng’s commitment to boost the UK’s economic growth rate through lower corporation tax and run counter to a promise made by Truss in the leadership race. conservatives. Although economists don’t think a cut in the corporate tax rate would have a big effect, most think it could slightly boost growth.

Stuart Adam, Senior Economist at the IFS, said: “Undoing the corporate tax hike will encourage investment in the UK and therefore help the economy grow – if businesses believe that it will last.”

Reduce public spending

By reducing government spending from current plans and forecasts, Kwarteng could reduce borrowing and bring the accounts closer to balance.

Neither Kwarteng nor Truss have pledged to increase social benefits for non-pensioners in line with inflation in April 2023, which the Resolution Foundation says could save £11billion a year. But those suggestions came under heavy criticism on Tuesday, with House of Commons Leader Penny Mordaunt and others saying she believed benefits should rise with inflation.

“We don’t try to help people with one hand and take them away with the other,” she said.

Column chart of the loss of income in 2024-25 if Universal Credit was increased by income instead of inflation over the next two years (£pa) showing that not increasing UK benefits based on inflation would save money but would be politically controversial

The Chancellor could also target the banks. With interest rates having risen so sharply, lenders are receiving much higher returns on the more than £800bn they have deposited with the BoE since 2009 as a result of quantitative easing programs.

Instead of paying interest on these “reserves” at the bank’s official rate, the government could decide to force the banks to hold the money in the central bank at a lower or even zero interest rate.

Frank van Lerven, senior economist at the New Economics Foundation, said £200 billion would be paid in interest to commercial banks by the end of 2026-27. “Instead of seeking funding cuts in public services. . . this [the government] could stop paying interest altogether,” he said.

A third option would be extremely tight spending plans for the years following the current spending review period, which ends in 2024-25. Kwarteng could simply tell the Office of Budget Responsibility that the government would freeze spending after the next election, sharply lowering the borrowing forecast. Even if the spending plans were not credible, the OBR is obliged to use them.

Facilitate compliance with fiscal rules

Kwarteng laid out an “ironclad commitment to fiscal discipline” in his speech to the Conservative Party conference, but he could move the goalposts and set new fiscal rules that didn’t tie his hands so tightly.

The chancellor has said he wants to reduce debt as a percentage of gross domestic product over the medium term, so he can extend the period over which the criteria for debt reduction are measured. The current rule states “three years in advance”, which equates to 2024-25. But if that period were extended by five years – as expected – it would mean 2027-28.

Extending the rule would allow the chancellor to cut spending later in the period, after a general election. For this to help Kwarteng, he should also drop the current additional rule that commits the government to balancing the “current budget”, ensuring that tax revenue pays for day-to-day expenditure excluding capital investment. This is likely to become the most binding constraint over a five-year period.

“Three years is a strange time anyway,” said Julian Jessop, a fellow at the Institute for Free Market Economic Affairs. “Five years also allows more time for the benefits of supply-side reforms to manifest themselves.”

Convince the OBR to project higher growth

If Kwarteng could persuade the OBR that government policies would increase sustainable levels of economic growth, it would bring in more tax revenue, reduce borrowing and help reduce debt.

In December 2013, the fiscal watchdog produced simulations of both higher and lower growth scenarios for the supply side of the economy. He found that higher sustainable growth ensures “that the underlying fiscal position is stronger, given the increase in future potential output”.

However, since its creation in 2010, the OBR has overestimated the potential for productivity growth and would therefore be reluctant to raise it.

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It would be “better if the chancellor and the OBR can agree” on the growth prospects stemming from the government’s new plan, Jessop said. “I can already see the headlines if the government’s own fiscal watchdog questions the economic assumptions on which policy is made,” he added.

Accept disagreement with OBR

There is no legal obligation for the government to produce a budget which, according to the OBR, complies with its budgetary rules. The law simply states that the fiscal watchdog will produce a forecast and “an assessment of the extent to which the fiscal mandate has been, or is likely to be, achieved.”

It is entirely consistent with the system for the Chancellor to allow the OBR to say he is likely to break his budget rules but respectfully disagree. This has happened fairly regularly in the past, but would be a presentation challenge given the current market turmoil.

One way to mitigate the difficulties would be for the OBR to produce a scenario of what public finances would look like if the government achieved its ambition of a sustainable annual growth rate of 2.5%.

But as Torsten Bell, director of the Resolution Foundation, pointed out, in the past, budget rigging and missing rules did not cause turbulence in the markets, because “it was not a time of soaring interest rates, so the attention was much less acute”.

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