Sunak’s economic woes

The British economic outlook for 2022 looks bleak. Living standards are set to fall at the fastest pace since the 1950s as inflation reaches a thirty-year high; absolute poverty looks set to rise for the first time since the Great Recession. All eyes have been on the Chancellor of the Exchequer to relieve the economic calamity that the country faces. However, Rishi Sunak’s spring statement was seen as underwhelming by many and out-of-touch by most. Those in the middle class will likely suffer the most from the recent tax changes, coupled with the recent inflationary bout. As tax receipts were better than economists had projected in 2021, Sunak should have taken steps to relieve the pain felt by households during this cost-of-living crisis. With this said, the former Goldman Sachs banker failed to deliver. The UK tax burden is forecast to reach its highest levels seen since WW2, taking the Conservative party away from the Thatcherite policies that brought economic success and prosperity to the nation.

Background

High inflation is a global phenomenon that central banks are struggling to grapple with. In the US, inflation reached 8% in March; in Europe, inflation jumped to 6%. These high inflation rates can be attributed to both demand-pull and cost-push factors – mostly the latter. As shops were closed in 2020 due to lockdown restrictions, households saved at a record pace. In mid-2020, the household savings ratio exceeded 20% for the first time since records began in 1955. Following the easing of lockdown restrictions in 2021, households started to spend their savings. The result has been demand-pull inflation – as aggregate demand has grown faster than aggregate supply.

Supply-chain shocks have been the leading cause of consumer price inflation. Severe supply shortages of various materials and components such as semiconductors have accompanied the easing of restrictions. Following a sharp drop in output in 2020, the supply of electronic products and equipment is only gradually returning to pre-pandemic levels. At the same time, strict lockdown measures still in place in Asian manufacturing hubs has left supply levels lagging behind demand. The recent conflict in Ukraine has only added to the supply chain bottlenecks. Restrictions on oil and gas imports from Russia have left consumers across Europe facing ever-climbing energy costs due to severe shortages. In just the space of three months, diesel has risen from €1.50 to €2.30 per litre in Germany. In the UK, diesel has witnessed similar price hikes; £1.50 to £1.80 per litre, an increase of 20% in the space of two months.

Sunak’s response to these inflationary pressures was tepid at best. Measures include raising the National Insurance threshold from £9,568 to £12,750 and temporarily cutting fuel duty by 5% for one year. A council tax rebate of £150 for around 80% of UK households has also been announced, in addition to the £200 discount on energy bills introduced in October. Whilst these measures are certainly better than nothing, they do not go far enough to address the looming cost-of-living crisis. The treasury announced a 1.25% increase in National Insurance in September. As a result, raising the NI threshold still amounts to a tax increase for those earning over £35,000 annually when taking into consideration both measures. An employee earning £30,000 per year will see their taxes decrease by £50 whilst one on a £50,000 salary will see a £200 tax increase. However, when adjusted for inflation, both earners will see their real wages fall drastically as inflation is projected to reach 9% by the end of the year. As a result, Sunak’s changes do little to prevent real wages throughout the economy from falling. Likewise, a £200 discount on energy bills is meagre relative to the £600 increase to the average household’s annual gas and electricity bill.

Alternatives

Numerous policy measures could help alleviate the cost-of-living crisis that most households find themselves in. Reversing the National Insurance tax increase would boost the disposable income of households, leaving them more money to fight rising prices. Keeping NI tax rates at 12%, coupled with raising the National Insurance threshold would leave an employee on a £40,000 salary better off by over £600 annually. Increasing NI by 1.25% has been introduced to increase social care funding; with this said, the £12 billion figure that the tax hike looks to raise can easily be found by eliminating waste and making efficiencies within the NHS, or by making reductions in needless spending such as defence and foreign aid.

Reversing the corporate tax increase announced last year should boost tax revenues in the long run through greater productivity and economic output. Although counter-intuitive, high and uncompetitive corporate tax rates discourage investment into the economy, thereby reducing potential tax receipts. In 2011, then chancellor George Osborne announced a sharp reduction in the corporate tax rate from 27.5% to 19% over five years. What followed was an increase in corporate tax receipts every year following these cuts. In 2012, receipts stood at £42 billion; by 2017, this figure had reached £58 billion – an increase of 40%. Last year, Sunak broke from Conservative orthodoxy by announcing the first corporate tax increase since 1974, raising the headline rate from 19% to 25%. Whilst intending to raise tax receipts, it is likely that investment into the UK will fall as a result of these corporate tax increases, reducing future potential tax revenues in the process. This is because of the uncompetitiveness of a 25% corporate tax rate; for comparison, the US corporate tax rate stands at 21%. Coupled with the lighter-touch regulation of the US economy, this makes the UK an even less attractive place to invest. Following the vote to leave the European Union in 2016, investment into the UK has fallen and has grown at a sluggish rate compared to European rivals ever since. Sunak’s corporate tax increase won’t reverse this trend and will leave the British economy lacking much-needed investment to boost economic activity. Lower than expected tax revenues from this corporate tax increase will give the chancellor less legroom to cut taxes and increase the disposable income of households which would go far to cushion the cost-of-living crisis.

Further deregulation of the energy market would also greatly help households by lowering gas and oil prices. The UK is home to one of the largest oil reserves globally in the North Sea. However, issuing new permits to further exploit these oil reserves has been long seen as controversial by ‘climate campaigners’ who raise concern at growing pollution levels from expanding drilling and fracking. These claims are dumbfounded by the fact that the UK is responsible for only 1% of greenhouse emissions globally. A slight reduction or increase in emission will have little to no effect on global emission but would greatly improve the living standards of millions of households facing rocketing energy bills. Increasing oil production through loosening drilling laws would go far to lighten the burden of higher energy bills through increasing supply in the energy market, driving down prices in the process.

Ultimately, the disaster that the British economy finds itself in has only been exacerbated by the inaction and poor policy response of the incumbent chancellor. Sunak has failed to contend with spiralling inflation; raising taxes on households, reducing potential tax revenues through hiking corporation tax are two of the chancellor’s numerous policy failures. Boosting energy output through deregulation and cutting taxes would go far to prevent a catastrophic fall in living standards. With this said, Sunak’s economic illiteracy, breaking Conservative orthodoxy by raising taxes, will have real-life consequences as families across the UK will suffer at the hands of his disastrous policies for years to come.