7/15/22, 5:09 PM Britain’s Conservatives seem oblivious to the coming budget crunch | The Economist

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Leaders | British understatement

Britain’s Conservatives seem oblivious to the

coming budget crunch
It is a bad time to be increasing deficits to pay for tax cuts

Jul 13th 2022

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A little more than a decade after the Conservatives declared Britain to be on

the brink of a bond-market crisis, many of the candidates to lead the party—
and therefore the country—are promising to dole out plenty of cash. Tom
Tugendhat wants to reverse a recent increase in national insurance, a payroll tax.
Liz Truss wants to do that and cancel a planned rise in corporation tax. Penny
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7/15/22, 5:09 PM Britain’s Conservatives seem oblivious to the coming budget crunch | The Economist

Mordaunt, the bookies’ favourite, wants to peg most tax thresholds to inflation and
temporarily halve vat on petrol.

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There is still time for candidates to flesh out their plans, and none admits to
throwing fiscal caution to the wind. Ms Mordaunt promises that she will get the
debt-to-gdp ratio down. But none of the candidates has given a credible account of
how they will finance all their giveaways. The implication is clear: most would
borrow more than planned under Boris Johnson’s premiership. Given the pressure
on government budgets around the world, that is worrying.

Politicians in rich countries ran up enormous debts during the pandemic and now
face demands that they help the public, which is dealing with soaring energy and
food prices. They must spend more on defence following Russia’s invasion of
Ukraine and in light of the growing threat posed by China. They have to find the
cash to decarbonise their economies, a project which in Britain could raise debt-to-
gdp by 20 percentage points by 2050. All the while they must contend with ageing
populations demanding more spending on pensions and health care.

The trouble is that this is an especially bad time to be increasing government

borrowing. Annual global inflation is 9.5% and interest rates are rising.

Stimulating economies with unfunded spending or tax cuts would only force
central banks
Inflation easestogovernment-debt
tighten monetaryburdens,
policy even
but more.
higher interest rates will mean that
governments will have to pay more to borrow. This feed-through from monetary
policy to government budgets will happen much faster than markets seem to
think, in part because central banks’ vast bond-buying activities have left taxpayers
across the rich world unusually exposed to higher rates. Britain is no exception.
Despite the fact that the weighted-average maturity of its bonds is over 15 years,
higher borrowing costs will affect half of its liabilities within about two.

Some contenders for the Tory leadership have argued that inflation is solely the
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7/15/22, 5:09 PM Britain’s Conservatives seem oblivious to the coming budget crunch | The Economist

Bank of England’s responsibility. They are sorely mistaken. Raising interest rates is
effective only when fiscal policy remains sound. In a tug-of-war between hawkish
central banks and spendthrift politicians, the politicians win. Just look at Brazil,
which has raised rates by over 11 percentage points since March 2021 but is still
suffering annual inflation of nearly 12%, in part because fiscal policy lacks long-
term credibility. Margaret Thatcher, the inflation-busting prime minister whom
Tories idolise, was a deficit hawk.

No rich-world country is on the precipice of a fiscal crisis—though fragile Italy will

also suffer rapidly rising rates. But if politicians borrow maximally today just
because the bond markets will let them, they will have less headroom tomorrow if
there is a war, say, or another pandemic. To use up fiscal space is to squander
insurance against the next disaster. Some Tories note that Britain has room to
spend before it breaks its fiscal rules. But that claim is built on a tentative official
forecast of the economic outlook. To erect the pillar of your fiscal policy on it is
reckless.

And for what? Many Tories say tax cuts would unleash economic growth. In fact,
because the stimulus would be offset by higher interest rates, the boost would be
marginal. A pro-growth agenda would make taxation as efficient as possible, for
example by shifting the tax burden from income towards land and inheritance. It
would not pretend that tax is unnecessary or that tax cuts will pay for themselves.

After Johnson, an honesty test

Regrettably, Conservative leadership hopefuls are as likely to redesign the tax
system as to condemn over-generous increases to public pensions, which benefit

their elderly voters and are the biggest waste of the state’s money. Financing tax
cuts with debt would help Conservatives avoid the contradiction of calling for a
smaller state when that state increasingly benefits their own supporters. The truth
is that an ageing society makes it harder than ever to combine falling debts with a
shrinking government and generous public services. A willingness to confront that
fact is the acid test of the next prime minister’s candour. 7
This article appeared in the Leaders section of the print edition under the headline "British understatement"

Leaders
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7/15/22, 5:09 PM Britain’s Conservatives seem oblivious to the coming budget crunch | The Economist
Leaders
July 16th 2022

→ Europe’s winter of discontent

→ The Democrats need to wake up and stop pandering to their

extremes

→ Japan should stay true to Abe Shinzo’s vision—up to a point

→ Britain’s Conservatives seem oblivious to the coming budget

crunch

→ What to do now about tomorrow’s code-cracking computers

→ The Catholic Church should scrap the requirement for priestly

celibacy

From the July 16th 2022

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