UK tax relief shows Thatcher’s spirit is alive, but can it survive?

True believers in lower taxes and smaller government have had little to celebrate in a long time as ‘spend, tax and borrow’ has become the new entrenched orthodoxy under governments of all colours.

In the Australian chapter of this story, pressures for more social spending have been mounting over many years in education (remember Gonski), health, aged care, child care and disability care — and to those ‘big five’ we can now add defence as the sixth.

The previous government had some success in curbing the growth of Commonwealth spending up to 2019, then the pandemic gave new meaning to the word ‘spendathon’ and now we are getting back to the same old pressure from the now big six.

On the tax side, stage 1 and 2 income tax cuts were implemented, but the further modest relief from bracket creep scheduled for 2024 (stage 3) is under daily attack from those who think they have better ideas for using the money.

Against this background, the package of tax relief measures announced by the new Truss Conservative government in the UK last week gives the true believers hope that the spirit of Reagan and Thatcher is still alive somewhere.

Truss flagged tax relief in her Tory leadership campaign, but the package announced last week goes further than generally expected. It cancels planned hikes in company tax and the national insurance charge (a British version of our Medicare levy); cuts personal income tax rates, including most notably the top marginal rate; and lowers stamp duty on home purchases.

But the key question is whether the package will be politically and fiscally sustainable. And for it to elicit the hoped-for supply-side response, it has to be both sustained, and expected by taxpayers to be sustained, if they are to be incentivised to adjust their economic behaviour.

The political challenge is not that the measures will fail to be implemented, but that they will in full, or in part, not survive a change of government at the elections due in late 2024. There is bound to be a campaign ridiculing the package as the last gasp of the supposedly failed doctrine of trickle-down economics. Imagine the barrage of criticism here if the stage 3 income tax cuts did not merely lift the threshold for the top marginal rate but actually cut that rate — as it should have, to give true meaning to the words ‘tax cut’.

The cut from 45 per cent to 40 per cent in the UK’s top rate is important to the economy but also invested with immense symbolic value. The Thatcher government slashed the top rate from 83 per cent to 40 per cent in two steps. It was then lifted to 50 per cent by the Brown Labour government in the midst of the global financial crisis and subsequently trimmed to 45 per cent by the Cameron government. In restoring it to 40 per cent, Truss is reinforcing her claim to be the torchbearer for Thatcherism.

In other ways, however, Truss is letting the Thatcherites down — which brings us to the question of fiscal sustainability. Thatcher was a deficit and debt hawk. This set her aside from Ronald Reagan, who favoured lower taxes but also said (only half-jokingly) that the budget deficit was big enough to take care of itself. When the Thatcher government came to office, the UK’s public debt burden was half its present level, and at the same time the government was slashing income tax it was almost doubling the standard rate of VAT (Britain’s GST) to 15 per cent in order to lower the budget deficit.

Thatcher had limited success in curbing government spending, but there is no sign yet that the Truss government will even try. To the contrary, massive new spending is in the works to subsidise energy bills. With rapidly rising interest rates on a rapidly rising public debt, there is the risk of a real or imagined fiscal crisis developing, which would create the climate for tax cuts to be reversed.

There is no way of knowing how high the public debt can go before it becomes a serious problem. The UK has had higher public debt burdens in the past than it has now; but usually associated with wars rather than an inability to reconcile the demands for ongoing social spending with an acceptable tax burden.

Truss has joined Reagan in leaving the big budget deficit to take care of itself. It is one thing for the United States to do that, but quite another for the United Kingdom.

It is a bold experiment. If inflation eases and there is a burst of economic growth before the next election, Truss’s gamble will be perceived to have succeeded.

A modest rate of inflation combined with a solid rate of economic growth would work wonders in lowering the debt burden if that combination could be sustained.

Robert Carling is a Senior Fellow at the Centre for Independent Studies and a former World Bank, IMF and federal and state Treasury economist.