Rishi Sunak, British third prime minister in seven weekstook office on Tuesday pledging to correct the “mistakes” of his predecessor Liz Truss and tackle a “deep economic crisis”.
Task won’t be easyhe acknowledged.
“It will mean tough decisions ahead,” Sunak said in his maiden speech from No 10 Downing Street.
The UK was already slide into a recession when Truss took over in September as soaring energy bills ate away at expenses. Now Sunak has another headache: he must restore the government’s credibility with investors after Truss’ unfunded tax cuts sparked a bond market revolt, forcing the Bank of England to intervene to prevent a financial collapse. Borrowing costs, including mortgage rates, have soared.
Achieving this objective will require providing a detailed plan to put public finances back on a more sustainable path. (A government watchdog warned in July that without major action, the debt could reach 320% of UK gross domestic product in 50 years.)
The problem? There is little appetite for public spending cuts after years of austerity following the 2008 global financial crisis. Moreover, failure to help households cope with the rising cost of living could prove politically devastating and further weigh on the economy.
“It’s not a particularly pleasant economical hand to deal with. [as] a new prime minister,” said Ben Zaranko, senior research economist at the Institute for Fiscal Studies.
Finance Minister Jeremy Hunt got the ball rolling last week when he canceled £32 billion ($37 billion) in the tax cuts that were the foundation of Truss’ plan to spur growth.
Yet Sunak and Hunt – who will remain in his post – still need to find between £30bn and £40bn in savings to reduce the share of public debt in the economy over the next five years, according to calculations by IFS, an influential think tank.
“It’s gonna be tough,” Hunt said in a tweet. “But protecting the vulnerable – and people’s jobs, mortgages and bills – will be front and center as we work to restore stability, confidence and long-term growth.”
Sunak and Hunt won’t be able to shed light on the details. If investors don’t buy into their plan and borrowing costs rise again, it will become more difficult to get the situation under control, as interest payments on the public debt rise.
“If the markets [see] if the plans are credible, then closing the fiscal hole could become even more difficult,” said Ruth Gregory, senior UK economist at Capital Economics.
One area Sunak might be tempted to exploit is the welfare budget. Questions have swirled over whether the Conservative government might try to avoid raising state benefits in line with inflation, as is customary. (U.S. Social Security recipients will receive largest cost-of-living adjustment in more than four decades Next year.)
Most UK working age benefits would usually go up 10.1% next April based on inflation data. But there is speculation that the increase could instead be linked to average incomes, which are rising at a much slower rate than inflation. This could save £7bn ($8bn) in 2023-24, according to the IFS.
Such a move would be controversial, however, especially as benefits have not kept up with runaway inflation in 2022.
“I would like to see if we could find a way to increase benefits through inflation, but what I will say is that trade-offs are involved,” said former Tory cabinet minister Sajid Javid. says ITV this week.
A more acceptable option, at least for households, would be to levy more corporate taxes.
Hunt has previously said corporate taxes will rise from 19% to 25% next spring. The Financial Times reported that Hunt could also target the profits of oil and gas companies by extending a windfall tax on profits.
In a BBC interview earlier this month, Hunt said he was “not against the principle” of windfall taxes and that “nothing is on the table”. Higher taxes on the financial sector are also under consideration, according to the Financial Times.
Industrial groups are already making the rounds of the wagons. Banking trade association UK Finance said its members already pay ‘a higher overall rate of tax than any other sector’ and urged the government not to ‘risk the competitiveness of the UK banking and finance sector’ .
Sunak could also walk back on Truss’ pledge to increase defense spending to 3% of the economy by 2030, though that carries its own political risks given Russia’s war in Ukraine. Other countries in the region, such as Germany, have said they will increase military investment, and the UK may be reluctant to fall behind, Zaranko said.
Investors and economists expect the government to announce a mix of tax increases and spending cuts soon. Hunt is due to reveal his plans in more detail on October 31.g
“Despite the fiscal about-face, the government will still have to show a fiscally credible path next week in the budget to balance the books,” Sonali Punhani, an economist at Credit Suisse, said in a note to clients this week.
This could worsen the country’s slowdown. The Bank of England has predicted that the UK is already in recession, and a business activity gauge in October fell to its lowest level in 21 months.
“We are seeing quite a dramatic shift in the fiscal outlook from being much looser than expected a few weeks ago to being much tighter than expected,” Capital Economics’ Gregory said. “I think the risk is that the recession will be deeper or longer than expected.”
A weaker economy would present its own complications.
No one wants to repeat the mistakes of the brief Truss era, when his bet that unfunded tax cuts would spur growth backfired spectacularly.
But business groups warn that completely abandoning the aim of reviving Britain’s anemic economic growth would also create problems.
The austerity of the 2010s produced “very low growth, zero productivity and low investment”, said Tony Danker, president of the Confederation of British Industry. told the BBC tuesday.
“The country could end up in a similar catastrophic loop where all you have to do is come back every year to find more tax increases and more spending cuts because you have no growth.”