The Decibel - How a tax cut for the wealthy almost tanked the UK economy

Episode Date: October 5, 2022

Liz Truss’s ‘mini budget’ didn’t get a mini reaction. The plan, which initially included a cut in personal income tax for the top earners, sent markets into a panic and sent the pound plummeting to near parity with the U.S. dollar — something that hasn’t happened since the mid-1980s.But why did the markets react that way to a budget? And what was Truss trying to do in the first place? Lucille Perreault is a researcher at the Sprott School of Business at Carleton University, and she specializes in taxes. She explains the economics at work and what Canada can learn from the fallout.Questions? Comments? Ideas? Email us at [e-mail]

Hi, I'm Mainika Raman-Wilms, and you're listening to The Decibel from The Globe and Mail. UK Prime Minister Liz Truss has been in the job for about a month now. And suffice to say, it's been a rocky start. The big announcement was a mini-budget, but it's really quite substantial. So on the personal side was probably the most controversial one that she eventually walked back is the tax rate for top earners. And top earners in the UK would be over £150,000. And that went from 45% down to 40%.

That's Lucille Perrault. She's a researcher at the Sprott School of Business at Carleton University, and she specializes in taxes. And Lucille has been looking at the UK's mini-budget, which was announced on September 23rd. There were a host of proposed cuts to personal taxes, corporate taxes, and some others, like even one on alcohol. All of that would have meant a loss of 161 billion pounds over five years to the country's coffers. The markets reacted very poorly.

And in effect, the pound fell even further. It hit almost parity with the U.S. dollar, which is pretty much unheard of. In the days after, Liz Truss and her chancellor of the exchequer, Kwasi Kwarteng, defended their mini-budget. But they gave up on a part of it on Monday. Today, Lucille will help us understand what the U.K. government is trying to do, why the markets really don't like it, and what Canada can learn from this mess. This is The Decibel. Lucille, thank you so much for joining me today.

Thank you for having me. So let's get into some of the details here then. So we saw the markets freak out. We saw the pound tank, all in reaction to the tax plan announced here. Why did investors react that way to this plan? I think investors reacted the way they did to the plan for two reasons. One of them, they were spooked by inflation fears. Now, what happened here is this trust government worked in almost contradictory to what the Bank of England and other central banks were doing in trying to tame inflation. Here, they were actually injecting more money into the economy through a series of either the subsidies or through the tax cuts. So in addition to inflation, there is also concerns about the sustainability of the UK economy. When you take on that much debt, are they going to be able to service their debt? Because the presumption of the list trust government is all these tax cuts, that their growth is going to go to 2.5%,

therefore paying for all the tax cuts. A lot of critics are indicating they're not too certain that these type of tax cuts will actually generate that full percentage point of growth. So I think that's where the negative reaction came from. Okay, so maybe we can talk about the economics at play here, like how this would work, how a tax cut would essentially generate growth. So that's really a concept under what we would call supply side economics, meaning that anytime you have tax cuts, and you tend to have deregulation associated with that as well, the thought process is going to actually encourage growth. Because on the flip side, there's a belief that when you have increased taxes, it tends to inhibit growth and it actually tends to produce behaviors to avoid taxes. So an

example of that would be from a high income tax earner that if you increase their rate because they are more mobile than a less well-off individual, that they will be able to move their capital to another country that will have a less higher tax rate. You said supply side economics. I've also heard the term trickle down economics. Are those the same thing? It is the same idea. And it is the thought process that if I have the tax cuts, that puts more money back into more discretionary income, both from investors, from businesses, and from individual taxpayers. And when we talk about trickle-down economics, is the idea that the wealth is actually supposed to trickle down, like you're helping the people at the top, and eventually it kind of permeates through all of society. Is that fair to say? Yes. That's the intent of it, that again, businesses would invest more in employees, and then investors would buy more shares, expanding the whole growth, and that would have ancillary effects, meaning that there would be more businesses that pop up or more other items

to consume. So overall growth in the economy is the thought process behind it. So this was the logic then that was behind the top earners tax cut that trusts initially instituted, but then walked back. Is that right? I guess I'm trying to understand the reason behind this plan. Is this about helping people with the increased cost of living due to inflation, everything is more expensive? Or is this about growing the overall British economy in bigger terms? Ironically, I would actually say they were trying to do both. So their viewpoints in terms of the subsidy for energy was to lessen the burden of inflation and particularly energy costs on individual taxpayers. But there was concerns about growth. 1.25% growth in a country of GDP is not great. But the problem is, and this is where some of the criticism is, that you need to work in tandem with monetary policy.

So currently, the Bank of England, just like every other central bank, is increasing interest rates. And that automatically slows down the economy. It slows down purchases because of the, you know, if you do have to borrow, for example, the cost of borrowing increases substantially. And so it does tend to focus on savings more. So I'm going to save more because I can actually earn more interest on my money rather than spend the money. Versus you have something like this with tax cuts. The actually you're trying to spur the opposite. You're actually trying to spur increased investment into the economy and increase spending. We'll be right back. Ronald Reagan and even Donald Trump more recently, and in the UK under Margaret Thatcher in the 80s.

What have we learned from those examples? The results are really mixed, and it's really hard to pinpoint, was it exactly the supply side or trickle-down economics? If we take Margaret Thatcher, she wrestled inflation first. So there was tax increases. And then from there, there was also on the monetary side, there was increases of interest rates to tame inflation. Once it was more tamed, then she started putting into her tax cuts. So once again, we see that there was some growth, but that was really only after she tamed inflation. Is there a reason to believe that we would get the same outcome now if we kind of applied the same principles? So for supply side economics to work, one, you need to control the money supply,

because you have to, you don't want rampant inflation. So that's one of the elements that I'm not, I can see they're trying to do that. But there's a question of right now we're in an inflationary environment. Was this the right time to do it? Now the trust government would say yes, it was because they have a growth problem. So that might be what they come up with on that side. The other element that is very different from the 1980s is resources. So right now we have a labor shortage. So I have supply-side economics, and I say I'm going to invest in more in the business, and I'm going to hire more people.

Can you hire more people? Globalization is also an element in terms of there was some free trade agreements in the 1980s. Now free trade agreements are abundant, and there tends to be more of a mobilization of capital that you can move from one country to the other country very easily. So that's a concern as well. She's only just started, and will she have the support of her party for the next two years? So will she be able to enact, because at List Trust, will she be able to enact her policies? And then from there, maybe businesses will be concerned

that given the polling of the conservative government in the UK, that a labor government will come in next and undo all of this. So would you necessarily invest in the UK if knowing that these tax reductions are just going to be reversed in two years? It's very different than it was in the UK if knowing that these tax reductions are just going to be reversed in two years. It's very different than it was in the 1980s. And when we talk about globalization,

I guess I just have to wonder, how much does Brexit play into what's happening now in the UK? I would actually say quite a bit. And the reason I say is this. EU was the biggest trading partner of the UK. Now you have to have agreements with the EU and they can be incredibly restrictive. So other people would work in the UK from other countries. So for example, people from Poland would come into the UK. Now, that's one of the reasons why Brexit occurred, but you do need the workers. And now you have to rely pretty much only on the citizenry of the UK, with obviously some immigration, but you don't have the flexible workforce that you had before, in terms of also investment. So there's concerns of, because of their low growth, would you necessarily invest here? Or would you invest somewhere in the EU, where they have access to all the other EU countries?

Okay, so that's how Brexit has impacted things. I'm also wondering about Canada. I guess, are there lessons here for our federal government, especially when it comes to the personal income tax side of things? So, as you know, in Canada, we have a progressive system. The more that you earn, the more that you pay. I think you're totally correct. The Canadian government can look at this and say that the reaction from the markets and their reaction from the populace from reducing the overall tax rate from the highest income earners is a political no-go. Even though you could somewhat justify in terms of they might have more spending and boost the growth of the economy, I'm not certain

this is the route to do it. So I think that'd be one of the elements that Canada can learn from this. Yeah. And I want to bring up one other tax policy that we know the Canadian government is intending to implement, the doubling of the GST rebate for people who get it. Wealthy people wouldn't receive it. So this is kind of the opposite, I guess, in some ways of what's happening in the UK, because we're actually giving money to people with less of it to help them with the cost of living during this time of intense inflation. I guess, how would you assess that? That's a good question. I would say targeting consumers who are more likely to be affected by inflation is a smarter proposal than an across the board, for example, energy subsidy. And I think that if we think about how

supply side economics works from a lower income level, that most of their income is consumption. So that's an immediate thing. So they pay their rent, they pay their mortgage, and they pay for the basics. And so the more that you give them, the more likely that they are able to spend. So the hit on their discretionary income because of inflation is lessened. So I think targeted subsidies or even tax cuts for a lower income is probably the better way to go to at least lessen the burden of inflation and then not have an overall inflationary effect that in contrast to giving money to everybody. The idea here then is if you give money to lower income people, they actually will spend it because they need to. But if you give money to people who earn more, they might not necessarily spend more because they don't need to. They may actually just save it then. They may actually save it, exactly, and not spend it in the economy. So that's always the concern. Just lastly here, Lucille, so TRUS's plan obviously wasn't well received. But I keep thinking there's got to be a reason for, you know, why the government would decide to do that. Could this plan pay opportunities in the UK? And I think that is

really what the crux of this mini budget was for, is that there's concerns that the tax policies have an impact on the growth and investment in the UK. So I think the thinking is that if you invest in it now, it will pay dividends in a couple years. My concern with that is, yes, it's possible, but you have to have a lot of elements working in your favor. And one of the elements working in your favor is labor. You need to have access to labor. If you don't have access to labor, it's questionable whether this will work. Lucille, thank you so much for taking the time to speak with me today.

Well, thank you, Monica. That's it for today. I'm Mainika Raman-Wilms. Our producers are Madeline White, Cheryl Sutherland, and Rachel Levy-McLaughlin. David Crosby edits the show, Kasia Mihailovic is our senior producer, and Angela Pichenza is our executive editor. Thanks so much for listening, and I'll talk to you tomorrow.