On the UK’s Controversial ‘Growth Plan’

Editors’ Note: MarketMinder favors no party nor any politician and doesn’t advocate policy proposals. We review political developments solely for their potential market impact.

Global stocks sold off again Friday, capping another trying week for investors with a decline that has world and US markets hovering around their June lows. Many attributed the drop to the newly installed British government’s “Growth Plan” announcement, which includes tax cuts, the reversal of planned tax hikes, select deregulatory moves and relatively large subsidies designed to offset rising energy prices. UK stocks sold off, Gilt yields rose and the pound fell sharply, briefly touching record lows against the dollar before rebounding on Monday. Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng argue this plan, which we will highlight below, will boost long-term UK GDP growth to 2.5% annually, up from the 1.8% average in the 20 years before the pandemic. Yet many fear the plans will fail to spur growth, risk stoking further inflation and, worse still, put the UK’s public finances on an unsustainable path. Theatrically, some claimed it puts the UK on a path to become an unstable Emerging Market.^[i] While the plan may not deliver the faster growth targeted—if it becomes law later this autumn—fears tied to it are far overstated, in our view.

The motivation for the plan is straightforward enough, and at root, it seems largely like a traditional economic proposal from Truss’s Conservative Party. It lays much of the blame for the growth slowdown in the 20 years pre-pandemic on lower private investment than many peer nations. These are well-known factoids that have circulated in many hifalutin discussions of “structural challenges” facing the UK economy for years and years. They aren’t new.

To confront them, Truss’s government proposes the following actions:

• Eliminate the top tax bracket, reducing the rate from 45% to 40% for earnings above £150,000
• Bring forward a planned cut to the basic income tax rate from 20% to 19% to be effective a year early, in April 2023
• Eliminate a planned hike to the corporate tax from 19% to 25%
• Reverse the National Health Service-related tax hike of 1.25 ppt
• Reverse the planned 1.25 ppt dividend tax hike
• Amounts exempted from the government’s stamp tax on home purchases will double from £125,000 to £250,000
  • For first-time homebuyers, the exempted amount will rise from £300,000 to £425,000
• The government’s previously announced plan to cap household energy prices
• Eliminate the government’s fracking ban
• Strike down banker bonus caps and eliminate a tax surcharge levied on banks (although a higher corporate tax rate will remain in effect for them)

Whatever you think of the merits or timing of such measures, we don’t see them as giant. They are far from big enough to spur inflation materially, in our view. Perhaps exempting a greater portion of home purchases from stamp taxes would buoy home prices by spurring demand and keep shelter costs elevated. But this would be a one-time charge. So whatever the inflationary effects of cutting it are, they could pretty easily be offset by rising mortgage rates, an ongoing expense.

Some other measures, like the corporate tax move, simply forestall changes that haven’t even hit yet! Cutting the top tax rate would change the existing code, but it would have only affected approximately 440,000 UK taxpayers in fiscal 2021/2022, or 1.4% of all taxpayers.^[ii] The effects of cutting this rate, for better or worse, are likely pretty small.

As to the UK national debt, the government estimates it would have to borrow £72.4 billion ($81.0 billion) extra to fund the plan.^[iii] That is spurring a whole lot of handwringing over UK debt, and stoking market volatility accordingly. For example, 10-year UK Gilt yields rose by 0.34 percentage point to 3.82% on the day while the pound plunged.^[iv] This sentiment reaction is perhaps enflamed by the fact the government didn’t include an Office for Budget Responsibility (OBR) assessment of the plan. The OBR is a nonpartisan body established in 2010 to give unbiased assessments of policy effects. The omission of an assessment here, even though Kwarteng says the government will seek one before the full budget is unveiled later this fall, was widely touted as irresponsible. Hence, some of those Emerging Market claims.

But here is the thing: We don’t think the UK was over-indebted before this plan and, even if it is enacted in its present form, that won’t change much. According to the IMF, the UK finished 2021 with a lower debt-to-GDP ratio than Japan, Italy, Portugal, Spain, the US, France and Belgium. The Office for National Statistics, which tabulates this figure a bit differently than the IMF, says its net debt was 96.6% of GDP in August. That seems set to fall looking forward, tied in part to inflation. While growth is floundering on an inflation-adjusted basis, the UK repays debt with nominal pounds. And on a nominal basis, UK GDP grew 9.1% y/y in Q2 2022. Public-sector debt didn’t come close to keeping pace, resulting in a decline in the UK’s debt-to-GDP ratio. If the UK estimates are right and the government borrows £72 billion to fund the plan, that could amount to another couple percentage points of GDP. But that is about it, and even this increase could be offset by growth, inflation or spending cuts elsewhere, which the Growth Plan hints at.

Then again, you don’t repay debt with GDP, either. You repay it with tax revenue and, as we wrote here recently, UK interest payments were just 12.1% of total tax revenue in fiscal 2021/2022—less than half their share from the 1960s – 1980s, which the UK navigated without a default crisis.

Furthermore, all this presumes the plan passes as-is. It may not. The Conservative Party is pretty far from united on many things, as the recent ouster of former Prime Minister Boris Johnson and the ensuing leadership contest prove. These measures reverse quite a few Johnson-era provisions and could stoke further internal divides requiring negotiation.

So whatever you think of this package of cuts, deregulation and energy-price cushioning, we don’t think it spells default, currency crisis or a fast track to the UK becoming a submerging market like Argentina. Those claims seem highly politicized to us—and fairly detached from economic reality. Set them aside to see the fiscal and market impact here more clearly.