The race to succeed Boris Johnson as leader of Britain’s Conservative Party, and as prime minister, has focused on dueling tax cut plans from the two contenders, Foreign Secretary Liz Truss and former chancellor of the exchequer Rishi Sunak. I hope my friends across the pond won’t mind a word of advice based on the United States’ long experience with similar frenzies: Don’t buy the supply-side snake oil.
The idea that tax cuts pay for themselves has long animated conservative politics in the United States. It is true that people spend and invest more if they have more money, and the economy therefore grows a bit faster than would otherwise be the case. So far, so good.
But the additional activity generally does not generate enough tax dollars to make up for the revenue lost from the cuts. President Donald Trump’s 2017 tax cuts are a case in point: Federal revenue after the cuts dropped compared with pre-cut projections despite the added growth. This was no surprise even to its advocates. The supply-side friendly Tax Foundation, which touted the proposed cuts before their passage, acknowledged they would reduce federal government revenue by nearly $1.5 trillion over the subsequent decade.
Likewise, suggestions that Truss’s proposed tax cuts would pay for themselves are balderdash. (Truss, for her part, has been wise to avoid making such an argument.) That means Britain would finance the proposed cuts the old-fashioned way: by increasing public-sector borrowing. That should worry any conservative.
Britain’s recent fiscal history is remarkably similar to that of the United States. Britain, like the United States, has run annual budget deficits for most of the past 50 years. Despite years of spending cutbacks derided as austerity, Conservative governments between 2010 and the beginning of the pandemic managed to trim the annual shortfall from nearly 9 percent of gross domestic product to only a bit more than 2 percent. Its gross government debt is now more than 102 percent of GDP, triple what it was in 2001.
American conservatives have followed the supply-side mantra for decades to no great success. The U.S. economy has grown in that time, but much of that is because of population growth, including from large immigration inflows. The United States’ annual budget deficits were even larger than Britain’s before the pandemic, and the U.S. debt to GDP ratio is a startling 125 percent. U.S. experience should not give British conservatives comfort.
Britain would likely suffer more than the United States from a debt binge because the pound is not the world’s reserve currency. The United States can finance its debt in large part because demand for U.S. Treasury bonds is fueled by the dollar’s global dominance. Investors will accept lower interest rates because they either need the dollars to finance trade or because they value the dollar’s perceived safety. The pound offers neither advantage, and Britain would likely start to see rising interest rates if it followed the United States’ path.
The next Conservative prime minister should instead look for ways to generate new investment that will generate jobs and take pressure off the public fisc. Britain’s ban on fracking, for example, should be immediately repealed. That would generate significant investment and help both Britain and Europe replace Russian gas imports. Such a move would be highly controversial, but it would create high-paid working-class jobs, lower energy prices and improve national security.
Health care is another field in which government policy impedes private activity. Unlike in the United States, employer-provided health insurance is taxed in Britain. The next prime minister should make those premiums tax free, thereby encouraging employers to offer this valuable benefit and expanding private health care in the country. This could help reduce the massive waiting lists plaguing the National Health Service. That would also be controversial, given Britain’s affection for the NHS, but the alternative is large increases in public spending.
Politics will always play a role in tax policy, and to that extent, the next PM must favor the Tories’ new working-class voters. Truss’s proposal to reverse the hike in National Insurance contributions (Britain’s version of the Social Security payroll tax) is politically sound. She or Sunak should also consider cuts in Britain’s 20 percent value-added tax. The VAT is a regressive tax, hitting those with lower incomes harder than the well-to-do. Cutting it would give working-class voters more purchasing power. It would also be a political winner, as Canada’s Tories found in 2006 when they promised to cut that country’s sales tax by 2 percent and went on to victory.
Britain’s next Conservative prime minister will face a daunting task: revitalizing economic growth while rebuilding the new working-class-based political coalition that Brexit and Boris Johnson bequeathed to the party. Adopting American-style supply-side economics won’t solve either problem.