The UK chancellor Rishi Sunak is under mounting Conservative pressure to radically cut taxes in the coming months. The question facing him is whether he can do it without pouring fuel on the inflationary fire.
Cabinet ministers including Liz Truss and Jacob Rees-Mogg have led calls for Sunak to reduce the highest tax burden seen in Britain for 70 years, to help households cope with inflation that has hit a 40-year high of 9 per cent.
Conservative MPs in recent days have piled pressure on Sunak. Sir Bernard Jenkin, a senior Tory MP, told the Financial Times he wanted to see value added tax abolished on domestic energy bills.
Sir Edward Leigh, another Tory grandee, said Sunak had to move “in a far more radical direction on the overall tax burden”. According to one former cabinet minister, the chancellor should “cut taxes and reduce VAT across the board”.
To the dismay of some Tory rightwingers, Sunak has left open the idea of actually increasing taxes on one sector, in the form of a windfall tax on UK oil and gas companies.
David Canzini, Prime Minister Boris Johnson’s influential deputy chief of staff, is opposed, according to Conservative party insiders. “Canzini is always telling us we need to go back to Tory fundamentals,” said one.
However, Johnson’s allies insist a windfall tax is still “on the table”. Meanwhile, polling suggests the policy is very popular. Some Tory MPs admit to having no idea what Sunak’s strategy is on tax or financial support for families generally.
“During turbulent times it’s especially important to lay out a plan so people can recognise the course being taken,” said Greg Clark, former cabinet minister. “I hope the chancellor will set this out clearly in the near future.”
Sunak wants to be remembered as a tax-cutter. Most Tory MPs expect him to start cutting income tax, or VAT, as part of a broad package of measures later this year, but the chancellor is treading cautiously.
In particular, he fears that unfunded tax cuts now could fuel inflation, forcing the Bank of England to raise interest rates further, worsening the cost of living crisis and pushing up the government’s debt servicing costs.
One Treasury figure said that rightwingers calling simultaneously for tax cuts and for the BoE to take a tougher line on inflation were “intellectually incoherent”.
Sunak argued in his Mais economics lecture this year that tax cuts had to be paid for through higher economic growth or lower spending, adding the idea that tax cuts could be self-funding was “neither serious nor credible”.
The problem for Sunak is that getting the sluggish British economy to grow faster is a long-term project. His plan to cut taxes on business investment will not yield instant results.
As for cutting spending, Johnson came to office in 2019 refusing to contemplate any return to austerity, a word he hates so much that he once claimed he had banished it from his lexicon.
Rees-Mogg, minister for efficiencies, has set out some ideas for saving money, but none is politically cost free. His plan to axe around 90,000 civil servant jobs is unlikely to win many Tory votes in the public sector.
“How do you explain to your staff that their jobs are superfluous?” asked one mandarin. “You can imagine what morale is like.” Public spending cuts carry big political risks in the “red wall”, traditional Labour strongholds won by Johnson in the last general election.
Sunak has already committed to cutting income tax by one percentage point in 2024 and could bring that forward. He has vowed that every “marginal pound” would be used for tax cuts.
But Anthony Wells, political director at YouGov, said the politics of tax cuts were complicated. “People like tax cuts, but only if they think it is sensible and not part of an attempt to bribe voters. It’s the smell test.”
The economics of cutting taxes in the midst of soaring inflation, when the BoE is raising interest rates to control rising prices, are, however, the main preoccupation of the Treasury.
David Davis, former Tory cabinet minister, rejected the idea that tax cuts could drive up inflation. “It’s how you drive up productivity and growth,” he told the FT.
BoE governor Andrew Bailey was tight lipped on how the central bank will respond to tax cuts, when giving evidence to MPs on Monday. “We do not speculate on what government policy might be in the future; we only use announced fiscal policy as the conditioning assumption [in our forecasts],” he said.
What he left unsaid was that if tax cuts raised the BoE’s inflation forecast, it would be duty bound to tighten policy further, adding to the financial pain of corporate and household borrowers.
While the economics suggest that tax cuts could bring further interest rate rises, there is an exception if the economy is already sliding into recession.
This is what Rupert Harrison, portfolio manager at BlackRock and the economic adviser to former chancellor George Osborne, fears. He said on Thursday the government should cut VAT by 2.5 percentage points.