British Prime Minister Liz Truss, who took office in September, has announced an extensive program of economic reforms.
David Dee Delgado | Reuters
drastic tax cuts
Truss is a staunch supporter of a number of central Reaganomics themes and is a co-author of a book, along with other Conservative MPs, lamenting Britain’s weak productivity and advocating for the reduction of regulation, government spending and tax cuts.
Indeed, during this summer’s election campaign, Truss made it clear that tax cuts would be the platform on which he ran. You have, in the past, tweeted on the Laffer curve – the 1974 bell curve analysis that was used to argue that tax cuts can lead to higher tax revenues.
As Britain panicked over an impending massive increase in energy bills, Truss insisted lowering taxes would be a key way to cushion households and businesses from the blow. He has also repeatedly stressed that his priority as a leader would be to revive the UK’s economic growth, which has been sluggish for decades.
Time for rate hikes
There are certainly parallels between Reagan’s time and the present. When the 40th president was sworn in on January 20, 1981, year-on-year inflation in the United States was 11.83%. Today in the UK it is slightly lower, but still at 9.9%. An energy crisis was a key factor in both cases.
The surge in inflation also meant that leaders were taking office at a time when their countries’ central banks had favored rising interest rates, albeit on very different scales.
The Bank of England has so far raised its key rate from 0.1% to 2.25% in seven meetings since December 2021 and is expected to rise. Paul Volcker of the Federal Reserve began a famous rate hike cycle in 1979 that on Reagan’s first day had brought the federal funds rate to a record high of 19-20%.
President Ronald Reagan holds an ax in his hand that reads “The Official TAX AX!” in a speech in 1986.
Diana Walker | Images of life over time | Getty Images
Both Truss and Reagan moved quickly to enact policies guided by their ideology. Reagan passed the Economic Recovery Tax Act in August 1981, reducing federal income taxes – bringing the maximum rate from 70 to 50 percent – as well as cutting capital gains, inheritance and corporation tax.
Meanwhile, within a month of coming to power, Truss had announced the the largest tax cut program the UK has seen in the past 50 years. This included reductions in income tax – even for the highest incomes in the UK – and the elimination of a planned corporation tax hike from 19p to 25p.
In a 1981 speech to the nation, Reagan stated, “With our budget cuts, we have presented a comprehensive program of reducing tax rates.”
“Our aim was to provide incentives for the individual, incentives for businesses to encourage the production and hiring of the unemployed and to free up money for investment,” he added.
Truss said last week that his policies had “ensured that people and companies will pay lower taxes … which means we can continue to do the things that will help people, whether it’s getting to work. or to create their own business and grow the economy. “
The consequences of Reagan’s tax bill saw a falling equity and bond markets and concerns about public debt and inflation, but the reaction to the UK government’s economic plan has been extreme.
The so-called mini-budget of Truss and his finance minister Kwasi Kwarteng has been criticized by various think tanks, billionaire hedge fund managers and politicians within their own conservative party. Polls show that the opposition Labor Party is reaching a level of popularity not seen since the 1990s. In a rare statement, even the International Monetary Fund said it was not the right time for such a fiscal pivot.
In the days following their announcement, the pound fell to an all-time low, mortgage offers were withdrawn from the market, and British government bonds began selling at a historic rate, forcing the Bank of England to initiate a buy program. temporary due to calm volatility.
A key factor in the market reaction is the fact that the central bank is tightening monetary policy in an attempt to cool inflation, while, at the same time, the government announces a new stimulus that could prove to be inflationary. Analysts also said there had been panic over the extent of the unfunded tax giveaway.
British Prime Minister Liz Truss and British Chancellor of the Exchequer Kwasi Kwarteng.
Dylan Martinez | Afp | Getty Images
While federal debt eventually increased under Reagan, from $ 995 billion to $ 2.9 trillion, his program cut government spending on several national programs, including welfare.
Truss allies have suggested that this could happen too, and the government is expected to expand its government spending cuts in the coming weeks. But in the short term, the huge support package that the UK government has promised to households and businesses in the face of skyrocketing energy bills, which is expected to cost more than £ 100 billion in two years, is important. Markets have yet to be convinced of the government’s fiscal credibility, according to the Institute for Fiscal Studies, a research group.
One point of notable difference between the current UK and the 1980s US is the strength of the currency. Aside from the sharp decline in the pound seen after Truss’s announcement, the British pound has been down against the US dollar for the whole year, and has also lost value against the euro.
Critics of Truss say this makes his policies even more unsustainable, as further weakness in the pound will drive up the price of imports.
Reagan also managed to woo the more conservative wing of the Democratic Party and passed his 1981 bill in the 89-11 Senate. Truss’s party, by contrast, remains bitterly divided and his plan has faced vocal criticism from high-profile conservative politicians.
Paul Winfree, a researcher at Queen’s University in Belfast, noted that while the first Reagan tax cut significantly reduced marginal rates (or income tax, as it is known in the UK), many of the other cuts were nearly immediately downsized when national revenues fell.
“Monetary policy was also central to the story,” Winfree said. “The Federal Reserve significantly boosted the growth of the money supply to curb inflation and a recession ensued.” This also threatened the first Reagan tax cuts.
As of Monday, Truss had already turned U on a key part of his plan, scrapping plans to cut taxes for the highest incomes. This despite her Sunday insistence she was “absolutely committed” to the cut.
In the United States, the Fed began easing monetary policy in mid-1982, which “provided the basis for the economic expansion that followed,” according to Winfree.
“It was within this expansion that the Reagan administration could afford to both increase defense spending and further reduce marginal tax rates, although capital gains taxes were raised again to 28% in 1986,” he said. added.
US President Ronald Reagan addresses the nation
David Hume Kennerly | Getty Images
The Reaganomics legacy remains a matter of sharply divided opinion. GDP growth and business expansion have been satisfied, but so have increased federal debt, rising income inequality and a higher trade deficit.
David Blanchflower, a professor of economics at Dartmouth University and a former member of the Bank of England’s Monetary Policy Committee, said he was skeptical of the similarities between Truss and Reagan.
“What we’re seeing here is total chaos in the markets,” he told CNBC via email last week. “At least Reagan had a mandate from the electorate.”
Truss was elected on an open vote to just about 170,000 Conservative party members.
His legacy, of course, is still being shaped as debate rages over what benefits, if any, his extensive program of tax cuts and investment incentives will have for the UK.