The UK tax cut campaign has a narrow path to avoid a big mess

LONDON, Aug 30 (Reuters Breakingviews) – Britain’s prime minister candidates are having a strange conversation about the economy. The country is bracing for higher gas and electricity bills in the coming months, while Citi analysts estimate inflation could hit 18% early next year. But in the battle for the leadership of the Conservative Party, the most vigorous debate is about lowering taxes.

Foreign Minister Liz Truss and her opponent Rishi Sunak, the former finance minister, want to cut taxes. But Truss, who is the favorite to replace Prime Minister Boris Johnson in the contest which ends next week, has upped the ante. It plans to cut state levies on business income and profits by £30 billion.

The government would normally have to cut spending by an equivalent amount to avoid adding to the national debt, currently at around 95% of GDP. However, Truss may have a workaround, according to the Institute for Fiscal Studies think tank. Rising prices will increase revenue from income and sales taxes, while spending on public services like schools – which are not directly linked to the price level – will increase at a slower rate. This phenomenon, which the IFS calls “involuntary austeritycould boost tax revenue by £37 billion by 2024.

Unfortunately for Truss, the windfall is uncertain. The effects of inflation on public spending such as social care and servicing the state debt are certain. Future tax revenues depend on unusually opaque economic conditions. Economists polled by Reuters earlier this month assumed The UK official interest rate would drop from 1.75% to 2.5% this year. On Tuesday, however, money markets were implying a 75% chance that rates would hit 3.5% by the end of December. If the Bank of England meets these expectations, the economy will collapse.

Then there is the energy crisis. The annual cost of electricity and gas for a UK household could reach £6,000 by April next year, three times the level twelve months earlier. If the state supports 100 billion pounds ease proposed by the energy industry, or if Truss cuts UK sales tax drastically, as the media suggests, the budgetary picture will change dramatically.

The uncertainty surrounding energy costs and interest rates makes forecasting government revenues even more complicated than usual. It’s a strange time to try to cut taxes.

Follow @gfhay on Twitter

BACKGROUND NEWS

Foreign Secretary Liz Truss, the favorite in the race to replace Boris Johnson as British Prime Minister, said on August 9 that she favored tax cuts to grow the economy instead of providing direct support to households faced with unprecedented increases in their energy bills.

Charities, business groups and politicians called Truss and his rival, former finance minister Rishi Sunak, to explain how they would help Britons cope with a projected 82% rise in oil prices energy in October.

Sunak, who as finance minister presented a £15billion support package in May to help households struggling with rising energy bills, pledged more direct support.

Truss is considering cutting income tax and VAT as part of a contingency plan, The Sunday Telegraph reported on August 28, citing an unnamed source.

Editing by Peter Thal Larsen, Streisand Neto and Pranav Kiran

Our standards: The Thomson Reuters Trust Principles.

The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and non-partisanship by principles of trust.