Six takeaways from the 'mini budget'

On 23 September, Kwasi Kwarteng set out his ‘Mini Budget’ – an eye-watering £45 billion in tax cuts alongside an energy relief plan projected to cost £60 billion over the next six months.

It was a huge departure from the fiscal policy of the Johnson government, which had planned tax rises to pay for health and social care and to manage the post-Covid deficit.

Kwarteng claimed his ambitious plans would drive growth and reduce inflation. The financial markets disagreed: in the days after his announcement, lenders pulled mortgage packages, the pound hit a record low against the dollar, and the Bank of England started buying bonds at ‘an urgent pace’ to calm the markets and stop pension funds going bust.

While the Chancellor has since reversed the most controversial part of his mini budget ­– the abolition of the 45% income tax rate – he and the Prime Minister are insistent that their plans will drive growth. But is it that simple? We asked some of our experts to explain the implications of this ‘new era’ in economic policy.

Arun Advani is a CAGE Associate and an expert on tax and inequality

Ludovica Gazze is a CAGE Theme Leader and an expert on environmental economics

Amrita Kulka is a CAGE Associate and an expert on urban economics

Dennis Novy is CAGE Impact Director and an expert in trade and macroeconomics

Mike Waterson is CAGE Deputy Impact Director and an expert in competition policy and consumer behaviour

This article was updated on 7 October to reflect the Government's decision to keep the 45% income tax rate.

1. Economic growth is not assured

The government has heralded Kwarteng’s mini budget as a growth plan that will tackle high energy costs and inflation, and deliver high productivity and wages. While weak growth is a long-standing problem in the UK and needs to be addressed, the evidence that large-scale tax cuts like this can generate growth is thin.

Dennis Novy explains, ‘The tax cuts disproportionately benefit high earners. Those earners tend to save a relatively large proportion of their additional income. The evidence does not suggest that these savings end up in productive investments which in turn propel economic growth. It therefore does not come as a surprise that financial markets reacted by increasing UK government borrowing costs and marking down the value of sterling in foreign exchange markets.'

The government’s plan to make infrastructure investment faster and easier could raise the growth rate of the UK economy in the long run, but, Novy argues, this will not happen quickly. He indicates the importance of the government following through with its promise to ask the Office for Budget Responsibility to assess their proposed fiscal plans.

2. The package favours high earners

From income tax cuts to the abolition of the cap on bankers’ bonuses, this package favours high earners.

As well as cancelling the plans made by former Chancellor, Rishi Sunak, to raise National Insurance Contributions, Kwarteng proposed to reduce the basic rate of income tax by 1% and abolish the 45% income tax rate (paid on taxable income over £150,000).

Bowing to public pressure, Kwarteng has since u-turned on the abolition of 45% tax rate. But plans to lift the cap on bankers’ bonuses will stay, alongside other proposed tax cuts.

Under the original plans, the very wealthiest people in the country stood to benefit the most. Cancelling the 45% tax rate would have affected all those earning over £150,000 a year – around 500,000 people or 1% of adults. But, Arun Advani explains, more than two-thirds of the total tax saving would have gone to those earning more than £500,000 ­– just 0.1% of adults. The richest 2500 earners would have received a £1 billion boost to their income – an average of £400,000 each.

Meanwhile, the tax revenue lost to the government would have amounted to £6 billion annually.

While the U-turn on the 45% income tax rate will reduce how much higher earners gain from tax cuts, the mini budget still favours the better off. The Resolution Foundation has calculated that the richest 5% of households will save £3500 on average next year: almost 40 times as much as the poorest 5% who stand to gain £90.

Lower earners will benefit predominantly from the cancellation of the planned rise in National Insurance Contributions (intended to pay for social care) and the lowering of the basic rate of Income Tax. Arun Advani welcomes the cancellation of National Insurance rises, arguing that there are better ways to raise money for social care. But, he explains, reversing this cut doesn’t provide a solution to the cost-of-living crisis, and increases the UK deficit.

3. The energy cap provides much needed relief, but firmer plans are needed on how to tackle energy consumption.

Kwarteng has promised that a typical energy bill won’t reach higher than £2500 a year, offering a saving of up to £1000 a year in current prices. But the government cap is not a cap on bills, but on the unit price of energy. So those who typically use more energy will save more.

The speedy relief to calm the energy crisis will be welcomed by all, but the government hasn’t yet set out clear plans to reduce energy consumption over the long term. Reducing consumption doesn’t just save money on energy bills. It’s an opportunity to reduce the UK’s carbon footprint and its reliance on fossil fuels in a market dominated by Russia.

‘There are plenty of ways the government could address energy consumption,’ explains Mike Waterson. ‘Whilst improvements to insulation is one obvious example of economisation for the medium term, another, potentially shorter-term solution, is to change the price mechanism so that higher-level consumers pay higher unit tariffs.’

This is important, Waterson explains, because the current energy price cap benefits most those who consume most. ‘Greater impacts on high consumption have the potential to reduce overall consumption. Increasing unit rates for higher consumption levels is a feature, for example, of the Pacific Gas and Electric tiered rate plan in California.’

Ludovica Gazze adds that the energy crisis should be addressed in line with net-zero goals. Kwarteng’s package includes a promise to lift restrictions on onshore windfarms, a move that has been welcomed by climate campaigners. However, Truss has also announced plans to renew fracking and to accelerate plans for the Cambo Oil Field, a prospective oil and gas field in the Shetlands.

Gazze argues that green energy should take priority. ‘The move to green energy would make the UK more independent from the global market dominated by Russian oil and gas faster than drilling more.’

4. Stamp duty cuts will only help house buyers once matched with increased housing supply

The government has promised no stamp duty on house purchases up to the value of £250,000 (£425,000 for first-time buyers). But these changes won’t do much to help first-time buyers in the short term. Amrita Kulka explains, ‘Even though lowering stamp duty reduces frictions in the housing market, the benefits will mostly accrue to wealthy households. As long as new housing supply isn't added, the effect of reducing stamp duty on first-time home buyers is limited, and higher sales prices benefit existing homeowners while eating up benefits of lower taxes for buyers.’

The eventual consequence, Kulka explains, is that landlords will be encouraged to convert rentals into owned units, which could increase overall homeownership (but potentially drive prices up for renters). And in fact, Kulka points out, there is no mention in the mini budget of measures to specifically target housing affordability, especially for less wealthy households and those that rent their homes.

The success of the government's plan to help house buyers rests, therefore, on its intention to increase housing supply through the introduction of investment zones, which will streamline planning procedures and potentially even allow building in green areas if it is expected to produce economic growth.

The plans haven’t been set out in detail. Kulka explains that, in principle, removing housebuilding restrictions could ease the tight space constraints that many UK cities are currently experiencing. But if these relaxations only apply to newly designated investment zones, the beneficial effects of the policy could be limited, since the supply of housing in some of these areas is not as strained as in the most productive cities in the country.

Careful thought will be needed to make the policy a success, says Kulka. ‘The details about which planning rules will be relaxed are crucial. Given the complexity and multiple layers of planning procedures, even if some regulations are relaxed, they can be replaced by other existing regulations that have similar effects.’

5. It’s not clear the UK can afford this ambitious package in the long term

Kwarteng has assured the public that the cost of the cuts are accounted for and that public spending on services won’t be affected. The global financial markets seem to have their doubts.

‘The government's proposed tax cuts are unusual in post-war UK history,’ says Dennis Novy. ‘The tax cuts are substantive and meant to be permanent. They will put severe downward pressure on spending and severe upward pressure on the budget deficit and government debt.

‘Some of the key long-standing UK economic challenges include low productivity growth, poor investment in skills and education, an ageing population and rising demand for health and social care. All these require public investment and fiscal space. But the tax cuts and rising interest rates have made long-run spending commitments harder to support. It’s not clear that the government will be able to meet its ambitious growth target in the long run. However, the tax cuts might boost the economy in the short run.’

6. A windfall tax is still a good idea

Liz Truss has ruled out a windfall tax – a one-off tax on the unanticipated profits of oil and gas suppliers . But such a tax could be used to pay for some of the expensive promises the government has made. It could provide a much-needed cushion for the government as it commits to subsidise energy bills in a volatile market.

‘Of course, a cap on prices is expensive,’ says Mike Waterson, ‘but we should not forget that on the other side of the equation many firms are benefitting from supplying at high prices. A windfall tax is an obvious additional measure, adopted by many European countries.

‘Rishi Sunak introduced a partial measure along these lines, although not calling it a windfall tax. But it can be extended to those firms on the Renewables Obligation (RO) scheme such as Drax and certain wind farms.

‘The RO scheme involves the firms selling into the wholesale market and getting a subsidy, so investment decisions will have been based on expectations at the time regarding energy prices. It is a legacy scheme, so taxation of these assets will not affect future investment via the scheme.’

Ludovica Gazze agrees on the benefits of such a tax to ease the energy crisis, ‘A windfall tax could be a better way to fund targeted cash transfers, or to fund energy efficiency investments for the long-term.’