UK’s Sunak is lonely Tory defending fiscal restraint

As the race to succeed Boris Johnson as leader of the UK Conservative Party and British prime minister heats up, the sole candidate not promising tax cuts needs to stick to his fiscal guns.
Rishi Sunak, the former chancellor of the exchequer, is the current frontrunner. He faces a tough fight, though, with all of the other candidates pledging to reverse much of his fiscal legacy by cutting taxes. Populism is alive and kicking.
It’s likely Sunak will proceed to the next and final stage of the somewhat Byzantine election process, as voting by his parliamentary colleagues winnows the field down to two. But winning over a majority of the 200,000 Conservative party members, a broadly right-wing leaning audience, will prove more difficult. Plenty of economy-boosting policies will be dangled by his opponents, but Sunak is offering thin gruel. At his official campaign launch he emphasized he would not cut taxes until inflation is under control. That may be too long a wait for many of those who get to select the country’s next leader; Sunak’s emphasis that there won’t be a “fairy tale” ending when it comes to fiscal discipline is a tough line to defend when the UK is faced with the sharpest cost-of-living crisis in living memory. “Whilst that may be politically inconvenient for me, it is also the truth,” Sunak said.
There is near unanimity across the rest of the field in reversing Sunak’s scheduled hike in corporation tax, set to rise to 25% from 19%, as well as unwinding a 1.25% increase in national insurance — an income tax on employees and employers — that came into effect in April. According to Bloomberg calculations, eliminating these measures would cost 34 billion pounds ($40 billion) annually.
Among Sunak’s rivals, Liz Truss would enact both of these measures, promising to lower taxes from “day one,” as well as further reducing fuel duty. Jeremy Hunt pledges to cut the basic rate of income tax to 15% (currently 20% but set to fall to 19% next year) in his first budget. Penny Mordaunt has announced plans to reduce the levy on fuel, but otherwise both she and Kemi Badenoch have restricted themselves to unspecified intentions to reduce the tax burden.
Sunak has to defend a record of huge spending during the pandemic twinned with his subsequent relatively restrictive plan to balance the government’s budget. In the meantime, economic growth has vanished, inflation is about to hit double digits, and energy bills are set to rise again this autumn to close to 2000 pounds annually for the average household.
It’s an extremely odd time to be tightening the fiscal screws, and it’s worth
noting no other major economy is trying this particular experiment.
No wonder some of the other prospective candidates are engaging in fantasy politics and promising the Earth while pretending the largesse can all be funded. Even Sunak will eventually find it impossible to resist loosening the purse strings, saying it is a question of “when, not if” he cuts taxes too; but it’s the size and immediacy of the splurge that differentiates him from other the candidates. “Tax cuts, but not yet” is a difficult message to deliver.
The perennial challenge for governments everywhere is curbing the ever-constant desire to spend more, which can be financed either by raising taxes or selling more debt. There will be some fiscal headroom to play with in the October budget, as tax revenue has risen by more than 20% over the past year, helped by a sharp rise in stealth levies such as a freezing of tax thresholds and booming fuel-duty receipts. While borrowing more is the easiest solution optically, it comes at a cost: Under Sunak, Britain’s ratio of debt-to-gross-domestic-product has risen close to 100% from 75% before the pandemic.
The UK government bond market expects gross issuance worth 131 billion pounds this fiscal year, leaving a relatively small net supply of 24 billion pounds after redemptions. There is an unknown though, as the Bank of England, having stopped its quantitative-easing bond purchases, is considering actively selling some of its holdings. Another consideration is that planned issuance of long-dated bonds in excess of 10 years is the highest for over a decade. So while raising extra debt is certainly feasible, it needs to be done carefully to avoid sending borrowing costs higher.
This is where the Office for Budgetary Responsibility comes in. It judges how the government is adhering to its own rules, marking its homework.
Under current government rules, the overall budget has to balance, planned spending not exceeding estimated tax receipts, over a rolling three-year forward projection. Of course, the next chancellor (no doubt under directions from the new prime minister) can move the goalposts, widening the definition of what falls outside regular spending, or extending the timeline to, say, five years. This looks like a racing certainty under all the other candidates other than Sunak.
However, it’s one thing to become party leader by making big promises to a narrow constituency, but winning the next election will require a level of competency and delivery that escaped the Johnson administration. It’s just how much of a break from the past that Conservative members decide is needed to win the next election that will determine the successor. Their bigger fear is of a Labour government, or a coalition with smaller parties, than the merits or drawbacks of any one individual. Ultimately, electability will be the characteristic that transcends all other considerations; the coming weeks will decide whether Sunak’s campaign pledge to “restore trust, rebuild the economy” is enough to get him to the top of the greasy pole of British politics.

—Bloomberg

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was chief markets strategist for Haitong Securities in London