What cost of living crisis? Tory hopefuls’ fuss over tax cuts is devoid of reality

By the time the Conservative party gets around to electing a new leader, Britain will either be in recession or perilously close. The cost of living crisis will be entering a new, more painful phase with a fresh surge in energy bills. A tough autumn will be approaching, with inflation – already at a 40-year high – heading for 11%.

These are far from ideal conditions for an incoming prime minister. Yet so far, none of the Tory candidates is offering real solutions to the cost of living challenge. Instead, the leadership contest is taking place in some parallel universe where the biggest tax cutter is king.

With the tax burden heading for the highest level since Labour’s Clement Attlee was prime minister in the late 1940s and early 1950s, this game of tax-cutting Top Trumps is perhaps understandable. The party feels it has lost its way, and needs a major reset. However, it’s a debate that is devoid of reality.

Of the leading candidates, only Rishi Sunak is arguing for restraint. The Sunday newspapers are full of pledges to cut rates for businesses, workers and consumers, with promises worth billions. Taken together, they would eradicate the tax base of a small country. In a big economy such as the UK, they would blow a serious hole in the public finances – something past Conservative leaders told us could turn Britain into Greece.

Tax cuts, big spending and budget deficits aren’t always bad news if they are backed by sound economic reasoning. However, planning fiscal policy to woo a narrow group of mainly affluent Tory party members isn’t likely to meet the needs of wider society amid the worst hit to household finances of our times.

Outside of this world of fantasy politics, economists warn that some of the tax cuts being dangled would throw petrol on the inflationary fire and turbocharge inequality.

Take VAT: cutting the rate from 20% to 17.5% would cost up to £15bn a year, but help richer households most. Inflation would be stoked by boosting the spending power of wealthier families, who were likelier to have built up savings during lockdown. Poorer households, suffering most from soaring living costs, would benefit least.

To kickstart a moribund economy, Sajid Javid and Jeremy Hunt are promising not only to scrap a planned corporation tax rise from 19% to 25% from next April – a move that was supposed to bring in about £17bn a year – but also go further, with a cut to 15% that would cost billions more.

It’s a demand that not even the big business lobby groups are making, and one that two former health secretaries ought to recognise would have serious consequences for public services.

Britain already has one of the lowest corporation tax rates among rich countries, and slashing it to 15% would fly in the face of the emerging global consensus that a race to the bottom on tax competition is a zero-sum game. Almost 140 nations – including the UK – agreed this much at the OECD last year, acknowledging that governments lose while footloose multinationals prosper.

There is growing recognition that headline tax cuts are terrible at promoting more business investment. According to a report by the Social Market Foundation, the UK spent close to £100bn with little to show for it when George Osborne slashed the corporation tax rate from 28% in 2010 to 19% today. Economic growth remained weak, while levels of business investment fell behind comparable rich nations.

When companies invest, they do so because of far more than just tax, often placing more weight on political and economic stability, as well as other key fundamentals that might benefit their returns – such as the skills of the local workforce, quality of infrastructure, and depth of their potential market.

Business investment has stalled because of Brexit and the pandemic – and now an imploding political system. It now stands almost 10% below pre-Covid levels.

Business leaders will this week warn that the wrong types of tax cut will make matters worse. The Confederation of British Industry, the country’s foremost business lobby group, will publish a report calling for a smarter tax policy rather than eye-catching measures to please the Tory faithful.

“We need tax changes that drive investment, not tax changes that fuel inflation,” it will say.

The lobby group is worried about the planned rise in corporation tax to 25% next spring, but has previously suggested it could be offset by a package of tax reliefs to support business investment. Such a move would be a far smarter way to develop a pro-growth economic stance.

Sunak, the architect of this carrot-and-stick approach to business taxation before his resignation as chancellor, has used his leadership campaign to kick back against the party telling itself “comforting fairy stories” of magical-sounding but ultimately reckless giveaways.

It’s an argument strikingly similar to Labour’s bitter infighting of recent years, reminiscent of Tony Blair warning the party against reaching for the comfort blanket of Jeremy Corbyn’s socialist policies. His argument was that this might feel right to the party faithful, but is splintered from mainstream opinion and not what the country needs.

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Sunak is right to argue that cutting taxes for the sake of ideological purity is not a recipe for sound public finances and a strong economy. Where his message falls apart, however, is that tight budgetary constraints should triumph every time. This embraces a Treasury orthodoxy that ought to have been binned after a decade of austerity. For years it has been recognised that budget deficits can and should be used to soften economic shocks and support recoveries, if good tax and spending decisions are taken.

For the Conservatives it’s important to remember that where Boris Johnson cut through with the public was on the need to escape austerity and “level up” Britain’s lopsided economy. Levelling up delivered an electoral coalition spanning poorer “red wall” constituencies and the more prosperous south. Blunt tax cuts are not the tool to achieve a better balance.

In focusing on ideologically driven tax cuts alone, the Conservatives are missing the point that a more fundamental rethink of Britain’s economy is needed than an old and tired reboot of Thatcherism.