Can We Trust the Tories' Tax Cuts?

Rishi Sunak described it as the tax cut that ‘every working person in this country is going to benefit from.’

Adding: ‘We want to do more because, as we manage the economy responsibly, we cut your taxes, give you and your family peace of mind, immediate relief from some of the challenges you’re facing and confidence that the future is going to be better for you and your children.’

While this will help relieve some of the financial stress on families, there is a general feeling that the cuts, combined with delaying the general election until ‘the second half’ of 2024, are just the Conservatives’ latest strategy to maximise votes.

Some sources maintain that the prime minister is ‘gambl[ing] on the Spring interest rate and tax cuts to deliver an Autumn election victory for Tories.’ Others warn that the reduction in National Insurance is doing little more than ‘holding off the headbangers demanding unaffordable tax cuts.’

Will Tax Cuts Increase Consumption?

Cutting National Insurance tax increases the amount of income people can keep.

For individuals and families, this will hopefully mean greater financial security, relieving pressure on those struggling to make ends meet.

From an economic perspective, this also means that consumers will have more disposable income. This is the amount of money a person has left after tax has been deducted and essentials (like food and energy) have been paid for.

Theoretically, with extra cash in their pockets, people start feeling more comfortable about spending their income on unessential items. This could be something small, such as luxury chocolate bars, to big-ticket items such as a new car.

The importance of consumer spending cannot be overstated, accounting for 60 per cent of the UK’s GDP each year.

As consumers buy more goods, business profits normally increase. This enables firms to develop and expand their business, which in turn increases investment. Both consumption and investment are key factors that boost the economy.

However, this is where things become a little fuzzy. A disposable income of £450 a year is not a large sum of money. The notion that ‘millions of people … will now be better off,’ is questionable. Better off how, exactly? springs to mind.

Considering that the average UK household spends around £32,655 a year (£628 per week), how much pressure can this relatively minute tax cut alleviate in the day-to-day expenditures of ordinary people?

An important point to note is that having more disposable income does not imply that it will be spent.

The current cost-of-living crisis has not been helped by falling job vacancies and rising unemployment. Add to this youth homelessness and soaring private rents, and the average person has little opportunity or incentive to increase spending on unessential items.

Many families will likely use their £450 to stay afloat or try and save to build a more financially secure future. From this sobering perspective, consumption is unlikely to increase by any significant amount.

The 2p tax cut, though nice in theory, in practice is little more than a placebo when it comes to facing the cost-of-living crisis.

Can Tax Cuts Harm the Public Sector?

There are growing fears that the proposed tax cuts will affect the public sector’s finances.

Tax receipts are the main source of government revenue, which was estimated to be worth around £1,027 billion in 2022/23. The Treasury uses our taxes to decide where best to allocate funds, from defence spending to supporting various public services such as schools, hospitals, and transport. However, if the National Insurance tax falls from 12 per cent to 10 per cent, tax receipts will fall too.

The government’s recent venture to help working parents with childcare costs further increases the state’s financial burden. Enabling parents to apply for 15 hours of free childcare doesn’t come cheap.

Increasing spending while simultaneously reducing the amount of revenue received is economically unsustainable and imprudent. Cutting funds from already severely underfunded areas of the public sector, such as NHS mental health treatments, will have serious consequences in the years to come. The public will be the ones paying for these quick fixes.

As Paul Johnson writes in The Times:

‘the extra spending on childcare has been accompanied by eye-wateringly tight spending plans for other public services. The only way that Jeremy Hunt can make his numbers add up is by planning another period of austerity for many parts of our already struggling public realm.’

The Long and the Short of It…

Short term, the proposed National Insurance tax cut (amongst other things) will gain the Conservatives some favourable headlines and potentially sway voters. But without sufficient fiscal tightening to offset the loss of tax revenue, the government’s finances could quickly spin out of control. That tightening is already starting to take place.

By using fiscal policy mainly as a political tool rather than a genuine economic roadmap, Sunak is putting undue financial strain on the Treasury and the public during one of the worst periods in the country’s recent history.