Defending the UK tax cuts
The UK has a new government, and one of their first steps has been to reverse some planned tax increases and make other tax cuts. Great news for British taxpayers and the broader UK economy, but it has sparked controversy as the usual crowd of big-government apologists condemn any policy that reduces the power of politicians.
The new UK government is right to be focusing on boosting productivity, and they are right that lower taxes are an important part of a sustainable productivity agenda. It's also good to see them addressing the over-regulation of the British economy. This is all good microeconomic policy that will ultimately lead to higher wages, more jobs, and lower prices.
Most of the critical commentary about the UK tax cuts has focused on the macroeconomic implications. Indeed, the critical media has almost entirely overlooked the crucial microeconomic rationale for the tax cuts, and have focused instead on the prospect of large budget deficits and excessive government borrowing. They are right to worry about debt, but wrong in their proposed solution. Critics of the UK government instinctively assume the need for higher taxes, but the better solution is for the UK government to cut wasteful spending. That would address the macroeconomic concern, while achieving the microeconomic benefits mentioned above.
While the media critics are partly right to worry about deficits, they exaggerate the situation. The drop in the value of the UK pound against the US dollar is not a problem (there is no “correct” exchange rate), and it is mostly unrelated to the tax changes anyway. The drop in the UK pound was matched by drops in the AUD, NZD & Euro, and reflects a general strengthening of the US dollar over 2022. The most likely cause of US dollar strength is that the US federal reserve has been increasing interest rates more quickly than other countries, with US interest rates now sitting on 3.25% compared to UK interest rates of 2.25% and Australian rates of 2.35%. Just this month the US increased rates by 0.75% while the UK only increased rates by 0.5%, and this difference in approach will strengthen the US dollar against the UK pound.
The focus on budget deficits and exchange rates is a distraction. It’s true that the UK needs to get their budget under control, but it’s also noteworthy that the critical media concern about budget deficits seems to ebb and flow depending on which political party is in power. The exchange rate story is even less relevant. The missing part of the discussion is the urgent need for productivity reform across the developed world. The new UK government has taken a step in the right direction by trimming taxes, and they should be commended. Hopefully this is just the beginning.