Truss - 'last thing' country needs is an election."

Interviewing Liz Truss on Thursday's Today programme, Nick Robinson suggested that no economists agree with her proposals on “cutting taxes” (or, actually, not raising taxes as rapidly as Rishi Sunak proposes). She named Patrick Minford as an example of someone on her side, but actually there are quite a lot of economists who would agree with her. Allow me to explain why.

At the time of his last Budget in October 2021, Rishi Sunak had in place a series of planned tax rises, including rises in national insurance and in corporation tax. These were expected to cut the budget deficit to £44 billion by 2026/27. The OBR expected CPI inflation to rise to 4.4 per cent in 2022.

By March 2022 the view of inflation had changed dramatically, with inflation by then expected to rise to 9 per cent. Partly as a consequence, because higher inflation drags more people into paying income taxes and means higher VAT and corporation tax receipts, the 2026/27 deficit forecast was down to £32 billion.

Now, of course, we are expecting inflation to be even higher, peaking at some 11-12 per cent and not falling back as rapidly as previously hoped. As a consequence, relative to Rishi Sunak’s plans at the time he originally scheduled his further big tax rises, there is some £60 billion of additional fiscal headroom.

In this context, “tax cuts” – the term people are using to describe Truss’s plans not to raise taxes as much as Sunak has scheduled – simply mean a shift back closer to “neutral”, taking us back to something more like Sunak had intended when he originally announced his plans.

Not raising taxes as much is not, of course, the only way we could use that fiscal headroom. We could leave taxes the same and use high inflation as a political opportunity to bear down on the deficit and on government debt more rapidly. That appears to be the UK Treasury’s priority and it is Sunak’s priority. It’s not in itself a dumb idea. The Covid period saw extremely high deficits and a rapid build-up of debt and it is helpful to see that fall.

However, such a more-rapid-than-planned inflation-fueled deficit reduction programme will have consequences. Chief amongst them may be that over the next year or so the economy grows more slowly than it would if taxes were not allowed to rise so much. There may even be a recession.

Recession would reduce pressure on the Bank of England to raise interest rates to tackle inflation. Politically, that might have the happy consequence for a Sunak-led government that by 2024, as we approached the next election, the economy was growing a bit faster as it recovered from recession and because interest rates had been lower in 2022 (interest rates can have a lag of about two years before they have their full impact).

By contrast, by cancelling some of the scheduled tax rises (“tax cuts”), Truss’s policy would mean there would be more pressure on the Bank to raise interest rates to address inflation, since there would be less likelihood of a recession this year. That might mean slightly slower growth in 2024.

But it would also potentially mean higher interest rates and lower taxes over the longer term. Both of these are required for the economy to grow more rapidly. Sunak’s policy reflects an economic consensus that has locked in emergency levels of near-zero interest rates for 13 years, with repeated episodes of temporarily higher inflation being “seen through” and the Bank of England avoiding every opportunity to raise rates.

Economies do not grow at their fastest pace over the long-term if rates are too low. Rates need to be higher so that businesses borrowing to invest are forced to add enough value to pay the borrowing costs as well as create profits for their owners.

Would the Bank actually raise rates, though, if taxes were cut, or would that just mean inflation stayed higher? Perhaps if Sunak were in charge they would not. Never once during his tenure as Chancellor did he admonish the Bank of England for its repeated misses of the targets he set it. He now styles himself as “Mr Anti-Inflation”, but when he was Chancellor he did nothing about inflation at all, not even accepting it was the government’s responsibility to do anything to control it.

Truss is different. She says the Bank of England kept policy too loose, that its conduct needs to be reviewed and that its mandate may need to be changed. Under her there is a much greater likelihood that the Bank’s mandate would change, its personnel would change if it failed to meet its targets, and its independence might be revoked altogether if its failures were persistent. So it would feel pressure to raise rates higher – which is precisely what we want.

The scale of the difference in policy between Truss and Sunak is not vast on macroeconomic management, at least in the short term. But the philosophical difference is important and over time would tell. Sunak is the candidate of Treasury orthodoxy – of continuing to do what we’ve done over the past 13 years even though that has delivered us poor growth and repeated inflation. Truss is the candidate of trying something new, hopefully producing lower taxes, higher interest rates and more rapid GDP growth over the medium to long term. I’m with Truss on this. And so are many other economists.