December 7, 2022

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LONDON — Britain’s new prime minister, Liz Truss, gambled on Friday that a heavy dose of tax cuts, deregulation and free-market economics would reignite her country’s growth — a radical shift in policy that unnerved global investors already rattled by an energy crisis, surging inflation and the specter of widespread recessions.

The British announcement came as markets around the world have been tumbling for weeks in response to higher interest rates and recession fears. The slide continued on Friday with the S&P 500 index falling close to its lowest point of the year and markets across Europe tumbling.

The move by Ms. Truss’s government indicated a sharp break with the previous prime minister, Boris Johnson, and with a generation of more fiscally minded Conservative governments.

For Ms. Truss, the measures — which critics liken to the “trickle-down economics” of the 1980s — amounted to a breathtaking bet that Britain’s economy would return to robust growth before she faces voters in two years. But the tax cuts, on top of extensive state intervention to cap soaring household energy bills tied to Russia’s war in Ukraine, are likely to require tens of billions of pounds of new government borrowing, deepening anxiety about Britain’s public finances.

British stocks and bonds and the pound all plummeted after the announcement, with the currency falling to fresh lows against the dollar, levels not seen in nearly four decades. The jitters spread to the United States and Europe, where stocks fell sharply amid fears that more aggressive increases in interest rates would be needed to quell inflation and that economies could slide into painful recessions this winter.

These fears are even more acute in Britain, where economic growth has ground to a halt, inflation is running at its fastest pace since the early 1980s, and the Bank of England has already raised rates seven times to curb surging prices.

Against that fraught backdrop, the new chancellor of the Exchequer, Kwasi Kwarteng, abandoned a proposed rise in corporate taxation and, in a surprise move, also abolished the top rate of 45 percent of income tax applied to those earning more than 150,000 pounds, or about $164,000, a year. He also cut the basic rate for lower earners and cut taxes on house purchases.

“We will focus on growth, even when that means taking difficult decisions,” Mr. Kwarteng told a packed House of Commons. He acknowledged that “none of this is going to happen overnight,” but said that the focus on tax cuts “is how we will turn this vicious cycle of stagnation into a virtuous cycle of growth.”

Credit…Jessica Taylor/UK Parliament, via Associated Press

It is hard to overstate the magnitude of the policy shift from Mr. Johnson’s government, which just one year ago had announced targeted tax increases to offset its increased public spending because of the pandemic.

While Ms. Truss had run for Conservative Party leader as a tax cutter, the breadth of the cuts announced Friday surprised the markets. They will cost £45 billion, or about $49 billion, over the next five years — the largest tax cuts compared with any budget since 1972, according to the Institute for Fiscal Studies, a London-based think tank.

The government contends that reducing taxes will encourage more investment and that the benefits will flow through the economy. But the risk is that the measures are insufficient to reverse years of lackluster productivity and business investment.

The tax cuts follow promises already made to shield households and businesses from the soaring cost of energy, which have tempered both the projected increases in inflation and the expected decline in economic growth. But together, they will mean more government borrowing, and one of the biggest dangers is that investors will be dubious that the government’s new policy will work. That could push the cost of borrowing to painful highs and make the debt levels unsustainable.

Those fears led to the steep sell-off of British assets on Friday. Some analysts said the risk that the pound and the dollar could soon reach parity had increased, reflecting both the pound’s tumble and the dollar’s role as a refuge during global economic storms.

Beyond fears of unsustainable government borrowing, critics said Britain’s fiscal and monetary policies were dangerously at cross-purposes.

The Bank of England is trying to quell inflation by using one of the few tools it has: interest rate increases that dampen economic activity. Yet the government is trying to fire up the economy, for example by stoking the housing market and by widely cutting taxes, a combination that could fuel higher inflation.

On Thursday, a former deputy governor of the Bank of England, John Gieve, told the BBC that the central bank and the government were “pulling in different directions.”

The chancellor’s statement in Parliament on Friday underscored the free-market, small-state, tax-cutting instincts of Ms. Truss, who has modeled herself on Margaret Thatcher, who was prime minister from 1979 to 1990. Thatcher’s economic revolution in the 1980s turned the economy around, although at a high cost for many, with rising unemployment and labor unrest.

Some dispute the comparison to Thatcher. The plans announced on Friday mean a large increase in government borrowing at a time of rising interest rates, and so far there has been no indication of corresponding spending cuts. While Thatcher was a committed tax cutter, she believed in balancing the books first.

Credit…Frank Augstein/Associated Press

Ms. Truss’s tax cuts, which disproportionately favor high-wage-earners, have instead drawn comparisons to the tax policies of Ronald Reagan, the U.S. president who argued that tax benefits for companies and the wealthy would benefit those with lower incomes.

Nonetheless, Mr. Kwarteng’s plans — and the ideology behind them — will probably set the framework for the campaigning before the next general election, which must be held by January 2025.

Ms. Truss will be hoping that, during the intervening two years, policies that she says are “unashamedly pro-growth” can engineer at least the start of a solid economic recovery, allowing her to appeal to voters to stick with the Conservatives — rather than risk switching to the opposition Labour Party.

By describing his announcement as a “fiscal event” rather than a budget, Mr. Kwarteng avoided the need for a government watchdog’s in-depth assessment of the economic and fiscal impact of his plans.

On Friday, the government gave the first glimpse of how much the caps on energy bills might cost, estimating that the price tag would be £60 billion in the first six months alone. Mr. Kwarteng also gave estimates of how much the tax cuts would cost.

Even as Mr. Kwarteng took questions from his fellow lawmakers in Parliament, British assets began tumbling in financial markets. He responded to that news by saying, “The markets react as they will, but the growth plan will very soon show we are on the right course and we are steering us to a more prosperous future.”

The pound has weakened against most major currencies this year, but those losses intensified on Friday. The pound fell more than 2 percent against the euro and dropped 3.5 percent against the U.S. dollar, to below $1.09. The FTSE 100, Britain’s benchmark stock index, lost about 2 percent.

The yield on government bonds, a measure of borrowing costs, jumped higher as investors digested the tax cuts and the policies that will require £72 billion more in bond sales than previously forecast.

Ms. Truss’s government now says that igniting growth by lowering taxes and cutting regulation is its central mission, even if that means courting unpopularity; it will also, for example, lift the cap on the bonuses that can be offered to bankers.

Scotland’s first minister, Nicola Sturgeon, said on Twitter that the announcement would send “the superwealthy laughing all the way to the actual bank” while increasing the number of people relying on food banks, which help those unable to pay for essentials.

Mr. Kwarteng also outlined plans to create “investment zones,” with liberalized planning rules, where targeted and time-limited tax cuts will be offered to encourage construction of shopping malls, restaurants, apartments and offices.

Mr. Kwarteng also said that he aimed to speed up infrastructure projects, including new roads and railways, by reducing the burden of environmental assessments required before work can begin.

Rachel Reeves, who speaks for the opposition Labour Party on economic issues, described the announcement as “a budget without figures, a menu without prices” and “an admission of 12 years of economic failures” from a Conservative Party that has been in power since 2010.

Credit…Neil Hall/EPA, via Shutterstock