Long Thatcherism

The British economy is suffering from a chronic illness caused by an ideological virus that has long been infecting the minds of politicians and policy makers: Thatcherism. When Thatcher first came to power in 1979, she reduced the top rate of income tax from 83% to 63% with the basic rate falling from 33% to just 30%—a considerably less generous concession for lower earners. Simultaneously, in order to make up for the shortfall in income tax revenue, she more than doubled VAT, an indirect tax on consumption that disproportionately impacts lower earners, from 8% to 15%.

By 1988, that top rate of income tax was cut to just 40% and hasn’t moved much since then, with the rate for earnings over £150,000 now at just 45%. The premise for these tax cuts was the bogus ‘Laffer Curve’. The Laffer Curve assumes that higher earners are paid more due to their being ‘more productive’, and, as such, that taxing them at a higher rate hinders their productivity. By this logic, lower taxes on the wealthy would lead to improved productivity, higher economic output, and higher tax revenues overall—a  myth that has long since be disproven.

Another core aspect of the Thatcher project was monetarism—the idea that inflation could be controlled by using interest rates to influence the supply of money. The reasoning behind the theory was that higher interest rates ‘incentivise saving’ and reduce spending, meaning lower demand in the economy. Less demand for goods means less demand for labour to make those goods, and so unemployment rises, meaning workers have less power to negotiate for higher wages with employers. Lower wage costs, in theory, mean employers don’t need to keep putting up prices.

As long as the government kept accommodating a ‘lower than natural’ rate of unemployment with loose monetary and fiscal policy, the monetarists argued, workers would continue to expect wage increases. The only way to break this cycle was to let unemployment reach its ‘natural’ rate by putting up interest rates. As such, in a misguided attempt to lower inflation, Thatcher put interest rates up to 17%. The rate hike caused unemployment to more than double, causing misery for millions—yet inflation remained persistent for years.

The simplistic reasoning of the ‘rational expectations’ theory completely overlooked the role of volatile exchange rates from the breakdown of the Bretton Woods system, rising energy prices from the OPEC oil embargo, and price-gouging from monopolistic corporations in contributing to inflation. Yet it is this same simplistic reasoning driving the debate today.

Irrational Expectations

The economic guru behind Truss’ proposed tax cuts is former economic advisor to Thatcher and academic Patrick Minford, whose career has focused the rational expectations model of macroeconomics. Minford is a believer in ‘supply side reform’, which means slashing regulations and taxes, leaving the ‘free market’ to efficiently allocate resources. Far from this being a change of pace from recent policy, it is a continuation of what has been Conservative orthodoxy for most of the past decade.

Since the Conservatives came to government in 2010, the rate of corporation tax has fallen from 28% to below 20%. Investment in the UK has increased, but this has predominantly been in financial markets, while growth in investment for productive assets remains significantly below 2008 levels. While GDP has increased sluggishly, inequality has grown at a faster pace. Pay growth for top earners has risen by over 2%, whereas for median earners pay growth has stagnated and has fallen by over 3% for the bottom decile of the income distribution. Public sector pay has been particularly hard hit, with nurses, doctors, teachers, and civil servants experiencing a real-terms pay cut of 7% or more over the past decade.

The squeezing of middle and low wage earners has coincided with soaring corporate profits in the UK, which have increased by 34% since the onset of the Covid-19 pandemic. According to the IPPR 90% of those increases have been made by the top 25 multinationals—indicating monopoly, not free markets. Despite rising profits, corporation tax fell from 8.5% of total tax revenues to 8.3% between 2016 and 2020. During this same period, income tax, NIC, and VAT collectively increased by a 0.3%. Further evidence of the shifting tax burden can be found in the 2022 House of Commons Tax Statistics Overview: the report shows that since 2000 corporation tax as a percentage of GDP has fallen from 3.3% to 2.8%, whereas income tax has risen from 9.2% to 9.6%.

Taxes on work, jobs, and consumption have been creeping higher while wages stagnate. At the same time, taxes on corporations have been falling as corporate profits soar. There has been little to no discussion throughout the leadership contest regarding this trend—yet this is where the real question lies. As we enter an era where global forces make prospects for economic growth increasingly bleak, the focus of policymakers should not be about when to have tax cuts. Instead, the debate should be around building a fairer tax system, with a focus on the redistribution of wealth.

The Case for Redistribution

One apparent difference between Sunak and Truss is that Sunak has pledged to cut income tax if inflation falls, but maintain the increase in corporation tax. At first glance, this might seem progressive—but Sunak is also making it easier for businesses to reduce their tax liabilities by extending the higher rate of capital allowances deductions, despite evidence of its rampant abuse for tax avoidance. Furthermore, the 25% uplift in corporation tax coming in 2023 is still low by historical and contemporary standards. Even under Thatcher corporation tax at its lowest was 34%, and at 25% the UK would still have one of the lowest corporation tax rates in the G20. Contrary to Conservative economic orthodoxy, many of the countries with higher corporation tax rates than the UK have higher growth.

Sunak’s aversion to lowering income taxes with inflation still high demonstrates the true intention behind them—to reduce inflation and protect investment by supressing wages. But whose savings and investments is Sunak protecting? It is estimated that the bottom 80% of UK households have £500 or less in the bank, whereas according to a report by the Resolution Foundation the richest 10% have increased their wealth relative to the bottom 50% by £300,000 to £1.2 million per adult on average. A lot of this wealth increase has been driven by asset inflation—but a discussion about reforming the UK’s outdated system of property taxation remains absent from the leadership contest.

Truss has said she would reduce the increase in NIC brought in under Sunak, which has already been largely offset by the increased NIC threshold. However, she has made no mention unfreezing the income tax thresholds and increasing them in line with inflation, which the IFS now estimates will bring in an additional £21 billion in revenue. Truss claims she wants to get people ‘back to work’ and that higher NIC is a tax on jobs, but this overlooks the fact that unemployment is already below 4%. According to ONS data two thirds of those not working are doing so because of long-term illness, impacted in part by record high NHS waiting lists.

Furthermore, pushing for lower unemployment is inconsistent with her advocacy for higher interest rates, which Minford says could reach 7%. Raising interest rates will increase unemployment and there isn’t evidence that cutting corporation tax will mitigate this by ‘boosting productivity’ with more investment and jobs creation. Instead, the tax cuts will continue to go towards share buy-backs and dividends, while higher interest rates benefit the wealthy with savings—further exacerbating wealth inequality. Even if the prospective prime ministers were successful in their tax cutting quest to improve productivity this would do little to help wage earners. Research from the LSE has shown that since 1981 wages have decoupled from productivity growth.

We Need Higher Wages

As RMT General Secretary Mick Lynch eruditely pointed out on a recent BBC interview, there is little point in reducing the rate of corporation tax—because the whole point of a corporation tax is to give allowances and tax credits to business to reduce their chargeable profits. He also pointed out that although taxes and public spending are at an all-time high, this isn’t being reflected in better public services—in fact, services are getting worse and more expensive.

Worsening public services are in no small part due to Thatcherite ideologues who have been gradually privatising more and more public sector assets. Contrary to their belief that privatisation will create competition, it often ends up with huge monopolies dominating industries. In the UK rail industry, 90% of all assets are owned by three companies. These rolling stock companies are taking millions of pounds out of the rail industry and shifting it to tax havens to service debt to corporate bond holders like investment banks. Squeezed wages for rail workers and exorbitant prices for customers mean better returns for investors. And despite increased revenues, corporation tax for these companies has fallen from £80 million to £53 million per annum.

The solution to addressing the cost of living crisis and fixing our broken economy is a recalibration of the tax system and higher wages, to place a lesser burden on workers and claw back some of the wealth accumulated by those at the top and profiteering multi-national corporations. Robust profit margins make it clear that wage costs are not driving prices up. As such, wage increases in line with or above inflation would represent a redistribution from wealth holders and corporations to wage earners. Stronger rights for workers and a reversal of Thatcher’s anti-trade union policies are needed to facilitate that—but the chances of this becoming a topic for discussion in the Tory leadership contest are unlikely, to say the least.