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In recent news that was shocking for most people around the world, Liz Truss was Britain's shortest serving prime minister. She handed in her resignation just 7 weeks after being in office. This followed after her policies led to a major government and economic crisis. One of the most important things Truss led her campaign with was proposing tax cuts as she believed was the right thing to do “morally and economically”. Truss’s plan was to lower taxes to keep the economy moving and increase government spending to help the general public with rising prices. Her ideology was most comparable to President Reagen’s idea of tax cuts. However, in the real world, tax cuts does not necessarily always lead to economic growth. The effect of tax cuts on economic growth truly depends on the state of economic markets.
The idea of lower taxes and increased government revenue leads back to the concept of the Laffer Curve. This concept may seem familiar to a few readers who are taking or have taken EC 101 at BU. Personally, I first learned about this graph from EC 101. The Laffer curve, a graph theorized by Arthur Laffer, suggests lowering tax rates might increase government revenue.
From the graph, it can be seen that tax revenue first increases when the tax rate is less than t*. However, tax revenue then decreases when the tax rate is greater than t*. The concept used for the Laffer Curve is quite straightforward: as tax rates increase, the incentive for people to work and invest decreases because eventually, they do not make as much money with the tax involved. However, there is no solid evidence of this theory being correct in the real world, therefore, we do not really know if this concept is applicable in economies around the world.
Unfortunately, Liz Truss’s policies on tax cuts only managed to cause further economic chaos in the UK. Britain was already facing a recession and increased costs of living and her policies only made the crisis worse. The proposed tax cuts brought down the value of the British Pound and increased the debt of the country. This was exactly what economists feared. When Truss announced her plan initially, critics were concerned that lowered tax rates would lead to an increase in borrowing.
With Truss’s resignation, the UK has a new prime minister, Rishi Sunak. His views on taxes were similar to Liz Truss. Sunak also wanted to cut income tax but not by an amount as large as Truss. Now, Sunak reportedly plans on increasing tax rates and cutting spending by 50 billion pounds to help the UK economy recover from this looming economic turmoil. Budget cuts are necessary for the economy and market to recover from costs of borrowing.
However, as the 2022 midterm elections approach in the United States, tax cuts no longer seem to be favored by the Republican Party. Perhaps, this is because taxes have already been lowered significantly or because of the current state of the UK economy post tax cuts.
Sources
Have Liz Truss’s 44 days in office destroyed 40 years of free market philosophy
Trump is giving Arthur Laffer the Presidential Medal of Freedom. Economists aren't smiling.
Biden: GOP tax cuts would cause ‘economic chaos’ like Truss in UK
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