The difference between the Tory candidates’ tax plans? One is bad, the other is really bad | Larry Elliott

Rishi Sunak is losing the battle to be Britain’s next prime minister and he knows it. The former chancellor’s announcement that he would scrap VAT on energy bills for a year is exactly what it looks like: a U-turn born of desperation.

Having set himself up as the candidate of sober rectitude, Sunak has bowed to the inevitable as opinion polls show Liz Truss’s plan for immediate tax cuts are proving more attractive to Conservative party members than his wait-and-see approach.

Let’s be clear. Judging by their campaigns so far, neither Sunak nor Truss have the first idea of what to do about the UK’s deep-seated economic problems. But Truss – more by luck than judgment perhaps – is on to something when she says Sunak’s previous tax decisions are making a bad situation worse.

Some economists think Britain is already in recession, others that the country is still teetering on the brink. One thing is certain: the decision by Gazprom to restrict supplies of gas to Europe through the Nord Stream 1 pipeline has amplified that threat. The International Monetary Fund (IMF) said this week that a sudden stop to Russian energy was one of the things that could turn a marked slowdown in the global economy into something a lot more serious. That recession risk seems to be materialising, and although Britain is not dependent on Russian gas it will still be affected by surging global gas prices.

It now looks as though the energy price cap will increase from just under £2,000 a year to at least £3,300 a year – and perhaps even higher – in October, pushing the annual inflation rate well into double figures. The IMF already expects the UK economy to have stalled by the end of this year and to be the slowest growing of the G7 group of major industrial nations in 2023.

Higher inflation is bound to trigger a response from the Bank of England. Interest rates have been raised at the last five meetings of the Bank’s monetary policy committee (MPC) and official borrowing costs will go up again next week. Up until now the MPC has preferred cautious 0.25 percentage point increases but there is every chance of a 0.5-point jump this time. The chances of overkill are high because the Bank will continue tightening policy until it is sure higher prices are not feeding through into higher pay deals and inflation is heading back towards its 2% target.

Meanwhile, the Treasury’s obsession with balancing the books means it too is bearing down on growth. National insurance contributions (NIC) went up in April, income tax thresholds are being frozen for three years and corporation tax will be raised from 19% to 25% next year. As a share of the economy, taxes this year will be at their highest since 1950-1.

The risk here is obvious. If the Bank of England is sucking spending power out of the economy through higher interest rates at the same time as the Treasury is doing the same through higher taxes, then the chances of recession increase, especially when the economy is already weakening.

Sunak has put forward two reasons to justify his tax increases. The first is that the high levels of debt and borrowing mean the UK has maxed out on its credit card. This, though, suggests that there is no difference between the finances of a household and the finances of the state, when that is not the case. States that can print their own currency do not go bust. There is no such thing as the nation’s credit card and it makes sense for the government to spend more when the rest of the economy is weak.

The second argument is that Truss’s proposed tax cuts – the reversal of the NIC increase and the scrapping of the proposed corporation tax rise – would lead to even greater inflationary pressure and hence significantly higher interest rates from the Bank of England.

This doesn’t really stand up to serious scrutiny either. Truss’s £30bn package is relatively small beer in the context of a £2tn-plus economy, and more than half the cost would come from not going ahead with the corporation tax increase. The boost to consumer spending potential would be modest and even under Prime Minister Truss taxes would still be at a 70-year high. Interest rates may be a bit higher than they would otherwise be.

A better critique of the Truss tax plan is that it does very little for the people who are being hit hardest by spiralling energy costs. As the Resolution Foundation has pointed out, only 15% of the benefits of reversing the NICs increase would go to the poorer half of the population against 28% going to the richest 20%. The average boost to incomes in London would be more than double that in the north-east of England or Wales.

Clearly, there is no way in which their proposed tax cuts – whether now or later – are a solution to a worsening cost of living crisis and more help is going to be needed to help households through the winter. It would make more sense to target support at those who need it most through the benefits system rather than provide tax cuts that favour the better off.

That, though, is not the choice being presented to those handed the task of picking Boris Johnson’s successor. They are being given the choice between Truss’s bad plan and Sunak’s really bad plan. As things stand, they look like opting for the former.

The Guardian