Monica Prasad is a professor of sociology and faculty fellow at the Institute for Policy Research at Northwestern University. She is the author of Starving the Beast: Ronald Reagan and the Tax Cut Revolution.
Behind the implosion of British Prime Minister Liz Truss lurks a question. If her insistence on huge tax cuts doomed her, does that mean the era of the tax cut zombie is finally coming to an end?
For years now, it has been clear that there’s no strong evidence that tax cuts fuel economic growth. But Republican politicians in the United States kept trying it anyway — it was the idea that wouldn’t die. One economist even wrote a book on the matter called “Zombie Economics.”
Liz Truss and her first Chancellor of the Exchequer, Kwasi Kwarteng, embraced the tax cut ideology and advertised it over the summer during the campaign for the leadership contest in the Tory Party. They won — so far so good — and they implemented the policy they had campaigned on. Almost immediately, the British economy was hammered with high interest rates and a plunge in the value of the pound. Truss’ poll numbers nosedived, and she quickly backed down. But this only made those who had voted for her wonder why they should still support her. She lost everyone’s confidence, and the end was clear.
What does this head-spinning series of events mean for American would-be tax cutters? Republican politicians ignore economists who argue against tax cuts, because it’s a policy that no one in the Republican coalition objects to. Even low-income Republican voters who don’t stand to gain much from tax cuts like tax cuts, which helped make George W. Bush the president whose policies most closely matched what the American public, even the poor, wanted. Cutting taxes was also the signature domestic economic accomplishment of the Donald Trump presidency.
At the same time, the British debacle comes at a time when the American right has been edging slowly away from free market orthodoxy. The GOP is embracing a more populist edge and is eager to be seen as a working-class party, criticizing trade and “woke” businesses.
Does Truss’ fate show that big tax cuts, particularly for the rich, just aren’t a credible option anymore? Have the markets finally wised up to what economists have been saying? Would the next American politician proposing big tax cuts meet Truss’ fate?
Truss cut taxes at a time when interest rates are edging higher, fueling worry among investors. When Trump cut taxes, interest rates were lower. On the other hand, interest rates were at similar levels under George W. Bush, and they were significantly higher when Ronald Reagan was cutting taxes, suggesting that something else is going on.
The ways of financial markets are inscrutable, even to the people who constitute those markets, but there do seem to be big differences between Britain and the U.S. that suggest the United States may not face a similar crisis the next time its government proposes big tax cuts.
One factor is that the U.K. — even under Margaret Thatcher — did not actually manage to cut taxes the way previous conservative U.S. presidents did. Thatcher is Truss’ idol. When she was 7 years old, Truss played Thatcher in her school’s mock election. During this summer’s campaign for the leadership, Truss adopted Thatcher’s blouses with bow ties and repeatedly proclaimed her Thatcherite credentials.
But when Thatcher took office in 1979, taxes in the U.K. were about 30 percent of GDP, and when she left office in 1992 they were about 30 percent of GDP; Thatcher had actually raised taxes considerably in her first term, only bringing them back down later. In fact, the argument that tax cuts would automatically bring economic growth had not gained much credibility in the U.K. at the time, as Thatcher’s Chancellor Geoffrey Howe later noted: “My Treasury team and I had never succumbed — never seriously anyway — to the mistaken interpretations of Lafferism, which have led some U.S. policymakers so far astray.” Supply-side economics was never a big part of Thatcher’s economic policies, which were about privatization and council house sales instead. Truss’ attempts to pass off her tax cut folly as Thatcherism show not only that Truss did not understand economics, but also that she did not understand Thatcherism.
The other difference between the U.S. and the U.K. is that the U.S. may simply be more able to finance its large debt — or at least has been so far. Until the 2008 financial crisis, general government debt stood at around 100 percent of GDP in the U.S., but only 50 percent of GDP in the U.K. After that period, debt rose in both countries, but was still considerably higher in the U.S. than the U.K. Only in the last few years, since the pandemic, has the U.K. started to close the gap, with general government debt around 150 percent of GDP in both countries. It took decades of experimentation and repeated incremental increases in the deficit and the debt to bring the U.S. to a point where investors are calm about these numbers.
American officials are nervously examining whether the U.S. could face its own turmoil after the U.K. calamity, and no one knows what will happen next. But examining the recent past suggests one reason markets reacted so badly to Truss’ policy is that investors have not gotten used to the idea that the U.K. is now a country with permanently high debt, just like the U.S.
John Maynard Keynes taught us that deficits and debts are not necessarily bad. In America, both the left and the right have rediscovered this, at different times and in their own ways. In the 1980s, the extreme right in the U.S. argued that deficits don’t matter if the economy is growing faster than the cost of servicing the resultant debts — and they thought tax cuts would cause the economy to grow very fast. Ironically, the extreme left, in embracing “modern monetary theory,” now argues the same thing — that as long as we use borrowed money in ways that make the economy grow faster, we can finance the cost and not worry about borrowing too much. Of course, they identify different policies for making the economy grow, but the resultant casualness about deficits and debt is the same. Neither the British right, nor the British left, has fully gone through these intellectual revolutions.
There are some fundamental reasons for this divergence between the two countries, including the different role that the United States plays in the world economy, but the bottom line is that the U.S. has been able to maintain high debt for decades without frightening markets. This means that markets may not panic in the U.S. at the idea of incrementally higher deficits the next time an American president tries big tax cuts.
All this said, the tax cut zombie was on its last legs in the U.S. even before all this happened. The GOP’s turn toward Trumpism has the party far more focused on waging culture war or simply suppressing the vote. Republican politicians aren’t really running on tax cuts anymore, because taxes have been cut to such an extent, especially for the poor and the middle classes, that tax cuts just aren’t as popular. So even before Truss’ downfall, the tax cut zombie was already almost dead.
But of course, that’s what the protagonists in the movie always think.
