Rishi Sunak Will Likely Disappoint Free Market Fans

Just 50 days after losing Liz Truss in a Conservative leadership election, Rishi Sunak is the UK Prime Minister anyway.

The Conservative Party originally rejected Sunak because of his tax policies as Chancellor of the Exchequer and his alleged role in the overthrow of former Prime Minister Boris Johnson. But after the financial turmoil that followed Truss’s “mini-budget” tax cut, Conservative MPs forced her out of office, paving the way for Sunak to jump into Downing Street.

In the hurried contest that followed, most conservative media outlets had rallied behind Sunak, given his perceived prescient warnings about the financial fallout from a Truss government. Johnson then decided not to stand and Penny Mordaunt, the only other declared candidate, stepped aside after struggling to reach the nomination threshold. Sunak was crowned unopposed on Monday in the most unlikely comeback.

Sunak had been appointed Chancellor by Johnson in February 2020 as a more pliable Treasury Secretary for Johnson and Dominic Cummings’ Downing Street. During the early stages of the pandemic, he became the most popular chancellor for 15 years, donating money to keep employees attached to closed companies through a massive “leave” program.

However, his relationship with the grassroots soured over the next two years. He first presented plans to raise the corporate tax rate from 19 percent to 25 percent to fund spending from the past pandemic. He then broke a manifesto promise not to raise personal taxes by raising British workers’ and employers’ social security taxes by 1.25 percent each. In addition to freezing income tax thresholds, the resulting tax burden would rise under him to its highest level in 70 years.

Sunak’s own resignation from the cabinet subsequently helped expedite Johnson’s eviction. The former chancellor had a polished video for his candidacy ready to go as soon as Boris left. Tory members smelled a planned knife, and as the leadership campaign developed, his unpopular tax policies became the central rift with Truss.

She pledged to waive Sunak’s corporate tax hike and reverse the social security tax hike. Without compensating for the cuts, Sunak argued that this would increase the UK government’s borrowing costs, which would lead to higher mortgage rates. Truss won the debate, but has since lost the argument.

Its ‘mini-budget’ delivered on its fiscal promises, but went much further than expected. She and her chancellor terrified the markets by also cutting two income tax rates and a number of smaller taxes and subsidizing a two-year freeze on household energy prices. Each had microeconomic justifications, but markets were confused by the size of additional loans and the uncertainty of their pass-through to interest rates. It didn’t help that the Truss administration refused to allow the Office for Budget Responsibility to prepare estimates of the impact of all this on deficits.

The pound became very volatile and British borrowing costs rose, as Sunak predicted, especially after Truss Chancellor Kwasi Kwarteng promised more tax cuts. Some pension funds exposed to bond yield risk nearly went bankrupt, necessitating emergency intervention from the Bank of England. Mortgage rates rose sharply. Conservative polls fell.

Truss made several fiscal commitments to restore market confidence as Tory MPs made it clear they would not tolerate major compensatory cuts. Bond yields became hooked on British political developments and fell whenever a fiscally conservative signal was given. Truss eventually withdrew completely, firing her chancellor and allowing his replacement, Jeremy Hunt, to give up almost all tax cuts except the reversal of Social Security, while committing to universal energy policy only until April. The party has once again embraced deficit reduction.

And so Sunak finds himself prime minister, who has made no policy promises at all in this more recent, short campaign. The new prime minister is a committed fiscal conservative and unafraid to raise taxes to achieve this. He regularly pays rhetorical tribute to free markets, but in the leadership campaign with Truss, he argued for producer-led trade policies and for the tightening of the UK’s already tough planning laws. Those hoping he will uphold Truss’ unrealized plans for supply-side deregulatory, non-tax policies will likely be disappointed.

Will the change of leader pay off politically? Tories will expect a boost, but Sunak is the kind of conservative that columnists who would never vote conservative say they respect. Will a super-wealthy jetsetter go down smoothly during a cost of living crisis he contributed to as chancellor? The jury is out.

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