The pound in crisis: firefighting or strategic planning?

  • September 26, 2022
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UK citizens awoke to dramatic news on this morning as headlines declared that the pound had slumped to an all-time low against the dollar.

UK citizens awoke to dramatic news on this morning as headlines declared that the pound had slumped to an all-time low against the dollar.

The media and political debate links this decline to Chancellor Kwasi Kwarteng’s recent mini-budget which commenced a shift towards redefining England, Wales, and Northern Ireland as low-taxation economies. Nevertheless, the mini-budget is only part of the story.

John R. Bryson – Professor of Enterprise and Economic Geography, University of Birmingham explains that the slump in the pound is also linked to the energy crisis and the UK having the highest inflation amongst G7 nations. The Ukrainian war has triggered a broader European economic crisis and the UK is the most vulnerable European economy. The decline in the pound relative to the US dollar is linked to a string of recent weak economic data from the UK with the Bank of England forecasting recession.

During times of uncertainty investment tends to flow to the US. Currently, the US is a safer investment haven compared to the UK or even the European Union or China. Part of the problem facing the pound was the decision made to increase UK interest rates last Thursday by half a percentage point to 2.25% rather than by three-quarters. This was the wrong decision, and it is likely that the Bank will have to raise rates rapidly and before the next planned meeting. Such a move will look more like firefighting than strategic economic planning.

The mini-budget is very much of a distraction to what are much broader problems facing the UK economy. However, the media and political debate on this budget must move beyond a discussion of the UK to consider taxation as an exercise in applied geopolitics.

Taxation is inherently a geographical issue in all nations involved in global flows of people, money, goods, services, and information. The mini-budget has produced a taxation geographical anomaly within the UK. From April 2023 Scotland will experience problems with the new 40% tax rate as this will be well below Scotland’s 46% top-rate. Individuals paying at the higher rate might now be tempted to relocate across the border to England whilst continuing to work in Scotland.

A country’s top-rate of personal taxation must attract and retain highly skilled individuals. It is these individuals that create jobs elsewhere in the economy and some of these high earners are highly mobile. This mobility alters over the life course as individuals become more geographically embedded and are reluctant to move.

Geography really matters as soon as the discussion shifts to corporate taxation. The removal of the bonus cap has resulted in a critical reaction from politicians and journalists. However, currently salaries in UK financial services are inflated to attract skilled workers who have the option of working in the US, Singapore, or the UK. Removing the bonus cap will result in a reduction in the base salary for financial service employees and will also reduce the fixed-cost base of financial service firms. Bonuses are performance-related and discretionary. All this means that the UK will attract more high performing financial service employees.

There was another surprising headline over the weekend. On 24 September 2022, Ireland doubled it forecasted budget surplus for 2022 to 0.9% of gross domestic product (GDP). Can you imagine the UK having a budget surplus? Why does Ireland have a budget surplus? The answer is remarkably simple. The Irish government appreciates that low Corporate Tax Rates attract foreign direct investment and encourage firms to book profits in Ireland rather than elsewhere. Ireland’s surplus could be 4.4 billion Euros this year, and this is up from the July forecast which placed the surplus at only 0.5% of GDP. This increase comes from enhanced corporate tax revenues. Ireland’s corporate taxation has surged in recent years as a direct response to the country’s policy to set a low corporate tax rate.

Ireland’s Corporate Tax Rate is set at 12.5% whilst the rate is 26.5% in France, 30% in Germany and 17% in Singapore. Currently, the UK rate is 19% and this was going to increase to 25% in April 2023. The mini-budget cancels this UK-wide increase. The agreed increase to 25% would have worked against the UK economy as businesses would have shifted some of their earnings to lower-taxed economies like Ireland. The planned rate of 25% would have meant that the UK joined a group of countries with some of the highest rates.

Decisions over tax rates create and destroy jobs. Economic growth requires corporate investment. Businesses require a tax system that incentivises investment and encourages job creation and not labour exploitation. It is time for the UK to appreciate that a country’s approach to taxation plays a critical role in economic growth. Thus, a tax system is not just about acquiring funding to support public service provision, but it must also encourage wealth creating activities that underpin national economic growth. All this means that decisions regarding taxation must be made with reference to the tax strategies of competitor countries and be balanced against initiatives intended to encourage investment in innovation and wealth creating activities.

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The pound in crisis: firefighting or strategic planning?