Mark Flanagan, the chief of the International Monetary Fund [IMF] UK team, has warned that debt-financed tax cuts could be a strategic error which exacerbates inflation.
Flanagan’s warnings come as most candidates for the Conservative party leadership have been promising to bring the tax burden down for households.
This is in contrast to former chancellor Rishi Sunak, who has been talking up the importance of controlling inflation first.
Now, Flanagan has warned that debt-financed tax cuts would be a grave error and it may be better for the UK economy in the longer-term to increase taxes.
However, the candidates that have been advocating tax cuts have highlighted the cost-of-living crisis and the need to alleviate pressure on the public.
Some of the suggestions made by leadership hopefuls have included reducing the basic rates of income tax and slashing fuel duty, but Flanagan believes that this could make inflation worse.
One of the factor’s contributing to the situation in the UK is the country’s reliance on fossil fuels, with global forces making these a key driver of inflation at the present time.
On the contrary, Flanagan said that tax revenue being increased could see more money being put into the transition to a green economy, digitisation and upskilling, which could create long-term economic stimulus by creating jobs, driving efficiency and bolstering energy security.
Flanagan’s warnings come as the IMF forecast the UK to display the slowest economic growth and most intensive inflation in the G7 over 2023.
He said: “The UK does have a below-average tax ratio relative to the rest of the Organisation for Economic Co-operation and Development. You can't have it both ways.
“At some point you have to decide, do we want to invest in the climate transition? Do we want invest in digitalisation? Do we want to invest in skills for the public? Well, if you do, you need the resources to do it. And the way to realise those resources is to lift the tax ratio a little bit.”
On investment, Flanagan talked up the need to resolve the current discord over the Northern Ireland Protocol.
He said: “It's going to be hard to convince companies to invest a lot in incorporating the UK into their supply chains, while issues related to cross-border movement of goods and services remain unsettled.”
JP Morgan chief market strategist Karen Ward, a former adviser to ex-chancellor Philip Hammond during his time in office, suggested that a drop-off in UK business investment seen after the 2016 referendum on EU membership has never recovered.
Highlighting that UK business investment is now 10 per cent below the peak of 2015, Ward argued that this decline had directly led to stunted wage growth and a less efficient economy.
Nigel Wilson, the CEO of Legal & General, believes that underinvestment has been going on for much longer.
"I think [the UK] is full of potential but we've had massive underinvestment for 30, 40 or 50 years in skills, in infrastructure,” Wilson said.
“As a consequence we're a low wage, low productivity, low growth economy, fraught by political infighting.”
