LONDON — Britain’s Chancellor of the Exchequer, Kwasi Kwarteng, on Monday abandoned a plan to cut the top 45% tax rate after turmoil in the country’s financial markets, intervention by the Bank of England and threats of a full-scale rebellion by Conservative Party lawmakers .
The turnaround is a major setback for new Prime Minister Liz Truss, who based her leadership on a major overhaul of the UK economy. The government, which only defended the measure announced late last month on Sunday, collapsed under pressure from international investors, who balked at the extent of the unfunded tax cuts, and Conservative Party lawmakers, shocked by polls showing that they would be almost wiped out in the next general election.
The pound edged higher after the announcement and is trading around the same levels as before the original plan rocked markets. The pound is up 0.3% against the dollar, buying $1.12 in early Monday trade. Borrowing costs in the UK fell for the most part, with the 10-year gilt yield falling 0.16 percentage point to 3.99%.
“I know that the plan, which was presented just 10 days ago, caused a bit of turbulence. I understand,” Kwasi Kwarteng, the chief of the UK Treasury, told members of his Conservative Party who met at an annual conference on Monday. He said he hoped scrapping the 45% rate cut would allow people to focus on the rest of the government’s pro-growth message.
He also tried to calm the financial markets: “Without fiscal responsibility, there is no path to higher sustainable growth.”
British Prime Minister Liz Truss attends the opening day of the annual Conservative Party Conference in Birmingham, England.
Photo: Oli Schalf/Agence France-Presse/Getty Images
The plan to cut the top income tax rate to 40% was part of a much larger stimulus announced Sept. 23 that linked large subsidies to help homeowners and businesses deal with rising energy bills, along with the biggest tax cuts on record Generation, a debt-funded package that caused alarm among investors.
The plan led to days of turmoil in UK financial markets, with the pound collapsing, the UK government’s borrowing costs skyrocketing and the BOE embarking on an emergency government bond-buying program to try to calm markets.
The most controversial part of the plan was the move to lower the top income tax rate for the wealthy at a time when high inflation is eroding real wages and a recession is looming.
Conservative Party lawmakers had lined up to criticize the elimination of the tax, which would make the wealthier wealthier, as many people face real wage cuts due to higher inflation. On Sunday, Michael Gove, a former senior cabinet minister, said it was morally wrong. The growing list of rebels meant the government would likely have struggled to get the biggest tax cut through Parliament.
The change will cost just £2bn, according to the Institute for Fiscal Studies, an independent think tank. It was estimated that the UK government would need a further £72.4bn in debt this fiscal year.
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This is “a rounding error in the context of public finances,” said Paul Johnson, director of the IFS. “The chancellor still has a lot to do if he wants to make a credible commitment to fiscal sustainability.”
Still, the move to reverse the tax cut was welcomed by some investors as an important signal that the government was responding to market concerns about the plan’s impact on inflation and debt at a time of rising interest rates and financial uncertainty.
“This is a first step in restoring the credibility that was lost after the financial report,” said Cathal Kennedy, UK economist at RBC Capital Markets.
Government officials said Monday they intend to push ahead with other measures announced in the mini-budget, including a cut in the lowest rate of personal income tax, which economists estimated would cost much more than removing the highest rate of foregone income. Other controversial measures remain in place, including removing a cap on bankers’ bonuses imposed after the 2009 financial crisis.
The International Monetary Fund rarely blamed the original plan, saying it risks further fueling inflation, which the BOE sees at 11% later this year. On Friday, the rating agency S&P downgraded its outlook for the UK government debt to negative, citing risks to the country’s economy.
Political analysts said the Truss government is likely to bow to political realities as much as economic realities.
“This move is more symbolic as it’s less about the amount of money being saved and more about the faint signal it sent for ideological tax cuts,” said Chris Turner, an analyst at ING Bank. “The move appears to have been driven by backlash from her own party and possibly the threat of a sovereign rating downgrade.”
The top tax cut threatened to completely overshadow the Conservative Party Conference currently taking place in Birmingham. The conference, normally a three-day show of devotion to the party leader, is instead turning into a more somber event as the Tories prepare for a difficult few years ahead of a 2024 election.
A series of opinion polls following the plan indicated a large loss of support for the Conservative Party among voters as it neared the gathering.
At the conference, Chris Philp, a senior finance minister, said he expected the party to support the rest of the tax cut package, arguing that the UK government has a strong balance sheet. “We think it’s the right plans because ultimately it’s those plans that make our economy competitive,” he said.
Monday’s announcement is the latest step to contain the fallout from the budget. Last week, after being pressured by the BOE, the government announced that the Office for Budget Fiscal Responsibility, an independent regulator of public finances, would lay out the total cost of the package in November and whether it would reduce annual economic growth 2.5% would generate government promises. The government had resisted the watchdog evaluating the plan.
Mr Kwarteng also pledged on Monday that no new tax cuts would come. Both steps were also welcomed by investors. “It’s quite a shift,” said Chris Jeffery, head of interest rates and inflation at Legal & General Investment Management.
The government said it would outline further steps to pay for November’s tax cuts, including likely spending restraints such as raising unemployment benefits below inflation. In the meantime, the government is hoping to win over doubters with a bang of new announcements of regulatory reforms to make everything from agriculture to childcare more competitive.
Concerns about the impact of tax cuts on government bonds helped push government bond yields higher early last week. On Wednesday, the BOE stepped in to halt the rise and risk serious damage to some pension funds, announcing it would buy up to £65 billion worth of government bonds in a series of daily auctions.
When bank intervention ends in mid-October, yields could rise again, but not as quickly as in recent days, said Orla Garvey, fixed income portfolio manager at Federated Hermes.
The decision to scrap the plan appears to have been made late Sunday or early Monday. On Sunday, the Conservative Party pre-released a snippet of Mr Kwarteng’s planned speech at the party conference, indicating there was no planned U-turn. “We’re staying the course,” it had said.
A copy of the Conservative Party conference program with a picture of British Prime Minister Liz Truss.
Photo: Oli Schalf/Agence France-Presse/Getty Images
write to Paul Hannon at [email protected], Max Colchester at [email protected], and Anna Hirtenstein at [email protected]
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