Tax U-turn leaves UK’s Truss with credibility gap

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British Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng attend the annual Conservative Party conference, in Birmingham, Britain, October 2, 2022. REUTERS/Hannah McKay

LONDON, Oct 3 (Reuters Breakingviews) - The UK government has “listened” to financial markets. Prime Minister Liz Truss on Monday scrapped the most controversial proposal of her so-called growth plan: the abolishment of the 45% tax rate on higher incomes. But it will take more than a partial U-turn to regain the trust of global investors.

The flip-flop by Truss and Chancellor Kwasi Kwarteng is welcome. The “mini-budget” announced on Sept. 23 caused UK 10-year government bond yields to soar as high as 4.6%, and forced the Bank of England to announce a 65 billion pound bond-buying plan to rescue the country’s pension funds. The higher rate tax cut was toxic even among Truss’ Conservative parliamentarians.

Despite the U-turn, investors still have reasons to worry about the government’s fiscal policies, set to more than double borrowing to nearly 4% of GDP by 2027, according to the Institute for Fiscal Studies. Keeping the 45% tax rate will save the government some 6 billion pounds a year – or 0.3% of GDP. But two other worrying measures remain on Truss’ agenda: the cancellation of a planned raise in social security contributions, and of an increase in the corporation tax rate. Together these alone will cost the UK Treasury more than 31 billion pounds a year, according to the IFS. That comes on top of the government’s energy price cap, which will cost 60 billion pounds over six months.

So far, the government has yet to outline how it will fund these tax giveaways, other than vague hints of further spending cuts, and faster growth. So investors will keep worrying – even if Truss embarks on a policy of destructive austerity, which will hammer growth and create political instability.

In the longer term, trust in Truss’ government, and resilience of British institutions, may have been weakened. Announcing a massive stimulus plan in a time of full employment, raging inflation and an 8% current account deficit was always likely to backfire. The government’s decision to push ahead without the scrutiny of Britain’s fiscal watchdog, the Office for Budget Responsibility, also sets a bad precedent.

After Kwarteng announced his flip-flop, yields on the government’s 10-year gilts fell briefly, but were still some 0.5 percentage points higher than Sept. 22, the day before the mini-budget announcement. And the pound is still down nearly 3% against the dollar since Prime Minister Truss took over on Sept. 6. For both Truss and Kwarteng, the road to economic credibility will be long and arduous.

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(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

CONTEXT NEWS

UK Chancellor of the Exchequer Kwasi Kwarteng said on Oct. 3 that the government would cancel plans to abolish the country’s 45% marginal income tax rate, hours after Prime Minister Liz Truss had gone on the radio to defend the policy.

“I'm announcing we are not proceeding with the abolition of the 45 pence tax rate. We get it, and we have listened,” Kwarteng said in a release, saying that the measure had become “a distraction.”

UK markets went into a tailspin last week after the government detailed plans to cut taxes on Sept. 23, forcing the Bank of England to announce a 65 billion pound bond-buying programme designed to cap soaring government bond yields.

UK 10-year government bond yields slid briefly below 4% on Oct. 3, down 15 basis points from Sept. 30, before rising again to 4.08% as of 0930 GMT.

The pound was up 0.1% against the dollar.

Editing by Neil Unmack, Oliver Taslic and Streisand Neto

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