U.K.’s Sweeping Tax Cuts Send Pound Tumbling, Yields Higher

0
8


LONDON—The British government unveiled the biggest tax cuts since the early 1970s in a bold bet to jolt the U.K.’s inflation-stricken economy into growth, prompting a slide in the pound and a jump in government bond yields.

In one of the largest shifts in British economic policy in decades, U.K. Chancellor of the Exchequer

Kwasi Kwarteng

said the government would cut payroll taxes, freeze corporation tax, ditch a cap on banker bonuses and spend billions to subsidize energy bills over the next two years.

Mr. Kwarteng, appointed by new Prime Minister

Liz Truss

after she took over from

Boris Johnson,

said the U.K. had become stuck in a vicious cycle whereby low growth produced less revenue that led to rising taxes to pay for public services, which in turn hurt growth further.

“This cycle of stagnation has led to the tax burden being forecast to reach the highest levels since the late 1940s,” said Mr. Kwarteng. “We are determined to break that cycle. We need a new approach for a new era focused on growth.”

The new measures, however, caused anxiety among investors about the sustainability of U.K. finances. “This is the biggest tax cutting event since 1972,” said Paul Johnson, the director of the Institute for Fiscal Studies, an economic think tank.

The pound, which had already fallen by nearly a fifth this year against the dollar, slid another 1.5% Friday to $1.110, hitting a fresh 37-year low. U.K. borrowing costs rose quickly, with yields on both short-term and longer-term government bonds shooting up by more than a third of a percentage point, a massive jump in bond-market terms. The 10-year U.K. government bond yielded 3.8%, shooting higher than the U.S. equivalent for the first time in several years.

The large tax cuts are a sharp change in direction for a Conservative government that has long championed its reputation for cautiously managing the nation’s finances and balancing the books. The package of subsidies and tax cuts—which will be largely funded by borrowing—will cost more than 150 billion pounds, equivalent to $169 billion, over the next couple of years, analysts say, in what amounts to a big play by Ms. Truss to jump-start the economy. The government said it would borrow an additional £72.4 billion to fund the package.

Economists have said the package reminds them of Reaganomics, the series of tax cuts, spending hikes and deregulation put in place by the former U.S. president in the 1980s that caused debt to swell but also led to higher growth.

Mr. Kwarteng said the top rate of tax for people who earn more than £150,000 a year will be 40%, compared with 45% currently. Basic income tax will be cut by one penny per pound to 19% from 2023, a year earlier than planned. The government also announced lower taxes on property transactions for first-time home buyers. The government is reversing the 1.25-percentage-point increase in dividend tax rates that would have landed in 2023. This was announced alongside a series of cuts to regulation, freezes to alcohol duty and the creation of new low-tax investment zones.

Mr. Kwarteng said the U.K. would adhere to fiscal responsibility and said the country had the second-lowest ratio of debt to annual economic growth among the Group of Seven rich countries. But some economists say the scale of spending involved could make investors nervous about the stability of U.K. finances.

The energy subsidy alone is expected to cost around £60 billion over the next six months. The cost of the tax cuts will be £26.7 billion next year, £31.4 billion in 2024 and £44.8 billion by 2026, the Treasury said. While the energy subsidy is expected to expire after two years at most, the tax cuts will permanently reduce government revenues and risk putting the U.K.’s debt on an “unsustainable” path, the Institute for Fiscal Studies said.

“All told, we believe that the economic outlook has not been transformed by these tax cuts,” said Pantheon Macroeconomics, a research company, noting that the tax cuts are focused on the wealthiest in society, whose expenditure isn’t that responsive to changes in their incomes.

Antoine Bouvet, a senior rates strategist at ING, said the flood of new U.K. government debt issuance to pay for the tax cuts comes at a time when demand for U.K. government bonds is already under pressure. High inflation erodes the value of the fixed payments bonds offer.

“The market is gearing itself up for more bond issuance in a very fraught market environment,” he said.

Mr. Kwarteng defended the government’s plan and denied that it was reckless. “What will end in tears is high taxes and low growth,” he said.

How have China, Mexico and Greece handled inflation, and where does the U.S. fit in? WSJ’s Dion Rabouin explains.

The plan carries both economic and political risk. Ms. Truss has refocused the party on being pro-business and said she has no qualms about making unpopular decisions in her efforts to boost the economy. Some of the policies, including scrapping a cap on banker bonuses, are unpopular with Britons, polling shows. Ms. Truss, just a few weeks into her tenure, already has a negative satisfaction rating, according to Ipsos Mori, a pollster.

Mr. Kwarteng and Ms. Truss are “two desperate gamblers in a casino chasing a losing run,” said

Rachel Reeves,

the opposition Labour Party’s shadow chancellor. The Labour Party has already criticized the government for not raising a windfall tax on energy companies to pay for the energy subsidy.

The fiscal package pits the government’s pro-growth fiscal policy against a more cautious approach by the Bank of England, which has been quickly tightening lending rates along with much of the industrialized world. The central bank raised its key lending rate by a half-percentage point on Thursday to 2.25%, its highest in 14 years.

The central bank said Thursday the government’s energy subsidy will likely reduce peak annual inflation to 11% from 13% later this year, but could add to inflationary pressure in the medium term. Analysts expect the Bank of England to continue to raise rates in part because the new stimulus package will add to price pressures in the longer run. That could dent longer-term economic growth.

Before the government’s package was announced, many economists were bracing for a long but shallow recession in the U.K., as price increases cut into consumers’ incomes. However, the scale of the government intervention could stave off recession next year, with the U.K. economy instead bumping along at just above 0% growth, according to analysis by

JPMorgan.

The British government said it would borrow heavily to fund the cuts.



Photo:

Chris J. Ratcliffe/Bloomberg News

It is the latest vision for the British economy espoused by the ruling Conservative Party. Ms. Truss, a libertarian, is ripping up predecessor Mr. Johnson’s plan for a more high-tax, interventionist government. Ms. Truss instead champions what she says will unlock 2.5% average annual economic growth.

Alongside tax cuts the government also announced the creation of new low-tax investment zones, which aim to bolster business investment, and a plan to streamline planning restrictions to make it easier to deliver major infrastructure projects. Also presented were regulatory reforms to make London more attractive as a financial hub. This included removing a restriction that prevented banks from paying bonuses of more than twice an employee’s salary.

“That is how we will compete successfully with dynamic economies around the world,” said Mr. Kwarteng.

Write to Max Colchester at [email protected]

Copyright ©2022 Dow Jones & Company, Inc. All Rights Reserved. 87990cbe856818d5eddac44c7b1cdeb8