“I understand the concerns about the financial market turmoil. (But) I support the tax cuts we announced.” Until the 2nd, British Prime Minister Liz Truss’s stance on tax cuts was firm. There seemed to be no U-turn. There was also a report (Bloomberg) that Finance Minister Quaji Kwateng, who announced a large-scale tax cut, personally met and persuaded members of the ruling Conservative Party who oppose the tax cut.
However, within a day, the atmosphere suddenly changed. This is because voices calling for the policy to be scrapped have increased, focusing on Conservative Party lawmakers, whose approval rates have been severely delayed. As a sense of crisis the entire Truss cabinet could be shaken, it was finally decided to withdraw the tax cuts for high income earners.
UK reverses tax cuts for high income earners
Minister Kwateng announced on Twitter on the 3rd that he has decided not to pursue the abolition of the top tax rate (45%) on high income earners. He acknowledged that “[diddymu’r gyfradd dreth uchaf o 45% ar gyfer enillwyr incwm uchel]is a new approach for a prosperous economy,” but he had to abandon the policy in the face of deteriorating public opinion.
Among the tax cuts announced by the British government ambitiously, giving up the ‘tax cuts for high income earners’ means that it will not deliver the tax cut as it is. The Financial Times said Truss would face pressure to withdraw other tax cuts.
Earlier, the British government, led by Prime Minister Truss, introduced aggressive tax cuts on the 23rd of last month. This was the largest tax cut since 1972. However, this bill did not include how to fill the government fiscal vacuum caused by the tax cut. The market accepted this as the UK government issued huge amounts of government bonds to compensate. As a result of this shock, UK government bond prices fell (treasury yields rose). The yield on the 30 year UK Treasury bond was 2.3% per annum on 1 August. However, after the tax cut was announced, on the 27th of last month, the annual rate was higher than 4%. On the 28th of last month, it was also more than 5.1% per annum.
The yield on the 5-year government bond was also above 4.5% per annum, which is higher than Italy (4%) and Greece (4%). This means that Italian and Greek government bonds are more expensive than British government bonds. When interest rates rise, bond prices fall. British pension funds received a £1 billion profit call after government bonds, considered long-term safe haven assets, failed. This is because they demanded extra profit when the price of British government bonds fell, which served as profit.
The pound also fell in value. On the 26th of last month, it fell to $1.03 a pound, the lowest level for 37 years. As the pound and government bond prices plunged, the Bank of England (BOE) announced an emergency purchase of £65 billion worth of government bonds. However, the BOE’s measures were said to be contrary to the policy view of raising interest rates to contain inflation.
A reduction in the approval rate is a critical factor
The British government has also been humiliated and publicly shot down by the International Monetary Fund (IMF), saying the tax cuts were “wrong”. Global credit rating agency Standard & Poor’s (S&P) downgraded the UK sovereign credit rating outlook from ‘stable’ to ‘negative’ on the 30th of last month.
According to the FT, as of the 1st of last month, there were close to 1,688 mortgage products that UK commercial banks had withdrawn or stopped selling. As interest rates increased, interest rates on principal loans also increased, raising concerns that loans could not be recovered. As a result, there was even hope that the financial turmoil could turn into a real economic crisis.
Truss was under pressure to resign after a month in the job. In particular, the abolition of the top tax rate of 45% applied to high income earners was criticized as an unfair policy at a time when the working and middle class were suffering from a sharp rise in energy prices. According to a survey carried out by YouGov on the 30th of last month, the opinion that “Prime Minister Truss should resign immediately” was 51%. Only 29% of respondents said they should “continue to serve as prime minister”.
Shortly after the tax cuts were withdrawn, the pound rose almost 1% against the dollar. The New York Stock Exchange also performed positively after opening. Major indices rose at the same time. The Dow Jones Industrial Average rose 1.2% from the previous trading day shortly after opening. The S&P 500, which reached its lowest point since October 2020 on the 30th of last month, also rose 1%.
Reporter Se-min Heo/ Hyun-woo Oh [email protected]