UK government dishes out extensive tax cuts as country braces for recession

LONDON — The new U.K. government announced a sweeping program of tax cuts and investment incentives Friday, as Prime Minister Liz Truss seeks to boost the country’s faltering economic growth.

Speaking to the House of Commons, Finance Minister Kwasi Kwarteng said the government wanted a “new approach for a new era focused on growth” and was targeting a medium-term 2.5% trend rate in economic growth.

“We believe high taxes reduce incentives to work, deter investment and hinder enterprise,” Kwarteng said.

The measures include:

• Cancellation of a planned rise in corporation tax to 25%, keeping it at 19%, the lowest rate in the G-20.
• A reversal in the recent 1.25% rise in National Insurance contributions — a tax on income.
• A reduction in the basic rate of income tax from 20 pence to 19 pence.
• Scrapping of the 45% tax paid on incomes over £150,000 ($166,770), taking the top rate to 40%.
• Significant cuts to stamp duty, a tax paid on home purchases.
• A network of “investment zones” around the U.K. where businesses will be offered tax cuts, liberalized planning rules and a reduction in regulatory obstacles.
• A claim-back scheme for sales taxes paid by tourists.
• Scrapping of an increase in tax rates on various alcohols.
• Scrapping of a cap on bankers’ bonuses.

The government estimates the tax cuts will total £45 billion by 2026-27.

“It’s half a century since we’ve seen tax cuts announced on this scale,” said Paul Johnson, director of the Institute for Fiscal Studies.

The pound fell to a fresh 37-year low against the dollar below $1.103 in the hours after the announcement, while investors ditched U.K. government bonds and the FTSE 100 fell to its lowest level since March. Johnson said markets appeared “spooked” by the scale of the “fiscal giveaway.”

It comes a day after the Bank of England said the U.K. economy was likely to have entered an official recession in the third quarter, as it hiked interest rates by 50 basis points to combat decades-high inflation. The economy contracted by 0.1% in the second quarter amid a squeeze in real incomes.

Despite containing extensive reforms, Friday’s package is not being described by the government as an official budget as it has not been accompanied by the usual economic forecasts from the Office for Budget Responsibility.

Critics of the proposals warn that the combination of extensive tax cuts and the government’s plan to shield households and businesses from soaring energy prices will see the U.K. take on high levels of debt at a time of rising rates. The energy support package is expected to cost more than £100 billion ($111 billion) over two years.

Data published Wednesday showed the U.K. government borrowed £11.8 billion in August, significantly above forecasts and £6.5 billion more than the same month in 2019, due to a rise in government spending.

Kwarteng said Friday the U.K. had the second-lowest debt to GDP ratio in the G-7 and would announce a plan to reduce debt as a percentage of GDP in the medium term.

On energy, he said price caps would reduce peak inflation by 5 percentage points and lower the wider cost-of-living pressures. He also announced an energy markets financing scheme, in conjunction with the Bank of England, that will offer a 100% guarantee to commercial banks who offer emergency liquidity to energy traders.

The opposition Labour party argued that the tax cuts will disproportionately benefit the wealthy and be funded by unsustainable borrowing.

Speaking in the Commons, Kwarteng’s Labour opposite Rachel Reeves called the plans trickle-down economics and quoted U.S. President Joe Biden, who this week said he was “sick and tired” of the policy and that it had never worked.

“As fiscal events go, this was a seismic one,” said Chris Sanger, head of tax policy at accountancy EY.

“The reversal of the decision to deny VAT rebates for travellers leaving the UK, only implemented on leaving the EU, and the introduction of new super-powered special economic zone, reinforce the message that the UK wants to attract foreign direct investment and travellers. In essence, the government is doubling down on growth, providing tax cuts across the board,” he said in emailed comments.

Shevaun Havilland, director general of the British Chambers of Commerce, said pledges to focus on growth and speed up infrastructure development would be welcomed by businesses.

“The introduction of investment zones also has the potential to finally deliver on the Government’s long-standing promise to level up, if the scheme is truly UK-wide,” he said.

“Lessons also need to be learned from the past, it will be crucial to get these zones right from the start, otherwise they can simply displace growth and investment from one area to another without creating new economic activity.”

Samuel Tombs, chief U.K. economist at Pantheon Macroeconomics, said low-income households would be worse-off following the changes as they would see limited benefit from tax cuts but be hit hard by a rise in the cost of imports caused by the lower pound.

“The current level of sterling points to a 0.5% boost to CPI inflation in 2024 from import prices,” he said in a tweet.

Meanwhile Torsten Bell, chief executive of think tank the Resolution Foundation, said the policies were a “simply staggering huge tax cut for richer households.”