As U-turns go, the scrapping of plans to axe the 45p tax rate is a particularly humiliating one for Liz Truss’s UK government. It comes after a week of doggedly defending chancellor Kwasi Kwarteng’s radical “mini” Budget in the face of severe financial market turmoil and fervent criticism from their own Conservative MPs. In the middle of their party conference, a moment Truss and Kwarteng hoped would mark a rapturous beginning to their tax-cutting agenda, the volte-face only underscores how much their authority has been sapped. While the move may ease some political pressures, the government needs to go much further to restore Britain’s and its own economic credibility.
For all the market chaos left in the wake of Kwarteng’s announcements, it was the parliamentary revolt facing Truss that forced her into a surrender. The plan to abolish the higher tax rate — a big giveaway to wealthier households — was unpopular with many Tory MPs who considered it to be bad optics in the midst of a cost of living crisis. The U-turn may help to mend internal rifts, as the government seeks support for its finance bill, and could blunt criticism from the Labour party over the prospective rise in inequality stemming from the new economic plans.
More fundamentally, though, the U-turn will make little difference to Britain’s debt dynamics, which have been set on an unsustainable path by Kwarteng’s unfunded borrowing splurge. Removing the top rate of tax represents only about £2bn of his overall £45bn tax-cutting package. The Bank of England will still need to push interest rates higher to bear down on inflationary pressures emanating from other measures. The chancellor’s plans remain reliant on the unfounded belief that driving growth via tax cuts will help balance the books.
Financial markets will not see this as significantly easing the economic uncertainties that Truss and Kwarteng helped create. Though the retrenchment on top-rate tax reflects a pragmatic softening of hardline ideology, due to their weakened bargaining power within the Tory party, this government has a long way to go to regain investors’ trust. The pound edged higher against the dollar and gilt yields fell immediately after the announcement, but downward pressure on the currency will remain and bond yields are still worryingly high after last week’s market ructions. Concerns over how pension funds will cope when the BoE’s emergency bond-buying scheme expires on 14 October also remain.
The loss of political authority is likely to make it harder for Kwarteng to pass unpopular spending cuts, including a potential plan for real-terms cuts to benefits. This, in turn, could force him into reversing a broader swath of his tax cuts. There may be no other way to convince overseers at the Office for Budget Responsibility, and investors, that the government can finance its plans, including its huge energy price support package. Bringing forward the OBR’s independent assessment of the chancellor’s agenda will also be important. The longer the market waits for convincing evidence that the fiscal plans add up, the greater the risk of volatility. Kwarteng’s conference speech, in which he conceded his plan had caused a “little turbulence” but said he was committed to delivering the “major parts” of it, will settle few nerves.
This is a moment of acute embarrassment for Truss and Kwarteng. It may buy some political breathing space, but the economics of their “mini” Budget are still stacked against them. The U-turn on top-rate tax at least shows a capacity to listen. But it should not be the end of the rethink. It should mark the beginning of a wider climbdown from the disastrous “mini” Budget.