Britain’s new government on Friday unleashed historic tax cuts and huge increases in borrowing in an economic agenda that floored financial markets, with sterling and British government bonds in freefall.
Treasury chief Kwasi Kwarteng scrapped the country’s top rate of income tax, canceled a planned rise in corporate taxes and for the first time put a price tag on the spending plans of Prime Minister Liz Truss, who wants to double Britain’s rate of economic growth.
“We need a new approach for a new era, focused on growth,” Kwarteng told lawmakers in the House of Commons.
Investors unloaded short-dated British government bonds as fast as they could, with the cost of borrowing over five years seeing its biggest one-day rise since 1991, as Britain raised its debt issuance plans for the current financial year by 72.4 billion pounds ($81 billion). The pound slid below $1.11 for the first time in 37 years.
Kwarteng’s announcement marked a step change in British economic policy, harking back to the Thatcherite and Reaganomics doctrines of the 1980s that critics have derided as a return to “trickle down” economics.
“Our plan is to expand the supply side of the economy through tax incentives and reform,” Kwarteng said. “That is how we will compete successfully with dynamic economies around the world. That is how we will turn the vicious cycle of stagnation into a virtuous cycle of growth.”
A plan to subsidize energy bills will cost 60 billion pounds just for the next six months, Kwarteng said. The government has promised households support for two years as Europe wrestles with an energy crisis.
Tax cuts – including an immediate reduction in the Stamp Duty property purchase tax plus a reversal of a planned rise in corporation tax – would cost a further 45 billion pounds by 2026/27, he said.
Kwarteng said the government would cut the basic rate of income tax to 19% next year, from the current 20%. The top rate will drop to 40% from 45%. He also canceled a planned six percentage point increase in the corporate tax rate, leaving it at 19%.
“This was the biggest tax-cutting event since 1972, it is not very mini,” said Paul Johnson, director of the Institute for Fiscal Studies, an independent think tank that scrutinizes government spending. “It is half a century since we have seen tax cuts announced on this scale.”
The government said raising Britain’s annual economic growth rate by 1 percentage point over five years – a feat most economists think unlikely – would increase tax receipts by around the same amount.
Britain will also accelerate moves to bolster the City of London’s competitiveness as a global financial center by scrapping the cap on banker bonuses ahead of an “ambitious deregulatory” package later in the year, Kwarteng said.
The plans were immediately attacked by the opposition Labour Party, which said they were a “desperate gamble,” and criticized it for what it said was favoring the interests of business over working people and failing to provide any analysis about the impact on the government’s fiscal targets.
“Never has a government borrowed so much and explained so little … this is no way to build confidence, this is no way to build economic growth,” said Labour’s finance spokesperson Rachel Reeves.
“It is a budget without figures, a menu without prices,” said Rachel Reeves, Labour’s spokesperson on Treasury issues. “What has the chancellor got to hide?”
The Institute for Fiscal Studies said the tax cuts were the largest since the budget of 1972 – which is widely remembered as ending in disaster because of its inflationary effect.
The market backdrop could barely be more hostile for Kwarteng, with the pound performing worse against the dollar than almost any other major currency.
Much of the decline reflects the U.S. Federal Reserve’s (Fed) rapid interest rate rises to tame inflation – which has sent markets into a tailspin – but some investors have taken fright at Truss’s willingness to borrow big to fund growth.
The announcement comes just three weeks after Truss took office. She has said the Conservative government’s core mission is lowering taxes to drive economic growth and declared this week that she was ready to make “unpopular decisions” such as removing a cap on bankers’ bonuses to attract jobs and investment.
The plan runs counter to the view of many Conservatives that governments shouldn’t rack up huge debts that taxpayers will eventually have to pay.
“In 25 years of analyzing budgets this must be the most dramatic, risky and unfounded mini-budget,” said Caroline Le Jeune, head of tax at accountants Blick Rothenberg.
“Truss and her new government are taking a huge gamble.”
A Reuters poll this week showed that 55% of the international banks and economic consultancies that were polled judged British assets were at a high risk of a sharp loss of confidence.
On Thursday the Bank of England (BoE) said Truss’s energy price cap would limit inflation in the short term but that government stimulus was likely to boost inflation pressures further out, at a time when it is battling inflation near a 40-year high.
In the past two weeks, the government has announced that it would cap gas and electricity bills for households and businesses, amid fears that the poorest won’t be able to afford to heat their homes and companies will go bust this winter. Kwarteng said this initiative would be funded by borrowing.
Financial markets ramped up their expectations for BoE interest rates to hit a peak of more than 5% midway through next year.
According to the central bank, the U.K. may already be in recession, defined as two consecutive quarters of economic contraction. The BoE expects gross domestic product (GDP) to fall by 0.1% in the third quarter, below its August projection of 0.4% growth. That would be a second quarterly decline after official estimates showed output fell by 0.1% in the previous three-month period.
“We are likely to see a policy tug of war reminiscent of the stop-go 1970s. Investors should be prepared for a bumpy ride,” said Trevor Greetham, head of multi-asset at Royal London Asset Management.
Despite the extensive tax and spending measures, the government had decided against publishing alongside its statement new growth and borrowing forecasts from the Office for Budget Responsibility (OBR), a government watchdog.
Kwarteng confirmed the OBR would publish its full forecasts later this year.
“Fiscal responsibility is essential for economic confidence, and it is a path we remain committed to,” he said.