U.K. Govt to Abandon Cut to Top Tax Rate

By Geoffrey Smith 

Investing.com -- The U.K. has abandoned plans to cut the top rate of income tax after several high-profile Conservative Party figures came out against the move over the weekend. 

"We get it, and we have listened," Chancellor of the Exchequer Kwasi Kwarteng tweeted, sealing the first big u-turn of the new government of Prime Minister Liz Truss. In a statement accompanying the tweet, Kwarteng said that the tax cut - which would have benefited only the country's top earners - "has become a distraction from our overriding mission to tackle the challenges facing our country."

The top rate tax cut was a relatively small part of the £45 billion ($48 billion) giveaway announced by Kwarteng in his mini-budget two weeks ago, which triggered an extreme selloff in the pound and U.K. government bonds over fears that the budget deficit would get out of control. Kwarteng had said the cuts would be funded by a sharp increase in borrowing. 

Kwarteng had initially proposed scrapping the move, which benefits only those who earn over £150,000 a year, as part of a package that also canceled a planned increase in corporate income tax. That had exposed the government to criticism that it was more intent on helping the very wealthy and businesses rather than poorer consumers who are struggling to cope with surging inflation. The move particularly dismayed those Conservative MPs who had won their seats in poorer constituencies at the last election on the more economically centrist policies of Boris Johnson. 

Market volatility, and the political messaging of the package, triggered a furious backlash against the Conservative Party, and was criticized by - among others - former party kingmaker Michael Gove on Sunday, who said he wouldn't vote for the measure if they were proposed to parliament. 

The pound reacted positively to the news, gaining 0.5% against the dollar to trade at $1.1212 by 05:30 ET (09:30 GMT). The yield on the benchmark 2-year U.K. government note, or Gilt. also fell 6 basis points to 4.22% on perceptions that the government's tax package will now be less inflationary and put less pressure on the Bank of England to raise interest rates. 

Yields on longer-term 5- and 10-Year Gilts still edged higher, however, as concerns about the package's impact lingered. The government doesn't intend to publish any more detail on how the package will be funded until November. The FTSE 100 meanwhile fell 0.7% on a morning when all European stock markets were in decline. 

Torsten Bell, director of the Resolution Foundation think-tank, tweeted that the move will help the Conservatives ride out the political storm created by the initial plans, but wouldn't "change the big picture of a £40 billion package of unfunded tax cuts which drove the market reaction" or avoid "big spending cuts that will follow."

Others suggested that, after an initial phase of panic, U.K. markets may now stabilize as the medium-term political outlook changes. Some opinion polls since the 'mini-budget' have put the Conservatives on course for a wipeout at the next election, due in 2024, trailing 33 points behind the opposition Labour Party.

"At some point markets may start to price in two years of the current policy and then a change," said Paul Donovan, chief economist with UBS Global Wealth Management, in a morning briefing. "Looking ahead to a potential change of government may set a floor for asset prices now."