Truss and Kwarteng’s awkward about-face

In the wake of the U-turn, the scrapping of plans to scrap the 45p tax rate is particularly humiliating for Liz Truss’s UK government. It comes after a week of dogged defense of Chancellor Kwasi Kwarteng’s radical “mini” budget in the face of severe financial market turmoil and fierce criticism from her own Conservative MPs. In the midst of their convention, a moment that Truss and Kwarteng hoped would mark a stormy start to their tax-cut agenda, the reversal only underscores how badly their authority has been undermined. While the move may ease some political pressure, the government needs to go much further to restore Britain’s and its own economic credibility.

With all the market chaos that remained after Kwarteng’s announcements, it was the parliamentary revolt Truss faced that forced her to surrender. The plan to scrap the higher tax rate – a huge giveaway to wealthier households – was unpopular with many Tory MPs, who saw it as poor optics amid a cost of living crisis. The about-face could help mend internal fissures as the government seeks support for its finance bill and may ease Labour’s criticism of the likely rise in inequality from the new economic plans.

Fundamentally, however, the turnaround will do little to change UK debt dynamics, which have been thrown onto an unsustainable path by Kwarteng’s unsecured borrowing. The abolition of the top tax rate accounts for just about £2bn of its total £45bn tax cut package. The Bank of England will need to push interest rates higher still to cushion inflationary pressures from other policies. The Chancellor’s plans remain based on the unfounded belief that growth through tax cuts will help balance the books.

Financial markets will not see this as a significant reduction in the economic uncertainties that Truss and Kwarteng helped create. Although the top tax cut reflects a pragmatic softening of hardline ideology, this government has a long way to go to regain investor confidence given its weakened bargaining power within the Tory party. The pound edged up 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 turmoil. Concerns also linger over how pension funds will deal when the BoE’s emergency asset purchase program expires on October 14th.

The loss of political authority is likely to make it more difficult for Kwarteng to push through unpopular spending cuts, including a possible plan for real-world benefit cuts. This, in turn, could force it to reverse more of its tax cuts. There may be no other way to convince Bureau of Fiscal Responsibility overseers and investors that the government can fund its plans, including its huge energy price support package. It will also be important to advance the OBR’s independent assessment of the Chancellor’s agenda. The longer the market waits for compelling evidence that financial plans are working, the greater the risk of volatility. Kwarteng’s speech at the conference, acknowledging his plan caused “small turbulence” but declaring he is determined to deliver the “big chunks” of it, will calm few nerves.

This is a moment of acute embarrassment for Truss and Kwarteng. They may get some political breathing space, but the economics of their “mini” budget still stand in their way. The reversal in the top tax at least shows the ability to listen. But that should not be the end of the rethinking. It should mark the beginning of a broader descent from the disastrous “mini” budget.

https://www.ft.com/content/c8715aa6-03d7-4ddb-85ea-28df149dfbe8 Truss and Kwarteng’s awkward about-face

Adam Bradshaw

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