Further to our note on the Chancellor’s “mini-budget” announced on Friday 23rd September, we can share the following update.
After a tumultuous 10 days in which members of all political parties united to show their dissatisfaction with the “mini-budget”, the Prime Minister and the Chancellor have made a U-turn and cancelled the proposed abolition of the 45% additional rate of income tax rate.
Citing the reasoning for the U-turn, the Chancellor stated that the abolition of the 45p tax rate had become a “terrible distraction” from the wider growth plan.
The overall plan, including other measures such as the removal of the National Insurance increase, would have handed back approximately £10,000 to the richest households in the country, with the poorest saving on average £221.
Income tax is the highest tax revenue generator for the UK treasury, bringing in around £192 billion for 2020/212. Cutting the top-rate of income tax was estimated to only cost the treasury £2 billion in receipts, not a significant amount when compared to the £45 billion total tax cuts in the “mini-budget”3.
The Chancellor has brought forward the timing of his “medium-term fiscal plan”, which will be accompanied by an OBR forecast, to later this month (October) - a month earlier than originally anticipated. It is also of note that the remaining measures from the “mini-budget” still need to be voted in before they can come into effect, so it is not currently clear what the tax landscape will look like on 6th April 2023. What is clear is that the Prime Minister and her Chancellor need to solidify the policies of the Conservative Party and present a strong message to the British public if they hope to generate the growth required to fund the proposed tax cuts and increased borrowing.
Elevated volatility in rates and FX markets of late has largely been driven by developments in the UK, and this continued last week. After markets told us that a higher return is required for foreign investors to help finance the UK’s fiscal easing measures announced at the “mini-budget” two weeks ago, the Bank of England was forced to intervene last week. To restore orderly market conditions, they announced two weeks of unlimited asset purchases and postponed its planned commencement of quantitative tightening to the end of October. The 30-year UK Gilt yield dropped a staggering 107bps on the day, and sterling was able to bounce from its lows. And with the UK’s fiscal discipline also under increased scrutiny, the Chancellor announced this week that his government will not go ahead with the plan to scrap a 45% rate of income tax on top earners.
Still, the recent price action is concerning. The decoupling in Gilt yields and sterling is similar to what was seen in Turkish assets in 2018. Investors are pricing in a lot of UK-specific risk premia, with GBPUSD now trading at its largest discount to “fair value” since Brexit. Risks still seem skewed to the downside for sterling, and we now see cable ending the year at 1.05 (1.03-1.07) by year-end.
1 Resolution Foundation analysis of DWP, Family resources survey using the IPPR tax-benefit model
The UK’s “mini-Budget” or “ The Growth Plan 2022” arrives at the end of a busy week for UK politics. The new Conservative Cabinet must take action to provide reassurance to households at a point where energy bills are at an all-time high and inflationary pressures and the arrival of a recession weigh on people’s minds.
Prime Minister Liz Truss made a commitment to “no new taxes” during the Conservative Party leadership campaign, meaning there will be no new government receipts to fund the promised support, leading to increased borrowing by the government. The government’s current plan seeks to utilise tax cuts, the simplification of the tax system and the reduction of benefits for certain job-seekers, as well as the introduction of measures on the supply side in order to promote growth.
There was nothing ‘mini’ about the plan announced by the Chancellor Kwasi Kwarteng who outlined what is being described as the most significant reform to tax policy in the UK in a generation. The government’s objective with this series of measures is to boost growth and “unleash the power of the private sector”. These measures included a raft of tax cuts, crucially with no associated OBR forecast, which has been promised by the end of the year.
The key announcements from the Growth Plan 2022* are:
- A cancellation of the proposed Corporation Tax rate increase from 19% to 25%, which was due to come in on 1st April 2023.
- A cancellation of the recent 1.25% increase to Employer’s National Insurance, which will be effective from 6th November 2022.
- The planned Health and Social care levy on employees due from April 2023 has been cancelled.
- The additional rate of income tax of 45% on income above £150,000 will be abolished, effective from 6th April 2023.
- The additional 1.25% increase to dividend tax introduced alongside the Health and Social Care measure which came into force on 6th April 2022 will be reversed from 6th April 2023.
- The basic rate of income tax will be cut to 19% from 20% effective from 6th April 2023.
- The threshold at which stamp duty land tax starts to be paid has been increased to £250,000 from £125,000, effective from midnight on 23rd September (£425,000 for first time buyers from £300,000).
- The maximum value for first time buyer relief on property will increase to £625,000 from £500,000.
- The cap on bankers’ bonuses will also be abolished, and the government plans an ‘ambitious deregulatory package’ to support the UK financial services sector.
- The off-payroll working rules, known as IR35, will be repealed from 6th April 2023.
- Seed Enterprise Investment schemes (SEIS) and Company Share Option Plan (CSOP) limits to be increased, Enterprise Investment Schemes (EIS) and Venture Capital Trusts VCT reliefs to be extended beyond 2025.
- Introduction of sales tax-free shopping for overseas visitors.
The Chancellor also announced support for businesses, maintaining the Annual Investment Allowance at £1 million rather than the planned drop to £200,000. He is also in discussions to create 38 ‘investment zones’ which will offer time limited tax cuts for businesses and developments in specific regions.
These plans are part of the Chancellor's “new approach for a new era”, and it remains to be seen what additional measures could be announced in the Autumn Budget. This is currently predicted to be in November 2022.
Beyond the measures in place to counter the energy crisis, the government announced several tax cuts as part of their “Plan for Growth” to return to a lofty growth target of 2.5%. This marks the most radical package of tax cuts for the UK since the 1970’s, reducing levies both on worker pay and companies in an effort to boost the long term potential of the economy.
That said, these plans did not come alongside a concrete assessment of their impact, namely with an update on public finances from the independent Office of Budget Responsibility (which is expected in late Autumn). Despite a cap on near-term costs for households and businesses and the government’s hopes for stronger growth, such stimulus is likely to carry a price tag that complicates the inflation picture further down the line. This could ultimately require the BoE to tighten policy even more aggressively to tame inflation (particularly given that UK inflation expectations are on the rise), and bond markets are pricing this in. With that said, data released earlier this week showed that the UK government borrowed £11.8bn last month (almost double as much as expected) as high inflation pushed interest payments higher. This trend will likely continue, but the bulk of the announced fiscal easing is time limited, which should only lead to a temporary impact on borrowing.
Therefore, although the near-term prospects do look better for the UK economy, there is a risk that such measures could lengthen the period of weak growth and reduce the capacity for the government to intervene further down the line.
In terms of market reaction, UK assets are reflecting a lot of this pervasive uncertainty and the growing balance of payments issues. Gilt yields have been surging (5-year yields rose as much at 50bps today) while the pound has continued to weaken against the dollar to its lowest level since 1985 (at 1.11 GBP/USD). And although the sterling has felt a lot of pain already, it is difficult to see a clear path higher in the short-term given that the UK has the highest inflation rate in the G10, a weakening growth outlook, falling investor confidence and weak capital inflows.
Meanwhile, the UK equity market has outperformed globally this year thanks to a weaker pound that has benefitted exporters and the index’s higher weighting towards energy and interest-rate sensitive sectors. However, given that the UK economy still faces significant risks, we prefer to allocate to other areas in Europe (like France) over the UK, and the U.S. over Europe in general.
The Tax Plan
The government previously announced a package of proposed reforms to capital allowances and R&D tax reliefs for businesses to encourage additional investment which has lagged our OECD competitors for a number of years. Prior to the leadership election we had anticipated more detail in the Budget in the Autumn. The government has committed to continue the review, with any further reforms announced at a future fiscal event.
This not so “mini-budget” comes at a crucial time of change for the country. It marks the most significant tax cuts in decades and a drastic shift from the policies of the past 12 years of Conservative government. Undoubtedly, the funding for the cuts and the support for winter energy bills will need to come from somewhere, in the short term this will be funded by increased borrowing. The hope of the Chancellor is that his policies outlined above will drive the growth needed in order to fund that borrowing. How successful it will be will remain to be seen and will be one of the main tests of the new Prime Minister and her Chancellor.
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