UK announces U-turn on corporation tax following weeks of financial turmoil

AFP

After weeks of huge financial turmoil and harsh criticism from home and abroad, the United Kingdom (UK) government on Friday decided to scrap the cancellation of the increase in corporation tax.

Prime Minister Liz Truss told journalists on Friday that the corporation tax will now rise to 25 percent from 19 percent next year as originally planned.

"This would raise 18 billion pounds (US$20.2 billion) per year," Truss said, and would act as a down payment on the medium-term fiscal plan, which is scheduled to be unveiled at the end of this month.

The policy change marks the second U-turn on the "mini-budget," the fiscal plan announced by the UK government on September 23, which was to be the largest tax cut package in decades.

The corporation tax rise was originally announced in March 2021 by former Chancellor Sunak but got canceled on September 23 as a measure to back UK businesses.

However, that move has thrown financial markets into turmoil as the British pound fell to record lows and government borrowing costs rose sharply. Investors voiced concerns that the policy change would ramp up public borrowing, bring serious fiscal uncertainty and push up already high inflation.

On October 3, the UK government made the first U-turn, reversing its plan to abolish the highest 45-percent rate of income tax in order to calm the markets.

"It is clear that parts of our mini-budget went further and faster than markets were expecting. So, the way we are delivering our mission right now has to change," Truss said on Friday.

"We need to act now to reassure the markets of our fiscal discipline," she said, stressing that "spending will grow less rapidly than previously planned."

Truss also announced that Jeremy Hunt, former foreign secretary, has been appointed as chancellor of the exchequer, replacing Kwasi Kwarteng, who announced the tax cuts in September.

But criticism continues as the tax cut plan was still considered fiscally unsustainable.

According to Paul Dales, chief UK economist of Capital Economics, after the changes, there are still unfunded tax cuts worth 25 billion British pounds left over from the mini-budget (down from 45 billion pounds originally).

Friday's announcement will not be enough to regain the full confidence of the financial markets, Dales said.

The fiscal U-turn is insufficient to avert a credit-led recession, Samuel Tombs, chief UK economist of Pantheon Macroeconomics, agreed, arguing that the announcement "has done little to shrink materially the risk premium embedded in UK assets."

All eyes are on the medium-term fiscal plan now. Hunt, the new chancellor, will unveil the new plan on October 31, according to Truss.

The remaining tax cuts and a deteriorating economic outlook mean that Hunt may "still face some tough tax and spending decisions if he is to show the government is credibly committed to getting debt falling when the medium-term fiscal plan is announced in just two weeks' time," the Resolution Foundation think tank said.

Tony Danker, director general of the Confederation of British Industry (CBI), also called for government plans to "restore fiscal credibility to give markets and business confidence to invest" in the weeks to come. (1 British pound = 1.12 US dollars)