UK government forced to ditch plan to slash top rate of tax

London(CNN Business) The British government is reversing plans to scrap the highest rate of income tax, announcing the embarrassing retreat after a rebellion among its own lawmakers and a week of financial and economic turmoil.

In a statement on Monday, finance minister Kwasi Kwarteng said the tax cut for people earning more than £150,000 ($170,000) "had become a distraction" from the government's wider package of measures to tackle the energy crisis and to reduce taxes more broadly, in its efforts to end years of economic torpor.

"We get it, and we have listened," he said.

The announcement marks a major and abrupt climb-down for new Prime Minister Liz Truss, whose government has been roiled by the reaction to its proposal for sweeping tax cuts, which included slashing the top rate of income tax to 40% from 45%.

The government's retreat came just 24 hours after Truss admitted mistakes in preparing the ground for Kwarteng's "mini budget" on September 23 but said she was sticking with the measures.

"I stand by the package we announced and I stand by the fact we announced it quickly," she told the BBC on Sunday.

The proposed cuts of £45 billion ($50.5 billion) would have been the biggest in 50 years. Truss and Kwarteng said they were vital to shake the United Kingdom out of years of sluggish economic performance.

But the cuts sent the pound plunging to historic lows against the US dollar, and sparked chaos in the market for UK debt because they will require a large increase in government borrowing. Mortgage rates soared, and some pension funds struggled to remain solvent.

A degree of order was only restored by an emergency intervention last Wednesday by the Bank of England, which said it would buy UK government bonds worth £65 billion ($73 billion).

The government's decision to hand top earners a big tax cut while millions are struggling to pay their energy and food bills was the most politically controversial element of the plan. In a rare rebuke, the International Monetary Fund slammed the government's package, saying it would raise inequality and increase inflationary pressure in the UK economy.

Senior former ministerial colleagues of Truss and Kwarteng, including Michael Gove and Grant Shapps, lined up on Sunday to criticize the planned giveaway for the rich, and there were signs of a broader rebellion within the prime minister's Conservative Party that could have ended in the measure being blocked in parliament.

News that the abolition of the top rate of income tax was being reversed sent the pound up about 1.2% to $1.12 on Monday. But the about-face will likely only reduce the overall size of the tax-cutting package by £2 billion, leaving the government yet to reassure markets that it has a solid plan to fund the rest.

'Symbolic' move

"This move is rather symbolic, being less about the amount of money it will save (low billions) and more about the poor signal it had delivered of ideological (unfunded) tax cuts," wrote Chris Turner, global head of UK markets at ING.

The scale of the challenge was underscored late Friday when ratings agency S&P reduced its outlook for the credit rating on UK sovereign debt to "negative" from "stable."

"The negative outlook primarily reflects what we view as rising risks to the UK's fiscal position over the next two years," S&P said in a statement. It will publish its next rating on UK debt on October 21.

Like many advanced economies, the United Kingdom is likely heading into a recession caused in large part by the energy price shock triggered by Russia's invasion of Ukraine, and the sharp rise in interest rates designed to tame the soaring inflation that has ensued.

The botched "mini-budget" fanned the flames, ratcheting up expectations for UK interest rates. That in turn prompted UK mortgage lenders to drive up the rate they're charging for new loans and for refinancing existing borrowing, sparking talk of a house-price crash next year.

Crisis management by the Bank of England has bought the government some time to explain its economic strategy more clearly to investors. But the central bank's emergency bond-buying program is due to end on October 14, and the government has said it will publish a full budget only on November 23.

More U-turns or spending cuts?

Kwarteng's efforts to restore the UK government's credibility with markets continued later Monday when he spoke to the Conservative Party conference.

Acknowledging that his announcement 10 days ago had caused "a little turbulence," he said he was determined to "focus relentlessly on growth" while acting in a "fiscally sustainable and responsible way."

He said he would publish his medium term fiscal plan "shortly" alongside a full economic forecast from the Office for Budget Responsibility.

A powerful committee of UK lawmakers last week urged Kwarteng to publish his plan and the OBR forecasts as soon as possible, rather than waiting until late November.

The government is borrowing heavily to pay for enormous energy subsidies for households and businesses to help them through this winter. And it faces questions over how it intends to pay for the bulk of the tax-cutting package that remains. Cuts to public spending may be next.

"[Kwarteng] still has a lot of work to do if he is to display a credible commitment to fiscal sustainability," said Paul Johnson, director of the Institute for Fiscal Studies, on Monday.

"Unless he also U-turns on some of his other, much larger tax announcements, he will have no option but to consider cuts to public spending: to social security, investment projects, or public services," he added.

— Chris Liakos, Duarte Mendonca, Mia Alberti, Kara Fox, Alex Hardie and Julia Horowitz contributed to this article.