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What Historic UK Tax Cuts Mean For The Markets: 'Material Increase In Risks'

The iShares MSCI United Kingdom ETF NYSE:EWU plummeted 5.3% on Friday after investors were not impressed by an aggressive series of tax cuts unveiled by the new U.K. government.

What Happened? On Friday, new U.K. Prime Minister Liz Truss announced a bold new stimulus program that includes tax cuts and investment incentives. The U.K. government is planning to cancel a planned corporate tax rate hike, reverse a recent increase in the income tax and cut taxes for certain businesses in designated investment zones.

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The new stimulus program comes after the Bank of England said Thursday that the U.K. economy is likely already in a recession.

Why It's Important: U.K. Finance Minister Kwasi Kwarteng said Friday that the series of economic measures are part of the U.K.'s new focus on growth, which includes a target for medium-term economic growth of 2.5%.

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Here's an overview of all the potential changes:

  • The U.K. corporate tax rate will remain at 19% instead of rising to 25%. The 19% rate is the lowest among G-20 nations.
  • The recent 1.25% tax hike on National Insurance contributions will be reversed.
  • The basic rate of income tax will be cut from 20 pence to 19 pence.
  • The top income tax rate for earners making more than $166,770 will be cut from 45% to 40%.
  • Stamp duty, a tax paid on home purchases, will be cut.
  • The U.K. will create investment zones that will offer businesses special tax incentives, liberalized planning rules and reduced regulatory obstacles to encourage investing.
  • A planned tax hike on alcohol will be eliminated.
  • A cap on banker bonuses will be eliminated.
  • The U.K. will create a refund system for sales tax paid by foreign visitors.

Following the news, the British pound dropped to a 37-year low against the U.S. dollar. Investors also dumped U.K. government bonds, as investors appear concerned about the massive scale of the stimulus program and what it means about the current state of the U.K. economy.

On Friday, Bank of America economist Robert Wood said the new U.K. fiscal package represents the third major U.K. fiscal shock of the past 15 years and significantly ramps up the risk for U.K. investors.

"In short, in our view today's package represents a material increase in risks: to inflation; to Bank Rate; and to the currency," Wood said.

Benzinga's Take: Even after Friday's big sell-off, the EWU ETF is only down 21% year-to-date in 2022, slightly better than the 23% decline for the SPDR S&P 500 ETF Trust NYSE:SPY. However, the longer-term picture tells an entirely different story about the U.K. economy and the impact of the Brexit decision and its fallout. In the past 10 years, the SPY ETF is up 150.7% overall, while the EWU ETF is down 26.3% in that time.

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