Sunday, 23 November 2008

Cutting VAT won't work

Reports today suggest that the Government is considering cutting VAT as the main element of its fiscal stimulus plan.

If the Government does go down that route, it would illustrate how out of touch they are with the real problems people face in this country. Both Norfolk Blogger and Mark Gray have highlighted some of the problems of this approach and their concerns are valid.

In addition to that, the proposal doesn't really make sense economically. We had a boom fuelled by unsustainable levels of personal debt, but now that things have turned down, that level of debt means people are now worried about their jobs and staying in their homes. On the whole, they are certainly not thinking about going out to spend money on luxury or non-essential items, which is what VAT on the whole is levied on. People are not going to rush out and start spending just because goods are 2.5% cheaper, even if all the VAT cut is passed on and is not offset by the falling pound making imports dearer.

And that's why cutting personal taxation is a better route for stimulating the economy than cutting VAT. People would be able to decide for themselves where to put their money. Some would decide to put the money towards their mortgage or towards buying food, rather than buying goods that may not be strictly essential. And targeting those tax cuts on people on low and middle incomes makes sense - they are more likely to spend as a result of having more money in their pockets, thereby providing a greater boost to the economy than provided for by cutting VAT.

And rather than letting public borrowing rip, which is the Government's preferred means of paying for this stimulus, it would make sense for these tax cuts to be paid for by increasing taxation on the wealthiest and on pollution in the medium to long term (doing so immediately is probably not wise given the economic situation, but it should certainly be the priority when the economy recovers). The Government should also seek to cut some of its wasteful spending (eg ID cards).

But cutting VAT would be yet another symbol that Brown and Darling really don't have a clue what to do about the economy.


Stephen B said...

If only it were that simple...

I agree mostly about the VAT, I'm not sure that it is enough to tempt people to spend again.

From a small business point of view, it helps cashflow as I don't have to pony up as much at the end of the quarter. Putting it up to 22% or whatever at a later point though will make things interesting for a lot of us...

Will I pass on the cut? Probably, because I usually quote ex VAT but not sure I would if quoting with VAT.

'Tax the rich' is good populist politics but not necessarily good economics - the take from the top 5% of earners has increased as a percentage of total income tax revenues in line with falling marginal rates. A rise in these rates will means the less well-off will end up shouldering more the burden in the long run - something that doesn't strike me as particularly 'progressive.'

A genuine question: what is the evidence that 'people on low and middle incomes...are more likely to spend as a result of having more money in their pockets'?

I assume you mean 'more likely than people on higher incomes' or do you just mean 'they are likely to spend more if they have more money' (which strikes me as being obvious really)?

Bernard Salmon said...

With regard to your point about taxing the rich, there are means of raising more money from the very wealthy than simply raising top rates, such as the changes to pension relief and capital gains tax that the Lib Dems have outlined.
On the point about poorer people spending, there have been several studies which show a higher maginal propensity to spend among poorer people than among the wealthier and I can dig some of those out if you want.

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