UK VAT cut pitch sensible?

Tue 2nd Aug 2016

The investment bank, Bank of America Merrill Lynch, has proposed a temporary reduction in the UK’s standard VAT rate from 20% to 17.5%. It has suggested this to counter the inflationary effects of the UK’s currency, Sterling, falling by around 15% since the Brexit referendum, and to keep consumers spending.

Do temporary VAT cuts work?

Certainly they can provide subsidies to retailers or consumers – depending on whether the retailer choses to pass on the cut through price cuts. Crucially, such a tax subsidy can be introduced within a few weeks and so deliver an immediate economic boost. When the reduction is temporary it usually leads to expenditure switching as the reduction comes to an end and consumers bring forward spending. But this is only a temporary measure.

The UK Labour government temporarily cut VAT from 17.5% to 15% between 1 December 2008 and 31 December 2009. This emergency measure was implemented to support consumer confidence as the 2008 financial crisis gripped the country. It was estimated to cost around £12 billion. Shoppers canvassed at the time by a number of organisations overwhelmingly said it had no impact on their expenditure. Retailers, when surveyed, gave a similar response. Only 20% of them claimed to have not passed the reduction on.

Income tax or welfare payments instead?

Many economists believe a temporary cut in income tax is more effective at delivering extra cash to individuals, especially if targeted towards the lower income earners. However, changes to income tax rates take many months – up to a year to implement in payroll systems. The same problem applies to welfare payment increases.