The VAT cut
Dec 09
Most of the world has recently moved from taxing income and wealth to taxing consumption and expenditure. Last week, the UK government temporarily (for the next 18 months) decided to bring the rate down from 17.5% to 15%. Many critics have attacked the move as not being bold enough and wanted direct tax cuts (on income) instead. I feel this criticism misses the point and in this business angel blog I want to defend the action taken by the UK treasury.
VAT (Value added tax) is a tax which countries within the European have to apply on a range of products. The standard band is between15% to 25%. Your standard VAT rate cannot go below or higher than those limits.
So, the most the UK government could do is reduce the VAT rate down to 15%. This point has been sorely missed from many of the commentators criticizing the move.
A point I have made in my previous blogs is that what we really need to see is consumers spending again. During a recession or any period of economic uncertainty, the savings ratio tends to rise. In the UK and the US, the ratio has recently been as low as 2% to 3% (By contrast in Germany it has been around the 10% mark). If consumers were given direct tax cuts, the likelihood is that they will use this extra cash to pay off debt. Again, as I mentioned in a previous blog, whilst that may be good for an individual (managing my debt down is certainly my priority for next year!), for the economy it is a bad thing.
Therefore the only thing the government can do is cut the main tax on expenditure which will result immediately and directly in lower prices. That is what they have done.
The flip side to this is though that of course it brings down inflation. That is an undesirable side effect. To play devils advocate for a bit, what if rather than reducing VAT the government announced that it was going to increase it to 20% from the 1st of March 2009?
I would have thought that this would not only help balance the government books, which look simply awful (Government debt will be 57% of GDP – up from around 40%) and it might actually induce people to spend a lot ahead of the VAT increase. Assuming people are rational, if you know that prices will be going up in a couple of months, you will no doubt try to save money by bringing forward your planned purchases. This is the exact opposite to where I fear we are heading which is the built in expectation of lower prices.
As I have argued over many blogs in the past, what we really need in the UK is a good dose of inflation!
Hi and welcome to my blog. 
Dec 09 at 15:14
Good to have you back Permjot!!
You are wrong though my friend. Cutting VAT by such a small amount was the wrong thing to do. It will cost companies a fortune to administrate and the effect that it will have on most purchases will be negligible. Remember, there is no VAT on most food or kids’ clothing or books etc. And no-one is going to rush out to spend money on a big-ticket item like a car or a plasma telly when they are worried about losing their job next year.
What Brown and the Badger should have done is simple - they should have temporarily lifted stamp duty to get the property market moving again. The fact is that Britain’s economy is driven by property sales, and volume is at least 80% down on last year.
By reducing stamp duty, buyers would have larger deposits which would make the banks feel more secure about lending. Property prices would stop free falling (and might start rising again), which would make people feel a bit wealthier. At the very least, it would stop people from feeling like the sky is falling in on them.
What’s more, a 100% freeze on stamp duty for 2 years would cost the public purse less than the temporary 2.5% discount on VAT.
Brown and the Badger don’t know what they are doing. This shouldn’t be a surprise given that they managed to sell off our gold when gold prices were at their lowest, messed up on pensions, pontificated on Northern Rock, screwed up on the 10% income tax deal, backtracked on CGT when they realised they couldn’t get away with their erroneous plans and generally messed up everything else.
The biggest joke is that Cameron can’t seem to get this point across to the public. We should be marching on the streets to get rid of this incompetent bunch of morons.
Anyhow mate, much as I love you loads, you are wrong about the VAT thing and you are wrong about wanting inflation to come back.
On everything else in life, you are obviously 100% spot on.
Best,
m