Pre-Budget VAT Cut Unlikely To Save UK Economy

by Robert Lee, Tax-News.com, London

26 November 2008

While the UK government's pre-budget report has offered small businesses and low-income taxpayers some welcome support in these difficult economic times, tax experts are of the view that Chancellor Alistair Darling's flagship pre-budget announcement to temporarily cut value-added tax by 2.5% will not be enough to rescue the British economy from a widely-predicted slump.

According to Debbie Jennings, VAT Director at PKF Accountants and business advisers, the decision to reduce VAT to 15% between December 1, 2008 and December 31, 2009 is unlikely to have the impact on consumer spending that the government hopes going into the Christmas period.

“Experts agree that a cut in the rate of sales tax in Canada did not lead to increased consumer spending," she observed.

Jennings also said that the VAT cut will make pricing difficult for retailers who normally offer goods at round sum prices. She added: "In any case, many retailers are already offering much larger discounts in the run-up to Christmas. So any benefit for the rate cut is likely to be intangible and has to be seen more in the context of creating consumer confidence."

Other tax experts, such as Marc Welby, VAT Partner, BDO Stoy Hayward, believe that, if the government was going to use VAT as its main weapon to combat a looming recession, it should have increased the number of goods and services which qualify for the 5% lower rate rather than easing the main rate.

“The reduction in the VAT rate is too small to influence consumer spending. Moving key labour intensive services from the standard rate to the reduced rate of 5% would not only have stimulated consumer spending further and faster but would help staunch (and possibly reverse) unemployment in those sectors. It would have helped to create a virtuous circle," he argued.

“The VAT rate reduction will save the average customer little more than GBP1 per week on a GBP100 supermarket shopping bill – the VAT on crisps and fizzy drinks will come down but there’s no VAT on zero-rated foodstuff basics – bread, milk, meat and potatoes," he added.

What's more, with the Chancellor announcing the usual increase in alcohol duty in the pre-budget report, the small increase in consumer spending that may take place over the Christmas period may be cancelled out by lower sales of Christmas cheer. "The Chancellor has given with one hand and taken away with the other," Welby noted.

The biggest winners as a result off the VAT cut, according to Welby, will be the financial services sector, especially banks and insurers who can’t recover all the VAT on business costs.

"There may be a temptation for some of these to advance some of their business costs before the VAT rate goes up again at the end of 2009. It will remain to be seen whether they will pass the benefits of their reduced costs through to the lending rates to consumers and small businesses," he observed.

Another potential flaw in the government's thinking is that not all businesses are obliged to pass on the lower rates in the form of lower prices, as pointed out by Andrew Hubbard, Deputy President of the Chartered Institute of Taxation (CIOT).

“The CIOT had previously commented that VAT is one tax measure that is quick to introduce and was a likely candidate for use if the government wished to embark on a fiscal stimulus. Whether it achieves its aim depends in a large part on the response by businesses and consumers. They have no legal obligation on them to pass on the benefits of the VAT cut to consumers, whether in whole or part of a rate reduction," he commented.

The CIOT estimates that those earning GBP20,000 or less per year will save about GBP2.50 per week in VAT, which they could spend on extra goods and services. Those on higher incomes of GBP60,000 per year or above will have about GBP6.50 per week more to spend, if they spend the same way and the same amount as before. However, it must also be remembered that all taxpayers earning more than GBP40,000 per year will probably pay considerably more than this in extra tax from April 2011.

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