Why VAT increases won’t work.

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If it is true that VAT is to be cut by 2.5% to 15% in today’s pre-Budget report this is a mistake.

The cost is reported to be £12.5 billion, a proportionate part of the £84 billion the tax was meant to raise this year. This will make such a cut a major part of any stimulus package. But this will not solve the real problems in the UK economy.

There are several reasons why this is so. First, let’s be realistic. On an item costing £4.99 the VAT saving will be under 11p. Can you see anyone shifting that price to £4.89?

On £500 (VAT inclusive price) the saving is £10.60. That’s neither here or there: if you are going to spend £500 then £10.60 or so will not change the decision. Other influences are much stronger.

So at low price points this is a boost for the retailer who will take much of the gain. I really do not expect them to pass this on. At high price points I doubt the impact.

Either way the saving goes to marginal jobs in the UK, and Woolworths won’t be saved by this, whilst cheap imports are the only likely sector to see a boost. The business to business sector will see none at all: VAT does not impact them.

But it’s more than that: this might fuel deflation, which we can ill afford. So it’s a mistake.

VAT is regressive, but not as badly as some taxes (e.g. council tax) so the poorest who need help will not benefit most.

And VAT will be hard to raise again.

When we badly needed jobs we get a credit boost when credit is in short supply and the government is taking no action with the banks to make it available. Nothing about this makes sense.

We could work our way out of a recession with the right boost for new jobs: the one thing we can’t do is spend our way out of recession and yet that is exactly what the government is trying to do.