Cutting VAT (might not) won\’t work

Wish I\’d thought of this myself. But I didn\’t.

Between businesses of course the VAT rate doesn\’t matter, unless you want to argue minor points like cashflow.

In order to work, to provide a fiscal boost, VAT needs to change the prices paid by consumers in the shops.

But prices aren\’t determined by anything so logical as taking costs, adding a margin and then adding VAT. For almost all products, prices are set at "price points" which roughly approximate to what you would get if you did indeed do that calculation.

If by calculation you end up with a price of £1.03 then you\’ll probably have a retail price of 99p and take the lower margin. Ditto calculation to 96p and take the higher margin at 99p. Or £410 and £399 and £370 and £399.

So if items are priced at these price points, at £0.49, £0.99, £4.99, £49.99 and £499.99….how much difference is 2.5% off the 17.5% rate of VAT going to have?

Other than to widen retailer\’s margins, of course?

In other words, will the consumer see anything other than the most marginal benefit?

Further, let\’s say that it is indeed retail margins which will benefit from this. That will indeed turn up in their profit margins. Which we\’ll all be seeing the reports of in 14-18 months time.

Errm, that\’s quite a long time to be waiting for the visible effects of a fiscal boost, isn\’t it?

I guess the real measure of the effectiveness of this, umm, measure, depends on how much of consumer spending is subject to pricing at price points. Anyone know?

12 thoughts on “Cutting VAT (might not) won\’t work”

  1. Good point. There are questions about whether the VAT cut is (a) a populist gesture and/or (b) financially justifiable. But if it’s a populist gesture that turns out not to be popular, it surely fails on all counts.

    Presumably the Xmas retail sale figures will provide some test. Of course we’ll never know what they would otherwise have been, but if they still come out badly, that will tell us something.

    If you were seriously worried about the possibility of losing your job next year, would a 2.5% price cut (even if it all came through to you) tempt you to spend more?

  2. For sure, price rounding up happens. But there will be quite a few prices where the VAT cut trips a threshold and the price can come down a notch.

    Even if the retailer pockets it, the cut will show up immediately in their ability to defer redundancies or bankruptcy.

    I’d have preferred a raising of the tax thresholds, but that’s a right royal pain in the arse mid-way through a tax year. What else can Darling do at short notice? Tax credits? Pah!

  3. With tax incidence so hard to determine, all discussion about tax cuts should be reduced to one question: do we want the government to spend more or less of the total wealth produced in the economy?

  4. “do we want the government to spend more or less of the total wealth produced in the economy?”

    Well, with a 46% marginal tax rate the Government is pretty clear on what it wants..

  5. it would be nice to think that someone in the Government (and on the Left generally) had realised the “joined-upness” of things. Eg, if you prevent banks paying bonuses – then instead of getting 40% income tax on the bonus, the government only gets 30% corporation tax on the bonus not paid out.

  6. If you believe the Big Fat Lie that VAT is a tax on consumption ‘borne by the consumer not the producer’ you won’t understand the point of the VAT cut.

    However, if you understand the distinction between ‘legal and economic incidence of a tax’, you will realise that it is a tax on turnover (or, if Kay Tie twists my arm, a tax on gross margins, let’s not split hairs). Ergo it is a tax on business.

    I don’t expect that businesses will ‘pass on’ the VAT cut, because retail prices are set by supply and demand in the shops. If M&S have to cut prices by 20%, then they will.

    But the reduction will allow businesses to keep an extra 1.85p for every £1 gross turnover, which might be enough to keep a few more businesses afloat than would otherwise have failed.

    And let’s not forget that once you strip out banks and North Sea Oil, the rest of UK plc pays four times as much in VAT as in corporation tax. So a 2.5% VAT reduction is worth as much to them as a 14% reduction in corporation tax.

  7. “So cut corporation tax and reward success.”

    So out of A) cut taxes in a way that allows firms on the margins of survival to survive, whilst helping all firms B) cut taxes in a way that only benefits firms who’re already making lots of money and have no risk of not surviving, you’d choose B? Hatstand.

  8. I’ve been thinking about tax schemes fairly carefully for almost 40 years (and for another 20 years before that–less carefully). The only conclusion that I’ve been able to reach is that there is no “solution” to the problems, no matter from which angle viewed.

    In the short run, all changes in the incidence and magnitude of taxes will injure the interests of some to the (partial) benefit of others; in the long run, market-price changes and activity will tend toward an economically-sensible (I was going to say “fair” but there’s no such concept involved) distribution of the burden.

    Nobody LIKES taxes–even including those whose incomes are dependent upon them; everyone wants to escape them as much as possible but also doesn’t want to be viewed by his fellow men as a shirker of his righteous duty.

    I’d emphasize (by repeating) that the largest perceived inequities in taxation will occur with changes—and those especially in the short run.

    The (rational) tendency of legislators is, insofar as possible, to minimize the visibility of tax increases the incidence of which is likely to burden an appreciable fraction of their partisan constituency. In practice (since even majorities are never monolithic), the necessary compromises, especially with ideologic opponents, tend toward a regime of lower and lower rates of taxation applied to more and more of the potentially taxable activities and a preference for taxation the incidence of which falls on those not directly burdened by either the tax or changes thereto (but who must, in turn, include the tax or tax change in prices to consumers). Myriad (and distributed) taxes indeed serve best the interest of the legislators and anger fewer taxpayers at a lower level of intensity. But, simultaneously, such a tax regime is enormously expensive, consuming vast labor resources both in administration, enforcement, and compliance. The downside of the simpler tax regimes is (at least in the short run, which is the most important visible consideration both to legislators and the public) is the starkness of the differential burdens on various payers, the high value of the “premium” they thus engender to the benefit of avoiders (legal) and evaders (illegal), and the disarrangement introduced into previously-established economic processes and relationships.

    My conclusion about the matter of taxation is that it is WORSE THAN USELESS to spend the time and intellectual energy currently dedicated to discussion and organization surrounding the matter. The only constructive avenue, the only efforts worthy of expenditure (because of the relative likelihood of melioristic change) is in the direction, both generally and specifically (and in every aspect of existence) of REDUCING GOVERNMENT INTERFERENCE
    in every nook and cranny of everyday life. The reduction in laws (government) will translate immediately into a reduction in the expense of those remaining. EVERY unsatisfactory area of governmental interference is OPPORTUNITY for improvement through elimination. Don’t worry that you’ll go too far—such problems can be addressed once they’ve arisen.

    It may be true that the market cannot provide certain essential services people currently expect from their governments: they are few. Moreover, when those manageable by the market are the norm, the few remaining to authority will be so inexpensive that just the difference will be sufficient to render everyone
    far more prosperous than can be presently imagined.

    And that’s the entirety of what I have (or am able) to say on taxes.

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