Has the VAT cut worked?

7:35 pm - February 7th 2009

by Chris Dillow    

      Share on Tumblr

Does Nicolas Sarkozy have a clue? He says the VAT cut had “absolutely not worked”:

Britain is cutting taxes. That will bring them nothing. Consumption continues to decrease.

However, official figures (pdf) flatly contradict this. They show that the volume of sales actually rose by 1.6 per cent in December, to stand 3.9 per cent higher than last December. Of course, there are all sorts of ways to quibble with this data – ordinary noise is magnified by uncertainties about seasonal adjustment processes and the fact that the statisticians’ definition of “December” actually stretched to January 3.

And yes, the CBI and BRC data do show that sales are falling. But these are smaller samples of retailers than official data, and refer only to the value of sales, which would fall as prices fall.

What’s more, one retailer in particular seems to be thriving. John Lewis – one of the few major retailers not run by baboons – says its January trading was “hugely fruitful.”

Far from showing that the VAT cut hasn’t worked, the data has for me had the opposite effect. My immediate reaction was that the cut wouldn’t work, as consumer spending is not terribly price-elastic. But the data has caused me to have a little (only little) doubt about this.

But even if the cut hasn’t worked yet – and we’ll never know the counterfactual – it does not follow that it will bring us nothing. The move has an income effect. If shoppers don’t spend more in response to lower prices, they’ll have more cash left over. Which they could spend. They needn’t have done this already. It’s possible, therefore, that even if the VAT cut hasn’t worked yet, it might eventually do so.

Sarkozy’s dogmatism is, therefore, inconsistent with both data and theory. But I suppose his mind is on other things.

    Share on Tumblr   submit to reddit  

About the author
Chris Dillow is a regular contributor and former City economist, now an economics writer. He is also the author of The End of Politics: New Labour and the Folly of Managerialism. Also at: Stumbling and Mumbling
· Other posts by

Story Filed Under: Blog ,Economy ,Europe ,Foreign affairs

Sorry, the comment form is closed at this time.

Reader comments

Well I’ve got a number of thoughts about this.

Firstly it’s whether – if the VAT cut does significantly effect levels of spending – the aim is worthwhile. Does it improve the sustainability of the economy to encourage consumer spending?

Secondly – the VAT is being paid for from a mixture of increased borrowing (is this a good thing?), “economies” (government employees being laid off), which does not help stabilise the employment figures – which may well be a lot more important than personal spending levels, and lastly and most importantly in 2010 we will have an increase in National Insurance contributions – which adversely impacts on the lower half of the income scale.

To my mind if we were going to spend over ten billion pounds on an economic measure this one seems particularly weak. If we were going to spend this money (and personally I believe we’re paying for it in entirely the wrong way) I suspect it would be more important to focus on jobs and the base of the economy rather than deducting 5 pence from a Starbucks Venti Mocha.

It might have worked slighly, though its difficult to say the small rise in sales was down to the VAT cut… but even then I think it was a poor tool that has had a negligible effect.

Agree with Jim Jay’s last point.

‘UK retail sales values fell 3.3% on a like-for-like basis, and 1.4% on a total basis, from December 2007. By both measures, this was the worst December since the survey began 14 years ago and, barring Easter distortions, the worst performance of any month in that time. ‘…. Not sure this piece has done enough to give a context , its tone is apologetic and I take the writer knows he is talking rubbish.

I agree it must have had a small effect , if I blow and the Atlantic it has a small effect , it must do . So nothing . It was the right idea but we were already over borrowed and could not prusue a tax citting policy. Personally I think VAT was mostly a public relations driven initiative allowing Brown to ditch his rules and call it Keynesian which works for those with no sense of proportion ( Oh how I have laughed at the American parallels yanked out of context) .

The best taxes to drop would be Nat Insurance and income tax as they are taxes on employment as well as removing money from the economy into the dead wood state . This must also be done sustainable which requires cutting government expenditure .
The Party that goes to the electorate with the lowest tax promise will win and that cannot be New Labour .The Conservative problem is not winning it is winning without having made politically impossible promises. The leaves a gap for the ever opportunist carrion feeding Liberals to invent tax cuts but that is a risk a responsible government will have to take .

Incidentally while I discuss the fracturing New Labour settlement it was rather interesting to see that thre wild cat nationalist strikes were organized via the internet . If the Nationalist and conservative working class vote escape the hierarchy of the left then it truly is the end of the left intelligentsia for whom they have paid

PS Sunny see you got a Protectionist elected . Nice work Told you , they next thing I told you was that America was going isolationist under a duvet of multilateral sanctimonious hum bug…. I am always right

4. Caroline Ford

But have prices actually gone down? From my experience the things that were always £5.99 are still £5.99. Some shops took extra off at the till but the high street seems to have absorped the VAT cut. I think the effect on consumer prices has been minimal.

Caroline – I think some have made that cut but the thing is many goods aren’t subject to VAT so there would be no impact there anyway.

More importantly at the moment, many shops are in a massive price war with their competitors anyway so the cut pales into comparison next to the sales – which started just before the VAT cut was announced so it’s almost impossible to unpick.

At the moment, for example, all the shoe shops in cambridge (where I live) have huge “70% off” signs up – what effect the 2.5% reducing on the rate of VAT has had in that context I’m not sure it’s actually possible to tell.

The 2.5% reduction in VAT has cost £12.5Billion. This is roughly the cost of the Olympics, 2/3 of the cost of Crossrail or the cost of a high speed rail line London to Manchester . To me, spending on high quality infrastructure which the country needs is a better use of public money. I cannot see how a 2.5% reduction in cost is going to increase spending when shops are offering 50% cuts already. This is typical example of Brown fiddling to produce an affect rather than something effective.

Hmm, interesting..you see, for me I’d say sales rose in December because there was a seemingly never ending sale going on in pretty much every major store to try and get people spending, and several retailers going bust meant they were selling whatever they could for whatever price.

If you could come back with figures that take that situation in to account I’d be more agreeable about how the VAT cut has worked.

8. dreamingspire

Nobody has yet mentioned the effect of the VAT cut on the RPI – my guess is around 1% – which I think was the reason for the VAT cut.

Dillow really is weak here – you cannot isolate the VAT cut from the unusually high level of pre-Christmas discounting which retailers were doing anyway.

(As Lee basically says…)

“This is roughly the cost of the Olympics, 2/3 of the cost of Crossrail or the cost of a high speed rail line London to Manchester . To me, spending on high quality infrastructure which the country needs is a better use of public money.”

I agree. Unfortunately the number of projects you could throw £12bn at in December and have men with shovels going in in, say, January is fairly small, outside London at least (and even here the most obvious project is being held up by Boris arguing with the DfT). It takes years to work projects up to the stage where they’re ready to go, and unfortunately most of the projects in this state which were merely waiting funding were roads projects, which therefore got the lions share of the cash. Very welcome for petrolheads, and of course it does create/retain employment, but its not really sustainable investment.

What we need are sustainable projects where you are literally just waiting for the money. Here’s one idea – I had the notion a few days ago to find every preserved railway that’s scraping together the money to expand, and giving them cash to build the extension ASAP, perhaps in return for running more frequent public services. This will employ a few people in the construction industry, not be a waste of money and go some way to helping the tourism industry.

Another other option is to find house building projects which are in financial trouble, nationalise them, complete them and use them as social housing, which kills two birds with one stone.

11. dreamingspire

Tom, my thoughts about John McFall (Treasury Committee) and the Newsnight discussion with Kirsty and others echo yours here (particularly about housing) – his Committee should start to be imaginative and specifically targeted, because none of the Ministers are able to do that.

I think it is too early to judge. A VAT cut is not just for Christmas but for a whole 13 months. What does surpise me is that it ends after Christmas 2009. I would have ended it in November and tried for 2 pre Christmas peaks next year.

It should also be remembered that the point was not just to pass the benefit to consumers. The Treasury were quite content for retailers to not pass the cut on and to protect their margins.

What does throw it into doubt is is the scale of the discounting. If a sale price is cut by 70% then the VAT take will be reduced far more by the price and margin cut than by the rate cut. It will be interesting to see the December VAT figures and to see how much of a fall is rate based and how much activity/margin based.

As for whether it was a good use of £12bn there are two questions, the measure and its timing. The measure has been discussed, its timing has not. As a country we have spent £12bn and its not there. Other countries still have their 12bn to spend and perhaps think its effect is better spent accelerating out of the curve rather than braking into the curve. (I have no view.)

13. David Heigham

Dillow is cautious here. The Institue for Fiscal Studies – normally he best critics of Treasury manoeuvres – reckon it is likely to work in full. French fiscal dogma could be summarised as VAT is always a better tax than any other; and their experts are often very annoyed that the Brits take a more pragmatic view of this tax.

To me, spending on high quality infrastructure which the country needs is a better use of public money

If this recession has not ended by the time a high speed rail line London to Manchester has even been started, things will have gone very, very badly. And the next election will have been and gone.

If the government wants to spend money to stimulate spending, as I gather is the idea, what could possibly be quicker or better targetted than a VAT reduction? You can call it a spending subsidy, if you like.

a bit of this and a bit of that.
is the VAT cut part of that tinkering…..hovering around some fundamental issues …. and not wanting to address ’em.

at present, it surely must be pretty scary to be so challenged.

I used to get a few coppers in change when I bought my coffee from Costa’s. They’ve now put the price back up because customers complained. I think it should have been 5%; it should have been substantial. I suppose the profits of the shops are going to be better so les of them will go bust. That’s a good thing.

“at present, it surely must be pretty scary to be so challenged”

at present, for the person with whom the buck stops, it sure must be pretty scary to be so challenged.

Reactions: Twitter, blogs
  1. Liberal Conspiracy

    New blog post: Has the VAT cut worked? http://tinyurl.com/b78h45

Sorry, the comment form is closed at this time.