What Benefits Would The UK VAT Cut Bring?

Summary

• To be a mixed bag, likely to be introduced as a temporary relief measure to businesses
• Could boost spending and consumer demand to a certain extent
• Since the economy is undergoing recession, it may need to be timed correctly- IFS

The UK Government is contemplating over introduction of a temporary reduction in the prevalent rates of Value Added Taxes (VAT) across the nation. It is expected to be announced by early July this year. This could stimulate consumer demand in general and may be targeted to particularly revive sectors critically impacted by the coronavirus crisis like tourism and hospitality.

VAT is a tax which is imposed on products and services at each selling point, wherever value gets added, from raw material procurement to the sale of final goods or services.

To help businesses fight with the corona pandemic’s devastating economic impact, the UK government had announced earlier that deferring VAT will be possible until March 2021 for payments due between the period of March to June 2020. These deferred payments were also exempt from any interest or fine.

At present, the applicable rate of VAT is 20 percent on most goods and services, with some exceptions such as real estate dealings, financial transactions, books, newspapers, children’s clothes etc., where a zero rate of VAT is applicable.

Rates of Value Added Tax Applicable in the UK

(Source: Government of UK)

The Expected Impact

The effect of a VAT reduction is same as that of cut in any other tax, which is that it leaves more money to spend in the hands of people. Hypothetically, with other things remaining constant, a VAT reduction translates into lower prices, with companies passing on the tax-cut benefit to its customers. Companies would thus be able to offer discounts, without taking a hit themselves. A lower price in turn pushes up the demand for that particular product or service, which raises the total consumer demand in the economy.

• Positive

Most of the industry associations are in favour of the proposed VAT rate cut. For e.g. British Retail Consortium, Federation of Small Businesses, and UKHospitality have claimed that such a move will assist in economic recovery across their respective sectors.

Many members of parliament are asking for a cut in the rate by more than 10 percent, at least for the worst affected sectors. A similar move was undertaken in the year 2008 during the financial turmoil period, when VAT rates were slashed to 15 percent for one year, and it did boost the consumer sentiments.

When VAT cut is implemented on durable goods such as vehicles or television sets, it is seen to drive the demand, at least in the short-run. With a rise in demand, production also gets a push and employment rises accordingly in the related sectors, generating a multiplier effect and aiding economic growth.

• Neutral

On the other hand, a recent IFS (Institute for Fiscal Studies) report has warned that merely a VAT tax cut may not be enough to revive the UK economy, grappling with severe recession, and could turn out to be a very simplistic assumption.

The 2008 financial crisis was different as the economic impact was not so deep and widespread, as is being felt during the Covid-19 pandemic. It is quite likely that firms may not pass the VAT cut benefits to the consumers.

It is also possible that despite a VAT cut, production levels continue to remain sluggish since firms are struggling with supply chain disruptions, cash constraints, and the difficulties of delivering output by ensuring social distancing measures in place.

Further, the consumers are fearful of their own uncertain futures and are saving money for the suspected rainy days ahead. They might continue to buy only essentials despite price falls across most goods and services, even if the VAT cut is implemented across the board.

Moreover, when the lockdown opened up, Britain already experienced raining discounts and offers by most non-food retailers, to increase their sales. The third phase of reopening will begin on July 4. So if the demand starts to pick up on its own, the trend of which will be visible with the June retail sale statistics, then a top-up VAT cut will un-necessarily eat into the already falling government tax revenues. VAT collections had totaled up to £136.6 billion for the financial year 2020, hovering at around 6 percent of the country’s GDP (Gross Domestic Product).

Government stimulus measures

Being very well aware of the poor state of the British economy, severely hit by the coronavirus pandemic, the government has already announced a spree of various measures that could help it get back on the growth trajectory. The UK government is running schemes to support businesses with inexpensive corporate loans, helping self-employed individuals with doles, and providing salary relief to furloughed employees. The Bank of England has already pegged the interest rates at an all-time low level of 0.1 percent, and has not ruled out the possibility of negative interest rates, if this doesn’t help.

The public debt to GDP ratio had crossed 100 percent at the end of May 2020, according to latest UK government statistics, and is worrisome.

So what should be done? IFS suggested that while any VAT cut is welcome, but its timing is very important. It should only be introduced at a time when the businesses are in a position to efficiently deliver their output. Probably few weeks of wait is not a bad idea, since the lockdown restrictions are still in the process of being lifted up completely. In fact, the expiry date of the VAT cut should also match the time when economy gets on to a sustained path of recovery.

It is pertinent to note that on Friday 26 June, the corona infections totaled 309,360 in the UK, with a daily infection count of 1006.

So finally, while the British consumers can definitely expect a VAT cut announcement in the next few days, but one can’t be sure how much of it will actually translate into a higher demand for goods and services, given the complexity of issues involved with coronavirus continuing to spread in the nation.