Saturday, November 22

The PBR and VAT

Speculation is mounting of a deferred increase in VAT to pay for a borrowing splurge. That could be politically indefensible from a Labour chancellor. 

The Spectator's Coffee House blog today picks up a blog post by Robert Peston about Monday's Pre Budget Report, in which Peston predicts:
So which taxes will rise?
Well my prediction is VAT.
For the sake of transparency I should say that I don't know that there will be a VAT rise.
But a deferred increase from 17.5% to 22.5% in the VAT rate would raise around £20bn.
And it's one of the few future tax rises which might actually stimulate a bit of increased economic activity ahead of its implementation, rather than encouraging us to save.
To use the economic cliche of the moment, it would give us all quite a "nudge" to spend now, before the swingeing increase in VAT would kick in.

Sales taxes are regressive taxes - those on lower incomes tend to spend a higher proportion of their income on goods and services, and so spend more on VAT as a proportion of their income than those on higher incomes.

Necessary goods - food, energy, transport, children's clothes - are either zero-rated or reduced-rate VAT items, which admittedly accounts for some of the more significant expenditure by households. But zero- and reduced-rate VAT levels recognise the regressive nature of ad-valorem taxation.

Which is why it is puzzling a deferred rise in VAT might feature in a Labour budget. Ultimately, those on lower incomes will pay a higher proportion of their income in sales taxes in order to fund a stimulus for all today. This seems peverse to me.

If anything, the Chancellor should cut VAT to the lowest permissible rate under the European VAT area, which is 15%, as part of the stimulus to encourage greater expenditure. Exactly how he would pay for it is quite another question...

UPDATE: I've just discovered an interview with former Chancellor Ken Clarke in this morning's Times in which he advocates a temporary cut in VAT to 15%. I hadn't read the article before making my post, but the reasons Ken Clarke makes his suggestion are essentially the same as mine - a reduction on taxation on expenditure is more likely to stimulate spending, than tax rebates (which are more likely to be saved...).

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