VAT was all the fuss about?

Conservatives and their supporters bemoan a cut in VAT. Why?

It is a rather perverse state of affairs when Labour, not the Conservatives, champion tax cuts (albeit temporary ones). Of the policies in today's pick 'n' mix PBR which seemed to incur the greatest ire of those on the right - judged by blog reaction, and the collective animal noises of those on the opposition benches - was the cut in the rate of VAT from 17.5% to 15%.

The principle argument in opposition to the VAT cut is simply that it will not work: a 2.5 percentage point cut in a sales tax is hardly likely to spur consumer spending enough to stave off a sharp recession; business won't pass on the cuts, but boost profits (or at least revenue) instead; the costs to business to factor in the changes will dwarf the benefits of making the cut etc.

This all misses the point. And the Conservatives are missing a trick.

Economically, the policy makes sense - sales tax is regressive and provides a channel through which consumer spending will be directly stimulated (assuming cuts are passed on to consumers), rather than tax rebates which are typically used to save or pay off debt (just look at the US experience from earlier this year - and they are now proposing another fiscal stimulus 25 times our own). Even if business does not pass the cut on to consumers in full, it won't hurt their profit margins in the current climate (and hence their ability to continue employing staff who can themselves continue to spend).

Plus the argument often levelled at the measure - that a change in price from 99p to 97p won't be enough to modify consumer expenditure - ignores the cumulative effect of a VAT cut. The PBR itself suggests that the measure will cost the taxpayer £8.6bn next year - not inconsiderate for a marginal cut in VAT. Cumulatively, the measure may save the average household between £250 and £500 a year. Again not inconsiderate, and more likely to be spent than tax rebates.

But that is besides the point. The Conservatives shouldn't oppose the measure on the basis that it may not work. They should embrace the measure as a cut in an unnecessary and unfair tax (surely a desirable aim for the Conservatives?). Moreover, cuts in VAT are consumer friendly - particularly to those on lower incomes. All parties should commit to maintaining VAT at the lowest possible level under EU VAT area rules - the 15% should remain beyond the end of 2009.

If the Conservatives did so, DC and GO can claim to be both tax-cutting and friendly to the poorest in Britain in one fell swoop. The opposition to VAT may serve a short-term political objective, but it will make it difficult for the Conservatives to emphasies any tax-friendly credentials in future.

PS It was interesting to note the reaction over the weekend to the interview with Kenneth Clark in the Times:

"We can expect to see a lot of Ken Clarke over the next few days; the Tories know that he is still on of their most convincing voices on the economy. His interview in the Times today is helpful to the Tory cause. But it is worth noting that he breaks with the leadership in endorsing the idea of a stimulus package albeit one of a very different stripe from the one Brown and Darling are said to be planning, Clarke favours a temporary reduction in VAT to 15 percent." (emphasis added)

James Forsyth, Spectator Coffee House Blog, 22nd November 2008

Oops.