Why cutting VAT is a bad idea (right now)

 Hi All,

According to the news feeds the latest great idea from Thatcher Clone 1 is that VAT should be cut to zero or 5%. This is a bad idea and will only make matters worse. For those who don't know VAT is a sales tax paid by the end consumer of the product i.e. you and me. It is currently 20%, but 5% for domestic utility rates. 

The reason why Truss thinks this is a good idea is that a £100 item could in theory be reduced to £80, thus helping people out in the sense they will go on an spend and lift the economy. 

The problems are : 

1. The current crisis is about food and energy costs .Most basic staples don't get a VAT charge anyway, so there would be little of the relief people are asking for  and domestic utilities only charge 5%, which would mean that the increase is mitigated to only 75% and that is before the even bigger increases expected in January and February. The reduction in VAT for petrol (gasoline as Americans call it) would be welcome, but there is no legal requirement for a company to pass this on, in fact as energy producers  are subject to windfall taxes, they are likely to just keep a £100 bill at £100, if not raise it. 

2. As for the rest of the economy, there is as noted above, no legal compulsion to reduce a product in line with a VAT reduction and companies- struggling themselves or out to increase their margins, take your pick- are highly unlikey to pass on any tax reduction to the consumer. I remember this to be the caese way back in 2008 when Labour Chancellor Darling reduced VAT from 17.5% to 15% for a couple of months, wherein many companies simply took the cut onto their own profit margin, rather than pass the cut onto the consumer. 

3.If most companies do not pass on the VAT cut then when this is reversed by the government it will see prices automatically rise by 20%, thus adding further to inflation. 

4. If we do see companies pass on the VAT cut, then when it is reversed it will raise prices by 20% and thus create inflation.

5. VAT is a consumption tax, thus reducing it is supposed to encourage people to spend when they might not ordinarily do so. Except that because the increase in energy bills is not addressed by this idea, then it is doubtful that most people will have any spare cash to spend, even if there is a 20% price reduction.