The VAT cut and higher-rate income tax increase: what will be the impact?

by Stephen Tall on November 24, 2008

According to the widely-leaked reports of the Chancellor Alastair Darling’s pre-budget reports, we can expect the following measures:

VAT: Temporary 2.5% cut
Income tax: 5p increase for top earners after next election
Vehicle excise duty: Postpone planned increase
10p tax rebate: Extend for another year
Corporation tax: Next rise postponed

The Lib Dems’ Vince Cable is sceptical of the impact of the measures, especially the temporary cut in VAT: “The principle of tax cuts we don’t question – you have to have a tax cut – but a small and temporary reduction on value added tax may not have an effect”. Instead he once again urged the Government to follow the Lib Dem proposals to cut income tax for low- and middle-income earners to “give people their own money back … which they can then choose to spend themselves. That’s a better way of doing it”.

There are two impacts by which the success of these measures (assuming the leaks are accurate) will be measured: the economic and the political.

The economic: will a 2.5% drop in VAT, together with the other measures, really stimulate the economy? The Sun’s Trevor Kavanagh won’t be alone in his scepticism: “If you’re deep in debt, scared of the sack and watching your miserable pension pot evaporate, will you celebrate with a bottle of wine tonight to save 15p? Or splash out £500 on a plasma TV to save £12.50? If you’ve got £12,000 in a building society, will you keep it there or save £225 on a new car? Probably not, especially when you’re going to have to pay it all back later, with interest.”

The political: regardless of the actual effectiveness of these measures, how will they be perceived by the public? The Tories’ immediate response has been to condemn “the politics of envy”, a weak charge in the current economic climate. They’ll need to strike a less defensive pose in the coming weeks if they’re not going to be outmanoeuvred by the Prime Minister. As Jackie Ashley puts it in today’s Guardian: “What is important is that Brown seems to know what he is saying and has some apparent confidence that we will get through it all – this matters much more than the fact that he’s had to eat his words from the good times. He’s an experienced man who’s getting on with the job. He may be taking a huge gamble with our money, but just now impressions count.”