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.”

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The 2.5% VAT cut is reasonable but:

a) It might not be passed on – how is it that the underlying sale price plus VAT always “magically” comes out at £19.99 or something similar? Do we really think that with the cut now mean that all such items appear in the shops at £19.56? Of course not! Retailers have always fixed the prices to be these absurd “magic” levels and arent about to break them now.
b) It is temporary. When it is increased again it will hurt proportionately to how much it was passed on.

The 45% rate, well! It:

a) Blows apart Gordon’s hollow argument that abolishing the 10p rate was about simplifying the tax system by removing a band – because now just a few months later he has added another one again! He is clearly making policy on the hop. This shows that abolishing the 10p rate was a political stunt designed to out-manoeuvre the Tories, and so is this new 45% rate.

b) It raises such a tiny amount of cash (£1.5bn) that even a slight push of top earners towards more tax avoidance will wipe it out completely.

The Lib Dem proposals to pay for our tax cuts now by closing loopholes used by those with cash to spare and cut income taxes directly for the poorest still are by far the best package on offer.

by Mark Wright on November 24, 2008 at 11:54 am. Reply #

The argument Trevor Kavanagh makes against VAT cuts can equally by applied against the Lib Dem’s income tax cuts.
Of course the Lib Dem cuts are much bigger, although they only apply to those on low incomes who are in work, and not those out of work.
However the more fundamental point is that more money in your pocket can pay off your debts and pay your fuel bills.
Going on a spending spree would be silly, that is why we got in this mess in the first place.
Interesting to note that Vince Cable now accepts the principle of the higher tax rate on high income earners.

by Geoffrey Payne on November 24, 2008 at 12:04 pm. Reply #

Hi guys, I found some debates about the PBR here: http://www.debatewise.com/pre-budget-report Currently LabourHome have a link to this but we should join the debate as well so it doesnt get too onesided!

by B on November 24, 2008 at 12:06 pm. Reply #

Geoffrey – what you’re forgetting is that Vince was rightly convinced that there was an even better way of redistributing wealth than higher income taxes at the top end. Closing the top-rate pensions relief and other tax loopholes raised more cash in a more efficient way – that was why we dropped the 50p rate, not because we were opposed to the rich paying a bit more.

I find it ironic that Labour sees fit to steal our policies only when we discover and even better way to do the same thing! Duh…

by Mark Wright on November 24, 2008 at 12:14 pm. Reply #

I think the cut in VAT is ok but let’s be honest it isnt really worth alot is it?? I read in the centre pages of the Indepedant the reductions but it doesnt make an awful lot of difference so i see it as a bit of a gesture to be honest…

by Darrell on November 24, 2008 at 2:02 pm. Reply #

Raising income tax is a necessary move by Darling, though it’ll be eaten up by the ID cards and worthless IT projects.

Tax avoidance is bound to dwindle with an Obama administration in the US and increasing worldwide hostility to tax havens. The argument that tax avoiders will always find a way is unconvincing, a similar argument could be made about currency forgers.

by Anax on November 24, 2008 at 2:08 pm. Reply #

Anax,

Well quite…taken together these measures still do not amount to an awful lot do they?? What they really amount too is getting Labour on a good pre-election footing…Darling really should rename this the ‘Pre-election budget report’….

by Darrell on November 24, 2008 at 3:18 pm. Reply #

Common sense says that the country will have to repay the deficit created by this VAT cut at some point. The 5% raise on income tax for high end earners will generate around £1.5 billion a year, so it will take just a measly 10 years to cover the deficit created in a single year! The government have already been forced to admit they were ‘considering’ raising the VAT rate to 18.5% in 2011. There is real reason to suspect the government will go ahead with these plans at some point – not only because they would generate an extra £5 billion a year! Add to this the fact that NI contributions will rise for everyone in 2011 as well, and you start to wonder if the government even realise there is a recession on….
[Shameless Plug:]
I cover this topic and the whole VAT Rate Change topic on my own blog http://vatratechange.co.uk – I’d love to know your oppinion on what I’ve been saying – I’m not an expert by any stretch of the imagination, I’m just putting 2 and 2 together and realising the government is putting together one giant scam!

by Liam Wiltshire on November 29, 2008 at 1:11 am. Reply #

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