“Timely, temporary and targeted” was the advice given to the Treasury Select Committee on stimulating the economy by the former US Treasury Secretary Larry Summers in the depths of the 2008 financial crisis.
These words found their way into the pre-Budget documents to describe the immediate 13-month VAT cut from 17.5% to 15% announced by then Chancellor Alistair Darling.
The same phrase was used by current Chancellor Rishi Sunak in his Budget in March to describe the first steps in pandemic support packages. And, following Germany’s temporary 3% cut in VAT, the prospect of a similar tax cut is again up for discussion in the UK.
The policy is certainly timely, because it can be enacted with immediate effect. And because it is reversible, it serves as a temporary stimulus.
In 2008, it was argued that a general VAT cut was targeted because it was aimed at supporting consumer confidence. But that is far more debatable. It certainly was expensive, though. The upfront cost was £13bn over two years, amount to half of the Darling stimulus package.
Most of this shifted spending in time into the cheaper VAT period. The net impact? A 1% increase in retail sales, just shy of the 0.5% overall boost to consumers predicted by the Treasury at the time, according to the Institute for Fiscal Studies.
The argument floating around government earlier in the month was that there was little point in stimulating shops, restaurants and pubs that were not open. Physically enabling trade would be a prerequisite.
The thinking in Germany was to incentivise spending and consumer confidence as soon as retail reopened, rather than see those who could not physically spend during lockdown, and were so forced to save, choosing to maintain high savings.
The point about the temporary cut is to get money flowing in the economy quickly. It has some interesting quirks as a policy. Back in late 2008, 43% of local shops only changed their prices at the till, leaving shelf prices unchanged. It is a considerable logistical cost to do so.
However, the impact on consumer confidence was marked. There was a significant rise in sentiment towards both buying household goods and making major purchases, according to the Nationwide consumer confidence survey.
The major purchases index went above boom time levels and continued even after VAT went back up, but then fell sharply when VAT was increased again under the Coalition in January 2011.
The considerations here are whether the Treasury chooses to make this truly targeted on particular sectors – such as pubs and restaurants, rather than pass further boost to say mainly online retailers.
The cost may be less than normal, too, given VAT revenues are in any case going to be sharply down. But it is still pricey.
Also, it is unclear how much additional difference a 2.5% cut in prices will really achieve on top of already anticipated reopening sales and price cuts?
Wherever things go, a clear decision will be needed quickly. Speculating that VAT will be cut in the near future will simply serve to delay purchases, as consumers wait for an anticipated saving.