If cutting VAT worked it would cost nothing
If the VAT cut was going to work in reflating the economy it would be self-financing. The fact that it is costing £12bn proves it is an expensive waste of effort.
The initial days of the 15 per cent VAT rate have proved what most people would have guessed – that a 2.1 per cent price cut is insufficient to make people buy things they had already decided not to buy.
Retailers have had to slash prices by 20 per cent or more to win sales – and much of that business comes from shoppers transferring their purchases from rivals, not from expanding total turnover.
So the Treasury maths are as follows. On every £117.50 worth of VATable goods sold the taxman loses £2.50. On every new item sold because of the stimulation to demand he gains £15. If sales increased by one sixth therefore, the £15 of new tax would pay for the six £2.50s lost on existing sales and the cut would be revenue neutral.
But sales will not increase by one-sixth. Different goods have different elasticities of demand but it is hard to think of any where a 2 per cent price cut would cause a 17 per cent sales rise.
The maths is slightly more complex than that, however, because the VAT cut on some goods – petrol and drink, for instance – was offset by higher duties. That part of the cut should be revenue neutral, therefore and they can be removed from the equation, just like no-VAT items.
Nevertheless, sales of all other Vatable goods – crisps, televisions or adult clothes, for instance – still have to rise by one-sixth to cover the tax lost, and that is still highly unlikely.
Any boost to sales from a 2.1per cent price cut will probably be less than the boost from the posters and point-of-sale marketing boasting of cuts. But that effect will wear off after Christmas whereas the £12.4bn subsidy to our existing shopping will last throughout 2009.
And that figure assumes the Treasury has got its sums right. True the money goes into the economy – some on buying extra Vatable items, some on non-Vat goods, some saved or used to repay debt – but expecting people to pay £115 to save £2.50 was always an idea that would not work.
