Cutting VAT—hydroxychloroquine for a Covid-ravaged economy

In 2008, at the height of the financial crisis, the Treasury cast around for ways of using the tax system to provide an immediate fillip to the UK economy. Many options were rejected as being too complex, too narrow or too slow to administer. Only a temporary cut in the VAT rate offered a widespread injection of cash across the broad swathe of consumer spending and retail activity. It did not involve the machinery, complexity and risks of cash grants and could be delivered more or less instantaneously.

In the current crisis, if it is the reluctance of the public to spend that stands in the way of economic recovery, or if prices in particular industries are too high to tempt back customers, and if that reluctance to spend is due to lack of bargains or shortage of cash, rather than the fear of contagion or the lack of open shopping centres and restaurants, then a case for VAT cuts may be made.

Indeed, those usual suspects “sources close to the chancellor” are reported in this week’s Financial Times to be considering just such measures, and former chancellor Alistair Darling has called for a re-run of his 2008 cut.

As a man of tax I defer to the judgment of economists. But if a further experiment with VAT is to be attempted, a few truths are worth considering.

-It is a business choice how much of any VAT cut to pass on to the consumer. Recent research suggests they choose no more than half. And not always that quickly.

-VAT is paid by all, but as life’s essentials benefit from VAT zero rates, big spenders pay proportionately more as a share of their expenditure. In this sense the tax is progressive as a share of spending and any rate cuts (if they are indeed passed on) will give more to the rich than the poor.

-Selective cutting—extending zero rates to the most hard-hit businesses—has been mooted. This is dangerous territory. Complexity, definitional shenanigans and unintended consequences ensue from selective tax cuts. Existing zero rates, however well-intentioned, have some odd results. The less well-off receive VAT support for food and children’s clothes. But is zero-rating caviar at £100 an ounce or a £300 Gucci baby bib efficient use of tax reliefs?

-Careless talk costs lives. The lack of any pre-briefing and the swift delivery of Darling’s VAT cut in 2008 avoided the risk of compounding consumer stasis through deferred spending decisions. Now we know a VAT cut is in the mix, who would buy a new car this month if July’s mini-budget might slash the cost?

Of course, a single dose of VAT cutting, appropriately administered, may do no harm to the patient. But side-effects apart, it risks creating a craving for more and reinforces the perennial view of all supplicants to the Treasury that, other remedies having failed, tax must inevitably be the answer.

The 2008 VAT cut proved itself a hydroxychloroquine for some symptoms of a major financial shock. The Treasury has shown itself adroit at supporting businesses and furloughed workers but Chancellor Rishi Sunak and his team of economy physicians should think twice before applying the same measure to a very different illness.

Edward Troup held senior positions in HMRC and HM Treasury from 2004 to 2017