Will a 2.5% cut in VAT beat the recession? (UK taxation)

Member Name: dbarcl10

Product:	UK taxation
Date:	24/11/08 (459 review reads)
Rating:

Advantages: Could lead to lower prices, but only marginally

Disadvantages: Greedy businesses not passing on the tax cut

The government today announced a cut in the standard rate of Value Added Tax, more commonly known as VAT, from 17.5% to 15%. VAT is a tax on most goods and services, although different types of goods attract a different VAT rate. The different VAT rates currently are:

Standard Rated - 17.5% (15% from 1 Dec 08)
Reduced Rated - 5%
Zero Rated - 0%
Exempt from VAT
Outside the scope of VAT

It is not possible to give a list of items that are standard rated as the list would be endless, instead it is better to assume that all goods and services are standard rated, unless there is a provision in law that entitles the good or services to not be standard rated.

Reduced rated VAT (also known as low rate) applies to domestic energy (i.e. the gas and electricity to heat your home), mobility aids for elderly and disabled people and certain health products, such as smoking cessation products. Generally products are reduced rated to encourage certain behaviour, i.e. to stop people smoking.

Zero rated products include foodstuffs, newspapers and books, public transport and children's clothes. However as with all things, there are always exemptions, such as foodstuffs. Goods supplied as part of catering are standard rated, therefore if you eat a meal in a restaurant the meal is subject to standard rate VAT, whereas to buy the ingredients would be zero rated. A plain biscuit is also zero rated, but cover it in chocolate and it becomes subject to standard rate VAT.

Quiz time - is a Jaffa Cake a biscuit or a cake?

United Biscuits, the makers of Jaffa Cakes, actually went to court for a ruling on this question! The importance lay in the different tax treatment of cakes and biscuits, as cakes are zero rated (being considered a necessary food item) whereas biscuits either wholly or partly covered in chocolate are, by law, considered a luxury, and are therefore subject to the standard rate of VAT.

The court decided that Jaffa Cakes are indeed cakes, as on becoming stale they go hard (unlike biscuits) and are made from egg, flour and sugar (similar to a cake mix). The fact that they are often marketed as biscuits and sold beside biscuits wasn't important.

The rent of a business property, unless subject to a valid option to tax, is exempt from VAT (which is different from a VAT rate of 0%) as are loans and most financial transactions.

Items sold that are outside the scope of VAT include items bought or sold outside the UK, or items that are sold by a business, but have never been used by the business.

Now that I have given you some background to VAT, I want to discuss whether a cut in standard rate VAT will have the effect desired by the government - an increase in consumer spending.

Given the short time given to implement such a change, it is unlikely that many businesses will be in a position to immediately cut their prices. I can't imagine many businesses will change all their prices from 1 December 2008, reducing the majority of prices by 2.5%.

Think of the time that will be required to re-programme till systems to recognise and calculate a 15% VAT rate. Add to that the time, and expense, in changing the prices on shelves, changing paperwork, etc and it is unlikely that prices will drop for quite a few weeks.

Indeed some businesses will no doubt see the VAT cut as an advantage to them. They can continue selling goods for the same price, but pay less tax over to the taxman, and keep the difference for themselves.

Certainly some businesses will be in a position to implement the new standard rate soon, and will need to charge a reduced price. Places like Costco and Makro, where goods are displayed at the value before VAT, with the VAT charge being added at the checkout will need to start charging 15% as soon as required. However these shops do not sell to the general public, just trade businesses, therefore small businesses will be able to benefit from reduced prices and a higher share of their sales.

This will also apply to any services where the cost is invoiced, such as phone bills, which from 1 December 2008 will need to show a VAT rate of 15% rather than 17.5%.

What were the alternatives? If the government done nothing, the country would have been in danger of entering a deep and long lasting recession, with hundreds of thousands of people being made redundant, and looking to the government for benefits to allow them to feed themselves and keep a roof over their heads. This in itself would have cost billions of pounds and the government would have had less tax revenue coming in to pay for it, forcing the government to borrow more.

By reducing the tax rate, the government is trying to kick-start the economy, by effectively giving people more money to spend, which will keep shops open, and keep factories open to make the goods to sell in the shops.

Unfortunately, this tax cut may have a negative effect on one group of people who the cut was probably intended to help - the small businesses. They will have to spend a considerable amount of time and effort updating their systems and re-pricing their goods, and it may take a while for them to recoup the money that they could ill afford in the first place.

I think the government should be applauded for trying to kick-start the economy, giving people more disposable income to spend, which in turn keeps the shops open and the factory producing.

On its own I don't think a 2.5% cut in VAT will be enough to revive the economy, but as part of a raft of measures, I think, and hope, that any recession will be short lived.

Thanks for bearing with me on this one!

Summary: Will 15% VAT be enough??