A temporary VAT cut could help stimulate the U.K. economy, but only if it is timed correctly, a think tank said amid reports that the government may announce a cut in July.
The United Kingdom is in the grip of the sharpest economic contraction since records began, researchers at the Institute for Fiscal Studies (IFS) said in a June 26 briefing note. This recession is unusual in that it is largely the result of deliberate shutdowns for the sake of public health, they noted. The government announced on June 23 plans to ease the lockdown in England starting July 4.
Chancellor of the Exchequer Rishi Sunak is “drawing up plans for deferred tax rises and cuts to public spending in his autumn budget after he delivers a further fiscal stimulus for the U.K. economy in the weeks ahead,” the Financial Times reported on June 21.
Fear of the Virus
“If consumer demand rebounds slowly as we emerge from lockdown, the government will need to think about measures to stimulate the economy. A temporary VAT cut could play an important role in a broader mix of policies aimed at boosting output and employment, but only if implemented under the right conditions,” Peter Levell, IFS senior research economist, said in a statement.
“There is little point introducing a VAT cut if continued fear of the virus, or continued social distancing restrictions, mean that firms are unwilling to cut prices or consumers are simply unwilling to spend,” Levell added. The IFS researchers noted that supply is still restrained by social distancing measures and that it is not yet clear how much stimulus will be needed when consumers are able to spend more freely.
A temporary VAT cut will be most effective as a stimulus when social distancing measures are no longer limiting supply, when firms are considered likely to pass a VAT cut on to customers through lower prices, and when uncertainty and fear of the virus have reduced, the authors suggested. A cut should not be announced in advance because “that would lead consumers to delay purchases to when the cut comes into effect,” they said.
The researchers pointed out that a temporary VAT cut during the crisis may be less effective than the cut made in 2008 by Labour Chancellor of the Exchequer Alistair Darling as part of a stimulus package following the global financial crisis. “If you want to stimulate the economy, the most obvious thing to do is a time-limited VAT reduction,” Darling told the House of Commons Treasury Committee on June 4.
The passthrough of the VAT cut to consumer prices is crucial, but consumers’ responses to price reductions may be limited by continued fear of the virus, and uncertainty over future economic conditions may make consumers “particularly careful about purchasing expensive durable goods . . . [and] reluctant to bring forward purchases,” the IFS researchers said.
A lower VAT rate for the tourism sector is “one option being discussed,” according to those close to the chancellor, the Financial Times reported. The IFS researchers identified some potential advantages and disadvantages of a targeted approach.
Javid Calls for Review of U.K. Tax System
Separately, former Chancellor of the Exchequer Sajid Javid, who resigned in February, and the Centre for Policy Studies (CPS) have set out a “vision for economic recovery” after the coronavirus pandemic. “Javid is calling on the government to review the U.K. tax system and rewrite the fiscal rules to prioritize balancing the budget, but only after the recovery is secure. Recommendations include significant temporary cuts to employers’ National Insurance [contributions] and VAT to boost employment and growth,” the CPS said in a June 23 release.
The CPS report, titled “After the Virus,” sets out a program for economic recovery that “combines the new drive for leveling up and public investment . . . with the pro-market, low-tax agenda the CPS has always championed,” CPS Director Robert Colvile said. The report recommends “a general shift away from taxing incomes and profits towards fairer, more progressive taxation of property and tightening reliefs which favor the wealthy.”
Social Distancing Rule Relaxed
Prime Minister Boris Johnson announced on June 23 a series of measures to “safely ease the lockdown” in England. Following a review, the 2-meter social distancing rule will be relaxed from July 4.
“Where it is possible to keep 2 meters apart, people should. But where it is not, we will advise people to keep a social distance of 1 meter-plus, meaning that they should remain 1 meter apart while taking mitigations to reduce the risk of transmission,” Johnson told members of Parliament.
Pubs, restaurants, and hairdressers will be able to reopen on July 4 providing they adhere to “COVID-secure” guidelines, Johnson said. The government published on June 24 guidance intended to help those businesses reopen safely. Further guidance issued on June 25 sets out plans to help pubs, restaurants, and cafes serve customers outdoors.
Separate guidance published on June 24 outlines processes and facilities that businesses in the tourism sector must put in place before reopening on July 4.
Finance Bill Amendments Proposed
MPs will debate the finance bill at its report stage and third reading in the House of Commons on July 1 and 2. Amendments and new clauses proposed in the period leading up to June 24 include the new provisions on taxation and recovery of coronavirus support payments, and changes to the statutory residence test in connection with COVID-19.