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Is a Cut in VAT the Answer?

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Is a Cut in VAT the Answer?

In the face of almost daily evidence that many economies are slipping fast into recession, financial experts are doing their best to come up with answers to the growing problem of a seemingly insurmountable global credit crunch.

If last week it was the turn of interest rates, this week economists and financial experts have shifted their attention to taxes. Not income tax rates – the target many people would have prefered to see – but VAT rates. The Centre for Economics and Business Research (CEBR) believes that a 5-point reduction in the UK VAT rate would go a long way to helping consumers fight the credit crunch. The CEBR proposes reducing the current standard VAT rate from 17.5% to 12.5% for a period of 2 years.

The European Union (EU) sets the minimum VAT rate permitted in any EU member country at 15%, although it does allow for temporary derogations of this rate. Within the 27-member union, there are currently only 2 states (Cyprus and Luxembourg) with the 15% rate. The UK’s 17.5% rate is lower than average and other countries have considerably higher rates. Denmark with 25%, Poland with 22% and Ireland with 21% are just 3 examples.

According to the CEBR, the reduction in VAT will kick-start the economy by making more money available for consumers from the moment the rate is cut. A further advantage advocated by the CEBR is that a VAT reduction will have no negative effects on businesses.

The proposal has sparked plenty of debate and many financial experts have welcomed the proposal. “A reduction in VAT is certainly an interesting idea,” comments Ken Thorkildsen, Director of Obelisk Private Finance, “but this may not be the best way to put more money into consumers’ pockets.”

Ken believes that income tax reductions would be more effective and also have an important psychological impact. “I feel that with a VAT reduction there’s a danger that retailers may use this as an opportunity to fill up their profit margins,” says Ken, “thereby defeating the objective in the short term. And everyday items such as groceries and utilities will be unaffected by a VAT cut. However, any move that helps relieve the financial burden on consumers is extremely welcome.”

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