VAT cut would bring mixed benefits, IFS says

The boost to Britain’s economy from a temporary cut in value-added tax (VAT) would be smaller than in 2008, and any reduction needs to be timed carefully, a leading think-tank warned after media reports that a cut is likely next month.

Chancellor Rishi Sunak is due to make a statement on the public finances in July, as Britain lifts coronavirus restrictions and begins to recover from its sharpest economic shock in centuries.

A one-year reduction in the rate of VAT last took place in 2008 to soften the immediate impact of the global financial crisis, but the Institute for Fiscal Studies (IFS) said the arguments for doing so again were “mixed”.

“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,” IFS researcher Peter Levell said.

Unlike in 2008, businesses’ capacity to meet higher consumer demand is limited by coronavirus restrictions, and people’s incomes have been boosted by a government job support programme, the IFS said.

Any cut would need to be timed carefully to boost demand only when businesses could cope with it, and risked subsidising a rise in spending that would take place anyway.

“The government is perhaps better off … waiting to see how quickly consumer spending recovers over the coming weeks as fears of the virus recede before deciding whether and how to implement it,” the IFS said.

Shops selling non-essential goods reopened on June 15, and pubs and restaurants will be able to restart operations on July 4.

Official data showed a partial rebound in retail sales in May after they collapsed by nearly 20 per cent in April, though many retailers are pessimistic about the chances of a full recovery.

Restricting a VAT cut to the hardest-hit sectors such as hospitality was an option, but would favour richer households who spent more on non-essential services and who were also likely to save money rather than spend it again, the IFS said.