Tax and Fiscal Policy

Cutting VAT might kickstart demand but it will have large deadweight costs

Responding to press reports that the Treasury is considering a cut in VAT, IEA Economics Fellow Julian Jessop said:

“It’s good to hear that the Treasury is thinking of ways to lower the tax burden. A cut in VAT, especially if temporary, might help to kickstart demand by encouraging people to bring forward spending. But it would also have large deadweight costs, because a lot of this spending would have happened anyway.

“A few extra per cent off the price at the till won’t make much difference if consumers are worried about their health, or jobs. The main benefit would go to big spenders, who tend to be better off to begin with. And last but not least, it would be expensive: each one percentage point off the standard rate of VAT would cost about £7 billion a year.

“If the government is looking for tax cut ideas, it may make more sense to focus on reducing labour costs, for example a holiday for employer NICs and scrapping the apprenticeship levy. Getting unemployment back down quickly again would give consumers more confidence to spend.”