This PBR has been re-spun so many times it must be dizzy. However, in lieu of any alternative (other than - perish the thought! - hearing the announcement in Parliament rather than relying on gossip to favoured journalists), let's assume that there is going to be a cut in VAT.
This isn't what I'd have done. It is, however, what Ken Clarke and the CEBR recommended. I consider this approach unnecessarily dangerous in a way that suggests the concept of the tax cut is misguided - it's only a good idea (only better than leaving well enough alone) if the effects would be the same as an income tax rebate, in which case why not simply cut (rebate) income taxes. I shall explain.
The single most significant danger to the economy at the moment is deflation. If we lose control of deflation when households are so horrifically over-indebted as now, then there will be mass defaulting on loans and this will go from an extremely nasty recession to a disaster movie.
A VAT cut, if passed on, would tend to add to deflationary forces over the next year. Now, it is true that after a year the VAT reduction will "drop out of the statistics", tending to counteract deflation in a year's time. But by then the deflationary momentum could already be decisively in play. I think the idea of trying to create an effective 2.5% rise in VAT in a year's time and thereby raise prices so as to counter deflationary psychology at that point is too clever by half, and too risky by three quarters.
If VAT is to be cut, the only excuses would be (a) if it were believed that firms would not pass on the cuts, and so would take the VAT cut in the form of higher profits, limiting firm failure - unfortunately, the pricing environment is likely to be so keen that this probably won't work; or (b) that most households would take the price cuts as savings, with only credit-constrained households spending extra.
I fear that this technique of fiscal stimulus relies upon the wrong analysis of why fiscal stimulus might be justified. As I have argued previously, the only case I accept for fiscal stimulus is that private sector credit markets may currently be impaired (or become materially so over the next year), so via an income tax rebate now and income tax rises later, we could substitute borrowing via the government for the private sector borrowing that would have occured without the credit market impairment.
A VAT cut seems to me to involve a different, much more Keynesian, sort of analysis. The thought seems to be that "people aren't spending enough" so we need to "boost demand". What Brown wants is for us all to spend the tax cuts - so he is saying that only if we spend do we get the advantage. But it is by no means obvious that extra spending is really desirable. The thing about an income tax cut was that it was a low-risk option - if people saved instead of spent then there was no need for the fiscal stimulus (there was no material credit impairment) and there was nothing lost by it, either (we could always tax the money back). The "demand boosting" route seems to me flawed.
On the other hand, it is certainly possible to exaggerate the difference between consumption and income taxes, and if prices are cut but people purchase no extra, then they are saving anyway - so, again, it's no harm no foul and the VAT cut is just as good as the income tax cut I imagined. So it might be okay, but I'm worried about the psychological effects of deflationary headlines. In the first Thatcher term there was a major tax reform - switching away from income tax to VAT. The government attempted to make this seem less inflationary by trying to get us to use a "taxes and prices index", but no-one used it, and the impression of the VAT increase was that it fueled inflationary expectations. Perhaps we are all much more sophisticated now and the deflationary effects of VAT will be "seen through", but I'll believe that when I see it. And if that was really the concept, why not cut income tax in the first place?