Andrew Morrison: Why the cut in VAT is flawed

Andrew Morrison is a chartered accountant based in Glasgow, where he is a Conservative activist and volunteer for Citizens Advice Scotland.

All three main political parties agreed that tax cuts are the answer to mitigating the effects of our current recession.  Where Labour has missed the point, is that tax cuts are beneficial because they remove the need for state planning, which is ultimately flawed in any command economy.  Instead of cutting the tax burden, Alistair Darling merely reconfigures the tax system in a centrally co-ordinated way.  The borrowing figures show what an expensive mistake this is.  Take the jewel in the crown of the Pre-Budget Report: the VAT cut.

What we are crying out for at this point in time is some assistance with the basic necessities, such as groceries, council tax and utility bills.  For a start, the typical shopping basket containing food such as bread, meat, milk, butter and so on, are not charged to VAT because they are known as ‘zero-rated’.  This means the expensive cut in VAT will do nothing to combat the rising cost of the routine supermarket visit.

Domestic electricity and gas supply costs have increased significantly in recent times, which has received extensive press coverage.  What has not received extensive press coverage since the Chancellor’s announcement is that domestic utility supplies are charged to VAT at a reduced rate of 5% - and the lower rate has not been cut.

These essential living expenses are hindering low and middle income families alike.  Cuts in Income Tax would have been effective at helping people when they need it most, for the expenditure they need help with. 

Ultimately though the biggest flaw is how the VAT cut is supposed to trickle-down into consumers pockets.

To demonstrate to you in simple terms, if you go to a barber and pay £10 for a haircut, under the current 17.5% rate, £8.51 of the sale is his, and the balance of £1.49 goes to the Treasury. i.e. the consumer is paying the ‘net’ cost of £8.51 plus the VAT charge of 17.5% combined, and of course 17.5% of £8.51 gives £1.49.

High-street shoppers don’t see the VAT element of goods and services because they are labelled with a comprehensive ‘gross’ price. High-street goods and services tend to be charged at rounded prices too. It would be peculiar indeed to pay £327.19 for a TV, or £7.54 for a haircut, and that is because retailers round costs up to simple amounts such as £329.99 - or £10. As a result of the change to the VAT rate, that £10 haircut will most likely still cost £10, because how many shop keepers will pass on the negligible saving of 19 pence? That would mean £10 becomes £9.81, which would lead the shop-keeper to round up.

The result is the shop-keeper will keep slightly more of his sales and pay the treasury slightly less, but this doesn’t help hard pressed families at all – in fact it will hinder them, because the revenue forgone by the Treasury will have to be paid for in higher personal taxes, if not now, then later.

Of course, criticising ideas without putting forward any alternatives of your own contributes nothing. This will be a charge levied at the Conservatives in the coming weeks. So I will set out what I believe should happen.

I am concerned that as unemployment creeps up, there will be increasing numbers of people for whom VAT rates will become irrelevant; who is going to go out and buy a computer, or a car, if they are facing redundancy? Marginal price cuts for goods manufactured overseas will sustain the retail sector for a while, until people simply do not look at the prices anymore, because they cannot afford luxury goods at any cost.

Therefore, one of the more important things that should be done, and along similar lines with what David Cameron previously proposed, is to relieve employers of the National Insurance cost – the rate of tax which Gordon Brown increased by 1% in 2002, and increased by a further 0.5% on Monday.

The more people who are kept in productive employment, the more economically-active participants the nation has. If there are a high number of economically-inactive people, we will end up with the further problems of deeper social breakdown, a longer recession, a loss of skills, and a fall in national morale. That is why we should campaign to remove as many barriers for firms who employ people as possible.

Employers' National Insurance, which is levied on employers at 12.8% of their workers’ salaries is essentially a ‘tax on jobs’. The money squandered on the VAT cut should have been used to drastically cut the National Insurance ‘tax on employment’ for all sizes and types of business, and also to even offer rebates to firms who recruit unemployed persons who have been out of work for a long time, such as three months.