Size Matters

There are a couple of reasons why the rumoured reduction in VAT is more likely to fail than succeed.   One is the fact that much of peoples' basic spending is not subject to VAT and the other is one of relative size.

This change in 'price' highlights a problem that all large institutions face, and a converse benefit in some instances, in that the price change you make looks different depending on which side of the fence you sit on.

For example, if a company with a huge turnover in sales (say £5 billion) of small-ticket items (say an average price of £10) makes a 1% increase in its prices, it sees its income rise by a handy £50 million, but the consumer sees a small price increase to £10.10 - a change they will hardly notice but an increase in income the company takes quite happily.  I've seen this happen in financial institutions before.  This means a company can generate additional revenue whilst not alienating customers.

The converse is true for the Government with VAT.  Here, it costs billions to make a small reduction in the VAT rate, but people will hardly notice a 2.5% reduction in prices - especially in the current climate where they have seen massive increases in food (which is not VAT rated), utilities (which presumably won't see a reduction in the 5% rate) and mortgage/rent costs.  Sure, 2.5% less is better than nothing, but it will hardly cause a stampede to the shops, because, whilst the cost to the public finances is high, the benefit for individuals is small.  It's the relative size issue in reverse, and one that way well work against the Government in this case.

This is one reason why the VAT changes might not make much difference, or at least a difference which is proportionally smaller than the general public is 'paying' in terms of the deterioration in the public finances. 

Another is that the effect on individuals' existing costs is also small, especially at the lower end of the wealth scale.  Much of their budgets is either not VATable (food, mortgage/rent, etc.) or already low VAT (utilities) and therefore not subject to the reduction.

As for those who will see a reduction in their overall weekly/monthly costs, I imagine that most will either put the benefit (however small) to repaying their borrowing overhang, or save it for the tax rises to come later.

And, of course, cutting a few quid off a telly is hardly likely to encourage someone to go further into debt at this point, even if they can.  What HMG seems to fail to understand is how strapped for cash generally people are - and not just low income earners, but also middle income earners.  It's only by either helping them reduce their debts that we can get back to some form of normality.  How much thought has been put into examining a number of individual scenarios, as opposed to broad brush thinking, I wonder...

It will be interesting to see just what emerges later today, but what's been trailed so far looks to me, as a consumer and personal taxpayer, to be hardly worth the effort and wrongly targeted.