Despite the original UK implementation of it as a luxury tax, VAT has become a significant stream of government revenue (circa £79bn in the financial year 2011/12). Ed Miliband announced plans yesterday to cut it temporarily from 20% to a unspecified lower level to “boost economic growth.” Labour have implemented this policy before and it is often rolled out to achieve headlines. First impressions make it seem attractive but will it achieve the goal of stimulating demand?
For background it should be understood that retail prices are determined by a wide range of factors including input cost, market competition and perceived value. The key driver after those considerations is the retail price point, i.e. the price at which it appears for sale. A LCD TV which sells for £799.99 does so as to be psychologically under £800, yes that extra penny still does matter in the eyes of consumers. If VAT came down to 17.5% that retail price would not be £783.32. Why should it? Retailers are under margin pressure and face massive costs for implementing a VAT rate change in systems and stores. Perhaps more importantly, that 2.1% price reduction will not influence the customer decision to buy a TV when they were not thinking about doing so. So why would any sensible profit led retailer choose to bring down the retail price? Such products are usually categorised as considered purchases not spur of the moment impulse buys, well at least in my house.
This price point issue flows all the way down the retail spectrum all the way to that £3.99 bottle of wine and beyond. To appease perceptions prices might come down in the very short term but thanks to years of study and research retailers know how consumers minds work. Through promotions, labelling changes and general inability to remember prices one week to the next the bottle will be back up from £3.91 to £3.99 before we next visit our favourite supermarket.
So is there a proposition that is workable? Can a VAT rate change be used to stimulate the economy. I believe it can but it has to be product category specific and highly measurable to the shopper. It has to make a significant difference to consumer confidence. Otherwise it is dead money and just further debt to add to the UK pile. There are a few obvious options. Make gas and electricity VAT exempt or reduce the VAT on petrol/diesel to 12.5%. All the government needs to do then is sit back and watch a feeling of positivity be embraced by the public. That will lead to increased spending on luxury products and improve the economy in general.
So which party is brave enough to propose that?