We see in the news today that Shadow Chancellor, Ed Balls is urging the government to temporarily reduce the rate of VAT to stimulate the economy. Good news dare I say it for VAT advisors, but would it be good news for the economy? Karen Mulcahy looks at all the angles.

If we think back to the last reduction in the standard rate from 17.5% to 15%, this is credited with maintaining a higher than expected level of consumer spending during the economic crisis.  However, when the rate reverted to 17.5% at the beginning of 2010, spending stagnated. With a further increase to 20% on 4 January 2011 consumer spending in the period immediately prior to the increase escalated, but spiralled as soon as the new rate took effect.

But what will a further temporary reduction in VAT achieve?

For consumers, a lower rate of VAT would give them a great opportunity to reduce the impact on the domestic purse at a time when spending power is being stretched. As VAT is a tax on spending not income, consumers would feel encouraged by a reduction of VAT.

For businesses, however, it would be a  further complexity to an already complex regime in which they have already had to suffer the administrative cost and inconvenience of variations to the standard rate over the past few years.

Costs include software revisions, employment related expenditure and general overheads all of which need to be wrapped up into the price charged by the business to its customers.  This means that, at the end of the day, the consumer is still paying the price – it’s just called something else!

Of course, from a tax perspective, The Exchequer still needs to balance its books and any decrease in the take from one tax must be countered by an increase in receipts from another tax. However, the theory is that a decrease in VAT will lead to a higher VAT yield as consumers will have more confidence and consequently spend more – albeit that it is the consumer currently suffering with less cash to spend!  As mentioned above, the software businesses hired to assist with the rate change software will have extra work and probably enhance their own profits – leading to more additional tax.  In addition, the businesses affected by the change, and having to employ more staff (or extend employment hours) will end up paying more in PAYE and NIC.

 We will have to wait and see whether the call is answered.