VAT Cut: Success or Failure?
Small businesses up and down the country have been fighting against the effects of the credit crunch and economic downturn over recent months. Official figures confirmed last week that the UK has spent the past six quarters in recession - the longest period of negative economic contraction on record.
Retailers have borne the brunt of the downturn, with many consumers choosing to reduce their spending due to job insecurities and tighter credit conditions from banks. However, in response, a major government policy has been put in place to stimulate retail spending and protect businesses from collapse: reducing the rate at which VAT (Value Added Tax) is charged from 17.5% to 15%.
The temporary reduction, imposed in November 2008, is scheduled to be reversed on New Year's Day 2010. With retailers getting into the swing of the crucial Christmas period, analysts are considering whether or not the policy has been a success.
Reducing taxes, reducing revenue
VAT was originally reduced following last year's Pre-Budget Report from chancellor of the exchequer Alistair Darling. The tax cut came alongside increases to alcohol and petrol duty - and reflected concern that the economy was facing a precipitous decline in output caused by the global credit crunch. At the time, Mr Darling said that he was taking "exceptional measures" to avoid this scenario. A year later, official figures show that the economy is still shrinking - but that the rate of contraction has slowed. GDP dropped by 2.4 per cent over the first quarter of 2009, but by only 0.3 per cent over the third quarter.
Apart from its immediate economic impact, sceptics will also point to a potentially damaging side-effect of the VAT cut. By reducing tax rates, the government reduces its own revenues - exacerbating deficits in the public finances. This concern becomes particularly relevant during recessions, when rising unemployment and shrinking business profits lead to falling PAYE and corporation tax revenues and increasing benefits claims. The government's own figures suggest that the UK will build up a record £175 billion in net debt during 2009 - a total which is partially attributable to tax policies. Figures from the National Audit Office also suggested that the VAT reduction directly resulted in a drop of £6.4 billion of government revenue over the 2008-09 financial year.
Rising sales
A more immediate concern with the VAT cut is its efficacy in boosting sales. Latest retail figures seem encouraging on this score, with apparent improvements in economic conditions being reflected by people's willingness to shop. The latest distributive trades survey from business group the Confederation of British Industry (CBI) indicated that retail sales for November 2009 rose at their fastest rate for almost two years. Retailers also responded to the question of whether corporate conditions were getting better or worse more positively last month than at any time for over five years.
While there seems little doubt that the environment for retailers is getting more positive - and could continue to improve into Christmas - the question of how much this change is attributable to the VAT cut remains open. Shoppers could have become more willing to spend for a variety of reasons unrelated to tax, such as an improvement in the willingness of banks to lend.
Advocates of the tax cut would suggest that the apparent sales surge represents people buying high-value items for less before the "deadline" of New Year's Day. Commenting on the CBI figures, Richard Dodd from the British Retail Consortium said: "I think the VAT cut has made a modest difference to improving retail sales.
"Therefore the fact that VAT is going back up again will only make a modest difference to sales. There is no question that things are better than they were 12 months ago but we are still not out of the woods by any means. People are still worried about jobs, worried about things like taxes and public sector jobs and how they might be affected after the election."
A poll conducted by the BBC earlier this month showed that 23 per cent of people spent money as a consequence of the VAT cut, while 27 per cent planned to bring forward spending to beat the January 1st deadline and 32 per cent said they would rein in their spending in 2010.
Current retail trends
While the effect of VAT on sales remains an issue, one thing that retailers seem to agree on is that they will enjoy a strong Christmas for sales. There is also evidence that many shoppers have become much savvier about what they are willing to spend their money on due to the recession, increasing the onus on vendors to offer bargains in order to drive sales.
A principal beneficiary of recent shopping trends appears to be shopping businesses which maintain an online presence - with many buyers attracted by the lower prices offered for goods and services by internet vendors. A poll from eBay showed this month that 51 per cent of online businesses expect a stronger Christmas than last year for 2009, with 29 per cent expecting to increase stock orders by 15 per cent. The UK Payments Administration also suggested that the number of internet shoppers could increase by 15 per cent from December 2008 to December 2009 and that 32 million Britons - over half of the population - currently shop online.
New Year's Day
Following a bumper Christmas, retailers will be faced with a VAT-related headache. Teams of employees will face the administrative burden of changing prices to reflect the tax change from January 1st, while issues could also arise from customers waiting until 2010 to return unwanted gifts - and finding that the goods are now more costly than before. Bars, clubs and pubs planning to stay open past midnight could also be in technical breach of the rules if they continue to charge "2009" prices for the tail-end of the New Year revels.
In order to simplify matters for this last issue, tax authority HM Revenue & Customs has stepped in with a promise that all hospitality businesses will be able to continue to charge VAT at 15 per cent until 6am on January 1st. The same rules will apply to mobile phone calls and texts.
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The change in the rate of VAT may have impacted on your business already. We can talk through any concerns you may have and can complete your VAT Returns for you.
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