UK to follow Germany with Covid recovery VAT cut?
Germany’s announcement last week of a temporary VAT rate cut from 19% to 16% signals countries entering the ‘recovery’ phase of the coronavirus pandemic and foreshadows a similar UK VAT cut in the mini-Budget.
Germany announced on 4 June that it was to slash its standard VAT rate from 19% to 16% from 1 July to 31 December 2020. Its reduced rate will also be cut from 7% to 5%. This will cost Germany €20bn.
This is the first major global attempt at fiscal easement to stimulate consumer demand. It signals policy moving into a new phase as governments attempt to deal with the rapidly moving health and resulting economic crises. These phases can be summarised as follows – with Germany’s VAT cut falling into number three:
- Emergency: Immediate employment and welfare support to prevent an economic and social collapse. In the UK, this included the furlough employment scheme.
- Containment: Keeping the economy on life support during the lockdown. This includes continuing refinements and rollovers to the initial emergency measures. This could include an extension to the VAT payment deferral which ends this month.
- Recovery: Stimulus to accelerate the restart of consumer and business economic activity as the lockdown is eased.
- Fiscal Consolidation: The long journey to paying down the massive expansion of government health and welfare crisis debts. The heavy lifting on this will fall to taxes. Another round of austerity after the last decade’s is off the table given the continuing health and welfare costs of a seemingly prolonged pandemic. As billions of pounds are at stake, there will have to be a wholescale re-imagining of tax policy. Measures likely to appear may include: VAT on financial services; a carbon import tax; full implementation of digital taxes; wealth taxes; and a land-use tax.
The UK could cut its standard VAT rate down as low as 15%, with a 5% reduced rate reclassification for hard-hit restaurants, cafes and hotels.
As the UK exits the lockdown phase of the pandemic and faces up to the economic crisis, it will require seismic fiscal and welfare support to reignite consumer demand. But temporary VAT cuts – like the 2009/10 Labour cut to 15% - are of the worst type of measure with limited economic benefit and a colossal implementation headache for businesses. But the politics of grand gestures will overrule the logic of economics.
Supporting the hospitality and tourism sectors – UK is Europe’s laggard
The entertainment, hospitality and tourism sectors have been shut down around the world since March, and face a long, slow re-opening.
To recognise this hardship and threat to long term viability, many countries around the world have brought forward temporary VAT cuts to the hospitality sector. This includes cafes, restaurants, bars, catering, take-away food, amusement parks, cinemas, theatres, hotel, B&B and house-sharing accommodation.
Prior to last week’s announcement, Germany had already agreed a reduce VAT liability for sector by cutting its VAT classification from the standard 19% rate to the reduced 7% rate.
The UK is one of the very few European countries which does not provide a tax subsidy to the sector already via reduced VAT rates. It is second only to Denmark in terms of VAT liabilities on the tourism and entertainment supplies. In addition to a standard rate VAT cut for the whole economy, the UK may, therefore, reclassify hospitality to the reduced 5% rate as it will need confidence rebuilding as social distancing rules are relaxed.
Do crisis VAT rate cuts work?
Do temporary VAT rate cuts work for an economic crisis? Certainly, they can provide subsidies to retailers or consumers, depending on whether the retailer chooses to pass on the cut through price cuts.
Crucially, such a tax subsidy can be introduced within a few weeks and so deliver an immediate economic boost. There is conflicting evidence on the effects on prices, and whether retailers pass on the cut to retain it and prop-up profits.
Some studies on VAT rate changes have shown asymmetric movements on prices: cuts are retained by the vendor; rises are passed onto the consumer. But the Covid slump is not like previous recessions: supply chains on many goods have been devasted and so pricing changes do not have the same important economic signalling effect.
However, when the reduction is temporary it usually leads to expenditure switching as the reduction comes to an end and consumers bring forward spending. It is therefore important to give as little notice as possible of any cut – despite the problems this creates for businesses in adjusting their accounting, billing and pricing strategies.
Politics may ignore the 2008/09 crisis cut experience
The UK Labour government temporarily cut VAT from 17.5% to 15% between 1 December 2008 and 31 December 2009. This emergency measure was implemented to support consumer confidence as the 2008 financial crisis gripped the country. It was estimated to cost around £12bn.
Shoppers canvassed at the time by a number of organisations overwhelmingly said it had no impact on their expenditure. Retailers, when surveyed, gave a similar response. Only 20% of them claimed to have not passed the reduction on.
Income tax or welfare payments instead?
Many economists believe a temporary cut in income tax is more effective than VAT rate reductions at delivering extra cash to individuals, especially if targeted towards the lower-income earners. However, changes to income tax rates take many months – up to a year to implement in payroll systems. The same problem applies to welfare payment increases.
But the attraction of action will probably ignore this economic sense, and the politics will likely lead to a VAT cut next month. It will be big, too. This is not a time for tinkering. Expect 15% VAT by September.
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Richard Asquith is the VP of Global Indirect Tax at Avalara, a global transaction tax technology company. He leads Avalara’s outsourced international VAT compliance service. Richard originally qualified at KPMG in the UK, and then spent over ten years with EY in Hungary, Russia and France.