More on the VAT cut

Lots of people, including Cameron, and Germany, have been ruishing to claim that the Vat cut "won't work", just 11 days in. Their reasoning seems to be that the VAT cut involves a loss of tax revenue, which will have to be borrowed, which in turn will make people wary of spending as they worry about future tax rises to pay for the borrowing.

This argument ignores one fundamental point: in downturns, sales fall, and thus VAT revenue received will drop anyway. Therefore anything the government can do to support consumption, supports tax revenue and mitigates the need to borrow.

John Lewis says that the VAT cut has worked. They say that sales for the first week of December are down 6.7% on the equivalent week last year, but that sales in the pre-VAT cut period were down 13%-14% on equivalent weeks last year.

Lets say for ease of calculation, that John Lewis made sales of £1 million per week last year. A 13% drop in sales equates to £130,000 in lost sales and £19362 in lost VAT revenue at 17.5%. A 6.7% drop in sales equates to £67000 in lost sales and £8739 in lost VAT revenue at 15%.

Therefore the VAT cut, in getting people out to the shops, has reduced the rate at which VAT revenue was dropping. Paradoxically, more revenue would have been lost if nothing was done. Cameron's belief that a VAT cut results in a straightforward loss of revenue assumes that sales will be the same or more than last year. But it is self-evident that in a downturn sales drop. The question then becomes, how do we slow down this trend or reverse it.

People can deride the VAT cut as "too small" and a "gimmick", but anything the government can do to support economic activity, helps. Do-Nothing Cameron would have seen his tax revenue drop faster and his borrowing increase quicker than Do Something Darling.

As to why the VAT cuts work - people are programmed to just like tax-cuts, it seems to stimulate a different pleasure centre in their brains than mere discounts. And half the time they arn't being rational or logical about it. John Lewis was surprised - "Nat Wakely, director of selling operations at John Lewis, said there had been clear evidence that consumers were holding back on more expensive items until the cut in VAT spending was passed on 10 days ago - although he admitted it was "slightly curious" because the 2.5 point cut announced in the pre-budget report had appeared to be too little to make a difference". But then it is the Conservative party that has trained the general public to act like pavlovian dogs to tax cuts these last thirty years. Curious that they now no longer believe in what they themselves have wrought!