Why Ed Balls is wrong on cutting VAT

Ed Balls thinks we should cut VAT to 17.5% immediately as an emergency measure to ‘kick start’ the economic recovery. Should we?

I suspect it isn’t worth the bother. There is no doubt that the UK taxpayer is pretty beleaguered at the moment. But while this sounds like a reasonable way to cut their current pain it might not do them any good in the medium term.

The first thing to note is that any such cut right now would signal a change of policy to the market – it would suggest that we are somehow going soft on the deficit (Balls hasn’t offered any ideas about how to cover the loss to the Treasury). Given the rate at which Greece is imploding, this week just isn’t a good time to do that.

The result could easily be a further fall in sterling (which has already fallen 25% in trade-weighted terms since 2007), something which would lead immediately to higher prices for all imported goods and probably outweigh the two percentage point cut in a matter of days.

But even if we didn’t see a sterling sell off, there isn’t much good reason for a VAT cut. It wouldn’t have much impact on the prices of the things that really matter (food and fuel) and even if it kick-started consumption a little, the producers of imported goods would benefit just as much as domestic producers.

I’m usually for most tax cuts but given the deficit, the short shrift countries with sovereign debt problems are getting in the market, and the fact that we are supposed to be trying to rebalance our economy away from consumption, this one doesn’t make sense to me right now.

It was suggested to me today that, were the coalition to do any tax fiddling at the moment, it would be better off moving faster on its efforts to raise the income tax threshold. If we have to do anything to kick start the economy (it isn’t a given – look at this week’s employment numbers) that sounds like a better idea.