Labour’s VAT cut: bad economics and disingenuous politics

In the run-up to today’s county council elections, Ed Miliband has been taking to a wooden pallet in towns and villages around the UK, telling anybody who would listen about Labour’s plan to rescue the British economy by temporarily reversing the 2.5 percentage point increase in the rate of VAT.

Desperate, though, to avoid admitting this would involve a significant increase in borrowing, he’s been telling us that this would actually be a free tax cut because the economic growth that resulted from it would increase revenues by more than the upfront cost.

That unlikely-sounding claim was given short shrift by Chris Giles, the FT’s economics editor:

For Labour, the challenge is to persuade the country that such will be the economic boon from cutting the VAT rate to 17.5 per cent that it will offset the £13bn annual cost of the idea. As a rough rule of thumb, with the exchequer collecting 38.4 per cent of national income in receipts, the £13bn tax cut must raise gross domestic product by £34bn – some 2.6 times the size of the revenue cut – to expect total tax revenues to rise after a VAT cut, rather than fall.

Such a large “fiscal multiplier” is far in excess of the Office for Budget Responsibility’s estimate of 0.35 for a change in VAT. The OBR could be wrong by a large margin, but Labour is suggesting its estimate is close to seven times too low, indicating it believes the OBR has no clue about the way the economy works. If he believes his rhetoric, Mr Miliband should also be calling for the head of Robert Chote, chairman of the OBR.

There is a legitimate argument to be had about whether some sort of fiscal stimulus is needed in the UK, but Eds Miliband and Balls, schooled in the dodgy economics and low politics of Brown’s Treasury, are not engaged in it. If they were they’d be upfront about wanting to borrow more and follow the evidence on the most effective way to spend that extra borrowing to boost economic growth the most: capital infrastructure spending.

* Nick Thornsby is a day editor at Lib Dem Voice.

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32 Comments

  • Personally I would like to see some of the exempt categories being charged VAT.

    Gambling, lottery, Bingo, online gambling should all be reclassified into the standard rate on VAT
    Antiques should be at bare minimum reclassified into the reduced rate of 5%
    And culture should be reclassified into the reduced rate of 5% (except from museums)

  • Before the election, of course, the Lib Dems campaigned in front of a poster howling about the Tory tax bombshell (lest anyone forget: http://www.john-robertson.co.uk/wp-content/uploads/2010/06/Con-Dem-Tax-Bomb-300×178.jpg ). How times have changed.

    Your doing the wrong maths. No-one expects the VAT cut to balance the books in a single year, stimulus is paid back over the medium term not instantly. Growth is cumulative so the rise in taxation from the economic stimulus is reaped not just this year, but next year and the year after that and the year after… and so on. Similarly the prolonged depression that has resulted from the coalition’s disastrous economic policies will drag down tax receipts for years and years. It is this that has most profoundly caused the coalitions attempts to manage the deficit to fail.

    It’s a pity the Lib Dems have decided to sing from the Tory song sheet; the policies they went into the election with were far more coherent and plausible than anything they’ve supported in office.

  • Paul In Twickenham 2nd May '13 - 9:35am

    It was clearly nonsensical for Miliband to suggest that a reduction in VAT could be – in and of itself – revenue neutral.

    But it is certainly possible to construct an argument that VAT is a regressive tax that disproportionately affects the poorest, and decreasing it while increasing tax on high income or wealth can be presented as a progressive policy.

    The wealthy have done very well from QE and I would argue that there needs to be some rebalancing on the burden of taxation to those who are currently benefiting from the biggest (liquidity fuelled) bull run on the FTSE since the index was invented.

  • Sorry if this is a bit presumptuous but might I offer a tip: If you are going to engage in disingenuous politics and bad economics it’s probably more effective if you don’t signpost it in the title.

  • Daniel Henry 2nd May '13 - 10:24am

    In what way is the OP disingenuous?
    It just cites a valid criticism of Ed Miliband from the Financial Times.

  • “It was clearly nonsensical for Miliband to suggest that a reduction in VAT could be – in and of itself – revenue neutral.”

    But if one did want to be fair (it’s a lot to ask from a party activist on election day, I know), it could be pointed out that Miliband corrected his error two days ago:
    http://www.guardian.co.uk/politics/2013/apr/30/ed-miliband-vat-rise-borrowing

  • It is disingenuous in that it sets itself up to be simply citing a valid criticism of Ed Miliband from the Financial Times when it is in fact citing an article from the Financial Times that is, in that specific quote at least, both disingenuous and bad economics. It also goes on to elucidate the failings of the policy in terms that are disingenuous and economically irrelevant.

    If a VAT cut would help the economy grow it would help to reduce borrowing. If you argue that anyone who agrees with this statement is claiming that a cut in VAT would be entirely self-financing, and that it were possible to show conclusively that it was or was not self-financing, then you are engaging in bad economic argument for disingenuous political purposes.

    Has Ed Miliband really claimed that a 2.5% cut in VAT would in and of itself rescue the economy?

  • Foregone Conclusion 2nd May '13 - 11:11am

    “No-one expects the VAT cut to balance the books in a single year, stimulus is paid back over the medium term not instantly.”

    Yet that is exactly what Miliband seemed to imply in his WATO interview. I was surprised myself, but he said it. Now either he believes that and he’s hopelessly wrong, or he’s trying to fool the public. Which is it?

  • Foregone Conclusion,
    None of the above. This is what he was quoted as saying to correct that impression given in the WATO interview:

    “The point I was making yesterday was that if you can get growth going by cutting VAT, then over time you will see actually borrowing fall”

  • Daniel Henry 2nd May '13 - 11:58am

    JRC, Ed was claiming that a cut in VAT would pay for itself.
    The Financial Times say that the OBR predicts that the effect of a VAT cut would have an effect 35 times too small. Not sure what’s disingenuous about the FT doing the math on Ed’s claims…

  • Nick T Nick Thornsby 2nd May '13 - 12:22pm

    @ JRC

    No-one – not me, not Chris Giles, not the OBR – is saying that cutting VAT would not increase growth. It would. And no-one is saying the knock-on effects would not be an increase in tax receipts and reduction in spending.

    The question is whether those gains would be greater than the cost of the initial VAT reduction. The OBR says they wouldn’t – now, in the medium term or ever.

  • Paul In Twickenham 2nd May '13 - 12:22pm

    @JRC – there is nothing remotely disingenuous in the FT article – on the contrary it highlights the magical thinking that exists in both parties: As the author says, if a VAT cut is good because it stimulates the economy then why do Labour want to tax the rich more or introduce a mansion tax? An “average tax cut of £100,000 to millionaires” pays for an awful lot of new kitchens and porsches whose purchase can “stimulate the economy”. And vice versa for the Tories.

    If Ed Miliband is tying himself up in economic knots then it is because he doesn’t want to frighten the horses by simply stating : “We want to tax the rich more, borrow more, and thus reduce the burden on the poor”.

  • Geoffrey Payne 2nd May '13 - 12:45pm

    I agree with this article. Tax cuts are seen as vote winners, but it would surely be more effective to put money into infrastructure spending to get people into work.

  • Tony Dawson 2nd May '13 - 1:40pm

    @Ed Miliband:

    “if you can get growth going by cutting VAT, then over time you will see actually borrowing fall”

    But he TOTALLY refused to answer Martha Kearney’s straightforward question about how much extra borrowing there would have to be (and which lenders would allow Britain to borrow that much) for how many years before his ‘jam tomorrow’ solution might pay dividends – and hence made himself look like a complete pratt. Many reminders of the Paxman-Howard interview here. Politicians who think they can endear themselves to the public by sticking to ‘saying nothing outside my prepared script’ are fools. Their silence or robotic ‘off message’ mantras speak volumes.

  • Nick Thornsby,

    I assume that by no-one you are not including Ed Miliband but I have not found where he is saying the opposite to your point. I have only seen where he claims that growth would result from a VAT cut and that as a result borrowing would be reduced; the same point that you have made.

    Paul in Twickenham,

    I was careful to point out that it was the quote used rather than the whole article. However, it is disingenuous to claim that all tax cuts or rises have an equal effect on growth so therefore it must be incoherent to propose any tax rises on a specific group if you propose a tax cut in another area. It is also disingenuous to make out that each tax proposal made is magical thinking designed to con others into thinking that the proposer has a painless cure for the economy.

  • VAT is a regressive tax.

    This article is a bit embarrassing but I assume it was to generate debate.

  • Bill le Breton 2nd May '13 - 3:15pm

    Some interesting graphs here that add a little evidence to the debate:

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/04/consumption-taxation-and-economic-growth.html

  • I would support the conclusion Nick comes to in his article “There is a legitimate argument to be had about whether some sort of fiscal stimulus is needed in the UK, but Eds Miliband and Balls, schooled in the dodgy economics and low politics of Brown’s Treasury, are not engaged in it. If they were they’d be upfront about wanting to borrow more and follow the evidence on the most effective way to spend that extra borrowing to boost economic growth the most: capital infrastructure spending.”

    Based on the multipliers, tax cuts seen to be a poor substitute for stimulus spending on work programs, capital infrastructure and housing. This would apply equally to the cuts in Corporation tax over the past few years.

    With the exchequer collecting 38.4 per cent of national income in receipts, we need if anything to be gradually increasing the tax take year by year to a rate of 40% of national income and holding it there. Targeted and effective monetary policy coupled with higher rates of spending on job programs and capital investment offer more efficient tools for stimulating the economic growth we need.

  • Simon Shaw,

    So then presumably the logic of the OBR and others would be that increasing VAT would always bring in more than it would cost in lower growth. So why aren’t they arguing for higher rates?
    When VAT had been reduced prior to the election there was higher growth but detractors argued that it could not be proven that there was a causal link, yet we are now to believe that a causal growth level can be calculated and that it would always be lower than the tax revenues lost.

  • Eddie Sammon 2nd May '13 - 9:19pm

    This VAT policy is absolutely rubbish. First of all it is temporary and second of all it is unfunded.

    @JRC: If the fiscal multipliers were so favourable it wouldn’t have to be a temporary cut. It just goes to show the confidence they have in the policy.

  • Jrc,

    “So why aren’t they arguing for higher rates?”

    The Laffer Curve? Diminishing returns? International competitiveness? Politically difficult? pick your poison.

    I would be inclined to follow the recommendations of the Mirrlees review to end almost all zero rates, reduced rates and exemptions in VATIndirect and environmental taxation. I would apply the estimated 24 billion raised to simultaneously introduce a miniumum wage job guarantee to address involuntary unemployment and eliminate income tax and national insurance deductions up to the level of the minimum wage as both direct stimulus and redistributory measures.

  • David Allen 2nd May '13 - 9:55pm

    Yes, infrastructure spending is the better way to boost growth. A VAT cut has some beneficial effect and might possibly “pay for itself” in the longer term, but it isn’t so effective at boosting growth. Argument over?

    No, because Miliband is thinking about something else as well, which he does not want to admit. Putting money straight into people’s pockets attracts votes. Building ugly disruptive new roads etc is much less effective at boosting Labour votes.

    Does that mean Labour have got the electoral calculus right? Not necessarily.

    Sure, there are plenty of people who can best be wowed by being bribed by public money. On the other hand, as the Tories have shown, there are also plenty of masochistic voters who can be wowed by a cold shower, and who believe that nasty medicine always does you the most good.

    What we need to do is to target the masochists (and the realists!), but prove to them that we have medicine which not only hurts, but also works.

    Just chucking people out of public sector jobs is not medicine that works well. Building infrastructure, especially things like green energy and better insulated houses which will be vital needs in the future, is medicine that may hurt a little, but will work very well.

    My slogan: Austerity with a purpose.

  • Simon Shaw,

    Obviously you didn’t quite see what I did there. I copied the format of your ‘logical’ reductio and reversed it to show it up for its absurdity.

    Eddie Sammon,

    It’s temporary because it’s unfunded. It is designed as a temporary boost to growth.

    Joe Bourke,

    I would hope it is because it is highly regressive but concede that your reasons would serve just as well.

  • Simon Shaw,

    I’m sorry I must have misunderstood you. When you said (to paraphrase): that the logic of my and Labour’s position was that if a VAT cut was good then surely a bigger one would be better so why aren’t you arguing for it?, I thought you were facetiously trying to imply some sort of disingenuousness on mine and Labour’s part.

    In answer to your question then: I would assume that they aren’t arguing for a bigger cut in VAT because it would not be affordable.

  • In terms of my day to day spending, a 2.5 cut in VAT would be minimal at best. Simply cannot see my bus company reducing fares by 5p for instance. Ergo. I’d be spending the same as I was before, with no prospect of increased spending elsewhere.

  • Simon Shaw,

    Yes it does but given the growth figures last time there was such a cut and the drop in growth when it was reversed I would say that history is on his side.

  • John Broggio 3rd May '13 - 11:57am

    It is hard to take anyone seriously who cites the Laffer curve, which is so obviously false.

    One could quite easily imagine a society in which taxation was 100% of all income with a voucher system in return for food, clothing, housing & entertainments (not an ideal of mine I hasten to add but allow the latitude) allocated on some form of basis of perceived need (rather than according to job title) where people would go out to work. Why? Because unless I’ve missed something, no-one is self-sufficient and we all interdepend upon one another to live. Thus people would go out and work as (pick any useful job) because they can’t feed, clothe, house themselves with a scalpel, textbook, etc etc The vouchers (a sort of very anti-liberal citizens wage that we inflict on certain claimants) would act as a proxy for money and thus (admittedly in extremis) the Laffer curve is false.

    Obviously, that’s a very extreme version of communism but considering that for a long time after WW2 we had a marginal tax rate very close to 100% and still managed very good average growth rates, it again suggests real empirical evidence that Laffer & his acolytes are incorrect to assert that a high tax rate reduces growth.

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