Could an emergency VAT cut save the economy? The evidence is equivocal

Former chancellor Alistair Darling tried it in 2008 and thinks Rishi Sunak should follow suit, writes James Moore

There was a rush when English shops first reopened but footfall was still down on the year (PA)

The reports that Rishi Sunak, the chancellor, is considering an emergency VAT tell you he’s worried. He’s right to be.

English shops opened their doors last week, but after an initial rush that gave media types something to write about for a day or two, things slowed down.

Footfall was still sharply down (57 per cent) when compared to the previous week last year as per the British Retail Consortium.

This shouldn’t surprise anyone. People are scared of coronavirus and they’re scared for their jobs. Boris Johnson might say it’s safe to go out and spend but he’s hardly proved himself to be the most trustworthy authority on that subject.

It looks like it’s going to take more than his bombast, and even people’s understandable desire to escape the four walls of their homes, to get them into the shops in sufficient numbers to get things moving again.

Given the trajectory of Sunak’s policymaking to date, with his job retention scheme and state-backed loans to help struggling businesses keep people in work, we probably shouldn’t be all that surprised to see him reaching for another Labour policy to try and address the issue.

Alistair Darling, the former Labour chancellor, tried cutting VAT at the end of 2008, in the midst of an economy reeling from the financial crisis. The levy fell from 17.5 per cent to 15 per cent on 1 December 2008. The cut lasted until 31 December 2009.

The now Lord Darling doesn’t seem minded to cry copycat if Sunak does follow suit. He’s called for the measure in the introduction to a Policy Exchange paper that urges a big increase in capital investment, pointing out that the crisis he dealt with pales by comparison to this one.

But was his policy a successful one? The evidence is equivocal. Sir Stuart Rose, the then boss of M&S, opined that the cut had “not made a material difference to our sales” in an interview shortly after the 2008 festive trading rush, despite having passed the saving on to the consumer.

A PricewaterhouseCoopers survey of 2,000 people in August 2009 found a big majority (88 per cent) basically agreed with him. They said the VAT cut had made little or no impact on their spending.

A HM Revenue & Customs survey of businesses found almost four in five had passed the cut on to their customers, which is good, but again, the majority took the view that it had had little impact, which is less good.

Alistair Darling, a Lord and Labour peer, was chancellor during the 2008 financial crisis (Getty)

All this suggests that a VAT cut could be little more than a very expensive panic measure – a full five point reduction from the current 20 per cent to 15 could cost £35bn.

On the other hand, what we don’t know is what would have happened to the post-financial crisis economy had Darling not acted when he did, because it isn’t possible to conduct an empirical analysis.

When the Institute for Fiscal Studies considered the evidence it said the cut “was likely to have been an effective stimulus”. So perhaps Sunak should jump right in because some form of stimulus is desperately needed at a time when the economy is coughing and spluttering as a result of a lack of demand.

A measure that says, here’s a price cut, so you shoppers, you’d best take advantage now before the tax goes back up again? That might appeal to some of the Britons still hunkered down in their homes.

But there are other ways to help the economy along that might prove equally, if not more, effective. One obvious way to give it a boost would be if people were to be made to feel more secure in their jobs.

A couple of the economists I spoke to in the course of researching this piece mentioned cutting employer National Insurance Contributions (NICs) as a measure that could help, potentially more than an emergency VAT cut.

How about little more help for struggling companies? The government has already underwritten debt financing for businesses hit by the pandemic. The TUC has called for it to consider partial bailouts for struggling businesses in struggling sectors by taking equity stakes of up to 30 per cent in firms which have hit the buffers, often through no fault of their own.

This contradicts Tory Party, but also government orthodoxy. But Darling did it with the banks during the financial crisis and what’s good for the goose...

Mightn’t this be a better Labour policy for Mr Sunak to steal?

The hard work for him is really just beginning. As he weighs his options, one thing he needs to rule out is a return to the great economic policy failure of the past decade. Austerity has simply served to squeeze the UK economy and deny it growth. Ushering in a fresh round of spending cuts at some point in the future when the economy has more or less found its feet could wreck Sunak’s burgeoning reputation. And wreck Britain in the process.