Can a reduction in VAT curb inflation and help households?

During the summer Steve Chamberlain, VAT Senior Manager at Albert Goodman, shared his thoughts about the possibility of the Government cutting the rate of VAT as a response to the cost of living crisis. With a new Prime Minister due to be announced soon (at the time of writing) this has not yet been confirmed, but we have reproduced Steve’s article here as his points remain useful.

If the Government has funds available, I hope it will spend them in a way that gives the best benefit per £ spent. I don’t see that an across-the-board reduction in the standard-rate VAT will do that. Rather, and I write this after fuel protests on the M5, I suggest that the Government introduces a temporary rate of VAT on road fuel for private vehicles.

Between December 2008 and January 2010, the standard rate of VAT was reduced during the “credit crunch” with the aim of boosting consumer spending and thus the economy. There’s little evidence that this was of great assistance, and the rate of VAT was subsequently increased to 20% in January 2011.

A key issue is that, absent any specific legislation, businesses are not obliged to reduce their prices and pass the savings from a cut in VAT onto consumers. During the pandemic, for example, VAT was temporarily reduced to help the hospitality industry. Not all takeaways or restaurants reduced their prices. As the stated driver for the VAT reduction was to preserve jobs and businesses suffering as a result of lockdown, I personally thought this was OK.

Further, not all of my household expenses that are rocketing up are subject to standard-rate VAT. My mortgage isn’t subject to VAT. My gas and electricity bill is subject to VAT, but at 5%. If this goes up by £1000, only £50 of the increase is VAT, so if the Government zero-rates domestic fuel and power, the whole benefit is a cost to the Exchequer and doesn’t save me a massive sum.

Better, I think, if the Government can reduce VAT on road fuel for private motoring.

Back when a litre of petrol could be purchased for £1.20, the Government received 20p by way of VAT. If petrol is currently (and I wonder how long it will be before this figure is out of date) £1.92, the Government receives 32p by way of VAT. The pre-VAT figure is £1.60. If the rate of VAT on petrol was reduced to 12.5% the Government would still receive its 20p on a pre-VAT price of £1.60. So long as the petrol retailer reduces its price to reflect the VAT reduction, I’d pay £1.80 per litre.

On the basis that consumers closely monitor the price of fuel, it should be difficult for a retailer not to pass on the VAT savings. After all, petrol is specifically sold by the litre. A retailer cannot just alter the “pack size” to meet a given price point. I did buy a multi-pack of my favourite confectionery at the weekend for a promotional price. Then noticed that the product was only about half the size that I remember it…

Steve Chamberlain can be contacted at steve.chamberlain@albertgoodman.co.uk or by telephone on 01823 286096.