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Coffee House

There is no reason to raise VAT

4 January 2011

1:39 PM

4 January 2011

1:39 PM

It is very clear that the government cannot carry on borrowing at current rates and the
coalition’s proposals for reducing government borrowing are prudent. However, today’s VAT rise is unnecessary.

As has been said before, we did not get into this situation because the government taxes us too little. Ever since Gordon Brown abandoned his self-imposed restraint in 2000, government spending,
financed mainly by stealth taxes and increased borrowing, has expanded rapidly to its current level of over 50 percent of national income. As such the whole of the balance of fiscal adjustment
should come through spending cuts.

The coalition’s spending reductions have reflected political expediency, not sound economics. The aid budget will rise, despite the empirical evidence that shows the damage that foreign aid
does to recipient countries. The NHS has been ring-fenced, even though it has experienced huge budget increases and has a shocking productivity record. Pricey gimmicks given to pensioners such as
the Winter Fuel Allowance, free television licences and free bus travel remain in place, whilst the government has promised to increase state pensions in line with the higher of inflation, earnings
or 2.5 percent – the “triple lock”, as the government calls it. This last profligacy is wholly unnecessary at a time when much of the working population is experiencing real wage
reductions.

[Alt-Text]


A 2.5 percent trim of the NHS budget, not increasing the aid budget, the abolition of the pensioners’ gimmicks and not implementing the triple lock would enable the government to cancel the
VAT increase with considerable room to spare.

If the government insists on increasing taxes, then there are better candidates than a general increase in VAT. The government plans major re-regulation of energy markets that will raise prices and
discourage energy use. Meanwhile, VAT on domestic fuel remains at only 5 percent. This is simply incoherent government. Pensioners also enjoy special tax allowances that are granted and then
removed using complex formulae – pensioners even receive a married couples allowance, a luxury long removed from couples with children! Imposing the full rate of VAT on domestic fuel together
with the removal of the pensioners’ special tax allowances combined with the spending cuts proposed above would enable VAT to be reduced today to around 16%. If the retirement age were also
increased immediately to 66, the Chancellor would have the fiscal freedom to be a tax-cutting, reforming Chancellor.

We should make no mistake about it. The VAT rise today is a result of policy choices. The spending cuts are insufficient and those spending cuts are guided by political expediency. Ed Miliband is
right about the VAT rise, but for entirely the wrong reasons.

Philip Booth is Editorial and Programme Director at the Institute of Economic Affairs.

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