VAT and macroeconomic management

VAT has risen to 20%, from 17 1/2 %. But the change in tax presents opportunities to introduce fiscal policy, macroeconomic goals with some consideration of price elasticities of demand and the incidence of a tax. The change highlights many aspects of conflicts over macroeconomic goals and at a micro level the conflicting interests of economic agents.

Is the change compatible with the desire to stimulate growth? Over time, will the new rate of tax depress consumer demand, investment spending, and the demand for labour? The fiscal change may trigger off some price rises, which will push the CPI and RPI upwards, giving policy makers at the Bank of England some food for thought as they consider changes to interest rates.

Today’s BBC outline has a useful calculator tool which allows colleagues and their classes to consider the impact of the VAT rise on spending.

Pupils could consider how far this indirect tax is regressive, but given that children’s clothes, fresh foods are not subject to VAT, this may stimulate discussion over how far this may be or may not be the case, read more here for some details.. Labour’s leader Ed Miliband claimed that the tax would cost the average family £7.50 per week, but does the average family actually spend in excess of £350 on goods and services which are taxed at 20%?

This BBC video considers some aspects of the tax change on consumers. Much of the media coverage of the impact of the tax has focussed on retailing and household consumption. “Online shopping group Kelkoo said the change would increase the price of a litre of petrol from £1.19 to £1.22, a digital camera from £131 to £133.79 and a Ford Focus car from £15,195 to £15,518.The British Beer & Pub Association said it would add 6p to the cost of a pint of beer, pushing it through the £3 barrier for the first time.”

The Independent’s report examines the impact on consumption but ignores the effects of VAT on business investment, as firms purchase or hire equipment for construction and manufacturing. Pupils could be asked how the tax rise will alter costs, and investment decisions. In another context, this tax is not cost free, firms have to adjust price lists, websites and catalogues, all of which takes time and incurrs a cost.

Yet this tax rise is only part of fiscal policy, reductions in central and local government spending could be considered alongside changes to income tax, National Insurance corporation tax and excise duty, but pupils should consider that VAT could have an impact on monetary policy. The new VAT rate will eventually trigger off some changes in the CPI, and the RPI, which could present The Bank of England’s MPC with new pressures to reconsider the present low Base Rate. Other issues pushing prices up include past decisions to allow sterling to fall, which gives students the chance to consider the J curve effect of a sterling depreciation on import prices and time lags.  On the other hand would this also lead to demands for higher wages?

Roger Bootle on the MPC considers the VAT change in the light of other pressures on the MPC.

The change in VAT also highlights price elasticity of demand and its importance in determining government revenues, as the Coalition attempts to reduce the budget deficit.

As a belated postscript, the BBC have reposted their European VAT rates table. I wasn’t greatly impressed when that table vanished into the ether when I was cross checking the earlier links.

Unit 2 Macro: Real Interest Rates [20 May 2012]
Unit 2 Macro: Government Spending [11 May 2012]
Unit 2 Macro: Monetary Policy and Inflation Glossary [5 May 2012]
Unit 2 Macro: Fiscal Policy Glossary [5 May 2012]
Where does my money go? [20 Mar 2012]
Unit 2 Macro: Revision Quiz on Monetary Policy [6 Jan 2012]
The Eurozone Crisis Explained (again!) [22 Dec 2011]
Ten Things About Tax [23 Nov 2011]
Australia lowers interest rate to 4.5% [1 Nov 2011]
How do you spend £691.7bn? [30 Oct 2011]
Study Note - Macroeconomic policy objectives [16 Sep 2011]
The morality of taxation [15 Sep 2011]
Interest Rates Held at 0.5% once again [5 May 2011]
AS Macro: Updated presentation on monetary policy [4 May 2011]
Recession, recovery and the redistribution of income [21 Mar 2011]
the latest data from the MPC [8 Mar 2011]
Martin Weale argues for higher interest rates now! [1 Feb 2011]
CPI, RPI overshoot targets. [15 Dec 2010]
Raising money from taxation - a BBC guide [31 Aug 2010]
How are taxes raised and spent? [8 Jun 2010]
A selection of revision notes on monetary policy [4 Jun 2010]
Skeletons in the Fiscal Cupboard [17 May 2010]
A2 Economics Revision - Direct and Indirect Taxation [9 May 2010]
AS Economics Revision - Managing the Economy [2 May 2010]
Mervyn King on Tailwinds and Headwinds [10 Feb 2010]
Revision Presentation - Monetary Policy for AS Economics [27 Dec 2009]
Is monetary policy becoming less effective? [16 Dec 2009]
Japanese unemployment rises to record high [29 Aug 2009]
The Birth of Macro_Prudential Policy [6 Jul 2009]
Blanchflower reflects on his time on the MPC [1 Jun 2009]
Read the small print! [12 Jan 2009]
Revision: The UK Budget Deficit [1 Jun 2008]
Ricardo Rules OK? [15 May 2008]
Stabilising demand - will the tax rebate work? [28 Apr 2008]
Revision Mind Map: Monetary Policy [21 Mar 2008]
Fed opts to leave a little powder left [18 Mar 2008]
UK base rates held at 5.25% in March [6 Mar 2008]

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