Wednesday, December 24, 2008
Misunderstanding tax cuts
Posted by David Smith at 10:00 AM
Category: Thoughts and responses

Olivier Blanchard, the IMF's chief economist, is the latest to criticise the government's temporary VAT cut. "Temporarily cutting VAT, a measure that was adopted in Great Britain, does not seem to me to be a good idea - 2% less is not perceived by consumers as a real incentive to spend," he said in an interview with Le Monde.

This is something of a bugbear of mine and, far be it of me to say the IMF's chief economist does not know how tax cuts work, but surely that's too simplistic? The effect, as with all tax cuts, is cumulative and it is also a significant fiscal transfer from the government to the private sector. There may have been better ways of cutting tax, but it is still a tax cut.

For the record, this was the Treasury said in the pre-budget report: "Consumer spending is forecast to decline in 2009, reflecting various factors. Apprehension over labour market prospects and increased saving from the very low level of 2008 are likely to put downward pressure on consumer spending. The temporary cut in the rate of VAT, by boosting real purchasing power as it is passed through to lower prices and by incentivising purchases before the lower rate reverses, is expected to increase the volume of spending relative to the level that would have prevailed in the absence of such a cut. The forecast assumes that around half of the increase in real purchasing power will feed through to an increased volume of spending and half to the adjustment of household finances."

Finally, two sets of figures. GDP fell by 0.6% in the third quarter and is heading for a bigger fall in the fourth. More here. But the current account deficit, while up slightly in the third quarter, appears to be trending down fast. One of the economy's imbalances may be on the mend. More here. Interestingly, last year's deficit has been revised down from 52.6 billion to 39.5 billion.