VAT Budget Cuts and the UK Economy

VAT Budget Cuts and the UK Economy

Trading Features / Strategies from Simon Denham of Capital Spreads.

Pre-Budget

The leaks on what will be announced in the Pre-Budget announcement sum up the absolute paucity of both the country and in political and economic thinking in the top echelons of government.

The madness of an ever greater public sector funded, in an ever increasing proportion, by a booming service sector at the expense of a weakening manufacturing division had been pointed out ad-nauseam by various commentators over the past ten years. The huge tax revenues created by the tsunami of, not necessarily cheap but definitely, accessible funds lulled the Treasury, the Government and the population as a whole into a false sense that we had created a stable economic foundation.

Now that the chickens are coming home to roost we have the rather unnerving vision of the Chancellor and the Prime Minister scrabbling around trying to think of ever more dramatic ways of keeping us going to the shops every weekend. Is this all we have been reduced to?

Amidst all this woe one gem has arisen out of the muck. The proposed reduction in VAT has been a long time coming and might also focus minds on what has become one of the most pernicious brakes on economic growth it is possible to come up with. VAT is a tax at point of sale and as a consequence has a multiplier effect throughout its chain.

To understand this we must look (simplistically I admit) at the economics of Government fiscal stimuli. If the State borrows to fund a project the idea is that this will have an effect through the economy far greater than the initial sum spent. £1bn spent will then be spent again and again in an ever decreasing spiral as salaries get spent, profits get reinvested, so the next business down the line then also pay salaries, builds more capacity etc etc...as tax and external spending (imports) take their toll on the original sum so the effect reduces but the intention is obvious and the overall impact is reckoned to be many times the initial spend. “The Multiplier Effect”.

VAT is a curious item in that it is almost the exact opposite of a multiplier stimulus. Its effect is almost that of a series of tiny little brakes at every level.

It is charged and offset by a myriad of businesses across the country, as I get charged VAT so I charge it to somebody else, he then charges his VAT services to someone else and so on and so on until (at some point in the year) I sum up the difference in all these little numbers and pay it on to the VAT man.

A reduction in VAT from 17.5% to 15% should have an impact way beyond its decrease in the tax take particularly as it is an upfront reduction rather than a lagging one as is the case with most tax cuts.

Unfortunately in other areas the Government has once again reverted to type and gone down the easy route in projected spending projects. The proposed increases (or bringing forward) in capital expenditure plans once again bear the tag “NHS and Education”.

I am sorry, but spending vast sums, in tough times, on schemes that will do nothing for the medium term prosperity of the nation are once again building up long term indebtedness.

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Can anyone name a major infrastructure build that has taken place in the last ten years? No new roads /airports / railways / power stations / sewage plants / water works the list goes on.

All we see are repeated mend and make do as political will has virtually disappeared. A definition of success for politicians in the UK is to still be in power, not to have made the right decisions. In an effort to appease virtually everyone the easy route (spend on the ‘now’ and sod the future) has become almost a mantra.

Admittedly it is easy to denigrate without constructive comment. I do not have a myriad of concerns to ameliorate. Unfortunately this government is once again making decisions to help it win the next election not to dramatically help the UK economy and “bugger the electoral consequences”.

Many of the expected stimuli seem to be of the order of cancellation of future tax rises. Quite how these are supposed to aid an economy already reeling under the existing weight of the slowing economic juggernaut is difficult to imagine but I suppose it makes for a good headline.

The increase in Government Guarantees on small business loans sounds great but what does it actually mean? Banks do not stop lending for the fun of it. They have to make decisions on where to lend “Other People's Money”. Banks borrow from solvent small businesses, wealthy individuals, other financial institutions and, yes, you and me and then lend it (at a higher rate) to somebody else.

If I am going to trust a bank with my money I want to be sure that they are making the right decisions on who to lend to. Their remit is to the continuance of strong lending criteria, building a solid balance sheet, paying their shareholders (remember them) not some strange beast called “the public interest”.

Browbeating from the Chancellor to throw good money after bad is not conducive to sensible decision taking. The fact that the public purse has been used to fund rights issues is not pertinent. We would be horrified if the Sovereign funds who have invested in the capital raising programmes over the past year or so used their share holdings to manipulate the banks concerned lending criteria so why should we expect it to be any different with state funds. The banks may have made truly dire choices in some investment areas over the past few years but this is not in the small business arena.

Unfortunately as with Gordon Brown’s mirage of an “end to boom and bust” the idea that he can come up with some new way out of a recession by spending a few billion here and there is pure fantasy. The cupboard is bare and I fear that the downturn this time is going to make the eighties and nineties recessions pale into insignificance. The dead hand of the public sector is now so much of a drag on the economy that it will probably take some extreme measures to offset. New analysis shows that two thirds of all the ‘new jobs’ created in the UK since 1997 rely on government largesse in one form or another. This is the legacy of Tony and Gordon and it is one that we will all rue for many, many years to come.

The above comments do not constitute investment advice and neither Capital Spreads nor Clean Financial accept any responsibility for any use that may be made of them.

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'VAT Budget Cuts and the UK Economy' edited by DB, updated 24-Nov-08

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