Britain’s Chancellor of the Exchequer, George Osborne, delivered a new budget. The plan calls to eliminate the structural deficit by 2018 and then resume deficit spending. It is an instance of policy pandering to election prospects.
The shift in Britain is to move taxes away from direct taxes on income and toward indirect taxes such as the VAT. Now in Britain individuals start paying taxes after the 10,000 pound starting mark as opposed to the previous 6475 pound previous starting point and the VAT has gone up from 15% to 20% the last time a change like this happened was in 1979 when the Thatcher administration’s fiscal policy raised the VAT from a two rate system of 8% or 12.5% to a single VAT of 15%.
The effect of lower direct taxes and higher indirect taxes is to discourage spending and encourage saving. This is because people see a higher price for their goods and compensate for the increase in prices by saving a more, and the abatement to taxes will only be on several thousand pounds, which won’t mean too much in the way of a rebate. 5% of 3500 pounds is only 175 pounds more; the abatement will likely make the average person worse off.
Source: The rollercoaster ride
4 Comments
In theory, a VAT should shift intertemporal consumption. What however does the evidence suggest? My sense is that the effect is pretty small, perhaps below the threshold at which it would produce consistent significant empirical findings.
By inducing households to save more, wouldn’t this reduce the multiplier? This seems counter intuitive, as I believe this move would be a detriment to the country’s economic production. Further, won’t many households maintain their saving/spending ratio regardless of prices? Many households have to spend their entire incomes regardless of prices.
I agree that trying to encourage a change in the saving/spending ratio may not actually be effective because of many households that must spend their entire income no matter what to make ends meet. In terms of intertemporal consumption it may take longer to see the effects. Overall I agree with Oliver and feel that this policy may make the average person worse off.
Independent of the impact (or its lack) on saving, in an economy that still has excess capacity the multiplier is significant: austerity is recessionary. Perhaps due to ignorance of economics the British public may support contractionary policy (though I doubt it, I most definitely do not follow political polls — I skip the “domestic” section of the economy). But surely the timing of this policy move will ultimately be rued.
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