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<p><p>This paper analyses the likely implications of the temporary cut in VAT in the UK to 15 per cent, with a return to 17.5 per cent in place for the end of 2009. We distinguish between the income effect of the cut and the (intertemporal) substitution effect. The former is likely to be small because the change in lifetime income is minimal. The second effect is likely to be much more important because the reduction in the price of goods bought in 2009 compared with 2010 gives an incentive to increase consumer spending this year. With an elasticity of intertemporal substitution of about 1, we would expect the cut in VAT to boost consumer spending by about 1.2 per cent over what it would otherwise be. The distributional consequences of the VAT cut are regressive because goods subject to VAT tend to be luxuries. Unlike a cut in interest rates, there is no difference in the distributional consequences for borrowers compared with savers.</p></p>
Authors

Research Associate University of Bologna
Matthew is Associate Professor at the University of Bologna focusing on consumption and savings choices and how policy affects them.

Research Fellow University of Oxford
Hamish is the James Meade Professor of Economics at the University of Oxford, a Professorial Fellow of Nuffield College and a Research Fellow at IFS.

Research Fellow University of Michigan
Tom is a Research Fellow at IFS, a Research Professor for the Institute for Social Research at the University of Michigan.
Journal article details
- Publisher
- Wiley Blackwell
- JEL
- E62, H31, E21, D91
- Issue
- April 2009
Suggested citation
T, Crossley and H, Low and M, Wakefield. (2009). 'The economics of a temporary VAT cut' (2009)
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