The financial crisis has been the making of Gordon Browne we’re told. While Hank Paulson was holding masterclasses in crony capitalism Gordon Browne’s rescue package showed how it was done. His recapitalising the banks by buying equity in them was right out of the textbook, maximising state upside and minimising moral hazard.
Anyway, his next step has also been out of the textbook. But it seems dumb to me. He’s cut the UK’s VAT (which in this country we call a GST) by 1.5%. It’s a temporary cut. And the textbook tells you that this is better at stimulating consumption than giving people (say) a temporary 1.5% increase in their take-home pay because that gives them no incentive to spend the money now. I suspect that lurking here is the idea that the GST offers a very broad base over which to offer the goodies and that’s usually a nice thing – it’s one of the things that makes a GST more efficient (other things – like revenue – being equal) than a narrower tax base.
But I think there are big problems with this. A small but far from trivial point is that the GST is administratively intensive. And changing the rate means at the very least reprogramming everyone’s accounting system, dealing with a bunch of transitional issues and for really small operators like small stores, you might have to wander through the shop sticking new price labels on every item. All this for a price change of 1.5% some of which won’t even be passed on.
More importantly there will be a whole lot of things that are not price sensitive – food being a classic example, you can’t stock up on fresh food, for instance – you buy it as you go. A great many things are like this. And for more discretionary purchases will 1.5% look like a sufficient bargain to make a difference. I don’t think so. So I think a better policy would be to spend the same amount of money (revenue foregone) on larger and more targeted temporary subsidies or tax cuts for items which can be expected to be sensitive to incentives to pull forward consumption/investment. (Actually that just made me realise another objection to a GST reduction. Business only collects GST – it doesn’t pay it – so the change in rate has no effect on their bottom line except in additional costs for bookkeeping and what’s called in the jargon, ‘menu costs’ – changing labels etc.)
The increased first home owners grant for newly built houses is an example of targeted pulling forward of purchases. Some temporary depreciation allowance or whatever for new car purchases could do the trick (though it would have a low multiplier given the import intensity of the industry), but there are lots of places where you could pull forward activity with temporary tax credits, subsidies or whatever. One could have them for equipment, buildings, improvements to houses – extensions, or if one wanted to be more worthy, environmental improvements like insulation, solar hot water and water tanks for instance.
Anyway, Peter Martin seems to think temporary GST cuts make sense and has quoted a bunch of economists from a Crikey! ring around sounding encouraging. I raised some of these things on Joshua Gans’ blog but he was unimpressed – observing “Nicholas, that is what you do for a fiscal stimulus. It is expensive.”
Joshua hasn’t responded to my reaction to this comment, but my objection to it is precisely that it’s more expensive and so less efficient than alternative more targeted measures.
I’m pleased to see the Govt’s not interested. But perhaps I’m wrong. I’d welcome anyone with a good knowledge of the literature or any other insights I’m lacking setting me straight.