The coalition government has remained steadfast to its austerity measures, cutting public services and hiking VAT to reduce the budget deficit. But as a looming eurozone disaster piles upon gloomy growth figures, the IMF believes it may have to prepare to change tack.
“Fiscal easing measures... should focus on temporary tax cuts and greater infrastructure spending, as these may be more credibly temporary than increases in current spending,” Lagarde said, although she did praise the government’s fiscal consolidation over the last two years.
Andrew Smith, chief economist at KPMG, believes it is unlikely that the government will opt for a temporary VAT cut, but he believes this may not be the best way forward.
“We’re suffering from a lack of demand and should be thinking about how to boost it,” said Smith. “A VAT cut would do this.”
Smith points out that while companies remain supportive of the government’s deficit reduction plans, this has frayed, and he wants to see the UK adapting to changing circumstances.
Stuart Adam, senior research economist at the Institute of Fiscal Studies (IFS), remains on the fence over the question of whether the UK should be considering a fiscal stimulus now, though he says the argument for it is stronger now than it was a year ago.
Adam believes that if the UK is to go down this route, a temporary VAT cut would be one of the better options.
“A fiscal stimulus should be timely, targeted and temporary,” Adam said.
On the first point, a VAT cut would be easy to do and quick to bring in, unlikely other tax reforms which can only be introduced at the start of a tax year.
On the second, Adam notes that a VAT cut can be successful if it is temporary, but he cautions that people must be clear when it is going to end so that spending can be brought forward.
Adam points out that there will be a compliance cost to business with a temporary VAT cut as it will mean price and software changes. He says that there was business concern over previous VAT changes, especially as the last increase to 20% came in at the new year.
“But business would welcome a tax cut that applies to their products,” said Adam, noting that the benefit to taxpayers are likely to outweigh the compliance costs.
Before taking up her position at the IMF, Lagarde served as the French finance minister under Nicolas Sarkozy whose government, alongside the UK’s, was a champion of austerity measures to fix Europe’s ailing economy. But Sarkozy’s defeat to Francois Hollande could spell a turning tide away from austerity and towards fiscal stimulus.
If this is the case, temporary VAT cuts may become commonplace around Europe and governments looking to do so will be emboldened by the IMF’s recommendations.
