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Posts Tagged ‘VAT’

Happy Birthday VAT – 40 today

VAT was introduced on the 1st of April 1973, as part of the conditions for the UK entering the Common Market. Designed by a French tax expert, Maurice Lauré, it was initially envisaged as a straightforward replacement for purchase tax, which would be applied to most goods and services.

Forty years on, VAT is increasingly complex, with numerous exemptions, many anomalies in its scope, and increasingly expensive challenges to its imposition. How did we get to this point? And is it time for VAT to undergo a mid-life makeover?

All governments have to raise taxes – to redistribute income and to fund public spending. They have a number of mechanisms they can use, but essentially they have to tax incomes (direct taxes), spending (indirect taxes) or a mix of both. The main indirect tax in the UK is VAT, which now raises over £100bn a year, compared with £1.5bn in its first year (see above chart: click here for a PowerPoint version). Initially envisaged as a simple, cross-Europe purchase tax, the current system is complex and at times appears to have been formulated ‘on the hoof’, never a good way to build a tax system.

In the 2012 Budget, the Chancellor decided to apply the standard rate of income tax to hot takeaway pasties; previously they had been zero-rated. However, he had sharply underestimated the ability of the industry to lobby against the tax, working closely with the tabloid press. Perhaps more importantly, he also missed the complex nature of the good; when is a hot pasty just cooling down? And what is hot? The government backtracked and now 20% VAT is only charged on pasties that are deliberately kept hot. You might think that this change of heart avoided introducing an anomaly, but consider how you might feel if you sell takeaway baked potatoes, which are subject to VAT.

Apart from the complexity of the system, VAT is unpopular with some commentators who feel that it falls too heavily on low-income households. Although many foodstuffs are zero-rated and housing is exempt, VAT is charged at 20% on clothing and many necessities such as cleaning materials. Gas and electricity are subject to a reduced rate of 5% and both alcohol and cigarettes have additonal excise duties imposed and yet are disproportionally consumed by the poor. When the standard rate of VAT was temporarily dropped to 15% in 2010, but then permanently raised to 20% in 2011, many felt that this was a shift in the tax burden to the poor.

So complex, irrational and prone to changes following political lobbying or expensive legal cases, VAT does seem to be stumbling into its forties under something of a cloud. However, it remains the case that it raises a large proportion of UK tax revenues at relatively low direct cost and provides the Chancellor with a reasonably effective fiscal policy tool. Even if a government wanted to put in place an alternative, it is likely that the associated political risks would be too high for it to do so. We might hope for some rationalisation of the current system, but there is little doubt that we will be raising a glass to VAT’s 50th birthday in 2023.

The links below include some articles on VAT’s 40th birthday and some more general articles on VAT.

Articles
VAT is 40 years old- and now has middle-age spread The Guardian, Juliette Garside (31/1/13)
Is VAT suffering a mid-life crisis at 40? BBC News, Colin Corder (31/3/13)
VAT at 40, not simple, not popular, but central to government revenue-raising The Chartered Institute of Taxation (28/3/13)
Happy birthday VAT, here’s how not to pay you The Telegraph, Rosie Murray-West (31/3/13)
Poorest spend higher proportion of VAT than richest BBC News (31/10/11)
A Value- Added Tax offers much to love- and hate New York Times, Gregory Mankiw (1/5/10)
EC Standard VAT Declaration European Commission Roadmap (2012)

Data and information
VAT pages HMRC
Public sector finance statistics HM Treasury (follow link to latest Public finances databank (Excel file) and go to Worksheet C2)
Latest European Union EU VAT rates VATLive

Questions

  1. Explain why VAT might be deemed regressive. Can you formulate an argument that it falls more heavily on the rich than the poor?
  2. Why is VAT administratively cheap? Other than generating tax revenues, can you think of any advantages of the tax?
  3. Newspapers and books are zero-rated in the UK, while e-books and news apps are standard rated at 20%. Can you identify some other anomalies in the UK VAT system? Is there an argument that a better approach would be to charge a lower rate on all goods and services?
  4. Who pays VAT, consumers or producers? Illustrate your answer with a diagram, or two.
  5. A business has to register for VAT once it has a turnover of £77,000 pa. Does this system give rise to any perverse incentives?
  6. Countries across the European Union have varying VAT rates, applied to very different ranges of products. Explain why this might hinder the workings of a single European market.
  7. Imagine you were running a brand new economy; would you use a value-added tax to raise revenues? What are the alternatives open to governments?
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It’s fuelling anger

Petrol prices have been a bone of contention for some time. With household incomes remaining low and the cost of living rising, the fact that average petrol prices have reached their highest level of more than 1.37p per litre on average will undoubtedly put growing pressure on the approaching budget.

There have already been calls for the Chancellor to reduce fuel duty and with this latest data, the pressure will only mount. The problem is, if fuel duty does fall, so will tax revenues and as one of the Coalition’s key objectives has been to cut the budget deficit, this could pose further problems. Even the calls to cut VAT on fuel will also put a dent in the budget deficit.

Although everyone is undoubtedly feeling the effects of these higher prices, the key thing with petrol is its elasticity of demand. Whether the price of petrol was 0.90p or 1.37p per litre, I continue to buy the same amount. Therefore, for me, the price elasticity of demand for petrol is highly inelastic – at least between those prices. After all, if the price increase above say £3 per litre, I might think twice about driving to work!

So what has been driving this increase in prices? Petrol prices are hugely dependent on the cost of oil and on the demand for any product that uses fuel. With growing demand from countries like India and China, as they continue to develop and grow very quickly; the continuing concerns with Iran’s nuclear programme and the political problems in the Middle East, oil prices have been forced up. The future trend in prices will depend on many factors, not least whether or not there is any change in fuel duty in the 2012 budget and whether something like a regulator is introduced to monitor increases in fuel prices. This is definitely an area to pay close attention to in the coming months.

Petrol prices reach record high Independent, Peter Woodman (3/3/12)
Petrol prices hit record high with further rises expected Guardian, Hilary Osborne (2/3/12)
Appeak to regulate petrol prices This is South Wales (3/3/12)
Plea to slash duty as fuel costs soar to record high Scotsman, Alastair Dalton (3/3/12)
Petrol prices hit record high The Telegraph, David Millward (2/3/12)
Diesel prices predicted to reach 150p as petrol hits new record Guardian, Terry Macalister and Hilary Osborne (2/3/12)

Questions

  1. Which are the factors on the demand side that have pushed up the price of oil and hence petrol and diesel?
  2. What are the supply-side factors that are causing the rising price of fuel?
  3. Use a demand and supply diagram to illustrate the effects you have explained in the first two questions.
  4. In the blog, I mention that my price elasticity of demand is relatively inelastic between 2 given prices. What does this suggest about the shape of my demand curve for petrol? How does this shape affect prices following any change in demand or supply?
  5. Why is petrol a relatively price inelastic product?
  6. There have been calls for the government to cut VAT or reduce fuel duty. What are the arguments for and against these policies?
  7. How effective do you think a petrol price regulator would be?
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A retail slowdown

Growth in the UK for the final quarter of 2010 was originally at -0.5%. However, the latest data has revised that figure to -0.6% and not all of this was down to the snow. Analysts say that the snow effect is still believed to explain the 0.5% contraction, but the economy therefore declined by 0.1% because of other reasons and retailers have seen the effects. Primark has reported a ‘noticeable’ slowdown in demand since the beginning of 2011. With increasing VAT and rising cotton prices, clothing retailers are feeling the squeeze. The same is true of UK consumers. With an increase in VAT and high inflation, consumers’ purchasing power has simply fallen and so they are spending less. Despite this slowdown, Primark’s revenues are still significantly ahead of the same time last year.

The parent company, Associated British Foods (ABF) commented on the disappointing trading of 2011 so far, saying:

“Since the New Year, the performance in all our operations in Continental Europe has been very encouraging but there has been a noticeable slowing down of UK consumer demand.”

However, despite disappointing figures for Primark, UK retail sales did pick up in January, although analysts are warning against taking this information as a sign of recovery. As Hetal Mehta from Daiwa said:

“While we expected there to be some clawback from December’s dismal, snow-hit retail sales, today’s jump is a welcome surprise. But is still far too early to conclude that consumers are weathering the storm … and with the past week’s unemployment figures highlighting the fragility of the labour market, the housing market continuing to weaken and real earnings being hit hard by high inflation, it seems inconceivable that consumer spending will act as the driving force of the economy over the near term.”

There are many opinions about what to expect from the economy in 2011, but for any concrete information, we really have to wait for at least another month. Perhaps by Easter, we’ll have a better idea about the state of the UK. For now, there are a few articles considering the retail sector.

Primark owner warns of slowing sales in UK Guardian, Graeme Wearden (28/2/11)
Primark warns of ‘noticeable’ slowdown in UK demand BBC News (28/2/11)
Growth in UK retail sales slows sharply Wall Street Journal, Alex Brittain and Art Patnaude (24/2/11)
UK retail sales rebound: reaction Telegraph (28/2/11)
UK GDP figure revised down further BBC News (25/2/11)

Questions

  1. Why has higher VAT and cotton prices impacted retailers such as Primark?
  2. Why was Primark less affected by declining sales in the run up to Christmas?
  3. What do we mean by purchasing power?
  4. Why is it hard to draw any conclusions about the performance of the UK at the moment?
  5. What does a slowing down of retail sales mean for the UK’s recovery? Will it influence the Chancellor’s Budget?
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Car sales stall

For most people, buying a new car is a luxury and in times of hardship it is a luxury that many cannot afford. Sales of new cars did grow during 2010 by 1.8% compared to the previous year, although the end of the car scrappage scheme in March 2010 did see a fall in sales. Sales went from being 19.9 per cent up on 2009 in the first half of the year, to being 13.8 per cent down for the remainder of 2010. On top of this, they are predicted to fall by some 5% over the coming 12 months.

Part of the explanation of this trend is the VAT rise. While an extra 2.5% is hardly noticeable on many every day items (as we saw when VAT was reduced to 15%), it will have a much larger effect on more expensive items, such as cars.

It was expected that people thinking of buying a new car would try to beat the VAT rise and so car firms hoped for a surge in sales during December. However, this did not occur and with VAT at 20% during 2011, car prices will rise: a £15,000 car will cost an extra £320. Another contributing factor to the lower than expected sales in December was the snow. Retail sales in December collapsed by 37.5%, where as fleet sales, which are less likely to be affected by the adverse weather rose by 5.1%. Similar patterns were seen in Spain, Italy and France, but in Germany sales were up by 7% on the year from December 2009.

The good news for the UK car industry is that the second half of 2011 is expected to see growth, so there may be some recovery. Furthermore, UK-built cars have seen a rise in sales – up by 17%. Finally, as petrol prices continue to rise, it is hoped that this might encourage people to trade in their less efficient old cars for more fuel-efficient new cars. This will certainly be an industry to watch over the next few months.

Snow hits new car sales Telegraph, Graham Ruddick (8/1/11)
UK new car sales to fall in 2011, says industry BBC News (7/1/11)
Mixed end to the year for European car sales Independent (7/1/11)
Car sales set to stall? Daily Mirror, Clinton Manning (8/1/11)
UK new car sales rose 1.8pc in 2010 despite end of scrappage scheme Telegraph, Amy Wilson (7/1/11)
New car sales increased in 2010 Telegraph, Chris Knapman (7/1/11)
Car registrations fall 18% from year ago Financial Times, Norma Cohen (7/1/11)

Questions

  1. What type of tax is VAT? Illustrate the effect of such a tax on a diagram and explain why the higher the price of the good, the bigger the impact of the VAT rise. How might this impact inflation?
  2. Why are car sales expected to fall in the UK over the coming year? Given this expected trend, what might we expect to see in terms of car prices?
  3. What impact might rising petrol prices have on new car purchases? What figure would you expect to see for cross elasticity of demand?
  4. How might the expected decline in car sales affect the UK economy over the next 12 months?
  5. What type of market structure is the car industry? (Think about the characteristics of monopolistic competition and oligopoly.)
  6. How did the car scrappage scheme help car sales?
  7. What might explain the different trend seen in the German car industry?
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Unexpected inflation rise

It is the Bank of England’s responsibility to ensure that inflation remains on target. They use interest rates and the money supply to keep inflation within a 1% band of the inflation target set by the government = 2%. However, for the past 12 months, we have had an inflation rate above the 3% maximum and this looks set to continue. Official figures show that the CPI inflation rate has risen to 3.3% in November, up from 3.2% in October 2010 – above the inflation target. There was also movement on the RPI from 4.5% to 4.7% during the same months. The ONS suggests that this increase is largely down to record increases in food, clothing and furniture prices: not the best news as Christmas approaches. It is not just consumers that are facing rising prices, as factories are also experiencing increasing costs of production, especially with the rising cost of crude oil (see A crude story). Interest rates have not changed, as policymakers believe prices will be ‘reined in’ before too long.

However, the government expects inflation to remain above target over the next year, especially with the approaching increase in VAT from 17.5% to 20%. As this tax is increased, retail prices will also rise and hence inflation is likely to remain high. There is also concern that retailers will use the increase in VAT to push through further price rises. A report by KPMG suggests that 60% of retailers intend not only to increase prices to cover the rise in VAT, but to increase prices over and above the VAT rise.

Despite the planned VAT rise spelling bad news for inflation, it could be the spending cuts that offset this. As next year brings a year of austerity through a decrease in public spending, this could deflate the economy and hence bring inflation back within target. However, there are suggestions that more quantitative easing may be on the cards in order to stimulate growth, if it appears to be slowing next year. The Bank of England’s Deputy Governor, Charles Bean said:

“It is certainly possible that we may well want to undertake a second round of quantitative easing if there is a clear sign that UK output growth and with it inflation prospects are slowing,” Bean told a business audience in London.”

The following articles consider the rising costs experienced by firms, the factors behind the inflation and some of the likely effects we may see over the coming months.

Articles
UK inflation rises to a surprise six-month high The Telegraph, Emma Rowley (14/12/10)
UK inflation rate rises to 3.3% in November BBC News (14/12/10)
Inflation unexpectedly hits 6-month high in November Reuters, David Milliken and Christina Fincher (14/12/10)
Food and clothing push up inflation Associated Press (14/12/10)
Retailers ‘to increase prices by more than VAT rise’ BBC News (14/12/10)
VAT increase ‘will hide price rises’ Guardian, Phillip Inman (14/12/10)
Slower growth may warrant more QE Reuters, Peter Griffiths and David Milliken (13/12/10)
Factories feel squeeze of inflation The Telegraph, Emma Rowley (13/12/10)
Figures show rise in input prices The Press Association (13/12/10)
November producer input prices up more than expected Reuters (13/12/10)

Data
Inflation ONS
Inflation Report Bank of England

Questions

  1. What is the difference between the RPI and CPI? How are each calculated?
  2. Why are interest rates the main tool for keeping inflation on target at 2%? How do they work?
  3. Is the inflation we are experiencing due to demand-pull or cost-push factors? Illustrate this on diagram. How are expectations relevant here?
  4. Explain why the rise in VAT next year may make inflation worse – use a diagram to help your explanation.
  5. Explain the process by which rising prices of crude oil affect manufacturers, retailers and hence the retail prices we see in shops.
  6. How are the inflation rate, the interest rate and the exchange rate linked? What could explain the pound jumping by ‘as much as 0.2pc against the dollar after the report’ was released?
  7. Explain why the public spending cuts next year may reduce inflation. Why might more quantitative easing be needed and how could this affect inflation in the coming months?
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Not-so-cheap cheap fashion

Rising costs of cloth and a rise in VAT could mean that clothes prices are set to rise. Does this spell the end of cheap fashion from the likes of Primark and H&M? Or can they absorb the cost increases?

The following articles look at the causes of the rise in costs of clothing and what the cheap fashion chains can do about it.

Articles
Primark follows fashion rivals as it warns of rising costs Guardian, David Teather and Zoe Wood (13/9/10)
Primark warns on costs as growth slows Telegraph, James Hall (14/9/10)
Is this the end of cheap clothes era? Price of cotton has rocketed because of floods, Primark warns Mail Online, Sean Poulter (14/9/10)
Fashion chains far from cheerful about future of cheap chic Observer, Zoe Wood, David Teather and Julia Finch (19/9/10)

Data
Commodity prices (including cotton) Index Mundi
Cotton futures BBC Business: Commodities

Questions

  1. Why have cotton prices been rising? Illustrate your arguments with a demand and supply diagram.
  2. Would you expect a rise in the price of cotton of 45% to lead to a rise in the price of cotton clothes of 45%, or of more than 45% or of less than 45%? Explain.
  3. For what other reasons are the prices of clothing rising?
  4. How did the process of globalisation keep the price of clothing down?
  5. Next’s chief executive, Lord (Simon) Wolfson said that if prices of Next’s clothes go up 8% then the number of units sold will fall by 10%. What is the value of the price elasticity of demand that he is assuming?
  6. Why is the ‘Fairtrade system so important’?
  7. “Some retailers have already increased prices but there is more to come. The products most under threat are T-shirts, underwear and socks. More complicated garments such as heavy jeans will be less affected.” Why are the prices of more complicated garments likely to rise by a smaller percentage than those of simple garments?
  8. What has been happening to the demand for cheap fashion clothing and why? Combine this effect with those of costs on a demand and supply diagram.
  9. What type of market structure is the market for fashion clothing? What are the implications of this for the profits of retailers?
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Gobbling up a good deal

The market for food in the UK is highly competitive. From dining in style to a simple take-away, one of the key words when it comes to dining seems to be choice. Competitive prices and high quality are on offer, which is largely due to the sheer number of restaurants available to consumers. However, consolidation seems to be on the menu.

Nando’s is a well known restaurant and a popular eating destination on UK and Irish high streets, with more than 230 restaurants. This chicken restaurant group has made a £30 million bid for Clapham House, the company behind the Gourmet Burger Kitchen chain with 53 branches. Clapham’s shareholders were advised to accept the deal and on the 17th September 2010, it is reported that a deal was reached with Nando’s Group Holdings and its private equity owner Capricorn Ventures International. The 74 pence per share deal was met with disappointment by some analysts, who felt that the company was under-valued, despite failed attempts by Clapham House’s Board to persuade Capricorn to raise the offer price or find an alternative bidder.

The restaurant industry has suffered from the recession and especially by the weak economic recovery, so perhaps lower valuations are to be expected. Nando’s said:

‘As macroeconomic weakness has persisted in the UK, the trading environment for restaurant businesses in the UK has been difficult. This is evidenced by Clapham House’s vaolatile weekly trading performance.’

Nando’s intend to invest significantly in Clapham Houses’ businesses to reinvigorate their previous competitor. This may be essential, given the expectation that conditions in the UK will remain fragile, with consumer confidence staying low, as well as a somewhat untimely rise in VAT in January next year, which is almost certain to have an adverse effect on the restaurant business.

This take-over deal is not the first in the restaurant industry and nor is it likely to be the last, as the UK economy remains in a vulnerable state. The following articles look at this and over takeovers.

Nando’s to buy Gourmet Burger Kitchen for £30m BBC News (17/9/10)
UK restaurants serve up £50m in takeover deals Management Today, Emma Haslett (17/9/10)
Nando’s swallows Gourmet Burger Daily Mirror News, Clinton Manning (18/9/10)
GBK team plots next move after Nandos deal Telegraph, Jonathan Sibun (18/9/10)
Nando’s to buy Real Greek chain for £30m Independent, Alistair Dawber (18/9/10)
Mithcells & Butlers and Nando’s to feast on rival restaurant chains Mail Online, Ben Laurance (17/9/10)
GBK owner Clapham agrees to Nando’s offer Reuters (17/9/10)

Questions

  1. What type of takeover is Nando’s purchase of Clapham House?
  2. Why has the weak macroeconomic environment adversely affected the restaurant industry? What might be the impact of next January’s rise in VAT?
  3. Will Nando’s takeover (or indeed any other takeover in the restaurant industry) allow the company to prosper from the weak economic climate?
  4. In which type of market structure would you place the restaurant industry in the UK? Explain the characteristics of the market structure you choose and why you have placed the restaurant industry in it.
  5. How was the finance for the deal raised by Nando’s Holdings Group? What other sources of finance are available to firms for this purpose? What are the (a) advantages and (b) disadvantages of each?
  6. What other takeovers have occurred recently in the restaurant industry? What types of takeovers are they?
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Bank of England navigates choppy waters

Every three months, the Bank of England produces its Inflation Report. This includes forecasts for inflation and economic growth for the next three years. The forecasts are presented as fan charts. These depict the probability of various outcomes for inflation or growth in the future. “In any particular quarter of the forecast period, GDP is expected to lie somewhere within the fan on 90 out of 100 occasions.” Each coloured band represents a 10% probability of occurrence. “Although not every member will agree with every assumption on which our projections are based, the fan charts represent the MPC’s best collective judgement about the most likely paths for inflation and output, and the uncertainties surrounding those central projections.” The broader the fan the less confident are the forecasts. The fans have tended to get broader in recent Reports, reflecting the greater uncertainties in the UK and global economies since the credit crunch.

Since the last Report, the forecast for economic growth in 2011 has been adjusted downwards from 3.4% to 2.5%. Inflation, while still being forecast to be below the target of 2% in two years’ time, is forecast to rise in the short term, thanks to higher commodity prices and the rise in VAT from 17.5% to 20% in January 2011.

So what impact, according to the Report, will various factors such as the Coalition’s emergency Budget in June, rising commodity prices, falling consumer confidence and improving export performance have on the economy? And how much credence should be put on the forecasts? The following articles address these questions

Articles
Bank chief warns of ‘choppy recovery’ Independent, Russell Lynch (11/8/10)
King warns of ‘choppy recovery’ for economy Channel 4 News, Faisal Islam (11/8/10)
Bank of England warns UK recovery will be weaker than hoped Telegraph (11/8/10)
Bank of England lowers UK growth forecast Telegraph, Angela Monaghan (11/8/10)
Bank of England cuts UK economic growth forecasts Guardian, Katie Allen (11/8/10)
Bank of England forecasts ‘choppy’ economic recovery BBC News, Katie Allen (11/8/10)
Bank of England Cuts Outlook for Economic Growth Bloomberg, Jennifer Ryan (11/8/10)
Why is the UK heading into choppy waters? BBC News Analysis, Hugh Pym (11/8/10)
Bank of England overhauls forecast model after errors Telegraph, Philip Aldrick (11/8/10)
The Bank’s impossible balancing act Independent, David Prosser (11/8/10)
How uncertain exactly is the uncertain BoE? Reuters Blogs, MacroScope (11/8/10)
‘Slowflation’ – the combination the Bank of England fears most Independent, Sean O’Grady (11/8/10)
The Bank is right to paint a mixed picture Independent, Hamish McRae (11/8/10)
Sterling falls, gilts rally after Bank of England cuts growth forecasts Guardian Blogs, Elena Moya (11/8/10)

Report
Inflation Report
Inflation Report Press Conference

Questions

  1. Do the Bank of England’s forecasts suggest that the UK economy is on track for meeting the inflation target in 24 months’ time?
  2. How much reliance should be put on Bank of England inflation and growth forecasts? You might want to check out the forecasts made one and two years ago for current (2010) rates of inflation and growth (see Inflation Reports (by date)).
  3. What are the factors that have persuaded the Bank of England to reduce its forecast for the rate of economic growth in 2011? Are these factors all on the demand side?
  4. According to the fan chart for economic growth, what is the probability that the UK economy will move back into recession in 2011?
  5. Will the rise in VAT in January 2011 cause inflation to be higher in 2012 than in 2010 (other things being equal)? Explain.
  6. Why did the FTSE fall by 2.4% on the day the Report was released?
  7. If commodity price inflation increases (see Food prices: a question of supply and demand), what impact is this likely to have (a) on the rate of economic growth; (b) on the rate of interest chosen by the MPC?
  8. What policy should the Bank of England adopt to tackle ‘slowflation’?
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Getting burnt by VAT

Skin cancer is on the increase in the UK. Calls are thus being made by both retailers and cancer charities for a cut in VAT on sun cream.

At present the VAT rate on sun cream in the UK is the standard rate of 17.5%, which is due to increase to 20% in January 2011. But would cutting the rate to 5%, as is being proposed, be effective in cutting skin cancer rates? What information would you, as an economist, need to assess this claim?

Articles
Government urged to cut VAT on sun cream amid skin cancer fears Guardian, Rebecca Smithers (27/7/10)
Brits Get Burned By Vat Rise On Suncream PRLog (7/7/10)
Why we still think bronzing is tan-tastic Irish Independent, Susan Daly (27/7/10)

Evidence on sun creams
Sunscreen Wikipedia
Sun creams Cancer Research UK

Questions

  1. What would determine the incidence of a cut in VAT on sun creams between consumers and retailiers?
  2. If there were a 50:50 incidence of a VAT cut between consumers and retailers and the VAT was cut from 17.5% to 5%, what percentage fall in the retail price would you expect?
  3. Assume that the price elasticity of demand for sun cream is –1 and price elasticity of supply is +1, how much would sales of sun cream rise if the VAT rate fell from 17.5% to 5%? Are these realistic values for the price elasticity of demand and supply?
  4. Under what circumstances may promoting the use of sun creams encourage the development of skin cancer?
  5. Are people being rational if they choose to expose themselves to the sun for long periods in order to receive a ‘fashionable’ tan? How are time preference rates (personal discount rates) relevant here?
  6. What market failures are involved in the tanning industry? If the use of sunbeds contributes towards skin cancer, should they be banned?
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A Budget emergency

A large deficit which needs cutting and this needs decisive action. This was the gist of the message from George Osborne, and generally from the Coalition government. Although there is nothing confirmed in terms of what to expect, it is thought that there will be a proposal to ease National Insurance for new businesses. He said:

“And so we’ve got to deal with that [the country in Europe with the largest budget deficit of any major economy]. In that sense it’s an unavoidable Budget, but what I’m determined to do is to make sure that the measures are tough but they’re also fair and that we’re all in this together and that, as a country, we take the steps necessary to actually provide the prosperity for the future.”

We already know that there are plans in place to increase capital gains tax from 18% to nearer 40%, but beyond that, little is known. There are concerns that this policy may actually cost the government more in tax revenue than it will raise. Other policies we might expect include a rise in VAT, and a slashed spending budget for pensions. These spending cuts and tax rises will help Osborne to eliminate the structural deficit in current spending by 2015, when the Coalitions’ current term comes to an end. The success of the Coalition’s policies and their ability to reduce the deficit without causing the economy to fall back into recession will be crucial in determining whether the current term is the only term.

Budget 2010: Britain on ‘road to ruin’ without cuts (including video) BBC News (20/6/10)
Where could spending axe fall? BBC News (9/6/10)
George Osborne says emergency budget cuts will be ‘tough but fair’ Guardian, Larry Elliott, Toby Helm, Anushka Asthana and Maev Kennedy (20/6/10)
Budget 2010: capital gains tax Telegraph (20/6/10)
What’s the Chancellor planning to take away in reverse Christmas budget Independent, Alison Shepherd and Julian Knight (20/6/10)
Public borrowing at a peak, says ONS, but tough budget awaits Independent, Sean O’Grady (20/6/10)
A bloodbath none was prepared for Financial Times, Martin Wolf (22/6/10)

Questions

  1. To what extent is it necessary to cut the budget deficit now and not delay it until the recovery is more secured?
  2. How will easing National Insurance for small businesses affect the economy?
  3. If capital gains tax goes up, why is there concern that this could actually cost the government? How is this possible?
  4. The Lib Dems will oppose any increase in VAT, as they argue it is a regressive tax. What does this mean?
  5. How will the report by the Office for Budget Responsibility have affected Osborne’s emergency budget?
  6. What is the structural budget deficit? Illustrate it on a diagram.
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