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The Economics of a Temporary VAT Cut*

Crossley, Thomas F and Low, Hamish and Wakefield, Matthew (2009) 'The Economics of a Temporary VAT Cut*.' Fiscal Studies, 30 (1). pp. 3-16. ISSN 0143-5671

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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. © 2009 Institute for Fiscal Studies.

Item Type: Article
Uncontrolled Keywords: VAT; consumption; fiscal stimulus; intertemporal substitution; E62; H31; E21; D91
Subjects: H Social Sciences > HB Economic Theory
Divisions: Faculty of Social Sciences
Faculty of Social Sciences > Economics, Department of
SWORD Depositor: Elements
Depositing User: Elements
Date Deposited: 22 Sep 2013 12:10
Last Modified: 15 Jan 2022 00:52

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