In recent weeks, many have been mocking at Alistair Darling’s 2.5% reduction in VAT. It amounts to a measly two pennies in every pound, so they say, and is hardly likely to stimulate spending in the waythe Chancellor so desires. Who would cross the road for a 2% off deal?
Having run a small business, I can also say that a 2.5% change in VAT is not small change for everyone. Business-to-business transactions all require VAT to be charged (regardless of whether it is claimed back every quarter). A reduction of 2.5% on a five- or six-figure contract equates to hundreds or thousands of pounds, respectively. That could easily represent difference between solvency and insolvency.
Wandering around the expansive, yet surprisingly pleasant Westfield Shopping Centre yesterday, I marvelled at the legions of people flooding into the designer outlets, and tried to imagine how much money was beiung exchanged. I began to think that the critique of Darling’s VAT adjustments might be missing some maths. Or at least, some psychological insights into how people spend money.
It is not that we will notice the cheaper prices, and therefore go out and buy more of the “discounted” items. We will not. However, its a fact that if we maintain our current levels of spending, on similar items as we did before the VAT change, then we will be left with a little but of money left over at the end of the month. If a person on an average wage of £24,000 spends, say, half his or her salary in a given month, all on VATable items, then that amounts to about £16 extra each month. If that average person is anything like me, they will indeed spend it. Why? Because me and the average guy do not budget very well. The amount we save each month will probably be predetermined by standing order (perhaps even siphoned off into a pension scheme, for all the good that would do in this perilous financial climate). And as for the rest, well, we just keep spending on a whim until we reach a certain level. This threshold will be different for each person: It might be the point at which the bank account reaches its over-draft limit, or when the sight of the balance falling into single figures induces panic. Regardless, this threshold will be met when sixteen extra pounds have been spent (or whatever the figure actually is). If most people operate like this, then an extra few quid – equivalent to an extra evening a month in the pub, say – ends up in circulation. That’s a lot of money in the economy.