Who will benefit from Liz Truss’s proposed VAT cuts?

Reducing the 20% rate 

A reduction in the 20% standard rate of VAT would cost £7-8bn p.a. for each percentage point of decrease, according to the Government’s own figures. However, for every 1% of such a cut which is passed on in full, consumers spending £1,000 would benefit from a price reduction of just £8.33.  

If the VAT rate is slashed from 20% to 10%, it would cost upwards of £70bn a year, but consumers would have to spend £1,000 before seeing savings of just £83.33.  

Most spending on essentials would not be impacted at all as no VAT is ever charged on food, children’s clothes, residential rents, mortgages, insurance or bank loans*. If it is solely the standard 20% rate that is reduced, energy bills (which are generally subject to the 5% reduced rate) would not be affected either. Higher earners with disposable incomes would stand to benefit the most, to the extent that they spend money on standard rated goods and services. 

That is not to say there would be no winners from such a reduction in the 20% rate: banks and other large 'partly exempt' organisations (which are restricted in recovering VAT on their costs) would receive a windfall benefit. This is because they have large cost bases and pay corresponding large amounts of VAT, so the value of the VAT reduction would mount up for them.  

In addition, businesses which do not reduce their prices, and so do not pass on the reduction in the VAT bill to their customers, will be able to benefit from enhanced profit margins on their sales. Perhaps one could see this as a useful benefit of the policy, to bolster the margins of businesses struggling with their own increased costs. However, in practice not all businesses will be able to benefit, and the arbitrary benefit that the lucky ones will gain may not correlate with the amount of extra costs they are suffering.  

Therefore, critics may argue that the reduction in rate may not benefit those most in need of support. Inequality may arise because only businesses that have consumers as their main customer base (and which therefore quote prices on a VAT-inclusive basis) would be able to take a strategic decision to maintain their prices in this way. Businesses in the B2B sector, with most or all of their customers being other businesses, will miss out on the opportunity as most of their customers can recover VAT on their costs, so pricing to them is usually based on the net of VAT price (which is unaffected if the VAT rate changes). However, B2B focused businesses are equally likely to be feeling the pinch under the current situation as those with a more consumer focused customer-base. 

Reducing the 5% reduced rate on energy 

Focusing a VAT cut purely on energy bills would be cheaper for the Treasury (each 1% cut from the 5% reduced rate costs £500m p.a.). However, the saving for individuals is modest, a 1% cut saves £9.52 per £1,000 spent on energy. Even if the VAT rate was reduced to zero for such supplies (at a cost of £2.5bn p.a.), the saving on a £1,000 bill would be just £47.62.  

Accordingly, even though such a change would reduce the cost of fuel for all individuals, the biggest beneficiaries of such a policy would be households with higher energy consumption. 

Meanwhile, such a change would not help most businesses (which don’t pay the 5% reduced rate, unless their usage is very low) and in any case can generally recover VAT on such costs.

*These items are generally either zero-rated or exempt, so a reduction in the standard 20% rate would not affect them. 

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