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VAT reductions would not be sustainable in the long run, according to UK tax experts

While tax directors applauded a proposed 2.5 percent VAT cut in the UK, they questioned whether it would be in the country's long-term interests, given the country's economic challenges.

It comes after Rupert Harrison, a former adviser to George Osborne, the UK chancellor of the exchequer, said on BBC Radio 4's Today programme on May 19 that the government should lower the rate.

Rishi Sunak, the current chancellor, needs to "act quickly and on a relatively large scale" to reduce high inflation and boost the economy, according to Harrison.

"The one thing the government can do that sort of helps people, their incomes and directly addresses the inflation problem is to cut VAT, and I think that is quite likely," said Harrison, a portfolio manager at Blackrock in London.

He claimed that, despite the fact that it would be a large tax cut and costly to the UK Treasury, it would help to lower inflation.

Inflation in the United Kingdom has reached a 40-year high of 9%, the highest among G7 countries, owing to rising global fuel and food prices.

One tax director applauded the proposal to boost the economy, but cautioned that it might not be the best long-term strategy.

"I think a VAT cut is going to be favourably received by all … but is it right for the long-term fiscal policy? I doubt it is, at the end of the day we are still going to have to pay for it ,"  Arfan Syeed, group tax director at Canaccord Genuity in the UK, said.

However, in the short term, it would help businesses with cash flow and pass on benefits to customers, according to Syeed.

Following the pandemic relief effort, the UK government's borrowing increased to £317 billion ($398 billion) in the 2020/21 financial year, though this has since been reduced.

It is not unheard of for VAT to be reduced during a difficult financial period. During the height of the financial crisis in 2008, Alistair Darling, a former UK chancellor, famously cut VAT by 2.5 percent to boost the economy.

Inflation is expected to peak in the next 12 months, putting the UK economy in jeopardy of going into recession. A VAT reduction might be able to help with both of these issues.

"Well, look, that is the big call," Harrison said on the radio. " That’s the judgment they’ve got to make about whether this is enough of a very short-term economic crisis to go big."

Corporations believe that a VAT reduction would be both welcome and relatively simple to implement.

A VAT reduction, according to Syeed, "always does well," particularly with clients in the financial services industry.

"It would just be a change in [VAT] rates," he adds, "o it wouldn’t impact our systems much apart from just a change in our data, so it doesn’t cause any business issues."

According to the tax director of an international telecommunications company in the United Kingdom, the change would not have a significant impact on the company's internal systems because it would be simple to implement.

These viewpoints, however, are not shared by everyone. Another tax director at a UK toy company says that if a company is not well organized, it could be difficult for them to comply, especially with automated VAT determination systems.

"Once companies have made the adjustments, they would need to change their systems, test them to make sure they are giving the right VAT numbers to ensure there aren’t any issues of non-compliance," he adds.

Companies that have VAT-exempt supplies or partial exemptions, such as financial services firms, could be the big winners from a potential VAT reduction.

"If you are company without VAT-exempt supplies then it’s your customers that see lower prices," he says, "but companies with VAT supplies will love it because it reduces their basic overheads as they can’t reclaim all their input VAT."

Concerns about VAT exemptions for financial services, such as investment management, have also been raised by some tax directors.

"The government has come out to say they will make things clearer, but they have not come out with that [a proposal] … nothing seems to be happening at the moment ," Syeed says.

He claims that there are many grey areas, particularly in financial planning and advisory services, where companies are unsure whether or not to charge VAT.

As a result, there has been a market split, with some businesses being cautious and charging VAT, while others have not.

Governments around the world have shifted their focus from lowering corporate income taxes to raising VAT rates, according to some. Increased VAT compliance requirements and digitalized reporting systems are examples of this.

Furthermore, some tax directors believe that any potential VAT change will only be temporary.

"A VAT cut would help a lot with our cashflow … but I think this would be a temporary reduction, and I wouldn’t expect it to last very long ," says a top tax director at a UK telecoms conglomerate.

She claims that VAT is always the most heavily weighted tax in terms of revenue collected, and that the government will eventually require more funds to aid in the economic recovery process. As a result, the wisdom of a potential 2.5 percent reduction in government revenue would be called into question.

The UK Treasury's main concern could be balancing public finances in the face of multiple challenges, including high inflation, a cost-of-living crisis, and the overhang from pandemic borrowing measures.

The question will be how it balances the books with a potential VAT cut while also attempting to stimulate the economy, which will undoubtedly be a difficult task when viewed through the lens of long-term fiscal policy.



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