VAT to be reduced? Why you should save rather than spend

Speculation is rife that the government will announce a reduction in the VAT rate to 15% in the pre budget report on Monday. Reducing VAT may help boost spending now, but consumers would be wise to save some of the giveaways as taxes will increase in the next few years.

VAT receipt

The UK economy is in a bad way. The fact that interest rates have been slashed to 3% and the prospect of significant tax cuts shows us that the government wants to act strongly to stop a recession becoming a depression.

You, the consumer, is being encouraged to spend, spend spend as a way of stimulating a sick economy. The possible reduction of VAT is designed to make spending now more attractive.

Although seeing further price reductions in the shops is very welcome, we advise consumers to be cautious. Taxes have to rise in the future. In fact the Chancellor has to protect the strength of sterling by stating categorically that taxes will rise in future years, to bring the national debt back under control.

So any tax giveaways now, including a reduction in VAT, are not early Christmas presents, they are really a loan from the government. You should remember that the government will want that money back. In fact it needs that money back, so taxes will rise in the next few years.

In his excellent blog, Robert Peston states that he expects VAT to rise to 22.5% once the recession subsides.

So just when you start to feel good about the economic outlook, as we emerge from the recession, the tax man will come knocking on the door, wanting his “loan” back. As Robert Peston indicates, prices will rise again as VAT may be increased significantly.

Large future rises in VAT cause at least two problems:

  1. Prices increase causing inflation to rise. We all know how the government controls inflation – interest rates go up. So the cost of your mortgage is likely to rise.
  2. We tend to get used to paying VAT so governments are extremely reluctant to reduce VAT as it raises huge amount of tax revenue. Once VAT hits 22.5% it is very unlikely to be reduced back to the 17.5% that we currently pay.

So you have more money in your pocket from the recent interest rate falls, if you have a mortgage, that is, and you may well get a tempting offer from the government to spend more if they reduce VAT.

Heed my words, though. Don’t spend all that extra cash now. Put as much as you can afford into savings, or better still, use it to pay off some of your mortgage.

This sudden generosity of the government cannot last and having reduced borrowings, or more savings, will serve you well in the austere years to come.

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