Electric vehicle VAT cuts would not be passed on

Electric vehicle VAT cuts would not be passed on

Jul 13, 2023

Despite the high profile campaigns to scrap VAT on sunscreen and public electric vehicle charging, the changes would be an expensive waste of money and would not benefit consumers, claim tax experts

Tax Policy Associates analysis indicated that VAT cuts would be a waste of public money and consumers would not benefit, despite vociferous calls for change by a number of lobbyists and campaign groups.

In recent months, the Melanoma Focus Charity focused their sights on the removal of VAT on sunscreen products, pointing towards its expense as posing an ‘increasing risk’ of skin cancer.

Most recently the Society for Motor Manufacturers and Traders, representing the automotive sector, called for reduced rate VAT on public electric charging points.

Despite many making the assumption that cutting VAT would result in a price cut for consumers, this is not usually the case in practice.

The majority of the cut might be retained by retailers and suppliers, with only some being ‘passed through’ to consumers.

Dan Neidle, founder of Tax Policy Associates, said: ‘There’s a common intuition that a reduction in a producer’s cost will result in the producer lowering its prices. After all, the argument goes that the price of a product is made up of the cost of production plus a profit markup. So, if the cost drops, the price will drop. And VAT is a cost, so if we reduce VAT, the price will drop.

‘But that’s wrong. In a market economy, economic actors charge what the market will bear. Hence, in principle, there is no reason to assume that prices will reflect the level of VAT. Each case must be looked at on its facts.’

According to IMF research, which analysed 14 years’ of VAT changes across 17 countries, there were clear patterns in when changes in VAT were passed through to consumers, and when they were not.

It also found that the degree of ‘pass-through’ was strongly related to the percentage of overall consumption that is affected by the change.

There was also no significant pass-through when the consumption share was less than 10%, and when the VAT cut was targeted on one specific product or service.

For example, there were two recent VAT cuts resulting from high profile campaigns where industry pledged that consumers would benefit. These were the May 2020 abolition of VAT on eBooks, and the January 2021 abolition of VAT on tampons.

And despite the bulk of retailers promising to pass on the abolition of VAT on tampons, only 1% of the 5% cut was passed to consumers.

Comparing eBooks with other electronically-supplied products, as well as with paper books, also provided a similar result, with little to no evidence of any price cuts being passed to consumers.

‘It’s common for suppliers to lobby for VAT cuts, and I expect many of the VAT cuts included in the IMF research were accompanied by promises that consumer prices would fall. We therefore shouldn’t be surprised that these two UK examples are consistent with the general evidence on pass through’, Neidle added.

Campaigns ignoring the ‘deadweight cost’ were also cited as a serious mistake, with only a small percentage of the benefit going to ‘new’ consumers.

Currently, the UK sunscreen market is worth £169m, implying that a VAT cut would cost around £30m.

Neidle added: ‘Imagine if we could use that £30m to put high SPF sunscreen directly in the hands of the people that should use it, but don’t, and then persuade them to use it. That would be perfectly efficient, with zero deadweight cost.

‘A VAT cut doesn’t do that at all. First, a big chunk of the £30m will be kept by retailers, and not passed to consumers. Then, of the remaining part, most will go to cut sunscreen prices for people who were going to buy sunscreen anyway.’