First the Chancellor giveth, then the Chancellor taketh away.

Yesterday, the Chancellor Alistair Darling announced in his Pre-Budget Report the much talked about 2.5% cut in the VAT, bringing it down to 15% from 17.5%. In the same breath, he also announced an increase in income tax for those earning £140,000 and above. From April 2011, people falling into this income bracket will have to pay income tax at the rate of 45p.

The cut in VAT is to come into effect from the 1^st of December. This leaves ample time for businesses to revise their prices and change the all the labels in the stores, but at the same time, being just in time before the Christmas shopping.

So, how will the change affect the prices? Will a loaf of bread or a bunch of carrots be any cheaper? No, because food products do not attract VAT. Surely, utility bills as a result will go down. Sadly, no because the VAT on utilities such as gas and electricity already have a lower rate of VAT charged at 5%. A cut of 2.5% doesn’t look as if it will make a huge difference in prices, especially compared to the generous 20%, 35%, 40% discounts offered by the retailers already.

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Then, the motive behind the cut is to give confidence to the consumers to go out and spend. But, confidence cannot be used to pay for a brand new PlayStation 3, can it? You need something else, namely, money. The primary reason why people are spending less money on the high street is because they have very little surplus left over after paying the high utility and food bills. And those who have enough surplus choose to save it for a rainy day.

That’s because it’s almost impossible to see a news report nowadays without it mentioning yet another company announcing job cuts. This creates uncertainty among those who are employed about the security of their jobs. Those who have recently been made redundant have no choice but to save money. But those who have a job also save since they don’t know how they are going to put food on the table next month or meet their mortgage repayments.

Another thing that’s hard to miss in a news report is an interview with the boss of a SME (Small & Medium Enterprise) business who has been denied a loan from his bank, or has had his overdraft facility cancelled. This leads to cash flow problems which means the business cant pay its staff, pay its utility bills, or even buy raw materials to maintain production. In addition, creditors, who owe money to the business, are unable or reluctant to part with their money. As a result, staff numbers have to be cut down adding to the number of unemployed across the country.

How can such news create confidence?

Perhaps, the Chancellor should look at reducing the VAT temporarily on utilities, or even get rid of them for the time being. More importantly perhaps, he should make sure that SMEs, who are perfectly healthy, should have access to loans and overdrafts at a reasonable cost to maintain their cash flow. After all, the SMEs are not asking for charity, just for funds which they are prepared to pay back with due interest. It makes sense for the Government to ensure that businesses that are perfectly sound to not go bankrupt just because they do not have enough cash or credit to meet their current liabilities. After all, the SMEs employ a lot of people in the private sector of the economy and contribute to the Treasury in the form of National Insurance and Corporation Tax. Since people are employed, it saves the Government the trouble of have to pay job seekers allowance, hence reducing its outflow.

So, it is perhaps job security and income security that will encourage the consumers to go out and spend, as Alistair Darling and Gordon Brown along with countless retailers are eagerly hoping, fingers crossed.

But it seems highly unlikely that the cut in VAT will have the intended purpose of instilling confidence among the consumers and going on a spending spree, but for the sake of the economy and the countless people who are unemployed, lets hope its not all in vain. The high earners are certainly hoping for it, since they are going to be paying for it, come 2011.

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