Why choose Increased VAT to bring in the extra pennies

Of all the ways the UK chancellor could have chosen to bring in the much needed extra cash why choose VAT ?

You may be of the opinion, like some that we don't need to cut the defecit quite as drastically as the chancellor believes. Indeed, you may also be thinking that the pain should be borne by the banks and not the hard working man in the street.

I think I should come clean with my own opinions at this point. I firlmly believe we should reduce the defecit as quickly as possible, as quickly that is without dropping the economy back into recession. Yes we could target the banks, the ones who got us into this mess in the first place but the truth is, we need them to be strong, and we want them to regain their strength as quickly as possible because it's the large financial institutions that are one of the key pieces in the recovery jigsaw.

The capitalist world requires money to fund expansion. The governments need money, the banks need money, so does industry and the man on the street. Banks lend to industry, industry employs people who pump money into the economy by spending more. The more we spend, the stronger industry gets and the supply and demand process starts to kick in so a recovery starts to take shape.

Of course, we could simply cripple the banks, take a huge levy and reduce the taxes on the working man, leading to extra cash leading to more spend. The problem with this is that the levy is not sustainable unless it is small and this does not result in the necessary impact to fuel continued growth.

Yes we need the banks to be strong so can't hurt them too much because they will help the country recover. So back to the dilemma the uk government is facing.

A massive defecit and a challenge to reduce it quickly or the wrath of a potential downgrading of our tripple A rating awaits. Such downgrading would make things even more difficult to raise the cash because the cost of borrowing by our financial institutions and government would increase.

Why the rush, could we not simply gradually reduce the defecit as the economy grows. Of course we could do that, but as any loan company will tell you, the longer you have to pay off a loan, the more you pay in the end. Pay it off early and you save lots more money. Money that could be used to invest back into the services the country needs.

So back to the VAT question. Why choose VAT, he could have raised the tax rate, lowered the tax bands or increased the rate for higher earners.

Of course raising taxes in the normal way is an option, make more people pay more taxes and the money rolls in. VAT is also a tax, unlike normal tax however it is targted on spending. The more you spend the more VAT you pay so in one way it is quite a repressive tax. The standard tax route would have a similar effect but the tax is taken at source so the net effect could be the same, they both dampen the spending power of the consumer.

The subtle difference though is that VAT is borne by everybody equally. When consumers buy goods from a shop, the VAT they pay on the goods is passed to the shop who in turn offset their VAT payments against the cost of purchase of the goods and down the chain it goes, the government taking their cut each time there is a difference between the input and output VAT.

The key benefit of using VAT as the vehicle to raise funds quickly is that exporters are not affected, foreignen importers of UK goods are not affected (generally) which means the recovery can be industry led which helps to kick start the economy. Not that simple I admit but when your trade defecit is topping £4bn an export led recovery is not such a bad thing.