VAT has traditionally been charged at one rate with notable exceptions such as children’s clothing. This approach is inflexible and inappropriate for our retails sectors that cover such a wide range of products and price points. We need to approach VAT in a different way.
All products are associated with elasticity. They can be very inelastic and therefore demand is not influenced by price changes either way OR they can be very elastic where even a small reduction in price can drive up demand significantly.
If we use a lower rate of VAT on elastic products – the price reduction will drive up demand. To counter this a higher rate could be applied to inelastic products. If applied correctly there could be a overall positive combination of increased demand in the elastic products, driving up volume enough to increase the levels of VAT than previously being obtained PLUS a higher level of VAT being obtained from the inelastic item with no reduction in demand.
Elasticity variables can be applied across product types as well as price points. A good example would be a £15k car versus a £60k car. A lower rate on the £15k car would likely drive up demand more than a lower rate on the £60k car. This is due to the spending power of the targeted customer being very different. In fact a higher rate on the £60k car is unlikely to drive down demand for the same reason.
Many retailers already hold this information by product type. The information could be pooled to create a matrix that helps develop a successful strategy. This science drives most pricing decisions / hierarchies. There is no reason VAT should not follow the same science i.e using a variable scale to drive the largest gain.
Combining pricing science with a flexible VAT rate will only help the economy grow in healthy way. Tax income will grow through consumer demand growth as opposed to blanket rate increases.
Politically if we are happy to apply a variable income tax rate why would we not apply it to VAT especially as these changes would directly impact demand where it is most needed with a proved, tangible, scientific, positive response.