Rishi Sunak’s VAT U-turn is inflationary, warns Institute for Fiscal Studies

Rishi Sunak leaves Ealing TV Studios in west London after attending a TV debate - Marcin Nowak
Rishi Sunak leaves Ealing TV Studios in west London after attending a TV debate - Marcin Nowak

Rishi Sunak’s promise to scrap VAT on energy bills for a year is “inflationary”, the Institute for Fiscal Studies (IFS) warned on Wednesday as his about-turn on tax cuts appeared to backfire.

Mr Sunak promised to introduce the “temporary and targeted measure” for a year and said it would save households an average of £160 per year.

The Conservative leadership hopeful had rejected the measure in February, when he was still chancellor, saying it would “disproportionately benefit wealthier households”.

The IFS said removing VAT from energy bills would benefit poorer households but would not be well targeted at those “least able to cope with the rise in costs” and noted it would be “politically difficult” to reverse the cut after 12 months.

“While the policy would reduce energy prices directly, leaving more money in people’s pockets would encourage more spending on other items, slightly adding to inflationary pressures elsewhere,” it said.

Based on current energy price cap forecasts, the IFS predicted that Mr Sunak’s policy would save an average consumer £154 over 12 months, while costing the Exchequer an initial £4.3 billion.

Stuart Adam, a senior economist at the IFS, said: “By providing more support to those who use more energy, it would be well targeted at those who face the biggest rise in their energy bills, but not at those – the poorest – who are least able to cope with the rise in costs.

“As a permanent policy, removing VAT on energy bills would be a move in exactly the wrong direction, distorting households’ choices towards more energy use, making it harder to meet the UK’s net zero targets and meaning that any reduction in emissions happened in a way that was more costly overall to households than it need be.”

It came as supporters of Liz Truss, his leadership rival, channeled Margaret Thatcher to criticise him “for turning”.

Mr Sunak had previously only promised to deliver tax cuts once inflation was brought under control, while Ms Truss is pledging tax cuts from “day one”. Unlike the former chancellor, she also intends to cancel a planned rise in corporation tax next year.

Backers of Ms Truss pointed to Mr Sunak’s apparent change of heart and criticism of his rival’s planned tax cuts, including National Insurance rates, as economic “fairytales”.

Simon Clarke, the Chief Secretary to the Treasury, quoted Lady Thatcher’s remark at the 1980 Conservative conference when he wrote on Twitter: “U-turn if you want to. The lady’s not for turning.”

Kwasi Kwarteng, the Business Secretary, said on Wednesday morning he was “backing a candidate that was much more consistent” on the question of taxation.

Mr Kwarteng told LBC: “He said that tax cuts were, I think, a fairytale. That was the word he used. He also implied that he was the grown up, because he was simply going to continue the status quo of increasing taxes.

“Belatedly, I’m very happy to see that he’s changed his mind, and that the VAT cut that he’s proposing today was the very cut that he opposed when he was chancellor only three weeks ago.”

Grant Shapps, who abandoned his own leadership hopes to throw his weight behind Mr Sunak’s campaign, pointed to the introduction of £37 billion in cost of living support he had overseen while at the Treasury.

“He always said he would keep a very close eye on this,” he said. “We now know the position coming up to this autumn with regard to gas prices in particular.

“I think this is consistent with what he’s said all along which is always keep these things under review, and that’s what he’s done by announcing it today.”

Mr Sunak’s plans to cut VAT was a policy that “stacks up and helps people pretty quickly”, he told Sky News as he suggested Ms Truss’s planned £38 billion of tax cuts would be “inflationary”.

Labour urge Sunak to scrap non-dom tax status

Meanwhile, Labour on Wednesday urged Mr Sunak to perform a second U-turn and scrap non-dom tax status, previously used by Akshata Murty, his wife. The status allows people who live in Britain but were born abroad to pay tax only on their UK income.

Pat McFadden, the shadow chief secretary to the Treasury, wrote to Mr Sunak: “It has been surprising to see a sudden U-turn on bringing in a VAT cut on home energy bills for a year if you become prime minister.

“Given you seem to be in a changing your mind mood, I am writing to you today to see if you will break your silence on another Labour policy commitment: abolishing non-dom status?”

Ms Murty ultimately agreed to relinquish her non-dom status after media criticism and concern that it would undermine her husband’s leadership prospects.