Happy taxing new year

In January 2011, the UK will experience the joy of a rise in tax on goods and services, the Value Added Tax, or VAT. And don’t all the retailers just know it.

“BEAT the VAT!”, scream shop windows. Salesmen shake their heads wearily at the thought of the impending doom. Shoppers go slightly crazier on Oxford Street. Because VAT is rising from 17.5% to a whopping… 20%. Woah. Easy there.

Two weeks ago, a salesman from Dolphin Bathrooms, a bathroom company, came round to measure up and price a new bathroom for us. “You’ll be better off ordering now,” he said as he gazed at his laptop with the eye of a medium gazing into a crystal ball, “what with the VAT rise in January…” His voice tailed off, leaving the spectre of price rise hell hanging.

“So you’ll be passing on the tax increase?”, I asked. He looked at me, stupefied.

Yesterday, I received a letter from Talk Talk, a phone and broadband company, announcing the price rise as if it were the result of some kind of Economic Act of God.

“Please also be aware that the UK government will increase VAT from 17.5% to 20% from 4th January 2011. Applicable TalkTalk charges will change from this date to include the higher rate.”

So keen were Talk Talk to emphasise the UK Government’s role in this terrifying development, you could be forgiven for thinking that honestly, Talk Talk hadn’t wanted to pass any price rises onto consumers at all. It’s just that if it did, the chairman Charles Dunstone would have to live in daily fear of being dawn-raided and carted off by riot police.

Clearly, retailers do have a choice over whether to pass on tax rises or not. And you might note that a while back when the UK enjoyed a VAT holiday, not all shops passed on the “saving”. Basic economic theory will tell you that the amount of the tax that is passed on to consumers depends on how sensitive consumers are to prices. However, in practice,consumers’ sensitivity to prices depends on all sorts of things from the way a price is presented to how fair a price rise seems to be.

As found by Daniel Kahneman, Jack Knetsch and Richard Thaler, consumers are willing to accept price rises if a firm faces higher costs. But consumers also see it as acceptable for firms to maintain the same price level even if the firm’s costs are falling. By contrast, it is perceived as unfair for firms to raise prices in response to demand shifts: to take an extreme example, it’s seen as unfair to raise the price of snow shovels after a spot of bad weather. This all means that when costs rise, it’s an excellent opportunity for firms to raise prices without suffering much of a loss in sales.

So, Dolphin Bathrooms and Talk Talk, I know what you’re up to. Happy new year indeed.

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