The VAT cut and a natural experiment in economics

There is a VAT cut coming on certain items and services. There is a claim that not all of this will be passed on to consumers. This provides us with a nice natural experiment - which sectors of the economy are fully and properly competitive:

Shoppers and tourists expecting to see a cut in prices on Wednesday following the chancellor’s decision to slash VAT on hospitality could be in for disappointment as some organisations pocket the saving rather than pass it on to consumers.

Last week Rishi Sunak announced that the tax, which is charged on most goods and services, would be cut from 20% to 5% from 15 July until 12 January 2021 for entrance to restaurants, cafes, hotels and attractions such as zoos and cinemas.

The standard analysis says that VAT is a tax upon consumers. Which, in a competitive market, it will be. We can run this in reverse too - those sectors where the cut is passed on in full are competitive. Those where it is not are showing a sign of pricing power on the part of the producers.

So, here we have one of those nice natural experiments. We can assume, even though it’s not absolute and total proof, that those sectors where the VAT cut is passed along are indeed competitive. This being something we’d really like to know too.

For the argument in favour of the minimum wage is that producers do have pricing power and thus increasing wages by fiat reduces their profit margins rather than stings the consumer. Something which doesn’t happen in one of those competitive markets.

Our own intuition is that precisely those areas that are affected substantially by the minimum wage are those where the producers don’t have that market power and therefore are where the VAT cut will be passed along. Which does rather kill the intellectual base for that minimum wage. But that is only our intuition at this point - it’ll be nice to find out, won’t it?