THE chancellor should think about a temporary cut in Vat from 17.5% to 12.5% to help the economy through the recession, according to a report to be published this week.

The Centre for Economics and Business Research (CEBR) argues that significant fiscal measures will be needed on top of interest-rate cuts – in spite of the Bank of England’s dramatic and unexpected 1.5-point reduction last week.

“The emerging evidence is that the position in the UK is so bad that it cannot be resolved without Keynesian measures,” said Doug McWilliams, the CEBR’s chief executive. “Additional public works would take too long to organise, though they may be part of the solution for later years. What is needed now is an early and possibly temporary tax cut. A reduction in Vat at least until the end of 2009 to 12.5% would be a good start.

“The gross cost would be £24 billion, but the net cost would be much less – possibly even nothing if the impact on confidence is sufficient to stop the recession from intensifying.”

A cut in Vat to 12.5% would in theory contravene the European Union’s Vat directive, which sets a minimum standard rate of 15%. However, the directive also allows for temporary derogations.

Treasury officials said a number of options were being considered for the pre-budget report, expected in the second half of this month, but refused to be drawn on specific measures. Any help is expected to be directed at low and middle-income families and small firms.

The Bank’s new inflation forecast, published this week, will show the economy in a significant recession, alongside a big drop in inflation. Its report will be scrutinised for the scale of the drop in inflation it expects, which could imply scope for further interest-rate cuts.

Fathom Consulting predicts that consumer price inflation, the Bank’s target, will drop below 1% next year. Retail price inflation, which is affected by the level of mortgage rates, will be showing an annual fall of 2.5% by September next year, it predicts, in sharp contrast to last September’s 5.2% rate.

Deflation on this scale would pose problems for both the Bank and the government. September is the month used for the annual uprating of state pensions and other benefits.

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