The Chancellor was accused yesterday of using a flawed tool to stimulate the economy amid concern that the £12.5 billion temporary cut in VAT would not work properly.

The reduction from 17.5 per cent to 15 per cent was too little to be effective, may not be passed on to consumers and could be neutralised by people deciding to save, economists said. “This will do very little to give the UK economy the impulses it needs,” Hermann Simon, from the management consultant Simon-Kucher & Partners, said.

Mr Darling said that the reduction would take place from December 1, for 13 months, and would amount to a saving of £3.8 billion for consumers this tax year and £8.6 billion in 2009-10. It was, he said, “the best and fairest approach” for stimulating the economy. “It will make goods and services cheaper and, by encouraging spending, will help stimulate growth.” Mr Darling urged companies to pass on the lower rate as soon as they could.

Professor Simon argued that for every cut of 1 per cent in merchandise prices, demand was typically boosted by only 0.3 to 0.5 per cent. The economy needed “a massive shock” – for example a cut in VAT to zero for a month, he suggested.

Jonathan Loynes, of Capital Economics, also expressed doubts. “When retailers like Marks & Spencer and Debenhams are having to slash prices by 20 per cent to 25 per cent to get shoppers through the door, a 2 per cent cut in prices may seem pretty insignificant.”

There was also serious doubt about whether businesses would pass on the cut to customers. The cost and effort of changing price tags and adjusting IT systems could persuade companies to maintain prices and boost their profits instead.

Retailers would be reluctant to move merchandise from psychologically important price points such as £9.99, suggested Gary Harley, head of indirect tax at KPMG. “There could be resistance,” he said. “[Businesses] will have to bear two sets of systems changes, when the rate goes down and then returns to 17.5 per cent in January 2010. These changes are expensive, time-consuming and are coming at most businesses’ busiest time of year.”

The British Retail Consortium said that stores would not keep the benefit for themselves. “It’s such a ferociously competitive environment that no retailer would risk not passing on the cut,” a spokesman said.

Some retailers complained privately that the timing was terrible, and would mean staff spending time changing price tags and altering web-sites at the busiest time of the year.

Some industries were highly unlikely to pass on any benefits because of big increases in duty. Pub and restaurant operators are facing rises in alcohol duty on December 1, while the benefit for fuel retailers was offset by increases in petrol and diesel duty.

Even if retailers keep all the benefit for themselves that would still provide some stimulus, either by preventing job losses or because profits can be ploughed back into the economy through capital spending.

Experts said that the reduction of VAT was a better option than reducing income tax because income tax cuts, especially for the better off, might be saved, not spent. However, it still might not work because of fears of tougher times ahead. “With falling house prices and rising unemployment already putting pressure on households to save more, they may decide to put it aside for an even rainier day,” Mr Loynes said.

Moreover, the very poorest households might benefit less because most of their spending was on food and children’s clothing, which are VAT-free, and on heating and electricity, where the lower-rate VAT level is not being changed. There are also fears that the end of the VAT reprieve on December 31, 2009, could lead to a flurry of spending at Christmas 2009 followed by a sharp fall.

Mr Darling expects a recovery to start in the third quarter of 2009 but many economists fear the downturn could be more prolonged, meaning that the VAT rise will come when the economy is still weak.

One quirk of the measure is the boost it will give to the financial services sector. “A big winner will be the retail banks and insurers,” said David Bearman, a partner at Ernst & Young. These are VAT-exempt, meaning they cannot normally recover VAT payable on their costs. They should see a reduction in external costs of 2 per cent. Other organisations that cannot recover VAT include housing associations and universities.

Mr Loynes said that the fiscal boost was better than nothing. “But it is unlikely to prevent a severe recession and does not preclude the need for further cuts in interest rates.”

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