In August 2020, our price collectors were able to collect the prices for catering items in outlets in 128 locations across the UK. The price collectors recorded whether:
there was no adjustment for Value Added Tax (VAT)
the menu price had been changed to reflect the reduced rate of VAT
the price was being adjusted at the till.
For the latter, we adjusted the price to reflect the price paid by consumers. Further details are presented in the Consumer price statistics: resuming a field-based price collection article.
The temporary VAT reduction applied to holiday accommodation and attractions, in addition to the hospitality sector. In total, 12.3% of the Consumer Prices Index (CPI) basket by weight was potentially affected by the VAT reduction to 5%.
The Consumer Prices Index at constant taxes (CPI-CT) measure relies on holding indirect taxes rates constant at the rate prevailing at the start of the year. The VAT rate is adjusted at item-level and the calculation assumes that the entire VAT reduction is passed through at all outlets. Further details are outlined in Section 12.4 of the Consumer Prices Indices Technical Manual, 2019.
To calculate CPI-CT, we remove the item VAT rate (to calculate the basic pre-tax prices) from the average price and then apply the rate of tax at the start of the year. If, at the point of the VAT reduction, the basic pre-tax prices are unchanged then the CPI-CT 1-month rate would also be unchanged.
With the VAT reduction, we saw price reductions to consumers so the CPI 1-month inflation index would have reduced. It is also likely that the 12-month inflation would have also reduced as prices in the sector tend to rise steadily over the year. Table 33 of the Consumer price inflation tables presents the difference between CPI and CPI-CT (that is, CPI inflation rates minus CPI-CT inflation rates) so for the reduction in VAT we would expect the difference between CPI and CPI-CT to be negative.
For the purpose of your estimate, although the VAT reduced from 20% to 5%, the actual impact on consumer prices was a 12.5% reduction, rather than 15%. If we consider an item costing £100 including 20% VAT, the price with 5% VAT would be:
£100 divided by 1.20 multiplied by 1.05 equals £87.50 – a reduction of 12.5% resulting from the VAT change.
Since the hospitality sector, holiday accommodation and attractions accounted for 12.3% of the CPI basket, your estimated impact would become:
negative 0.125 multiplied by 0.123 multiplied by 100 equals negative 1.54 percentage points compared, with the actual movement of negative 1.69 percentage points
For comparison, we last saw a VAT reduction in December 2008, when the VAT rate reduced from 17.5% to 15% for vatable items excluding motoring fuels, alcohol and tobacco. This resulted in a difference of negative 1.18 percentage points between CPI and CPI-CT. This VAT reduction accounted for a -2.13% change in price to consumers (i.e. an £100 item would cost £100 / 1.175 * 1.15 = £97.87). Based on the 2008 CPI weights, the proportion of the basket affected by the VAT change was approximately 470 parts per 1,000 (based on the 2008 weights for vatable items excluding fuels and lubricants, and alcohol and tobacco) meaning your equivalent estimate would be:
negative 0.0213 multiplied by 0.47 equals negative1.00 percentage points compared, with the actual movement of negative 1.18 percentage points