What will be the effect of an increase in VAT within the UK on GDP?

VAT is an indirect tax that is applied to goods deemed by the government as a necessity. An increase to this tax will firstly cause a decrease to real incomes of individuals within the UK, as goods will become more expensive meaning they will be unable to purchase and consume as much. As consumption by individuals is a part of Aggregated Demand (AD), the increase to VAT will cause a shift in to the AD curve. A shift in to the AD curve (which can be demonstrated on an AD/AS diagram) will indicate a decrease to real GDP in the economy, thus having a negative long term effect.
Conversely, it could be argued that the increase to VAT will lead to greater revenues from taxation for the government. This additional source of income for the government will enable them to increase spending within the economy. Government spending is another component of AD, and an increase to the governments capability to spend will enable AD to potentially shift out. This will counteract the shift in caused by the fall in consumption. Due to these two effects causing the position of AD to effectively stay the same, we can look at how increased government spending may effect the Aggregate Supply (AS) of the UK. By spending more, the government may be able to increase the UK's productive output through investment into education and other industries. This means that AS will shift out, which will move the equilibrium within the UK economy and cause real GDP to rise. However, there will be a major time lag for how long this investment will take to have any effect, which means that in the short run GDP will likely remain stable, but in the long run it will rise.

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Answered by Kieran D. Economics tutor

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