VAT’s not fair

In early January 2011 the rate of Value Added Tax (VAT) charged on non-essential items increase from 17.5% to 20% as part of George Osborne’s emergency budget. As part of the coalition’s government debt reduction plan, the move came under intense criticism for its potential to slow down the UK’s economic recovery.
What was Osborne’s justification for such a decision? He claimed that VAT is a progressive tax, placing a higher burden on those with higher income – those most able to pay. Increasing the rate of a progressive tax would allow the government to collect more revenue from those who are in a position to afford it.
So what was the rationale behind Osborne’s thinking? As VAT is simply charged as a proportion of the price of the good or service, those that buy more non-essential goods and services should be paying more tax. Simultaneously, ‘essential items’ are exempt from VAT – children’s clothes, food stuffs (including cakes but not biscuits) and books amongst others. Therefore, the increase should theoretically not increase the cost of living for those on low incomes who cannot afford to buy luxuries, only affecting the more affluent. VAT could also be seen as an evadable tax – those wishing to pay less should simply stick to the tax-exempt items.

However, a recent report published by the Office of National Statistics (ONS) has concluded otherwise. It states that far from being progressive, VAT is actually regressive, hitting the poorest hardest. The richest fifth of society were spending a mere 5% of their incomes on VAT whilst the poorest fifth were spending 10%. The figures show that any increase in the rate of VAT is likely to hit the poorest the hardest. The report also showed that the gap between how much more the poorest pay than the richest has increased significantly from around 1% in 1986 to the 5% two years ago. Since 1986, the poorest members of society have always paid a higher percentage of their income in VAT.

A possible reason for the increasingly regressive nature of VAT is the changing spending patterns across society, especially for those on the lowest incomes. Spending less of their income on tax exempt items, changing consumer tastes have resulted in the poorest becoming more vulnerable to increases in VAT. The report found that “after taking into account changes in prices, the poorest fifth of households spent, on average, around 250% more on new cars, holidays abroad, meals out, audio/visual goods (including TVs) and photographic equipment combined in 2009/10 than in 1986.” Critics have questioned whether those who are able to spend money on holidays, cars and eating out should really be defined as ‘poor’ although they may be counted in the ‘poorest fifth’. These are clearly not people in relative poverty. Yet this does not show VAT to be any less regressive, as it is hitting the poorest the hardest, even if they are living comfortably above the poverty line.

What were the alternatives? Osborne condemned National Insurance and Income Tax as having “a more damaging impact” on society’s poorest. Whilst this may be true for National Insurance with decreasing rates on increasing incomes, it cannot so easily be said for Income Tax. A tax designed to be progressive, increasing bands of earnings are taxed at a higher proportion than the last.

Arguments have been put forward that a VAT bill is easier to reduce – only payable on items purchased, and hence within control of households to cut. Income tax, meanwhile, is unavoidable. Yet what this fails to take into consideration is that whilst those on higher incomes are more likely to earn much more than they need to spend for a comfortable lifestyle, and hence save more (which is not liable for VAT), poorer households may need to spend most if not all of their incomes to get by, often on items not exempt from VAT.

The facts remain. VAT is not, and has never been, a progressive tax. Whilst it may not be shocking to many that this latest political rhetoric has turned out to be false, one must question Osborne’s motives. A well meant but misguided effort for fair taxes, or simply a way to reduce the government deficit at the expense of the poorest to maintain traditional Conservative support?