Why Britain needs a progressive VAT

Much is unfair in Britain today. But one of our country’s most enduringly unjust features is the poor’s clobbering by VAT. This tax is applied universally but unlike income tax the amount we pay is not based on what we earn.

As a result, the poorest fifth in Britain today spend on average just over 12% of their income on VAT whilst the richest fifth spend just under 8%.[1] This means that VAT is deeply regressive: it hits the poorest the hardest. Anyone interested in making Britain a fairer place must seriously consider a progressive VAT in which the rich pay a higher rate than the poor.

There are many imaginable versions of a progressive VAT. We outline here one approach which would make use of recent technological developments and opportunities arising from Brexit.

First, citizens could be allocated a VAT band. As with income tax bands, these would be set by the state and the rate they are set at would be determined by democratic debate. Those on the right may argue that the differentials should be lower;those on the left may object they ought to be higher. Allocation of citizens to VAT bands could be based on their income, using existing HMRC taxation infrastructure.

Second, consumers could see different prices when shopping. As described by James Plunkett in an excellent recent blog post, this is already happening online – largely to the detriment of poor consumers. Anyone that has viewed flights on a website like Ryanair knows only too well that prices are already determined by individual browsing habits. A similar technology for implementing differentiated prices in supermarkets is not far behind.

Third, consumers could identify at point of purchase which VAT band they are in. One way of doing so would be for individual bank accounts to be registered to a particular VAT band.

The European Union governs VAT rates for member states, setting maximum levels of deviation from EU-wide averages. Because of this, a highly progressive VAT scheme – in which the rich pay a lot more VAT – seems unlikely to be workable for Britain within the current EU framework. While the outcomes of Brexit remain as yet unclear, our departure could allow us more flexibility in making VAT fairer.

A progressive VAT could be a real source of revenue gains for the Exchequer. Consumption expenditure is highly inelastic compared to other spending. This means the rich are unlikely to reduce their spending significantly in response to higher VAT rates and overall tax takes are likely to go up as a result. To extend the progressive benefits of this measure,the proceeds could be ring-fenced for a fund to fight poverty through targeted benefits, or distributed to councils across the country to tackle regional inequalities.

But a progressive VAT is also predistributive, meaning that it could tackle inequalities without the need for state-administered welfare transfers. Lower prices for those on low incomes would also help tackle the poverty premium.This could have a wide range of positive knock-on effects such as lifting people out of poverty and reducing their personal debt levels.

But, as with any new policy, the risk of unintended consequences still runs high. Trialling this scheme on a local level – with small changes to VAT rates for high earners only – would allow governments to iron out kinks and learn through doing.

Given these objections, you could be forgiven for wondering why we don’t advocate scrapping VAT altogether. Given the importance of VAT to the public finances, this isn’t a realistic possibility. Last year VAT receipts amounted to more than £125bn[2] – roughly equal to the Department of Health and Social Care’s spending in England in 2017/18.[3] In addition to these fiscal benefits, VAT is relatively easy to collect and stable in recessions, making it a vital foundation of public spending in Britain.

You may also be wondering why we don’t just apply VAT to ‘real’ luxury items. Whilst we clearly support scrapping VAT for certain goods – sanitary items, for example – we do not support this as a general policy for two reasons. First, any substantial narrowing of the goods that VAT applies to would substantially erode the tax base at a time when the Treasury coffers are already stretched. Second, such a policy would likely mean the price luxuries increasing and the poor being less able to afford them. We don’t believe this is desirable – access to luxury goods should not be restricted to the rich.

A very legitimate objection to a progressive VAT scheme is that it would likely create large informal markets for goods, as certain people can buy them cheaper than others and then sell them on at a profit. However, such practices should not be a cause for concern. Those on low incomes may even stand to make entrepreneurial gains from such practices. Economic theory also suggests that any gains from trading between poor and rich in these secondary markets can lead to welfare improvements as both parties benefit, with inequality reduced in the process.

The biggest issue many will have with a progressive VAT is that it just feels wrong. Paying different prices for the same good as someone else will rub against deeply engrained notions of fairness. Yet progressive taxation – once considered an outlandish proposition – is now a widely accepted norm. Likewise, anyone interested in making Britain a fairer place must seriously consider a progressive VAT.

 

This is a joint blog piece from Ben Glover and Thomas Bearpark, a Pre Doctoral Fellow in the Energy Policy Institute at the University of Chicago 

 

 

[1]https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/incomeandwealth/bulletins/theeffectsoftaxesandbenefitsonhouseholdincome/financialyearending2017

[2]https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/741981/Aug18_Receipts_NS_Bulletin_Final.pdf

[3] https://www.kingsfund.org.uk/projects/nhs-in-a-nutshell/nhs-budget