Analysis: VAT in the spotlight
The rise in the standard rate of value-added tax (VAT) puts this still newish tax into the spotlight – though it has arguably been there since its UK introduction in 1973.
By John Whiting, Tax Policy Director, Chartered Institute of Taxation
Why VAT – and what is it?
The UK introduced VAT (and abolished purchase tax) as a consequence of our joining the then EEC. Having VAT as a country’s sole sales-type tax is still a requirement for EU membership but the tax has arguably conquered the world. The US is the last bastion of traditional sales taxes in the developed world; many third world countries have introduced VAT as a simple and effective revenue raiser.
Sales taxes are normally added at the point of sale, and usually only to goods. VAT applies to goods and services; it is imposed at each stage of the production process, with a credit being given to the trader for VAT paid against the tax they charge and have to pay over to the authorities. VAT is also levied on importing goods into the country.
Rates of VAT
VAT started at ten per cent in the UK, was cut to eight per cent in 1977, went up to 15% in 1979 (as part of the new Thatcher government’s deficit-cutting package) and then to 17.5% in 1991 (to pay for the new Major government’s poll tax cut). The UK has flirted with a higher ‘luxury’ rate, imposed in 1975 at 25% on electrical goods and petrol, though this rate was halved a year later.
Nowadays EU rules only permit a member state to have two rates – the standard rate (15%-25%) and the lower rate (4%-9%).
The UK does have its lower (five per cent) rate, mainly applied to domestic fuel and power. However, we also have a zero rate that applies to many items that are taxed in other countries: children’s clothing, books, newspapers, new houses, most transport and a large proportion of food. This zero rate is controversial in Europe and we cannot add to it. Also, some things are exempt across the EU: insurance (though there is insurance premium tax), education and health are key examples.
VAT addictions – and problems
Governments the world over have become addicted to VAT. It is a simple and effective revenue raiser which virtually everyone pays. In the UK, it is scheduled to bring in £81 billion this year (the rate rise will add £11-12 billion in a full year), making it one of the ‘big three’ revenue raisers, along with national insurance (£99 billion) and income tax (£144 billion). Another, more subtle, attraction of VAT to governments is that its administration is largely down to the trader – the taxman just checks what is going on.
VAT is not without its problems. It is an administrative burden for businesses, particularly small ones. There is always a fraud risk: traders could charge VAT, collect it and disappear before handing it over to government (often known as ‘carousel’ or ‘missing trader intra community’ fraud).
It is also controversial in terms of its impact: because everyone pays it, the poor and the wealthy are arguably taxed at the same rate. Various studies suggest that the lowest income households, whilst (unsurprisingly) paying the lowest absolute amounts of VAT, pay a higher proportion of their income in VAT than high-income households. Against that, VAT has a measure of choice built into it: buying meat, vegetables and other basic foodstuffs (zero rated), cooking at home (five per cent VAT on gas/electricity), using public transport (zero rated) and getting a simple takeaway sandwich (zero rated) all save VAT compared with eating out, buying alcohol, chocolate, crisps and other snacks (all standard rated) driving (petrol is standard rated) or a hot snack/coffee (standard rated).
The UK has its problems with zero-rating, which can confuse buyers and leave many traders wrestling with boundary issues. Famously it took a court case to show that a Jaffa cake doesn’t carry VAT (as it’s a cake). Had it been a biscuit it would have VAT on it (so chocolate digestives, for example, carry VAT). Peanuts in shell don’t have VAT but a bag of salted peanuts does; and in these health conscious days, it may seem odd that fruit juice carries VAT whereas milk doesn’t. Children’s clothing is zero-rated, offering scope for the petite adult to buy VAT-free clothes and for the clothing retailer to make expensive mistakes. How about standard rate on all clothes and increase child tax credit to compensate?
Any silver linings in the VAT cloud?
The 20% rate seems to be with us to stay: it is far from out of line around Europe – indeed, it puts the UK in the middle of the pack. Lower rates are not far away, though: Jersey only charges three per cent currently and Guernsey has yet to introduce it (that may mean added impetus to the usage of the Channel Island for buying CDs and DVDs – a practice that utilises the ‘low value consignment relief’, allowing goods valued at under £18 to be imported VAT-free). Perhaps it will give a boost to DIY – rather than paying a craftsman plus VAT.
The hike in VAT may dampen sales. It will give a distinct nudge to inflation (costing the government money, assuming it continues to index benefits and tax thresholds). It gives an immediate challenge to retailers who have had to decide what to do to prices: with so many things sold at ‘price points’ such as £9.99, it is not obvious how to adjust prices (bear in mind that the taxman doesn’t require the rise to be passed on – they just want 20/120ths of the selling price, up from 17.5/117.5ths). It is unlikely many ‘poundshops’ will become ‘£1.02 shops’!
That may mean some opportunities for customers to shop around for deals driven by VAT. But, arguably, the main silver(ish) lining is that it could have been worse – 25% rate as in Denmark, anyone? And what it really brings home is that 2011 is a year of belt-tightening with VAT having to take its share of the strain.
