Anyone desperately searching for good news about the nation’s finances might look at the recent predictions by Deutsche Bank saying that UK inflation could drop to the Bank of England’s 2% target this Spring.

However, the backdrop is a continued cost of living crisis. Although prices are rising less slowly than before real wages are expected to remain below their 2008 level until 2028. Already hundreds of thousands of UK households have recently missed or defaulted on a mortgage or rent payment. The cost of renting a property from a private landlord is rising at the fastest rate since records began in 2006. Food prices were 29% higher in November 2023 than they were in September 2021, and energy prices were 66% higher.

April will see further increases in Council Tax and social housing rents. With an increasing number of local authorities on their financial knees, Council Tax is expected to rise by an average of around 5%. Social housing rents by around 7%. The increases will be worse in many areas. In Wales some authorities are looking at Council Tax increases of 11%, and Birmingham, which recently declared ‘effective bankruptcy’, has indicated that Council Tax will need to rise by 20% over the next two years.

Getting serious about addressing the cost-of-living-crisis requires that we address the costs of goods and services directly, and quickly. We believe that government should consider removing VAT from a wide range of goods and services (such as kitchen appliances and household fuel). Removing VAT, which disproportionately burdens lower income households, would be an immediate help. It would also spur government on to increase revenue through other, fairer, mechanisms – such as a rise in personal income tax for higher earners.

VAT: the basics

VAT is a tax charged on goods and services, but some are exempt or ‘zero-rated’ (e.g., most food and drink if not pre-prepared) and some are charged at a reduced rate (e.g., fuel).  Prescriptions from a pharmacist are zero-rated, while kitchen appliances attract the full rate.

Since its introduction, VAT has grown to become one of our most important taxes. In 1973, when it was introduced at a rate of just 10%, it accounted for 6% of government revenues and 1.7% of Gross Domestic Product (GDP). In 2022, it accounted for 20% of government revenue, or 7.3% of GDP. It is now the third largest revenue raiser behind Income Tax and National Insurance Contributions.

The default (‘standard’) rate of VAT has been set at 20% since 2011, although some goods and services (such as fuel) are subject to reduced rates of 5%, and VAT is not levied at all on most unprepared food and children’s clothes.

Is VAT regressive?

It is according to the Office for National Statistics (ONS). In 2010 - when George Osborne as Chancellor raised VAT from 17.5% to its current level - he argued that this was a progressive move. However, ONS analysis indicated that the poorest fifth spent 9.8% of their disposable income on goods attracting VAT in 2009/10, while the richest fifth spent just 5.3%. The year before that the poorest fifth spent 8.7% of their gross income on VAT, whereas the richest 20% spent only 4.0%.

The ONS noted that indirect tax burdens are determined by household expenditure rather than income. This means that lower income households have a higher VAT burden by virtue of the fact that they spend more of their disposable income.

This Commons Library graph shows that poorer households pay a higher percentage of their disposable income in indirect taxes than those with higher incomes.

The higher VAT burden borne by lower income households is not offset by their lower rates of Income Tax. Even after accounting for this, Tax Research UK has calculated that the poorest income quintile end up with the highest average tax rates in the economy as a whole.

How has VAT been used to help consumers and boost the economy in the recent past?

Reducing VAT either to help households through financial storms or in attempts to influence spending patterns has been done before.

Following Labour’s 1997 election victory, the new Chancellor, Gordon Brown, lowered the rate of VAT on domestic fuel and power from 8% to 5%; reduced VAT on the installation of energy saving materials from 17.5% to 5%, and reduced VAT from 17.5% to 5% on sanitary protection products, children's car seats, conversions and renovations of certain residential properties, contraceptives, and smoking cessation products.

In 2010, the then Chancellor Alistair Darling announced “a £20 billion fiscal stimulus”, which included a temporary cut in the standard rate of VAT from 17.5% to 15%, as the “best and fairest approach” to help households through the Great Recession.

Subsequent analysis of the effects of Darling’s temporary VAT cut has shown that the reduction helped boost the economy by encouraging households to spend. One paper found that 75% of the VAT reduction was passed onto consumers, which increased demand - something which might be useful as the UK is teetering on the edge of recession. Another study, by the Institute for Fiscal Studies, confirmed that most firms passed on the cut to consumers in the form of lower prices. The cut “raised the volume of retail sales by around 1% which on its own generated a 0.4% increase in total expenditure.” This study also found that sales fell after the temporary VAT cut ended.

More recently, as part of its COVID response, government removed VAT rating for personal protective equipment (PPE). To boost the economy in 2021, VAT was temporarily reduced to for the hospitality and leisure industries. The ‘tampon tax’ was also removed that year.

Would a VAT cut help today?

Research published last year by the Association of Charitable Organisations found that around 480,000 low-income households across the country (equating to close to 1.2 million adults and children), are missing at least one household appliance, such as a washing machine or fridge-freezer. Of these, 53,000 households, or 130,000 people, live without both. This situation is otherwise known as ‘appliance poverty’.

Many food banks also request donations of food items that do not require cooking because an increasing number of households lack the means to cook.

Unlike food, kitchen appliances are not exempt from VAT. Knocking VAT off the price of these would make them more affordable.

There are other reasons too. Whilst it is a swift mechanism to reduce the costs of living, it would also benefit businesses and sustain employment. Without money in their pockets, low to middle income households are cutting back their discretionary spending which impacts retail sales and the hospitality and leisure sectors especially, and which is placing jobs at risk.

Last November, the Scottish Tourism Minister wrote to the UK Government calling for a reduction in VAT to support Scotland's tourism and hospitality sector. Such calls have been made in England too, for example from Greater Manchester’s Night-time Economy Adviser. But other businesses are also impacted. For example, in recent weeks a VAT cut has also been called for by manufacturers of electric vehicles.

But should VAT be reduced as a temporary measure, or should it be removed from selected goods and services altogether on a more permanent basis? Now that the UK is no longer part of the European Union, we are no longer required to impose VAT at all.

We believe there is a strong case for exempting kitchen appliances altogether, and on a permanent basis. Temporary cuts in other areas may well also be useful to boost sectors of the economy, which are now clearly struggling due to a lack of demand. But there is also a need for any new government to overhaul taxation more generally to ensure a fairer distribution of burdens across the income distribution.

Feb 13, 2024

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