Is VAT regressive?

The conventional wisdom is that VAT is regressive, because poorer people pay a higher percentage of their income in VAT. Save the Children say the poorest 10% of families spend 14% of their disposable income on VAT, versus 5% for the richest. This is important because a lot of people suspect George Osborne might announce a significant rise (from 17.5% to 20%) in VAT in his emergency budget in June, which would worsen inequality.

However I thought I’d read somewhere an argument claiming it wasn’t actually regressive, because many items (childrens clothes, food, etc) are excluded from VAT, and these are the things that people on lower incomes spend most of their money on.

This IFS paper (love the IFS) sorts it out. Apparently if you look at the percentage of income that goes out again on VAT, then it is regressive, just as Save the Children claim.

However, the IFS researcher argues that, in some ways, it makes more sense to look at percentage of expenditure rather than percentage of income. This is because borrowing and saving can allow a relatively stable consumption level despite fluctuations in income. A retired doctor eating through their savings is going to have a low income level but a high expenditure. So is a student spending their way through a student loan, hoping to earn it back later on, as is someone who is temporarily unemployed as they use their savings from a previous job. All of these might distort the picture, raising the amount of VAT paid by those with low incomes.

It turns that almost everyone pays about the same percentage of their expenditure in VAT. So, on this measure, it’s not regressive (not progressive either, mind).

In some ways this is quite convincing. If you assume that those with the lowest incomes who are actually poor (rather than sitting on big savings) have to spend all their money rather than saving it (there’s probably evidence one way or the other?), then removing the ones who have low incomes but are actually spending more does make sense.

The paper also identifies that 55% of consumer spending is on goods taxed at the full rate of VAT, which lends support to the argument that people on low incomes might be spending most of the money on goods that are not subject to VAT (or not at the full rate).

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3 thoughts on “Is VAT regressive?

  1. Good effort will,

    There does seem to be a lot of misinformation around about this issue. I suppose this goes to show how important the VAT exemptions are to keep the tax as fair as possible.

    As you point out, just beause it is not actually regressive isn’t saying too much. If the tax system isn’t set up to work in a re distributive way after 13 years of labour government then I don’t feel too optimistic for the next 10. I know there are other taxes that are more progressive (income tax being the obvious example).

    Any idea how this compares with National insurance the “tax on jobs”?

  2. In the coalition agreement they say they’re going to leave employee national insurance alone, and only raise the threshold on employer national insurance, as a way of partly offsetting the NI rise, making no direct difference to individuals. (The money they were going to use to pay for the increased employee threshold is now being spent on increasing the income tax allowance – would be interesting to know which of these two measure would have been more progressive, but I assume the latter, particularly since I think the NI rise was only on incomes over £20,000, although might be wrong about that.)

    I guess the impact of the increased employer threshold is more indirect, mediated by the number of jobs saved/lost after the increase (don’t forget the jobs directly impacted are all those over £20,000), compared with the impact the forfeited revenue could have had (which depends on what budget they’ve cut to pay for it – I had a quick look for this but it wasn’t immediately obvious).

    Interestingly, in a nice bit of circular accounting, another bit of the document says “We will create a Cancer Drugs Fund to enable patients to access the cancer drugs their doctors think will help them, paid for using money saved by the NHS through our pledge to stop the rise in Employer National Insurance contributions from April 2011.”

    So they’re using money earmarked in the NHS budget to pay for the NI rise to pay for cancer drugs instead, which raises the interesting question of what they’re doing with all the money presumably being saved in other public sector budgets. Also, I I can’t quite work out if the reference to stopping the rise in contributions is just misleading, and actually they mean the money they’re saving by increasing the threshold, or if they’ve separately pledged to reverse the rise in NICs from next April, but not mentioned it anywhere else in their coalition document. Who knows…

    Finally, as many have pointed out – since total government borrowing last year was £7bn lower than had previously been thought, why was it so necessary to make £6bn in cuts?

  3. I thought the whole ‘CUT DEFICIT!!’ thing was a show more than anything else. To signal to ‘the market’ god that we are darn right serious about cleaning up this debt MESS that we’re in. So whether or not we need to cut £6bln (pretty paltry anyway) given the £7bln that’s turned up, is less important.

    No mention of private debt, obviously. That can swirl away funding The City (the backbone to our economy, apparently) and consumer spending until the next sub-prime crisis.

    Cracking housing, by the way, I’d always assumed VAT to be a horrid regressive tax. That said, as New Economic Foundation told The Times, “In November last year the Treasury Select Committee reported that HM Revenue and Customs was sitting on £28 billion of unpaid tax bills that had been agreed but not settled. A further £25 billion could be sourced by plugging tax loopholes that the Government considers contravene the spirit of the law. ” But New Lab had no interest in closing Tax Havens for the rich, and ConDem don’t either.

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