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).