Impact of VAT on the cost of living crisis

BBC Wales recently published an article about the impact of VAT on the cost of living crisis: https://www.bbc.co.uk/news/uk-wales-65620921. VAT Director, Glyn Edwards explores this more in depth below and its implications for VAT.

The piece had two central themes: VAT is an unfair tax which hits the poorest households harder than the richest; and that VAT is overly complex with absurd borderlines. Neither view is controversial, but is it possible to reform VAT to address both these problems?

Before looking at those questions, one idea might be to abolish VAT altogether. However, the BBC reported that Wales collected more in VAT than in income tax. That contrasts with the UK as a whole where in 2021/22 VAT contributed £143bn to public sector receipts, whilst income tax was almost 60% higher at £225bn[1]. That disparity between Wales and the rest of the UK might tell us quite a lot about the Welsh economy, but whatever the reasons behind it, we can be sure that VAT’s large contribution to the public purse means that it is here to stay for the foreseeable future.

VAT and other indirect taxes are inherently unfair. For the poorest fifth of the population, indirect taxes take 23% of disposable household income, but for the richest fifth the figure falls to just 9%. Indirect taxes do the exact opposite of what most people would think of as an ideal progressive tax system where the broadest shoulders should carry a heavier load.

That unfair distribution occurs despite the wide range of reliefs and exemptions, without which the VAT hit on low earners would be even worse. The zero-rate for food is a good example, but one where the BBC highlighted the strangeness of the rules. Some of those oddities arise from the age of the tax. VAT has just ‘celebrated’ its 50^th Birthday and when it was introduced in 1973, the government of the day introduced a zero-rate for what were considered essential food items at that time. That list has then been frozen since then, mainly because the UK were not permitted to add to its zero-rates whilst we were members of the EU. Bottled drinking water was a rarity in 1970s Britain, so wasn’t considered for relief at that time. That’s why supermarkets must charge 20% VAT on water, but can zero-rate tea bags.

We have greater freedom now, but how should that freedom be exercised and will it resolve problems? The difficulty is that any exemptions have borderlines. Let’s start with the BBC’s example of the distinction between biscuits (0%) and chocolate covered biscuits (20%). Why not just apply VAT to all biscuits? That would still leave to a debate about the difference between biscuits and cakes. Perhaps overcome that difficulty by applying VAT to cakes too? But then is a malt loaf a cake or bread? And if you apply VAT to malt loaf then what about other bread?

Another solution to food borderlines might be to apply the zero-rate to anything which can be eaten or drunk. That sounds nice and simple, but should we include alcohol in that relief? What about restaurant food – should diners at Michelin starred restaurants benefit from a relief which was originally designed to ensure that the poorest were not taxed on food?

Having left the EU, we have the power to reform VAT, but it’s easy to see why politicians and economists find it difficult to understand how to use this power. One final thought: does the introduction of zero-rates really benefit the consumer? The evidence is mixed. Research by Tax Policy Associates into the removal of the 5% VAT on feminine hygiene products suggests that only 1% of the reduction was passed onto the customer, with suppliers and retailers pocketing the remainder in greater profits[2]. There is now a similar campaign for a zero-rate to be applied to sunscreen products, but lessons of the past show that such reductions create their own borderlines and often fail to achieve their aim of lower prices in the shops.

Perhaps the answer is to apply a flat rate of VAT to everything? Good luck to any party proposing that idea at the next election.

[1] Source: Tax statistics: an overview - House of Commons Library (parliament.uk)
[2] Source: How the abolition of the “tampon tax” benefited retailers, not women – Tax Policy Associates Ltd