Thursday, 6 January 2011

Progressing the VAT debate

Is VAT progressive or regressive, that is the question?

Well, it largely depends on who you ask.

VAT is defined in the public consciousness as a 'flat-rate' tax, so the rise from 17.5% to 20% is seen as a reduction in spending power, but more contentiously as one which will hit those who can least afford it more.

Mmm, possibly.

There's a big problem with this argument as people in lower income brackets do not experience VAT in the same way as those in higher brackets - precisely because VAT is not designed as an entirely flat-rate tax.

Indeed, because VAT change impacts are measured as a proportion of expenditure, rather than as a proportion of income (and there are basic exemptions such as food and drink which are considered universally necessary) the balance of calculations are tipped slightly in favour of poorer sections of society.

Stephanie Flanders looks at Deloitte's analysis which shows poorer families losing 0.8% of income, middle income groups 0.96% and higher income groups 'just over 1%'.

This does disproportionately impact the discretionary portion of spending among lower income groups, but nevertheless that doesn't change the fundamental 'progressivity' of the change.

However the real distortion of the debate is not in whether higher sales taxes is better or worse for any different section of society, or that it is the easiest way for the state to gain cashflow, but in perception gap between the partially progressive nature of the tax and the public understanding of it.

VAT is actually applied at 0% (zero, or exempted rates), 5% (reduced rate) or 20% (standard rate).

And this depends on various considerations, such as who's providing them or buying them, where they're provided, how they're presented for sale, the precise nature of the goods or services, among other things, as measured against the universal need for them.

But there is insufficient flexibility in this tax system.

The sector I find provides the best illumination of the problem is accommodation.

We all accept that shelter is a basic human requirement in a country like the UK, so we can clearly see affordability and purpose provide a mutual balance in each individual choice we make.

If you are on the breadline and homeless a temporary hostel might be appropriate, if you're going on honeymoon you're obviously seeking something special, but if you're simply going away for a business conference it's unlikely you will justify the expense of a 5-star hotel.

So it's obviously perverse that the tax system doesn't take this into account.

My solution would be to introduce a new higher band rate.

The introduction of a 'luxury' rate of VAT would provide a greater amount of options for politicians to rebalance the economy while dealing with the deficit and this would do much to reduce public anger over the issue.

Placing a premium on top-quality products will give them a new exclusivity which adds value to their market sector - exactly what 'value-added tax' was designed around in the first place.

There may be howls of outrage from some borderline cases, but The Dorchester wouldn't be The Dorchester if it were found on every High Street in the country, now would it?

There's something deeply worrying when Labour Leader Ed Miliband and right-wing think-tank The Institute of Economic Affairs both reach the same conclusions (albeit for different reasons), and this should indicate to any reasoned commentator that it may not be the right policy solution, but also that neither opponents are correct and a new alternative approach should be found.

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