Whenever the “cost of living” comes up as a topic, we often hear lists of consumption taxes that can be reduced to lower it. Most recently have been the green levies on energy bills; last year a big deal was made about fuel duty; the year before it was the top rate of VAT. Some people even argue that taxes on cigarettes and alcohol hit the poorest and should be cut back.
I’m certain that there’s all sorts of taxes that we’d like to lower, but there’s no such thing as a free lunch, and any tax we lower requires us to raise another tax or cut spending elsewhere. Wealth taxes, and even a high rate of land value tax, would only raise so much, so if we’re to cut tax then we’re going to have prioritise.
My position is: whichever consumption tax you’d like to reduce, we’d be better off using the revenue to raise the Income Tax and Employee NI thresholds. This is for three reasons:
1) Progressiveness
Progressiveness is often our key concern when it comes to cutting taxes – will the tax cut most benefit the richest, or the poorest?
£12bn is the estimated “cost” of reducing VAT back to 17.5%. For the same £12bn, we could raise the income tax threshold by roughly £2,500, giving each full time worker £500 a year. For someone to make the same saving from the VAT cut, they’d need to spend £23,500 on top rate VAT goods, so not even including essentials like food or rent.
Cutting the top rate of VAT gives a big tax cut to big spenders and just a little tax cut to small spenders. Raising the threshold gives everyone the same amount. Much more progressive.
2) Choice and fairness
The problem with cutting a particular consumption tax is that the benefit will go entirely to people who consume a lot of that particular type of thing. Cutting the green levies will best benefit those who use a lot of energy, cutting fuel duty only those who drive and the main basics, such as food and rent, have no consumption taxes on them to cut in the first place.
Raising the tax thresholds gives everyone the same fair amount (£700 in our case) and then it’s entirely to them how best to use it. It’s the same for everyone and everyone gets to make their own choice on what to spend it on.
3) Economic effect
Another issue with taxes is the economic effect. Do they discourage people from doing a certain thing? In the case of consumption taxes, this is often the intended effect. We want people to lower their intake of cigarettes and alcohol and to reduce the CO2 emissions due to their fuel and energy usage. Even top rate VAT goods are often luxury items that use up minerals and/or leave waste.
At the least it’s less harmful than taxing income!
In Conclusion
Whatever consumption tax you’d like to cut, using the revenue to instead raise income tax thresholds would be fairer, more progressive, give people more choice and have a more positive economic effect.
I’d even like to see more of them, like taxes on unhealthy foods and taxes on legalised and regulated drugs, but that’s another topic altogether…
* Daniel Henry is a member in Leicester.
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43 Comments
“Whatever consumption tax you’d like to cut, using the revenue to instead raise income tax thresholds would be fairer, more progressive, give people more choice and have a more positive economic effect.”
Do you know of any quantitative evidence for the assertion that raising the income tax allowance would be “more progressive” than lowering VAT?
By household income – the usual measure – a VAT cut is categorically more progressive than income/NI tax cuts, despite your persuasive argument. Compare http://news.bbcimg.co.uk/media/images/50656000/gif/_50656900_vat_rise_incomegroups1_464.gif and (the black line in) http://www.ifs.org.uk/images/obs/income_deciles2.gif
Specifying that only those in full-time work receive the tax cut is a very important point (“you must be *this rich* to benefit”), and households with two such workers (who are richer) of course get twice as much as those with only one, and those with children don’t gain any extra.
Note also that direct tax cuts will be withdrawn at a rate of 65% from Universal Credit households (i.e. the poorest 30% of households). Consumption taxes are not.
The OBR also says that cutting VAT would, for the same cost, give more of a boost to the economy than income tax cuts.
On choice and fairness though, I do agree that we shouldn’t narrowly cut consumption taxes in particular areas, such as energy. We already have many such tax breaks that favour particular choices – not very liberal – and favour those rich households who consume most. Rather than tax gas at a lower rate than other consumption, for example, with most of this subsidy going to richer households, we could just (one way or another) boost poorer households’ spending power and let them decide what to spend it on. The *default* liberal position should be that all consumption is taxed in the same way, with the government not deciding for us what we should be spending our money on, just in the same way that benefits should not come in the form of food stamps or energy stamps.
@Adam
I’m with Daniel on this one. The IFS analysis looks at % change per income decile – but for the richest 10% a 1% change is an awful lot. And aside from the poorest decile (at just over 2%) each other decile shows a % change of between 1-1 just under 1.5% – one these are converted to absolute numbers, the richest lose far more by an increase in VAT than the poorest. One of the main flaws in the IFS analysis is that it ignores the effect the change in policy might have on moving people between deciles. Reversing an increase in VAT is not going to get anyone into work – but a higher personal allowance conceivably might do that, by alleviating the poverty trap that prevents someone who would otherwise lose benefits from taking work.
@Chris
Were you not happy with the argument made in the “Progressivity” section?
I thought it showed quite well if we were to give a £12bn tax break, the lowest paid benefit more from a rising of the threshold than they do from a VAT cut.
@Adam
Your first argument appears to argue against taking a percentage cut from income tax. After all, if we reduced income tax by 1% then someone on £50k would get £500 and someone on £10k just £100 – not very progressive.
If instead we raise the threshold so that both get £500, the person on £50k still only got a 1% rise but the person on £10k is now getting a 5% rise – much bigger than the 1-2% loss that the VAT rise cost them according to your graph.
(A similar point to what Julian made)
Your second argument was that the very poorest (those on benefits) do not benefit from raising income tax thresholds, which it correct. However, in their case their benefits do (usually) rise in line with inflation and VAT changes are taken into account when measuring inflation. So as long as their benefits keep in line with inflation, they neither benefit or lose out due to changes in VAT.
Not sure I agreed with your last line that liberals should tax ALL consumption in the same way. I think that nudge economics, taxing externalities and distinguishing between luxuries and essentials are all very liberal approaches to policy. At least we agreed on choice and fairness! 🙂
Household income isn’t the only measure of rich/poor. It can also be measured by household expenditure and household wealth. All of these are imperfect – wealthy people can be low earners and high earners can be of low wealth, and both income and wealth will determine a household’s expenditure.
So Adam, it’s not right to say that income is “the usual measure” and base all tax policies on making that one graph slope upwards, as we’d end up making some incredibly wealthy people even better off with our tax cuts.
The OECD says consumption taxes are better for the economy than income taxes, so you pick your experts, you make your choice.
@Adam
‘So as long as their benefits keep in line with inflation, they neither benefit or lose out due to changes in VAT.’
Wouldn’t the impact on inflation mainly be a one-off?
(Also, you seem to be implying that of the poorest 10%, all of their income comes from inflation linked benefits)
Apologies, meant the last message to be directed to Duncan
“…the main basics, such as food and rent, have no consumption taxes on them to cut in the first place.”
My understanding is that many basics, incuding many foods and adult clothes, have got VAT on them.
I don’t like consumption taxes because they are a government intervention that make the poor poorer. Raising income tax and national insurance thresholds aren’t going to do much for people on benefits or struggling self-employed people.
“Were you not happy with the argument made in the “Progressivity” section?”
Obviously I wouldn’t have asked if I had been.
I mean do you know of any quantitative analysis in which a comparison is made of the effects on different income groups (including people not in full-time employment)?
All “essential foods” are VAT-free, i.e. not snacks or takeaways.
Clothes do have VAT but the cost of “essential” clothes is much smaller compared to food and rent.
Are you sure it wasn’t directed at me John?
After all, it was one of my arguments you quoted! 🙂
You’re right that the “impact on inflation” of a VAT change would be a one-off. (Although a “one-off” impact on inflation is still a permanent change in prices. Either way, benefits are (usually) raised to match it.)
My assumption is that either they’re working and benefiting from the rise in the tax allowance, or that they’re claiming an inflation linked benefit (such as JSA, Housing or Pension) – am I wrong in any of those assumptions?
I agree, Duncan. We could look at it by expenditure, or on an individual basis, (ideally we’d estimate lifetime income or expenditure wouldn’t we?) but it is right that household income is the usual measure.
Daniel: Sorry I didn’t make clear what those graphs were that I linked to. They’re both from the IFS, and the second one is for personal allowance increases (not a rate cut). They show that VAT cuts are more progressive, and I’m afraid – as Chris says – that you’ll have to do better to prove otherwise!
That’s a fair point about VAT, inflation and benefits, though I note that because that inflation led to higher-than-earnings benefit increases we then cut working age benefits to undo that! I also – agreeing with John – very much doubt that such benefit increases would entirely counteract VAT increases for most.
I did only say that indiscriminate consumption taxes should be the *default* – I’m also all in favour of internalising externalities. But I really don’t think it is liberal or economically efficient for the state to decide that biscuits with a certain proportion of chocolate on them should be taxed at one rate while others should be taxed at another (or that books are better than computers, or milk better than trainers…). As I said it’s also an incredibly poor means of targeting those who need the help – rich people obviously spend the most on food, electricity, books etc. and so gain the most from these tax subsidies.
Hmmm…
That graph doesn’t tell me a lot on its own.
Can you link to some more information to the background behind it?
“That graph doesn’t tell me a lot on its own.”
Actually, it tells you that on the basis of household income the effect of raising the allowance isn’t progressive at all, as far as the first 7 deciles are concerned – because in that range the smaller the income, the smaller the percentage increase in income.
@Danial
Finally got the name right, third time lucky!
To clarify, you would agree that a VAT reduction would provide a benefit (after the first year) to the poorest, as any inflation would return to ‘normal’ but the reduced prices would stay?
In terms of assumption, I was thinking about those who worked part-time, received tax credit, receive non-state pensions etc.
@John
As a matter of interest, when you assert that that a VAT reduction would provide a benefit to the poorest, what VATable items do you have in mind that you think the poorest buy to any great extent?
Energy (i.e. gas and electricity) would be the obvious answer but they have remained unchanged at 5% VAT reduced and I assume that when people talk about a VAT rate cut they mean in the 20% standard rate. I have also got a feeling the EU rules do not permit a reduced rate below 5%.
“As a matter of interest, when you assert that that a VAT reduction would provide a benefit to the poorest, what VATable items do you have in mind that you think the poorest buy to any great extent?”
Do you not accept the IFS figures quoted by Adam above? It seems rather a waste of time to indulge in this kind of speculation, when someone has gone to the trouble of doing detailed calculations and published the results for us.
Re: Progressive/Regressive: I think part of the confusion is arising from the viewpoint being adopted by Daniel. Whilst consumption taxes such as VAT have been argued to be regressive (for example see http://www.taxresearch.org.uk/Blog/2011/01/04/why-vat-is-regressive/ ), the connudrum Daniel presents is whether changing the rate of a regressive tax (ie. VAT) with respect to a progressive tax (ie. income tax) leads to a more progressive outcome.
However, given the financial straits we are in, I suspect that most of the £12bn (being discussed) will be consumed by debt servicing. But that doesn’t prevent the strategy being adopted of increasing income tax thresholds ahead of reducing VAT and/or other consumption/indirect taxes. Also we shouldn’t forget that non-UK taxpayers visiting this country have difficulty avoiding consumption taxes, so a change in income tax directly benefits UK tax payers (and those who would pay tax if only they earned enough)…
@Simon
It’s a little old but, http://www.ons.gov.uk/ons/dcp171776_239565.pdf
Whilst energy bill and other 5% vat items may take up some of the ~10% of disposable income used on VAT, surely you would agree most of it will be 20% items?
To be honest I haven’t really looked in depth about which tax cut is more ‘progressive’ but was just taking issue with the concept that a vat cut would provide no benefit (or loss) to the poorest.
Raising the tax threshold does not give _everyone_ the same amount. I, and thousands like me, don’t earn enough to pay any tax at all. Everyone on Working Tax Credits gets tax back instead of paying it. Everyone on JSA, DLA, PIP. or basic rate pensions doesn’t earn enough. Anyone on minimum wage at less than 30 paid hours a week doesn’t earn enough. Anyone who works seasonally or contractually and doesn’t clock up 10k of pay doesn’t pay tax (all the hours you spend hunting contracts or auditioning or on ‘trial days’ don’t actually count as either paid work or job-seeking)
(Oh, and call me a scrounger? You try putting in 45plus hours a week times two people, for a little over £180. That’s hourly rate of around £2. Scrounge? Yup, sure have to.)
Daniel Henry: “My assumption is that either they’re working and benefiting from the rise in the tax allowance, or that they’re claiming an inflation linked benefit (such as JSA, Housing or Pension) – am I wrong in any of those assumptions?”
You are wrong in your assumptions, JSA, DLA/ PIP, Housing, and working tax credit have all been uncoupled from inflation. Inflation could run at 20% and I’d still only get a 1% raise. Meanwhile energy inflation is running at close to 10% and rent inflation is wildly variable, but personally running at (I think) about 6% averaged over the last 3 years
@Chris
“Do you not accept the IFS figures quoted by Adam above? It seems rather a waste of time to indulge in this kind of speculation, when someone has gone to the trouble of doing detailed calculations and published the results for us.”
And do you accept the IFS conclusion that the increase from 17.5% VAT rate to 20% VAT rate was “mildly progressive? https://www.libdemvoice.org/the-ifs-answers-is-increasing-vat-progressive-22157.html
To quote what the IFS said, in response to the question: Do you believe increasing VAT is progressive or regressive (and why)?
“We believe that increasing the standard VAT rate in the current system is mildly progressive when examined on a lifetime basis. The intuition for this is that, over a lifetime, poorer households spend a higher proportion of their (lifetime) income on goods that are zero or reduced rated in the current VAT system, such as food, children’s clothes and domestic fuel and power, and hence a lower proportion of their lifetime income on items that are subject to the standard VAT rate.”
As the IFS correctly point out, poorer households do indeed spend a higher proportion of their income on goods that are zero rated or reduced rated for VAT, such as food, children’s clothes and domestic fuel and power, and hence proportionately less on items that are subject to the standard VAT rate.
Which is why I asked the question: “what VATable items do you have in mind that you think the poorest buy to any great extent?”
I’m assuming from your response that you have difficulty in giving an answer to that, Chris.
“And do you accept the IFS conclusion that the increase from 17.5% VAT rate to 20% VAT rate was “mildly progressive?”
Simon, you must remember that this has been discussed at great length here in the past.
The conclusion you quote comes from a peculiar analysis, carried out in 2010, based on classifying households by expenditure rather than income. I believe that the IFS stopped using that method of analysis several years ago. That’s hardly surprising, as one of its more bizarre features was that the “poorest” decile had on average an income three times larger than its expenditure!
The point is that the graph already posted by Adam shows that increasing VAT is regressive over the lowest 7 income deciles, in the standard sense that the percentage of income taken increases as income decreases.
If you want to use some non-standard analysis to make a claim to the contrary, you need to explain exactly what definition of progressiveness you are using. Preferably, you need to explain why that is appropriate, but at the very least you need to state clearly your definition.
And I repeat, it is pointless for us to speculate here about the buying habits of any particular income group. The IFS has done the analysis for us, and the results are there to see,
What a peculiar blog post.
@Chris
“And I repeat, it is pointless for us to speculate here about the buying habits of any particular income group. The IFS has done the analysis for us, and the results are there to see.”
Exactly, and you just don’t appear to like what the IFS have to say.
“Exactly, and you just don’t appear to like what the IFS have to say.”
Simon, as you can see, I have just explained why I disagree with the analysis underlying the statement from the IFS that you quoted above. I have explained that the IFS no longer use that analysis (to the best of my knowledge) and I have explained that in that analysis the “poorest” decile of households have an income three times larger than their expenditure. I think that is self-evidently nonsensical, but if you disagree, by all means explain what sense it makes.
Now, as I have answered your question, perhaps you will answer the one I asked you initially. Do you accept the IFS figures in the graph posted by Adam above? In other words, do you accept that for the first 7 income deciles, the cost of a VAT increase as a percentage of income increases as income decreases? If you do accept that, then you must acknowledge that according to a widely used definition of progressiveness, increasing VAT is regressive.
As I have also said, if you think that definition is inappropriate, by all means explain why. But please do explain what definitions you are using, if you are going to talk about progressiveness/regressiveness. Discussion become meaningless otherwise.
@Chris
“Now, as I have answered your question, perhaps you will answer the one I asked you initially. Do you accept the IFS figures in the graph posted by Adam above?”
Answer: No.
“All “essential foods” are VAT-free, i.e. not snacks or takeaways.
Clothes do have VAT but the cost of “essential” clothes is much smaller compared to food and rent.”
I don’t think that is true. I think many of the foods you will find in the supermarket attract VAT (the famous “Jaffa” cakes case is a famous one). Of course, to many low-paid working people, snacks and takeaways are essential simply because they are out working all day and have to get food from somewhere. Do toiletries attract VAT? Sanitary products? Cleaning products? Home repairs? Car repairs? In general, I am wary of labelling any items as essential or not. It leads to the situation where low-paid people who want to dress well or eat well get accused of extravagance when all they are trying to do is bring some meagre pleasures into their life and retain some pride. in a society where low-paid people are disparaged.
Simon
Thank you. Would you care to tell us why you think the IFS is wrong?
“Of course, to many low-paid working people, snacks and takeaways are essential simply because they are out working all day and have to get food from somewhere.”
Can’t agree with that at all.
Even if they can’t make time to cook a full meal (and I suspect it’s more often “won’t”) then you can still get cheap convenient foods that aren’t snacks or takeaways. Bread, butter, baked beans, pasta, sauce from a jar, even microwave ready meals or frozen pizzas.
I think sanitary products are largely on the 5% rate of VAT rather than the top rate.
No one here is disparaging anyone. I’m even saying that raising the tax threshold would give all of us more choice on what to spend our tax break on (which may well be spent luxuries if that’s what we choose)
All I’m saying that the spending on luxuries itself doesn’t “need” a tax break at the consumption level.
@Chris
I consider the IFS to be correct when they say that “We believe that increasing the standard VAT rate in the current system is mildly progressive when examined on a lifetime basis.”
Would you care to tell us why you think the IFS is wrong?
Simon
I have already explained (twice) to you why I think the IFS analysis based on grouping households according to expenditure rather than income is inappropriate, and I have pointed out to you that the IFS itself seems to have decided the same, because it has stopped doing it. (I know you saw the comments where I explained that, because you replied to both of them.)
I am not disputing the actual figures given by the IFS for the effects of a VAT rise on different groups. You are, apparently. Why?
“All I’m saying that the spending on luxuries itself doesn’t “need” a tax break at the consumption level.”
I disagree on what you define as “luxuries.” I don’t think that snacks (crisps and biscuits, for instance) or clothes are luxuries.
Re: “Essential luxuries”
One of the things that is done with consumption taxes such as VAT, is they can be included in measures such as the RPI and Cost of Living, hence permitting tax and benefit rates to be set accordingly. Hence perhaps the £10k personal allowance should be viewed as a £9.5k allowance and a VAT rebate of £500 (warning figures have been plucked out of the air!).
I think we can get too carried away with trying to ensure that some sections pay no tax and others receive no benefits, it is far easier and often cheaper to accept there are grey areas and live with them.
@Chris
I’m not clear why you are having such difficulty with this.
1. Do you think the IFS are independent experts in this area? (I do)
2. Do you think that there is a lot of merit in asking independent experts a very straight and unambiguous question? (I do)
3. Do you think that the question “Do you believe increasing VAT is progressive or regressive (and why)? is about as straight and unambiguous as you can get? (I do)
4. Do you accept the IFS answer to that question, which starts “We believe that increasing the standard VAT rate in the current system is mildly progressive”? (I do)
@Ed
I consider snacks to be luxuries.
With clothes, obviously getting basic clothes isn’t a luxury, but buying the amount and quality where it costs a significant amount of money is IMO
Although we’ll probably have to agree to disagree there! 🙂
@Ed Shepherd
“I disagree on what you define as “luxuries.” I don’t think that snacks (crisps and biscuits, for instance) or clothes are luxuries.”
Just for the record most biscuits are zero-rated. The main exception is that chocolate biscuits are standard-rated.
VAT Notice 701/14 explains it all. See http://customs.hmrc.gov.uk/channelsPortalWebApp/channelsPortalWebApp.portal?_nfpb=true&_pageLabel=pageVAT_ShowContent&id=HMCE_CL_000118&propertyType=document
A rise in the income tax threshold does NOT give £500 to the poorest. The poorest don’t pay income tax. You argument is therefore flawed from the start.
You’re right – I should have said “Lowest Paid”
Once upon a time – and it was actually well within the last decade – we had a great flagship policy called the Green Tax Switch. We were going to take 4p off income tax by raising taxes on pollution and energy consumption. We were going to start the fight against climate change.
Hey ho, having serious principles and real ambitions to change things for the better is so old-fashioned now, isn’t it?
@David Allen
Can you really see your friends in the Labour Party supporting that? Also, increasing the 5% VAT rate on domestic gas and electricity would be highly regressive.