Thursday, 13 May 2010

How regressive is VAT?

Tim Horton told the Jeremy Vine show - in a discussion with Ruth Lea in which she proposed 50% on luxury yachts from the right - used a very good concise summary of how to get across the point that VAT hits the poorest hardest.

The richest 10% pay one in every 25 pounds of their income in VAT; the poorest 10% pay one in every seven pounds as VAT

There have been several requests on twitter for the source.

This is "The effects of taxes and benefits on household income" from the Office for National Statistics. (PDF file)

If you look at table 14 (appendix 1), which shows the income, taxes and benefit for all household decile groups. The figures are for 2007-08.

You can see that the bottom decile have an average gross income of £8820, and pay out £1240 in VAT - that is one pound in seven.

You can see that the top decile have an average gross income of £92936, and pay out £3688 in VAT - that is one pound in every twenty-five.

Gross income is the conventional way to look at what is the appropriate tax mix.

If we were to instead take disposable income (after direct taxes have been levied), the poorest 10% are in fact paying a higher proportion (one pound in six) in VAT - an even more striking impact - while the richest 10% are paying one in nineteen pounds. That again shows how the impact of VAT is very regressive.


It would be good if this were more widely known. It would stop silliness from people who should know better like London deputy Mayor Kim Malthouse proposing replacing all direct taxation with VAT, and even writing "But surely VAT is a regressive tax that falls unfairly on the poorest? Not necessarily".


Chris Smith said...

VAT is a terrible tax for the poor but brilliant for the tax-man. Increasing it should only be done as a last resort - and after an increase in direct taxation, which is immensely more fair.

jdc said...

Thanks. If that's what the figures say, that's what the figures say - though I still don't understand how they can possibly be right. Tell me where my maths goes wrong.

Gross income - so we're including housing benefit and so on, at £8820.
VAT paid: £1240. VAT rate: 17.5%
Income spent on VATable goods: (1240/.0175) £7085
Income spent on non-VATable goods: £8820-£7085 = £1735

So the average person in the lowest income decile spends a *combined total* of £144 a month on rent, food, clothes for their children, and other direct and indirect taxes?

jdc said...

Or if we take the 1 in 6 figure after direct taxes, it's even more staggering - they come out at just over £80 a month. The average person in the lowest decile is apparently living on £1.93 a day to cover their rent and food and other zero-rated essentials.

Do you see why this number puzzles me? The Family Expenditure Survey thinks the poorest decile household are spending just under £10 a day on rent or mortgage alone, and £5 a day on food.

Even if we assume generously that the average bottom decile household has 2.5 adults in it, that's £2190 a year per adult on those essentials, meaning that of their £7791 disposable income they can be spending at most £5601 on VATable items. Paying, to reach the £1240 sum in the ONS document, an average rate of VAT of just over 22%. Which seems unlikely.

It may be that something's skewing it; a large number of asset-rich but income-poor pensioners, or people in long-term residential care who are paying VAT on home fees though getting it reimbursed.

Let's be clear, VAT is not a progressive tax, and I'm not in favour of increasing it - and certainly not without significant compensating tax and benefit changes. If we can be 100% confident of our statistics, it will be an important wedge issue persuading social liberals to call time on the orange book tendency and get out of the coalition.

However we do need to rebalance our economy to consume a little less and produce a little more. Using 50% VAT on luxury yachts to reduce the taxes paid by the manufacturer of luxury yachts and their employer would be no bad thing; redistribution isn't the only goal of the tax system, if it were we'd have no tax on tobacco.

rb said...

So the con-dem-nation administration, will raise the income tax threshold, disproportionately benefiting the middle class, only to be paid for by a VAT increase, which disproportionately hurts the low paid. If only we had running commentary on every new channel, to debunk progressive policy gobbledegook.

Luis Enrique said...

Curious figures.

If you take the lowest decile, disposable income £7791 and VAT at £1240.

If VAT is 17.5%, you need to spend £7085 on goods that pay VAT in order to pay £1240 in VAT

(if some goods attract VAT at a lower rate, this increases the sum of money you'd need to spend in order to pay £1240).

If households have disposable income of £7791 and are spending £7085 on VAT goods, where are they getting the money to spend on the items that attract approximately £900 in other indirect taxes (tobacco, fuels, etc.)? Not to mention goods that have no indirect taxes at all (food?)

I guess I must be missing something (or have made an error)?