Happy New Year from George Osborne. A nice increase to the VAT rate from 17.5% to 20% welcomed us on 4th January.
The VAT rise was a strategy set up by the government to diminish the UK’s high budget deficit and raise more than £13 billion a year. However there are growing concerns the VAT rise could damage employment and the growth of the economy.
Essentially a higher VAT rate is detrimental for businesses
Trading conditions have become much tougher for retailers. Online shopping organization Kelkoo and the Centre for Retail Research conducted research into the impact of the VAT rise on retailers. They forecast in the first three months of 2011 the VAT rise would reduce sales by £2.2 billion. In contrast, the YouGov SME survey found 6 out of 10 decision makers did not feel the VAT increase would have much of a negative impact on their respective businesses.
Essentially a higher VAT rate is detrimental for businesses as it means less consumer spending, which could lead to fewer jobs for people who manufacture and sell for a living. Without private investment, the economy will fester, meaning unemployment looms and the deficit remains abundant.
…high income families have a greater share of their annual income remaining
Much debate fringes around whether the VAT rise is regressive or progressive. The Chancellor believes the VAT rise is a progressive manoeuvre: the policy will affect wealthier households more as they buy more expensive products more frequently. Data from the Office for National Statistics’s Family Spending Survey supports the Chancellor’s claims: as a share of expenditure, the richest face losing 0.2% more than the poorest, meaning, according to the ONS, the VAT rise is not regressive.
Defining a regressive or progressive tax is usually measured relative to household income not household spending. When measuring according to household income, the VAT impact to the poorest tenth makes up 2.5% of their income and about 1% for the top tenth, thus the VAT rise is regressive, when we properly calculate its impact according to real life. After buying everything they want or need, high income families have a greater share of their annual income remaining, whereas low earners allocate a greater amount of their income to satisfy their essential needs.
An annual excise of 1% on land value could acquire £50 billion a year for the government
Now there is great unease from the Institute for Fiscal Studies regarding the efficiency of the income-based perspective. Firstly there are issues with the lower tenth of earners; as this consists of unemployed individuals with wealth and pensioners, who are surviving off their savings. Also, there are issues with defining a big spender. Someone could have bought several big-purchase items on a one-off basis, yet as these purchases are burdened by the VAT rise they will be hit hard. They will be placed in the big spender bracket of the spending spectrum even though their spending will probably never reach that level in forthcoming years. The Chancellor has to find a way of assessing a person’s financial position which incorporates both how much someone spends and how much someone earns.
Several political commentators have suggested alternatives to the VAT rise which would amend the budget deficit, such as reducing spending by more than 3.3% and proposing taxes on carbon and financial transactions next year which, in turn, would impose tax on land values. An annual excise of 1% on land value could acquire £50 billion a year for the government.
In essence, the VAT rise seems unnecessary and may have a substantial impact on everyone, but especially those from low to average salary backgrounds. The government really needs to reassess how they define a person’s financial position and must consider better alternatives to cutting the budget deficit.