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James Mansell - Personal Site

VAT: A regressive tax?

A lot of people have been talking about how the increase in VAT  from 17.5% to 20% is a regressive tax. I’m not so sure.
Let’s take these two examples:

High Earner

They earn £3,000 per month and spend the money as follows:
Mortgage/Rent : £1000
Council Tax: £250
Energy: £120
Essential Food (zero rated): £180
Others: £1,450
They would pay 5% VAT on energy and 17.5% on the “Others”, this would mean they would pay £222 or 7.4% of their income as VAT.
High Earner – They earn £3,000 per month and spend the money as follows:
Mortgage/Rent : £1000
Council Tax: £250
Energy: £120
Essential Food (zero rated): £180
Others: £1,450

They would pay 5% VAT on energy and 17.5% on the “Others”, this would mean they would pay £222 or 7.4% of their income as VAT.

Low Earner

£650 per month , this would equate to about working about 65% of the time on the minimum wage. They might spend their money as follows:
Mortgage/Rent : £250
Council Tax: £100
Energy: £80
Essential Food (zero rated): £90
Others: £130
They would pay VAT of about £23 or about 3.6% of their income.

So an increase in VAT would increase the VAT as a % of their income paid by the high earner – to about 8.2% or an increase of 0.9% of their income whereas for the low earner this would increase to 3.9% or an increaseof  0.4% of their income.

In both scenairios the wealthier person is paying an increasing amount of tax due to the increase in the VAT rate. This is largely driven by the assumption that the poorer person pays a greater % of their outgoings on non-vatable items, such as Rent, Council Tax etc. There are two obvious counters to this arguement:

1. Wealthier people save  - therefore do not pay VAT -  This argument has some strength, however, at some point these wealthier people will consume the savings, at this point  they will pay the VAT (and probably more likely to be on VATable products).

2. Some poorer people consume more than they earn, therefore they pay a higher VAT rate.

The second argument is perhaps more convincing, consider for example a student earning £150 per month (say £30 per week) with outgoings as follows:
Mortgage/Rent : £250
Energy: £45
Essential Food (zero rated): £120
Others: £120

This person would pay £20 of VAT or 13.3% of their income in VAT (and therefore would be affected by a higher VAT rate). However, they are also spending £385 per month more than they earn. They could only do this with the support of others (parents, grants, student loan etc.) Therefore, in reality, are they really poor?

Pensioners are often in a similar position where they are drawing down savings. Broadly speaking any purchase tax is going to fall disproportionately on those with little income, but large spending. However, such people are often in that position because they are wealthy.

The large scope of exemptions in the VAT regime mean that in terms of spending, those who spend the least typically pay a lower total rate of VAT. Therefore, although there are more progressive taxes in the system, rising VAT is not particularly regressive.

Posted by James Mansell
20/09/2010 02:25:21

Two Economists: Three Opinions

So one set of Economists have come out and said that Government spending should be cut in 2010 and another group have come out and seid no leave it 'til 2011.

Surely the key thing as Greece is finding out is that you will have to cut when your creditors turn off the tap. The debate that assumes that cutting is in the hands of the government is to some degree artificial. If we are to convince our creditors that we are going to go on a diet, like going on a diet we can't say it will start tomorrow. I fear we have no choice but to start now.

Posted by James Mansell
21/02/2010 07:35:44

A Survey of the Tax System

Recently found this briefing paper about the UK Tax System produced by the Institute of Fiscal Studies, well worth reading.

http://www.ifs.org.uk/bns/bn09.pdf

Posted by James Mansell
13/02/2010 09:58:40

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