The EU introduced VAT in 1967, to avoid distortion of cross-border shopping and trade and to provide itself with guaranteed income from member states (“Own Resources”). Every member state is required to contribute a fixed percentage of its VAT Base (items on which VAT is charged) to the EU’s budget. This creates a clear incentive for the EU to widen the VAT Base as much as possible in order to boost revenue. And the Commission is zealous in ensuring it gets a cut of tax on as many goods and services as possible: the ECJ’s caseload is full of VAT cases and arguments about obscure (and frankly incomprehensible) points of VAT law.
Setting a rate of VAT harmonised across the EU has long been the EU’s aim. In 1992, the Council decreed that all member states were required to apply a standard VAT rate of at least 15%, with reduced rates of at least 5% on specified goods and services.
In December last year the European Council amended the VAT rules by limiting the number of items on which Member States can apply the reduced VAT rate of at least 5% to a maximum of 24 items – which must be on the EU’s approved list – while just seven items can have rates below 5% or be exempt from VAT. EU members must also phase out their reduced rates or exemptions for fossil fuels by 2030. Similarly, reduced VAT rates or exemptions on chemical fertilizers and pesticides will have to finish by 2032. This means that were we still members of the EU, our current 5% VAT on domestic energy bills and fuel would have to increase to 20%.
What better Brexit dividend could Prime Minister Truss possibly give the UK than to abolish VAT on fuel and energy? With one blow she would give UK consumers’ spending power a boost while simultaneously putting some clear water between UK and EU taxes. This would be a crucial display of fiscal sovereignty by the new government, making re-joining the EU much more expensive, and consequently a very hard sell indeed. This is of course why, quite unnecessarily, EU VAT law was sneaked into the Northern Ireland Protocol, with the aim of keeping the whole UK aligned in order to make rejoining the EU easier. At present UK VAT reforms cannot apply in Northern Ireland, meaning that taxes as well as trade and commercial regulations will diverge unless the Government tackles this issue.
The political risk of allowing Northern Ireland to drift off possibly made Boris Johnson’s Government hesitant about lowering VAT on fuel in Great Britain earlier in the year. What is incontestable is that the people of Northern Ireland should not be subject to taxes over which they have no say. And nor should the rest of the United Kingdom, because the government is afraid to cut EU VAT from the Protocol. It is certainly not needed to avoid a hard border between the Province and the Republic.
UK legacy VAT
The UK is still largely applying VAT under EU rules, although we have had no input on any changes subsequent to Brexit. VAT had to be adopted by the UK when it joined the EU. Now we have left it seems crazy to continue slavishly implementing this retrograde Continental tax. The system of charging VAT and claiming refunds on business inputs is time consuming and complicated, and thus costly for businesses to administer. It is also a gift to criminals, who claim refunds to which they are not entitled. VAT is therefore the tax most likely to be the subject of HMRC legal disputes, whether due to accidental misapplication/reclamation or deliberate fraud. This is costly for both HMRC and business, as well as for the taxpayers and consumers who ultimately pay both sides’ legal bills.
UK VAT is charged at either the standard rate, presently 20%; the reduced rate, 5%; or is zero-rated. Some items are also exempt from VAT. The products and services that are zero-rated are generally considered to be essential goods such as basic food, children’s clothes and books, while sports activities, gambling and admissions to museums, art galleries and zoos are exempt. This may have made sense 50 years ago (or maybe not even then), but now, as a short-term measure at least, the Government needs to rewrite the zero-rated list to include items that are essential to modern life in the UK in the 2020s. However, in the long run we should dispense with VAT entirely or replace it with a much simpler flat sales tax.
What goods and services should be exempt from VAT
Utilities
The first to go must surely be VAT of 20% for businesses on energy bills, electricity, gas, heating oil and solid fuel as well as on water supplies, sewer or drain clearing and maintenance and the emptying of cesspools and septic tanks. This is madness. Energy is existential for businesses. Whether they are making cement or running a dealing room, without power – they are closed. Water supplies and sewage maintenance are essential to health and hygiene in modern Britain. Taxing utilities just adds to businesses’ cost of production. And of course, businesses, like governments, don’t have any money of their own. Their money comes from their customers, so the VAT added to their energy and water bills will be recouped in the price of their products, that may also have VAT added to their sale price. The Government can hardly claim to be worried about inflation if it is happy to increase the cost of production of most goods and services with 20% VAT on energy and water use, and then increase the final sales price of the same goods and services with yet more VAT.
As for domestic energy and sanitation, this is just as essential to life in the UK as food and children’s clothes, and much more important than gambling or visits to museums, but domestic energy has 5% VAT added to the bill. Sensibly, domestic water supplies, domestic septic tank emptying and sewage services to domestic customers are zero-rated, so why not other utilities such as gas and electricity? However, 20% VAT is applied to sewer or drain clearing and maintenance for domestic customers. Good sewerage and water maintenance has done more for public health than modern medicine, so we should not be taxing it.
Communications
As more people work from home, mobile phones and Wi-Fi connections have become part of our lives, so we should also remove VAT on communications services. Mobile phones and the internet have moved on from being luxury novelties to essential tools. Even if the phone itself has VAT added to the price – people have a choice between buying a cheap one or a state-of-the-art model – why is the connection and usage subject to 20% VAT? Public phones, phone books, White Pages, are things of the past. Everyone expects you to be able to go online, read their website or receive their emails, press releases and texts – especially the Government and the NHS.
There are many other items on the VAT list that should be zero rated or exempt:
Energy saving materials
Rather than gluing themselves to the Speaker’s chair in the Houses of Commons, the good folk from Extinction Rebellion really ought to be demanding VAT is zero rated on energy saving materials permanently installed in residential dwellings and buildings – at the moment 5% VAT is added to their price. While energy saving materials, supply only, have 20% VAT added. If the Government is really concerned about the environment and saving energy, then remove the VAT. Additionally, why are these products rated differently from air source heat pumps, ground source heat pumps, wood fuelled boilers, central heating controls, draught stripping, insulation and solar panels? All the above are zero rated in Great Britain but they have 5% VAT added to them in Northern Ireland, as it is still operating under EU VAT law.
Taxing the elderly and infirm
The UK has an aging population, so why do mobility aids for the elderly have 5% VAT added to their price? We shouldn’t be making walking frames more expensive – no one buys one as a status symbol. Similarly, people over 60 with grant funding or in receipt of benefits must pay 5% VAT on gas boilers, electric storage heaters, oil-fired boilers, radiators as well as on the installation, repair and maintenance of boilers, radiators, pipework etc. This is incredible – we are giving people grant funding and benefits but still charging them 5% VAT for repairing or maintaining their boilers. An example of the Government’s left hand paying its right hand. Just drop this tax.
Increasing the cost of housing
However, people who are not over 60 with grant or benefit funding, must pay an enormous 20% VAT on their house maintenance bills. Even though the UK has a shortage of housing, and we should be encouraging anyone with a house to maintain it, the government still adds 20% to roof repairs, plumbers’ bills and electricians’ charges.
We don’t have enough homes to house the population as it stands. But regardless of this shortage, converting an existing premises into flats or increasing the number of flats in a building will see 5% VAT added to the bills, as will the renovation of a dwelling that has been empty for at least 2 years. Surely, we need to encourage more refurbishment of unused dwellings – after all, recycling is good for the environment, including house recycling. So, drop the VAT on house maintenance, subdivisions and refurbishment.
Mandatory equipment
There are other items on the VAT list that are either out of touch with the Government’s own rules on health and safety or simply revenue raising exercises. For example, new parents can’t leave hospital with their baby if they don’t have a proper carry cot, and both child car seats and booster seats for young children are mandatory, yet the Government also adds 5% VAT for complying with this regulation. This is extortion and shows how a tax originally designed to raise money from luxury goods has morphed into the go-to levy when government wants to dip its fingers into citizens’ pockets.
Health aids
Similarly, smoking cessation products such as nicotine patches and gum have 5% VAT added to their price. If the Government really believes that smoking is bad for people’s health and the Government provides free at the point of use medical care, why would they not zero rate products that help people stop smoking? Making these products as cheap as possible may reduce the number of major lung cancer operations performed by the NHS each year, saving the Government/taxpayers money in the long run.
Why should any government tax spending?
Many countries have consumer sales taxes which were once seen as a way to tax the cash economy which could avoid income tax. However, with more and more businesses going cashless and most payments electronically transferred, it is hard to justify why we still have consumption taxes such as VAT. People have already paid income tax or capital gains tax on their money when they earn it, so why should the government tax them again when they spend it – especially if they are spending it on essential or mandatory items?
There is also a complication with VAT where businesses are charged VAT on their inputs and then must reclaim it or pass it on to their customers. A simple and small non-refundable sales tax on non-essential retail products would be easier to administer, reduce fraud, boost economic activity and potentially raise as much revenue.
Consumer spending gives businesses their revenue allowing them to pay their employees and buy input materials, made by other companies employing other people and using other inputs, ad infinitum. In theory, money not spent on consumer goods will be held as savings used for business creation or invested in government bonds. I would argue that ultra-low interest rates are the main cause of the low savings ratio: high VAT is not going to change this.
There is a case to be made that increasing and decreasing sales tax rates is a more effective way to alter economic activity than changing interest rates, especially as many people under forty don’t have a mortgage, most baby boomers have paid theirs off, and almost everyone else has a fixed rate mortgage. Increasing and decreasing bank rates mainly effects businesses who generally have variable rate loans charged at a premium over the base rate. So increasing rates to counter inflation is more likely to depress businesses than dampen domestic demand. However, that only reinforces the idea that with the economy sliding into recession, now is a very good time to remove VAT.
An economy with low or no sales taxes would also benefit tourists, who could once reclaim any VAT paid on items purchased in the UK when they left the country. This useful rebate was quietly cancelled when we left the EU. It is perplexing that HMRC is happy to distinguish UK VAT regulations from those of the EU when the changes make shopping in the UK more expensive for tourists than shopping in the EU. Removing VAT would boost tourism as well as local demand.
It would be preferable if there were no consumer taxes, however I will grit my teeth and continue to pay a sales tax on non-essential items – new clothes and shoes, restaurant bills, alcohol, travel, new cars, facials, hairdressers, nail bars etc. – but not on modern life’s essentials. To live in the UK we need food, energy, sanitation, housing, heating, and communications. All of which should always be free of sales taxes.
Costs and benefits
Last tax year (2020/21) the Government raised £713 billion in taxes. This was almost £85 billion more than in 2019/20 – a mostly pre-pandemic tax year. The bulk of 2021/22 revenue, £394 billion, came from Income Tax, NIC and Capital Gains Tax – up £45.6 billion from 2020/21 which in turn was higher than 2019/20 despite the pandemic. VAT added £157 billion to the 2021/22 total, this included VAT that had been deferred from the Covid years, but it was also £27 billion higher than pre-covid 2019/20 levels.
With VAT contributing about 20% of total revenue, it would be expensive for the new Prime Minister to abandon it entirely, but she could remove VAT from essential goods and services and then start the process of replacing it with a less complicated sales tax for genuinely non-essential items.
The ONS publishes UK National and domestic final consumption by type of consumption and calculates the total domestic expenditure for 2021 at £1,363 billion. Using their sector totals, if the following categories are sales tax free: Food and drink; Housing; Health; Transport; Communications; Education; and Household equipment and routine house maintenance, while a non-refundable sales tax of 20% were charged on: Alcohol, tobacco and narcotics; clothing and footwear; Recreation and culture; Furnishings; Restaurants and hotels and Miscellaneous expenditure, then the government would collect a similar amount of revenue as it does from VAT. Alternatively, a lower sales tax of 10% charged on all domestic final consumption would raise a similar amount. In either case there should be no sales tax and refunds on business inputs. These make business taxes more complex and are open to fraud. Reducing tax complexities as well as tax rates will boost businesses and economic growth. It would also reduce the HMRC manhours required to collect and dispute VAT charges and refunds.
Removing VAT is quick. It can be changed with a pen stroke. As can the Climate Change Levy (CCL) on energy bills and Fuel Duty on petrol and diesel. Both add to the price of the underlying good on which VAT is calculated. Both CCL and Fuel Duty have served their purpose – everyone is reducing their energy and fuel use due to the high prices, without this added government enticement. According to the ONS, energy use by industry, source and fuel, 1990 to 2020, the UK’s total energy use peaked in 2004 at 231.61 million tonnes of oil equivalent (Mtoe) and has dropped steadily since to only 157.95 in 2019 down almost 32%. (Energy use was only 134.84 Mtoe in 2020, but as this was a year with Covid lockdowns I am not using it as representative.)
It seems crazy to me that the government is planning to cap energy bills for consumers, effectively picking up the difference between the cap and the retail price of energy if those capped bills also contain government charges such as VAT and CCL. Again, the government is charging consumers with its left hand and then paying for those charges with its right hand. Just removing these charges completely would require less bureaucratic time and still motivate consumers to use less of our limited energy – the very reason that prices are high.
Cutting VAT on essentials and removing environment levies won’t solve all of our problems. But it would lighten the load for consumers and hopefully keep them spending, which will help businesses. Without this load lightening, we will be in a recession – or a deeper recession. People are already reducing their discretionary spending to pay their energy bills: Retail sales volumes fell 1.6% in August; non-food sales volumes fell by 1.9% with department store sales volumes down by 2.7%. By the time “capped” October energy bills arrive with consumers, reduced discretionary spending will be really hurting the general economy and increased unemployment won’t be far behind, leading to lower income tax revenues and higher benefit payments.
Many people are claiming that they will simply not pay their energy bills but to use a product and then not pay for it is illegal – this is no different from eating at a restaurant and then leaving without paying the bill. The energy company has provided you with a product, which you have used and so must pay for.
However, whether the Government has such a clear-cut case on the VAT it adds to an invoice is debatable. And this is a debate that we should be having. Why are we being taxed for spending our after-tax income, capital gains or pensions on essential goods and services: business energy; domestic energy; fuel; communication services; mandatory protective equipment; walking aids; health products; or house maintenance?
The new Prime Minister, Liz Truss has already stated that she wants to review the entire UK Tax Code. I would like to suggest that she starts with VAT: replacing it with a simple sales tax on non-essential goods and services or scrapping it entirely.
