Micro and Macro Effects of Higher VAT (Edexcel 25 Mark Question)

Updated on July 20, 2022

Here is a revision video on shaping an answer to a 25 mark essay question on the possible micro and macro economic effects of increasing VAT in the UK

VAT

Most goods and services are subject to VAT, which is an indirect tax.
Although domestic gasoline and power are taxed at 5%, and some products including private school tuition, postal services, and rental accommodation are free from VAT, the general VAT rate in the UK is 20%.
An increase in the regular VAT rate to 25 percent will be examined in this essay.

Micro Point 1

If suppliers choose to pass on VAT to customers, the 25 percent VAT would have a small impact on retail pricing.

Increasing VAT to 25% generates a crucial inward shift in the supply curve, which allows providers to raise prices without suffering a significant loss in sales if demand is not price elastic. My analytical diagram illustrates this.

Some companies, on the other hand, will maintain their pricing as low as possible in an effort to acquire market share. This is dependent on their financial success. Protecting market share is a top priority in an oligopoly, for example.

Micro Point 2

Regressive effects on low-income families could lead to an increase in inequality if the VAT is raised to 25%.

As a whole, VAT has a regressive impact. One-eighth the disposable income of households in the bottom 20% of the income distribution is consumed by it, but only 5% is consumed by those in the top 20% of the income distribution.

However, this could change if the scope of VAT is altered. Private school fees, for example, may be perceived as progressive if 25 percent VAT is added to the cost of clothing for children.

Macro Point 1

Higher inflation and a decrease in real disposable incomes could contribute to a slowdown in GDP growth and an increase in unemployment if the VAT is raised.

Things become more expensive when the VAT is raised. From £649 to £676, the price of a television screen and a pair of shoes would rise. Millions of families that are just barely scraping by will be affected by this, and it will have a negative impact on consumer confidence and purchasing.

Whether or not wages, pensions, and other benefits grow in tandem with consumer prices depends on whether or not the increase in VAT is viewed as temporary or permanent.

Macro Point 2

A 25 percent VAT hike would bring in more tax income for the government, helping to reduce the deficit and, in the long run, helping to reduce the national debt level.

Each year in the United Kingdom, VAT generates about 17% of the country’s total tax income. Government finances might be improved with a VAT increase and more money could be spent on public services, such as the NHS or additional support for schools.

Taxes should be widened in order to include additional goods and services, or firms should focus on reducing VAT and corporate tax avoidance.

Examining inquiries

A final decision must be made!

There are a few things to keep in mind when evaluating:

When compared to other countries, how much is VAT in the United Kingdom?
It’s not clear how much additional money a 5% VAT increase would bring in. Food VAT might theoretically generate an additional £17 billion in tax revenue, but what are the ramifications for income distribution?
Do you think it will boost tax evasion and cross-border trade?
Is this a short-term or long-term tax change?
Other levies, such as national insurance, would they be reduced as a result so that the tax reform had no effect on revenues?
What is expected to happen to the motivation to work in the labor market as a result?