Value added tax

Updated on July 19, 2022

What is it?

Value-added

tax (VAT) is a charge on the purchase price of most products and services.

VAT was implemented in 1973 to replace purchase tax, a 33.3 percent tax on products regarded as ‘luxury’ which was enacted in 1940 to deter waste.

The normal rate was decreased from 10 to 8 percent in 1974 when a higher 25 per cent tax (on petrol and some consumer products) was implemented. This was lowered in 1974 and the two were consolidated into a single 15 per cent rate in 1979.

It was raised to 17.5 per cent in 1991 and again to 20 per cent in 2011 following a temporary drop to 15 per cent between December 2008 and December 2009. An 8 per cent lower rate (primarily on home energy) was implemented in 1994 and cut to 5 per cent in 1997.

Businesses (including the self-employed) must register if turnover of non-exempt sales exceeds the threshold (£83,000 in 2017-18). VAT paid on firms’ purchases is subtracted from VAT invoiced to customers.

What’s the problem with it?

Two fundamental features distinguish VAT from income tax: It does not tax savings or investment, and lower (and zero) rates are applied to consumption rather than people’s incomes.

A similar effect is seen in VAT, which has the same effect as income tax. People’s’real incomes,’ which are their earnings after deducting inflation, are lowered by both income tax and V.A.T. Reducing people’s after-tax salaries or raising the after-tax pricing of the products they buy will both make them poorer eventually.

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To put it another way: the consumption tax base of the VAT makes it less inefficient than the income tax.

However, the varying tax rates for various goods and services confuse consumer behavior and open the door to tax evasion.

A classic illustration of the issue is the long-running legal battle over whether or not a Jaffa Cake is really a chocolate-covered biscuit (subject to ordinary VAT) or a cake (zero-rated).

Both the administrative and financial burdens placed on businesses by the VAT are far greater than those placed on businesses by the sales tax.

The tax must be levied by all enterprises in the supply chain, not only retailers. It’s also important to keep track of your purchases and sales so you can subtract the VAT you’ve paid from your bills.

However, retailers’ incentive to dodge deductions available. A VAT is preferred in countries with high consumption taxes due to the tradeoff this creates over a sales tax.

What should be done?

There will be no new taxes or fees.
There will be no rate increases.
Nothing has been reclassified.
To be worthwhile, reform must be substantial.