Value Added Tax (VAT) Reform

The detail below lays out the thinking behind our policy position on VAT, and shows the potential impact of it on purchases using illustrative rates.

Without a detailed breakdown of current UK purchases and the impact of other tax proposals we are suggesting, we cannot meaningfully assess the final impact on total national tax receipts, but we believe that we would able to adjust the balance of the proposed changes to ensure this does not decline without undermining the proposed framework (our hope is that there would actually be additional receipts in total).

Overview of our suggested reforms

Current VAT

Currently VAT is assessed at 20% on a majority of end user purchases (i.e. the final consumer of a product or service).

It is intended as a tax on luxury purchases (i.e. non-essential), and "essential" purchases are therefore exempt (e.g. most cold foods and non-alcoholic drinks, children's clothes, sanitary products).

There is also a reduced 5% rate applied to energy bills and some health or personal welfare items, however these make up a small percentage of purchases.

VAT raises a little under 20% of total UK tax receipts.

Problems

It is a somewhat progressive tax, as (i) it collects more from those consumers who choose to purchase a greater volume of non-essential goods and services, and (ii) the £ value of the VAT collected increases in line with the price. However:

the classification of products and services as "essential" is subjectively applied, and doesn't always reflect modern shopping habits.
the 20% rate is applied to anything effectively deemed a "luxury" purchase, regardless of how "luxury" it is. While 20% of the cost of a slice of cake or a portion of fish & chips is a lot less than 20% of the cost of a super-yacht, these are clearly different levels of "luxury".
it does not collect additional income from those who purchase "luxury" versions of exempt goods.

Solution

We propose that:

that the reduced 5% rate be revised to 7.5%
that the standard 20% rate be reduced to 15%
an additional 25% rate be introduced for "super-luxury" purchases
the definition of "essential" (and therefore zero rated) goods and services should be updated to exclude luxury versions of basic goods and to reflect items that are generally regarded as essential, including below a threshold on certain services (e.g. basic energy use per year would be exempt, above a certain level additional use is not).
that the "super luxury" class of VAT be applied to specific products and services (e.g. sports cars, yachts, personal trainers, jewellery, analogue watches, bespoke tailoring, hot tubs)

Impact

We believe that our proposals would reduce the VAT charge for many, while balancing this with additional collection from consumers of truly luxury items and higher than average usage of basic/essential services.

Since the VAT is collected by companies on behalf of the government, the slight additional complexity of administering this will fall on them, and they would be given clear guidance on how to apply it, with heavy fines for serial misapplication.