FactCheck: Is a VAT hike better than a rise in NI or Income Tax?
“If you look at the population and how much they spend, then VAT is progressive…Income tax and National Insurance would have a more damaging impact on poorer people in our society and it’s worth remembering that in the Budget I took substantial means to reduce the NI burden”
Chancellor George Osborne MP, BBC Radio 4’s Today programme January 4, 2011.
Cathy Newman checks it out
George Osborne was in man of the people mode today. He argued that his VAT hike was the fairest way to restore the nation’s finances to health. That’s because the wealthy splashing out on big ticket items will be penalised, while the least well-off will do better because VAT is not levied on basics like food and children’s clothing. Labour says he’s got it wrong, and that raising national insurance or income tax would be fairer, because those on higher salaries pay higher rates of tax. So who’s right?
The analysis
The 2.5 per cent rise in VAT will haul £13bn into the Treasury’s coffers – it’s the biggest single weapon the coalition has against Britain’s deficit.
Setting out the VAT change in the Budget, Osborne said that poorer families spend more of their income than those better off on VAT-exempt goods - such as food, fuel and children’s clothes. On that basis therefore, a rise in VAT is progressive, Osborne said.
Is VAT a progressive tax?
There are two ways of looking at VAT, according to The Institute for Fiscal Studies (IFS): as a proportion of income, or expenditure. The IFS favours the latter, as it’s a better indication of long term household spending.
Over a lifetime, VAT will tend to be progressive because things that aren’t subject to the main rate of VAT are necessities that are consumed disproportionately by poorer households. And so increasing VAT on everything else will tend to hit the poor proportionately less, the IFS told FactCheck.
VAT is “slightly progressive”, the Institute’s senior research economist Stuart Adams said, “Particularly when you look at it over a lifetime.
“But income tax and National Insurance (NI) can potentially be much more progressive because they have a tax-free allowance for the first amount of earnings and because you have things like a higher rate of income tax which can be used specifically to target richer families.”
Labour of course, argues that VAT is regressive. And Richard Murphy of Tax Research deems the IFS “very obviously wrong”, for not taking into account the litany of differences between how the rich and poor spend their money.
“First, the poor must have savings, and they don’t. Second, they must have access to borrowing, and they don’t. Third, the consumption patterns of the rich must be the same as the poor, and they’re not,” he wrote last year.
Unlike the independent think tank IFS, as tax adviser to the TUC, Murphy is not without agenda.
Adams meanwhile, answers Labour’s charge with: “In any given year lots of people with low incomes will spend more than their income and therefore pay a lot of VAT relative to their income that year.
“But of course you can’t spend more than your income forever and people in that position will tend to have lower spending relative to their income.”
The “progressive versus regressive” argument could be a moot point.
David Frost, director general of the British Chamber of Commerce (BCC), says the VAT rise is a flat rate tax that will give everyone reason to grumble – but something has to give.
“Honestly I don’t know about expenditure patterns but clearly VAT is not going to be that much of a hit – the question to be phrased really is; which is the least worst tax when you look around?”
Impact on jobs
Osborne says a rise in VAT will do less damage to the job market than a rise in NI or Income Tax.
Shadow Chancellor Alan Johnson flags research by the Chartered Institute for Personnel and Development (CIPD), which claims a VAT hike will cost 250,000 jobs – more than three times that caused by a rise in NI, which would see 75,000 jobs axed by 2015-16.
But there’s little supporting evidence. Plus, Tory MP Matthew Hancock told FactCheck: “This so-called evidence from CIPD turns out in fact just to be anecdotal ‘soundings’”.
CIPD Chief Economist John Philpott, who is behind the estimate, responds that his figures are based on a straightforward calculation of the reduction in demand for labour as a consequence of the reduced demand for goods and services caused by the VAT rise.
Dr Philpott calculates this reduction of demand as 0.1 per cent, or 50,000 jobs per year. The 250,000 figure is the cost over a five year period.
He adds: “The primary source for our estimate was a VAT multiplier produced by the NIESR when the previous Labour government was proposing to reduce the standard rate of VAT. The more recent estimate from the OBR that the increase in VAT will reduce real GDP in 2011/12 by 0.3 per cent is consistent with the figures given by the NIESR multiplier”.
Hancock, who is an ally of George Osborne, said: “Given that raising National Insurance is a direct tax on jobs, and so costs businesses when they employ people, it’s hardly a surprise that international bodies like the OECD recommend VAT as the tax rise least likely to hit jobs.”
Indeed, the BCC’s Frost told us that with unemployment standing at 2.5m and looking to rise, a rise in NI “is very much a tax on jobs and it’s not the way to do it”.
“The focus in 2011 has clearly got to be bringing the deficit down – and as unpleasant as it is economic growth means increasing unemployment. You’ve got to look at the measures we take to encourage businesses to take on employees,” Frost told FactCheck.
But – the IFS told FactCheck that in the long run “there’s only a small difference.”
Adams told us: “VAT tends to weaken work incentives much like income tax or national insurance would. Rather than reducing the amount of take home pay that you can get for working an extra hour it reduces the amount you can buy with your take home pay. So VAT acts as a tax on jobs if you like – just like Income Tax and National Insurance do.
Cathy Newman’s Verdict
If the Chancellor had simply claimed that his VAT hike would hit the rich more than the poor he’d have been on firm ground. But he went on to make a comparison with Labour’s plans to increase national insurance. And that was his undoing. As the IFS points out, those who earn less benefit from tax-free personal allowances and lower rates of income tax. To say, as he did, that raising income tax or national insurance would place a bigger burden on the poor than putting up VAT stretches credulity.
There are 21 comments on this post
Brilliant Cathy as ever…….I will with your permission run this on the Duckhouse Blog COALITION DUCKHOUSE
UK NEWS BLOG:
http://tinyurl.com/pknlxn
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What on earth are we doing with a direct taxation system that is not progressive!
If Income Tax is not levied so as to take the most from those who can most afford it, then it must be reformed as a matter of great urgency!
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Income tax is broadly progressive. The poorest pay nothing, the rich pay a higher rate (curently 50%). National Insurance is less progressive. Since 1979 (when VAT was raised from 8 – 15% to compensate), Income Tax has been reduced & the number or rates “simplified”, so it’s less progresive than it was. The real problem is “fiscal drag”, where people are the poorer end of the scale face having to pay income tax when their incomes rise a small amount unless tax allowances are raised in line with inflation, which Governments sometimes fail to do – the classic “stealth tax”. The rich have been complaining that 50% is too great & threatening to move overseas (evidently forgetting the 83% top rate on earned & 98% on unearned icome which i recall from the 1970s).
Income tax is still more progressive than VAT. Why National insurance isn’t merged with it, with the same rules, is a mystery to me. It would be a large simplification & save Government costs. I suspect that it would produce unwelcome “headline” income tax rates, which the present system disguises – i.e. the 20% income tax rate is actually nearer 30% with NI added on top.
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Philip, my understanding is that originally NI was indeed an insurance which covered NHS and pension and it came to a big surprise to people of my generation to find that it all went into one pot which the government could spend as it liked.
Of course you are right that it would be much better to have just one tax on income but your guess is also correct, I suspect, that no government would argue for what the real rate of taxation would be.
I’m not sure if it is just that governments are cowards and prefer to raise the cash through VAT and other indirect taxes, or if it is we, the public, who are not grown up enough to accept that we have to pay and that things like income tax are the fairest method.
I’m reminded of a story when boxing manager Brendan Ingle fell out with one of his boxers over his commission. He said that there was no problem when it was £25 out of 100 but 250k out of £1m created problems. It seems (pace Philip Green et al) that the more we have, the more we feel we should be able to keep.
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[...] This post was mentioned on Twitter by C4 Newsroom blogger, Kerry McCarthy, FactCheck, Cathy, Adam Shulman and others. Adam Shulman said: RT @Kevin_Maguire: So Osborne talked out of his backside by claiming VAT was fair to poor. That @cathynewman calculator http://bit.ly/eybasD [...]
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Cathy,
Much more of this posting actual facts as opposed to propaganda and you will have men in suits at your door “suggesting a change of emphasis,” and maybe even subjecting you to “slimming down” (no, not your waist line!) or perhaps “relocation.”
As always, thank you for your work. It is as refreshing and clear-headed as ever.
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VAT is certainly the fairest way, it hits those languishing on benefits (who are often better off in real terms) as well as those who work
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Thanks for this blog
Did frost actually mean this or misspeaks? “The focus in 2011 has clearly got to be bringing the deficit down – and as unpleasant as it is economic growth means increasing unemployment.”
In this case I’m not sure what economic growth is presumably not about increasing production or use of services as that would mean needing more work not less
Please chip in and tell me why I’m wrong but i am clear at least that Frost misses the point of what economic growth is for
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Yes Embers, I noticed that little gem too. To so clearly imply that economic growth is necessary to help the rich and the big corporations take an even higher share of the wealth (causing involuntary mass-unemployment), must have been a freudian slip.
The fact that this approach also means that the pool of real wealth of-which the rich would now have a higher share, would automatically be smaller as a result of the loss of output (high unemployment), is clearly lost on him.
Mass unemployment here-we-come!
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Did you factor in that NI on incomes over £44k is 1%?
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Even if the item you are buying is as much as £100, it will only cost you an extra £2.50.
I feel there is a lack of perspective here, probably caused by media hype.
Great blog though
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Plus spending more only helps China and India that produce the goods we are buying. We need a solid countrywide manufactoring base if we are to earn our place amoungst the big world economies. Failure to do sees us return to pre 16th Century, when we were just a small island off the continent. Our Victorian ancestors must be turning in their graves!!!
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its not £2.50 per £100
what used to cost £117.50 (£100 + £17.50vat)
now will cost £120 (£100 + £20vat)
this equates to an additional £2.13 per £100
(what was £100 £85.11 + 14.89vat is now £102.13 £85.11 +£17.02vat)
However £2.13, £2.50 or even 5p per £100 is not an insignificant amount. I certainly will be more likely to buy high ticket items abroad when I take my additional relatively cheaper holiday there.
I think as a rich bean counter I will pay less tax proportionately than the paupers.
Thank you Osborne and thanks to all the other fellow Etonians. Hooorah.
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Why all this blather? The only fair way of raising money is by taxing the better-off.Raise income tax on incomes of over £75k,take a one-off levy of 2% on personal wealth of over £1m, create a land tax, subject all capital gains to tax including on sale of personal home and remove charity status from public schools.Not to mention serious attention to the matter of tax avoidance and evasion.
VAT increase adds to the cost of living of the poor,and the cost is not reduced by averring that it hits the rich more. They can afford it, The poor can’t. End of.
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It is claimed that by 2014-15 “the rise in VAT will haul £13bn into the Treasury’s coffers – it’s the biggest single weapon the coalition has against Britain’s deficit.”
However cuts to income tax, national insurance, corporation tax, and council tax will cost £12.4bn. Therefore net of Tory tax cuts, the VAT rise brings in just £1.1bn. New OBR boss and formerly of the IFS, Robert Chote, said in May:
“When Mr Osborne said that “the years of debt and spending” made the £13 billion increase in VAT unavoidable you might just as well say it was his desire to cut other taxes that made it so.”
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“poorer families spend more of their income than those better off on VAT-exempt goods – such as food, fuel and children’s clothes”
This claim is not the full truth either. All fuel is subject to VAT, though at the lower rate.
Quite a few elements of children’s food are also taxed at the full rate. By way of example, children’s fruit drinks and cereal bars[for lunchboxes], basic treats for a childen, fudges milky bars etc are all taxed. Takeaway food is also taxed… so that is the pizza or chinese takeaway on a Friday after a hard week’s work, regular fizzy drinks too… As for clothes, shoes over the size 6 are taxed at the full 20% and I’d say most children’s feet reach that size long before they are adults, just as they reach adult clothes sizes long before adulthood.
And then there are other household essentials which poorer families need as much as any other such as toilet roll, soap, shampoo, washing powder, cleaning products…
Overall, using data from the ONS, the Fabian Society has calculated that “the richest 10% pay one in every 25 pounds of their income in VAT; the poorest 10% pay one in every seven pounds as VAT”.
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Interesting that Osborne sees the new VAT rate as permanent. What’s the betting he reduces the 50% income tax rate on the rich before the next election.
I may be simple but how can a tax that costs a millionaire the same as a pensioner be fairer than one in which those who earn most pay most>
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Playing devil’s advocate here! Why do we all see it as fairer to hike up tax payable by he rich to subsiduse those not so rich. Maybe we should look more to the Hong Kong model. Keep taxes low for all and encourage entreneurs and ordinary folk to work harder cos they’ll earn more and want to become richer. Over the last 5 years, each time I was giving a modest pay increase, I never saw the benefit in take home pay. Takes away motivation to work harder completely!!!
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Channel 4 News opened with, ‘It’s estimated the VAT rise will cost the average family £500 a year’.
NONSENSE! 2.5% of £20,000 = £500.
Are you telling us the average family spends £20,000 per year on VAT applicable goods? The average income is only £25k!
Less of the voodoo maths – it spoils an otherwise good analysis.
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As VAT is charged on sanitary products, VAT rises are also a tax hike on being a woman. Apparently not leaving a trail of blood everywhere you go 4 days a month is a luxury not, y’know necessary for reasons of hygiene and not being a social outcast.
Presumably there’s a hut we can go and be unclean in somewhere in Westminster that’s VAT free.
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You are right, I for one think that these should not only be tax free but should be free – like condoms are for those who visit family planning!
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