Biscuits, with their varying chocolate content, illustrate the perplexing terrain of Value-added tax (VAT) in the United Kingdom. Chocolate digestives with excessive chocolate coating face a 20% VAT penalty, while their plain counterparts remain VAT-free. Chocolate chip cookies and gingerbread men adorned with minimal chocolate eyes escape VAT, but a slightly more generous application of chocolate incurs a 20% levy.
Such inconsistencies extend beyond the realm of biscuits. An array of items, including children’s clothes, newspapers, solar panel installations, and sports lessons, are exempt from VAT, resulting in a loss of over £70 billion in potential revenue annually. Compared to other developed nations, Britain’s VAT system is riddled with more exemptions than almost any, highlighting the need for reform.
Two primary rationales are often cited in defense of VAT exemptions: fairness and the pursuit of social goals. However, the argument of fairness is tenuous, as the overall tax system, rather than any individual tax, should address wealth inequality. Selective exclusions, such as exempting food and children’s clothing, can lead to poorly targeted benefits that disproportionately favor the wealthy.
The pursuit of social goals through VAT exemptions is also problematic. While some spending, such as on education or environmental sustainability, may have positive externalities, using VAT rules to promote such spending is not an effective approach. Subsidies should be tailored, targeted, and justified on their own merits.
Despite these concerns, there are continued efforts to expand VAT exemptions, driven by a range of motivations from well-intentioned campaigns to cash grabs. However, such exemptions distort spending patterns and necessitate higher taxes elsewhere, often income tax, which can be more detrimental.
Eliminating certain exemptions, such as the threshold for small businesses, could alleviate administrative burdens and encourage growth. Addressing structural reliefs in the tax setup, such as in financial services, presents challenges but is not insurmountable. However, political resistance to VAT reform remains a significant obstacle.
Wholesale VAT reform, instead of piecemeal adjustments, is crucial to address the overarching tax system. While it may engender some public outcry, offsetting tax increases with rate reductions and expanded benefits for the poor could ultimately lead to a more equitable, efficient, and less distortionary tax system.
