“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 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.