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VAT: Progressive or Regressive?

In his emergency Budget in June 2010, George Osborne, the Chancellor, announced an increase in VAT from 17.5% to 20.0% to take place from the beginning of 2011. When this came into place this year, Osborne, in an interview with the Today programme on radio on 4th January 2011, said:

“If you look at the population and how much they spend, then VAT is progressive…”

A progressive tax is one which takes a larger percentage from the income of higher-income earners than it does from lower-income earners, whilst a regressive tax does the very opposite.  Recent research published by the Office of National Statistics shows that the Chancellor is wrong and that UK VAT is in fact a regressive tax.

Research covering the period up to 2009-10, before the increase in VAT to 20%, shows that the poorest fifth of the population spent 9.8% of their disposable income on goods which required VAT to be paid, whilst the richest fifth only spent 5.3% of their disposable income. This can be seen in the graphic below.

Average household VAT as a proportion of household disposable income: by household disposable income groups.

Source: Living Costs and Food Survey, ONS.

It is tempting to think that VAT might be progressive, because important budget items such as food and non-alcoholic drinks do not have VAT charged on them, and thus poorer people would be less affected. However, this is quite clearly not the case.

What the graphic above also shows is that the difference between poorer and richer households in the effect of VAT on disposable income has widened and become even more regressive in recent years. In 1986 the gap was only 1 percentage point in the proportion paid but this widened to 7 percentage points in 2001-02. Although this gap has now shrunk to 4.5 percentage points, the evidence is unequivocal. The poorest 20% of households in the UK spend a higher proportion of their disposable income on VAT that do the richest 20%.

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