Instead of a taxi tax, Reeves should fix the absurd VAT system
Reeves’ tax grab on taxis highlights the absurdity of the VAT system and raises the question of whether VAT should be levied more consistently across goods and services, says Ben Ramanauskas
It has been reported that Rachel Reeves will announce at the Budget that taxi journeys will be subject to VAT. This has drawn criticism from many commentators and has already been dubbed as a ‘taxi tax’.
It is clear why the Chancellor feels the need to do this. Despite her last Budget increasing taxes by £40bn and public spending by £70bn, lacklustre growth and rising borrowing costs mean the government now needs to scramble around to find another £30bn in order to plug the deficit and calm the already nervous gilt market.
Although the Chancellor is doing this for fiscally dubious reasons, her latest tax grab does highlight the absurdity of the VAT system and raises the question of whether VAT should be levied more consistently across goods and services.
VAT is one of the most efficient revenue raisers. It helps to fill the Treasury’s coffers in a way that is far less distortionary than many other taxes. Unfortunately, the VAT system in the UK is needlessly complex as it is riddled with different rates and exemptions.
This increases compliance costs for businesses – not to mention lengthy legal battles over whether a Jaffa cake should be classed as a biscuit (no), or a mini poppadom should be classed as a crisp (yes). Time and money spent dealing with such issues could be put to better use developing new products or hiring more staff.
It is also bad news for the public finances. Exempting some items from VAT or levying a lower rate on certain goods and services means that the government is deprived of a significant amount of revenue and instead raises the money by borrowing or through much more economically damaging taxes.
Unsustainable
The current situation is unsustainable. In addition to supply side reforms to boost productivity and significant cuts to public spending, it is clear that a new approach needs to be taken. It is time for the government to follow the example of many other countries around the world and take a more rational approach to VAT.
The VAT system should be simplified. There should be only one rate, and it should be levied on far more goods and services – with the funds raised used to wholly or partially reverse the damaging recent rise in Employers’ National Insurance contributions, the problems of which were highlighted in ‘What Next for The Economy’ by Policy Exchange and which the OBR has now confirmed is damaging growth and increasing unemployment. Such a move would not only help to deal with the Chancellor’s fiscal woes, but it would also help the Government to achieve its laudable ambition of growing the economy.
Such a proposal may not be politically popular. Critics of the ‘taxi tax’ have rightly pointed out that it will likely make taxi journeys more expensive and that vulnerable people who rely on them will be disproportionately affected. Abolishing the different rates and exemptions would raise prices on a wide range of goods. If it was felt to be necessary, the government could choose to mitigate this by using some of the proceeds to reduce the headline rate on all goods (benefitting all consumers) or by targeted support to those on the lowest incomes, who might be most affected by the removal of exemptions.
Simplifying VAT would allow the government to simplify the system, reduce compliance costs and help to drive growth – as well as being a small first step to a more efficient tax system.
Ben Ramanauskas is a senior research fellow in Economics at Policy Exchange