Cameron’s VAT Opportunity
David Cameron took a bruising last week when his plan to remove or trim family tax credits descended into political chaos. The credits are costly and ineffective, and reforming them is a step toward a flatter, less-distorting tax code. But critics estimated that eliminating them would cost some families upwards of £1,300 ($2,007) a year.
So how should the Prime Minister recover the policy initiative and help working families? Our suggestion: reverse his government’s ill-considered decision from 2011 to raise the value-added tax to 20% from 17.5%—as punitive a tax on the poor as there is in Britain today.
The VAT increase was billed as part of the government’s austerity drive to put the fisc back in order. At £111 billion annually, VAT revenue is currently at an all-time high, up from £70 billion in 2009-10. In 2010 VAT payments comprised 16% of total government receipts. Today they make up nearly 22%.
British households in 2014 paid on average £3,933 a year in VAT under the 20% rate. Thanks to Mr. Cameron’s rate hike, plus economic growth and changes in the number of households, that amounts to a £1,300 increase over the average before Mr. Cameron took office.
Consumption taxes such as VATs are steeply regressive, since low-income households devote a much larger share of annual income to consumption than do higher-income families. In 2014 the bottom 10% of households spent on average £1,358 on VAT payments, or about 14% of their gross income, according to the pro-reform Taxpayers’ Alliance. By contrast, the top decile spent 5% of its gross income on the tax.
Mr. Cameron and his more austerity-minded advisers might argue that cutting the VAT rate is at odds with the budget balancing that the tax-credit reform is supposed to achieve. That betrays a failure of imagination when it comes to cutting the considerable excess spending that remains in the budget.
Suggestions? British taxpayers have a right to know what need there is for the Department for Business, Innovation and Skills. The same goes for the U.K.’s Department of Energy and Climate Change, or the £5.8 billion that Britain means to spend over the next five years on climate-change mitigation schemes in developing countries. Environmental vanity projects in foreign countries are never a good idea—all the more so when financed on the backs of Britain’s poor.
The political lesson from last week’s tax-credit skirmish is that excessive austerity for low-income workers is a political loser. VAT reform gives Mr. Cameron an opportunity to boost household spending power and economic growth. Good policy doesn’t always make for good politics, but a VAT cut is a chance to have both.