VAT rate change could cost you thousands

A flat rate of VAT on all goods has been proposed, but it could hit us all hard.

TMF Group, an accounting, legal and HR services provider, has uncovered a paper from the European Commission that recommends the abolition of VAT-free or reduced VAT goods across the EC, in favour of using the standard VAT rate on all goods and services.

Some reports have suggested the changes could cost families more than £800 a year. This was calculated using Office for National Statistics data, by adding up the cost of increasing VAT on food, tap water, trains, buses, books and newspapers at today's standard rate.

However, there are many, many more goods that have either the lower 5% rate of VAT or which charge no VAT at all. From smoking cessation aids to postage stamps to insurance to air travel, there would be a massive surge in VAT costs. Take a look at this:

Goods and services on which we usually don't pay VAT

• Most foods that aren't alcohol or snacks, including food for animals or plants that are usually produced for human consumption
• Books, magazines and newspapers
• Physical education and sports activities
• Betting, gaming, bingo and lotteries
• Admission charges to museums, zoos and art exhibitions
• Antiques and works of art
• Many charity costs and charity donations
• Many expenses for disabled or blind people
• Burial or cremation of people, or burial at sea
• Medical treatment and dispensing of prescriptions
• Education services
• Residential water and sewerage services
• Construction and sale of new domestic buildings
• Residential parking
• Transport in a vehicle, boat or aircraft carrying ten or more passengers
• Children's clothes
• Insurance

Goods and services for which we pay VAT at just 5%

• Energy saving materials permanently installed in your home, home heating systems, and renewable technology
• Mobility aids for the elderly
• Smoking cessation products
• Some sanitary and maternity products
• Gas, electricity and heating oil
• Altering and renovating an empty residential building

VAT rate would have to fall

It's obvious that far too many millions of households couldn't afford the extra VAT on all those items, which means that the Government would have to reduce the standard rate – after just putting it up to 20% from 17.5% in January 2011.

Who'd be hit worst?

But it's not as simple as lowering the tax rate and then all's fine again. Changing the sales tax system so dramatically would have huge knock-on effects. Consider that, currently, the construction and sale of new domestic buildings are usually exempt of VAT. Higher VAT could affect both house prices and the number of new homes being built.

Furthermore, low-income households spend a higher proportion of their earnings and benefits on food, heating and water services, so a sudden jump in VAT on those items will hit the poorest the hardest.

The changes might affect the UK particularly badly. We have a large international insurance industry which usually charges no VAT and we have a very successful budget airline in easyjet. VAT-exempt passenger travel in some countries is singled out as a problem by the report, as it creates a “distortion”.

Reading the EC paper, which is entitled “Towards a simpler, more robust and efficient VAT system tailored to the single market”, the authors clearly still believe that this is a worthwhile shift. International businesses will have lower costs, and more businesses would become international as EU trade becomes more simple. This could mean lower prices for customers – before tax, at least.

The paper also states that the change will boost real growth (which is a proxy for our living standards) by 0.2% and 0.4% but adds “the report admits these figures might be overstated”. It also admits that its belief that simplifying VAT in this way will have an overall positive effect is based on “the general feeling” of those it consulted.

I would hope there will be a great deal more research before the changes are implemented. As with any experiment, I also hope the changes are phased in slowly and carefully to test their effects, before going back again becomes too costly and irreversible. Thankfully, the paper indicates that member states would be “only prepared to consider gradual changes”.

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