31 October 2011updated 22 Oct 2020 3:55pm

Why VAT really does hit the poorest hardest

The data that proves Osborne was wrong to describe VAT as a "progressive" tax.

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

George Osborne, Today programme, 4 January 2011

When George Osborne rose VAT to 20 per cent in his emergency Budget, I, like others, warned not only that the tax rise would prove economically defective – it is expected to reduce annual growth by 0.3 per cent – but also that it would hit the poorest hardest. As a regressive tax that takes no account of income, VAT inevitably squeezes low earners.

But despite all evidence to the contrary, Osborne insisted that VAT was a “progressive” tax. On 4 January 2011, the day that VAT rose to a record high of 20 per cent, he told the Today programme:

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

The data, however, tells a different story. The number crunchers at the Office for National Statistics have published a new report showing that the poorest fifth of UK households pay significantly more in VAT as a percentage of their disposable income than the richest fifth. As the graph below shows, the poorest fifth spend nearly 10 per cent of their disposable income in VAT compared with 5 per cent for the richest households.

Average household VAT as a proportion of household disposable income

The effect of the 2.5 per cent rise in VAT was not included in the analysis but the data (from 2009-10) is recent enough to disprove Osborne’s assertion that the tax is “progressive”.

The Institute for Fiscal Studies has suggested that VAT is “progressive” since the poorest spend a higher proportion of their disposable income on VAT-exempt goods such as food, children’s clothes and domestic fuel and power. But this analysis fails to take account of changing spending patterns. As the ONS report notes, the poorest fifth now spend 250 per cent more on “new cars, holidays abroad, meals out, audio/visual goods (including TVs) and photographic equipment” than they did in 1986. As a result, VAT has become more, not less, regressive in the last 25 years.

It’s possible that VAT will become less regressive as the poorest, facing the biggest squeeze on living standards since the 1920s, reduce spending on non-essentials such as holidays and electronic goods. Indeed, since the height of the consumer boom in 2001-02 (when the poorest fifth were spending 13 per cent of their income in VAT), VAT has become slightly more progressive. But for now, it continues to hit the poorest hardest.

As one Conservative politician commented in April 2009 when asked what taxes he would raise:

You could try, as you say, to put it on VAT, sales tax, but again if you look at the effect of sales tax, it’s very regressive, it hits the poorest the hardest. It does, I absolutely promise you. Any sales tax, anything that goes on purchases that you make in shops tends to . . . if you look at it, where VAT goes now it doesn’t go on food obviously but it goes very, very widely and VAT is a more regressive tax than income tax or council tax.

His name? David Cameron.