Rising VAT is a prospect that has been met with resistance from the left. Richard Exell of the TUC argues on Left Foot Forward that increasing VAT to 20% would be regressive and should be opposed.

True, economic theory suggests sales taxes are more regressive than other forms of taxation, but I think such statement of theory is too simplistic when considering the likely impact of a VAT rise on lower income households.

We also need to consider:

1. The elasticity of demand for the goods subject to the sales tax – the tax is only regressive if demand for the goods to which sales taxes are imposed is inelastic.

   Not by chance, such issues have already been considered and codified in the taxation system, with ‘necessary’ goods, such as food and childrens clothing and heating, being subject to zero- or reduced-rate VAT.

   Click here for the HMRC list of reduced or VAT-exempt items.

2. The spending mix of those on lower incomes.

   It is likely that lower income households spend more of their income (as a percentage) on those necessary items which are subject to zero- or reduced-rate VAT. So an increase in the main rate of VAT is unlikely to affect this expenditure.

   On the margins, it may result in decreased demand/delayed demand for luxury goods, such as electrical appliances and cars; or in forms of substitution – either to lower quality goods of this sort, or to alternative goods (e.g. buying more children’s clothes instead of a new vacuum cleaner).

I think the most likely effect of increase in VAT is that higher income households would see a disproportionately higher increase in the amount they pay in indirect taxation compared to lower income households as most goods to which the standard VAT rate applies are ‘luxury goods’. (This could probably be demonstrated using sample data from the Expenditure survey undertaken by the ONS.) Note this is consistent with the justification for reducing the VAT rate to 15% as part of the fiscal stimulus measures last year – the rationale then was to increase demand for larger purchases, such as cars and electrical items, which are unlikely to represent a core part of the consumption basket of lower income households.

So I’m not sure the regressive nature of sales taxes in general is a solid argument against increasing the rate of VAT applied to ‘luxury’ goods.

The fact we have items to which we apply zero- and reduced-rate VAT invites a more pertinent question: have we got the right goods in these buckets? Are there some items in there to which we could actually apply a higher rate of VAT without making lower income households significantly worse off? And I think the answer to that question is yes – for example, it isn’t clear to me that gambling is a ‘necessary’ good, yet it is not subject to VAT.