VAT hike in the Budget would be money spinner for Treasury - but hit households hard

The black hole in the public finances has led to fevered speculation about what taxes may have to be hiked in the autumn Budget.

Among the latest muted is VAT, although doing so would open Labour up for yet more criticism given the party’s election manifesto pledge. It said at the time: “Labour will not increase taxes on working people, which is why we will not increase National Insurance, the basic, higher, or additional rates of Income Tax, or VAT.” But Chancellor Rachel Reeveshas argued that much has changed since then, fuelling rumours of a U-turn.

Top minister Darren Jones, the Prime Minister’s Chief Secretary, also failed to say whether Labour would still stick by its manifesto vow, only adding: “I am not ruling anything out or anything in.” Other reports suggest, however, thatVATwill not rise. But just what is VAT, how much does it bring in and what are options open to the Chancellor?

• Aldi launches new Lacura Beauty Advent Calendar for £20 - look what's inside
• Hair loss sufferer found 'lumps of hair in shower' until she took £1-a-day gummies

What is VAT?

VAT - or Value Added Tax - is added to most products and services sold by VAT-registered businesses. And it’s a huge money spinner for the Treasury, and one its biggest sources of revenues. The Office for Budget Responsibility forecasts VAT will raise £180.4billion this financial year, or 14.7% of all taxes, equivalent to £6,300 per household and 6% of national income. HMRC figures suggest increasing the 20% to 21% would raise around £8.8billion next year, while increasing the reduced 5% rate would raise around £490million.

What is VAT charged on?

About half of all the goods and services have VAT added to the cost of them.

The standard rate of VAT is 20%, but there is a reduced rate of 5% which applies to things such as household energy bills children’s car seats and some other goods. The UK is free to set its own VAT rate post-Brexit, although it had flexibility when it was member of the EU to put it anywhere from 15% to 25%.

Of the other 50% or so that is zero-rated for VAT, a big chunk is food - excluding most types of eat-in and hot food - although it also applies to books, newspapers, and children’s clothing.

What are the Chancellor’s options?

An across the board increase risks criticism that Labour is impacting working people, if prices go up as a result.

But the Chancellor could look to raise VAT on just certain goods and services, although none are an easy choice.

Private healthcare is currently VAT exempt (as opposed to zero rated) and it’s thought may be in the Treasury’s sights given it did the same on private school fees. Reports say putting VAT on private healthcare could raise £2billion, but would hit up to eight million middle-class families. But that now looks unlikely given Health Secretary Wes Streeting, speaking ahead of a speech at the Labour party conference, ruled out introducing the tax on private healthcare at the forthcoming Budget.

Bringing forward the date on which VAT on chargeable on solar panels is another possibility, though experts say it wouldn’t raise a great deal of money and could be an own goal given the government’s net zero drive.

Philip Munn, a VAT partner at audit, tax and consulting firm RSM, suggested another option could be to slap VAT on certain foods seen as unhealthy, such as cakes, that are currently zero-rated. That would bring them into line with chocolate and other confectionary. Mr Munn warned it would not bring in vast sums, but could still be “hundreds of millions”. He also suggested HMRC could crackdown on VAT evasion on goods imported to the UK.

There have also been reports that the Treasury is looking at cutting the threshold at which small businesses have to register for VAT. It currently kicks in at £90,000 but reducing it to, say, £30,000 or £40,000, would mean a large number of small businesses having to start adding VAT to the cost of what they sell, potentially making them more expensive and adding to their admin workload. On the flipside, being VAT registration means they could recover VAT on costs their incur, such as rent.

How likely is a VAT hike?

“There is a possibility,” is RSM’s Mr Munn’s assessment. “If we were in better times, the government would not want to.” For the poorest fifth of households, VAT is the biggest single tax that is paid, so any increase risks coming back to bite Labour. With VAT on private healthcare potentially off-the-cards, and the hit to small businesses from lowering the VAT threshold, it seems any changes may not bring in the big sums the Treasury needs.