50 Years of VAT – a Review

It’s 50 years since the introduction of Value Added Tax (VAT) in the UK, and the House of Lords Library published an article reviewing what has changed in that time.

Once upon a time, before World War II, Britain mainly depended on direct taxes—that’s the money taken from your income or profits. But as wars are costly affairs, the government started to look at other ways to make money. That’s when the idea of taxing things you buy, called indirect taxes, started to get more attention.

The Great Shift

The Conservatives always liked the idea of taxing consumption rather than income. The belief was that if you tax people less on their earnings, they’ll be more encouraged to work hard and set up businesses. Labour, on the other hand, was a bit skeptical because they thought this kind of tax would hit poorer folks harder. But by the 1940s, Labour started warming up to the idea. They figured that the gap between the rich and poor had narrowed enough to make it fair.

Baby Steps into VAT

During and after the war, we saw more taxes on what we buy. Taxes on alcohol, tobacco, and even a new “purchase tax” on non-essential goods came into play. Then in 1966, the Labour government tried another experiment by adding a selective employment tax (SET) on services, like getting your hair done. But that didn’t stick around for long.

VAT’s Grand Entrance

When Edward Heath’s Conservative government came into power in 1970, they had their eyes set on joining the European Economic Community (that’s the precursor to the EU). One of the conditions for joining was having a VAT system. So, in 1973, VAT officially made its debut, replacing the old purchase tax and SET.

The Evolution: How VAT Has Changed Over the Years

VAT’s Rollercoaster Rates

When it first started, VAT was a flat 10% on most things except essentials like food and housing. But that rate has been like a yo-yo over the years. It’s been as low as 8% and as high as 20%. Governments tweaked the rate to suit their needs—whether that was to encourage spending or to rake in more cash for the treasury.

The Special Cases: Luxury and Essential Items

While most items had a standard VAT rate, some were exceptions. Petrol, for instance, had a whopping 25% rate in 1974 because the government wanted to encourage energy conservation. That later became a ‘luxury’ rate for things like fancy boats and jewellery. However, that was scrapped because it was hurting businesses.

The Impact on Household Budgets

VAT has a big role in government earnings. In the early days, it was just a tiny slice of the revenue pie, 6%. But as of 2022, VAT accounts for a whole fifth of what the government collects. That’s a big leap, and it shows you how much this tax affects us all.

The Ongoing Debate: Is VAT Fair?

The Good, the Bad, and the Complicated

VAT is seen as a successful way for the government to make money without mucking up the economy too much. But it’s not all rainbows and butterflies. The system can be confusing, with different rules for different things, which ends up in loads of legal wrangles. Plus, as VAT stands, people with lower incomes tend to feel the pinch more.

The Inequality Question

Critics say VAT is a bit unfair. That’s because poorer households end up spending a higher percentage of their income on VAT than richer families. In absolute terms, richer families do pay more in VAT, but it’s a smaller chunk of their income.

Can VAT Be Fixed?

Paul Johnson, from the Institute for Fiscal Studies, suggests that VAT doesn’t have to be the villain. He thinks if we applied the standard rate to everything, it could bring in even more money—up to £50 billion more. That could be used to help lower-income folks through other means, like changes to benefits or other taxes. But changing VAT hasn’t been easy, mainly because people don’t like tax changes, and politicians don’t like angry voters.

Conclusion: Where Do We Go From Here?

VAT might not be perfect, but it’s a cornerstone of how our government funds everything from hospitals to schools. As consumers, it’s part of our daily life—whether we notice it or not. The debate around VAT is far from over, but understanding its past and its impact helps us all be better prepared for whatever comes next.