How to counter tax avoidance – raise VAT

With all the talk about how we need to raise taxes to deal with the deficit, combined with the general upset about tax avoidance and evasion, it seems odd that we hear so little about changes to the VAT system. We know that the main tax evasion takes place at the bottom and at the top of the financial tree.

Consider the bottom. A few months ago, Alice Miles, writing in the New Statesman, pointed to a study by an anthropologist working in a deprived area. He found that while the average official family income was around £4,000, thanks to unreported, cash-in-hand work, prostitution, bartering, trade in stolen goods and the smuggling of spirits, tobacco and drugs, it was actually more like £17,000. One in four people were “informally self employed.” 

Up at the top, there tends to be more avoidance than evasion – clever accountants can manage all sorts of things. But the net effect is the same. Across the economy, there is a huge amount of income getting away from the taxman scot free. You might think that is ok at the bottom end but not at the top. Or vice versa. I think it needs dealing with at both ends.

And VAT seems to be a good way of doing it. Think tank Reform looked at this last year and concluded that starting to charge VAT on food, children’s clothes and to raise it from its current low levels on household utility bills would be better than raising any other tax. That’s partly because they see VAT as less damaging to the economy as a whole than taxes on employment production and income. But also partly because this would make VAT less complicated and bring it into line with the VAT systems in most of the rest of Europe.

Finally, VAT is impossible to avoid (unless you live only on stolen goods). So the more it takes the place of income taxes the less overall avoidance/evasion there can be. The downside to broadening the VAT base of course is that it would hit lower income households proportionally more severely than higher income households. So you might need to fiddle with the income tax thresholds at the same time.

However, it might also be an idea to soften the blow by creating some kind of progressive VAT system. You could have a very low rate on food and essentials (with a higher rate on rubbish food such as ready meals and cake) and then bump the rate up as things turn from being needs into being wants and then into proper luxury goods.

This is how the tax operated in the 1970s (when it was first introduced). Then we paid 8% on standard goods and 12.5% on anything perceived as a luxury good. In 1975, Denis Healey imposed a 25% rate on real luxury goods (and electrical appliances). Doing something such as that again might not be particularly popular but doing it in tandem with a new low rate on food would at least address the problem that is vexing so many at the moment – that of tax avoidance and evasion. If it didn’t come with reductions in other taxes (which it should but probably wouldn’t) it might also raise some much-needed cash for the government.