Is VAT a Progressive Tax or a Regressive One?

29 May 2018, 12:22

You’ve probably never thought of VAT in terms of being progressive or regressive before. You know it is a portion of the price of some goods and services, but even then, you only look at the bottom line – the amount you are supposed to pay. You’ve likely never considered how this tax affects your own life, since it is the seller who must sort out VAT payments to the government, if they are registered to pay VAT in the first place.

So, which category does VAT fall into? Is it progressive or regressive? There is no firm answer to this. It depends which argument you agree with. VAT is a tax that is applied to consumption. This means the more you spend, the more you are likely to pay in VAT. Of course, different products and services incur different rates of VAT, although the basic rate is 20%. In theory, you could pay less in VAT for spending more on goods and services than your neighbour, if you bought products that are zero-rated or attract a lower rate.

A progressive tax is easier to understand, so let’s look at that first. Let’s assume you spend, say, £1,000 a year on VAT-rated products and services, and your neighbour spends £2,000 a year. That means they would pay more than you in VAT, because they are consuming more – hence the idea that this is a tax on consumption. This might then be called a progressive tax, because the more you spend, the more VAT you will pay.

So, if that is easy to understand, why is it some people think VAT is a regressive tax? Let’s first look at what this means. A tax is said to be regressive if you pay less of it the more you spend. We’ve seen that isn’t the case with VAT, so how can this apply? The idea is that it depends on your wealth and income. Let’s say both you and your neighbour spend £1,000 a year on goods and services that include VAT as part of the price. Let’s also say you earn £10,000 a year, and your neighbour earns twice that amount. This means the VAT you must meet on your purchases takes up a greater portion of your income compared to your neighbour’s, even though you both spend the same. The relative burden is more for you than for your neighbour. Hence why some people believe VAT is a regressive tax.

You may hold a different opinion on this, but it is easy to see how each example is correct in its own thinking. Do you think VAT is progressive or regressive? It certainly seems to put more pressure on the poor when you look at it from this angle.