In the 50 years since its approval, VAT has done much for the UK. As the second biggest source of tax revenues, it is not an exaggeration to say that there are hospitals, schools and roads today that would not exist were it not for VAT. Yet it is also true that the UK VAT system is now old and outdated. In particular, there are two key problems: a lack of digitalisation and the narrow base on which VAT is taxed. To bring the UK in line with international standards, we must progress on both fronts. 

Digitalisation of VAT

Developments over the past decade in the use of technology, such as real-time technology, in tax administration and compliance have been nothing short of outstanding. They have shortcomings, but are nevertheless extremely effective in combating non-compliance, as well as decreasing compliance and administrative costs. Such programmes can be particularly helpful in boosting compliance in problem segments, such as small businesses, where infringements, whether through error, negligence or evasion, are high.

Yet, the UK tax system has only seen limited digital transformation so far and has a long way to go to catch up with international best practices. We are now waking up to the imperative to change, but other countries are years ahead. 

VAT base reform

The elephant in the room when it comes to UK VAT is undoubtedly its base. At present, we only tax approximately half of all UK consumption. This is very low by international standards. Some countries have lower levels of consumption taxation, but they tend to be in developing markets with high levels of fraud or evasion. This is not the case for the UK. While there is some non-compliance, the bulk of non-taxation is a – misguided – policy choice. 

The deficiencies of narrow VAT bases are well known. The benefits are at best dubious: there is limited evidence that tax savings are passed on to customers, and instead they are often absorbed in higher profits; even where tax savings are passed on to customers, they overwhelmingly tend to benefit the richest households. The costs, on the other hand, are extremely high, and not only in terms of revenue loss: who has not heard of the (in)famous Jaffa Cakes case? This is not the best way to protect those on low incomes.

There has long been awareness of the need for reform, yet any small change proposed to the VAT base is met with fierce resistance. 

A public education campaign is therefore urgently needed. We cannot expect everyone to become VAT experts, but we need to demonstrate how previous campaigns, such as abolishing the tampon tax, have not turned out as expected and how there is a better way to protect the things we care about . 

Tinkering at the margins is not enough

A large-scale reform of the VAT base would be the most effective approach. In VAT, singling out specific sectors for gradual reform tends to backfire: too much time and political capital is lost trying to implement small changes, leaving little time or appetite for others. A large-scale VAT reform of the base is, of course, politically difficult – but it can be done. The 2023 reform of the Brazilian taxation system, which merged five taxes into one VAT, shows that radical change is possible, even in larger countries, with a federal structure. 

Addressing the lack of digitalisation and the narrow VAT base individually would yield significant improvements. Addressing the two together would yield significantly more. Alas, while digitalisation of tax administration is already under way, base broadening is not. Winning that battle will require the help of us all. The general public may be unaware of the impact that a reform of the VAT base could have on the country, on the standard of public services, and ultimately on their lives – tax experts, however, are not.