VAT prize-winners Sze Teen Wong, Cheryl Ong and Anna Poh point to international experiences to explain how the UK’s VAT system could be made simpler and more progressive.
How can the UK’s VAT system be reformed to make it fit for the challenges of the 2030s? That was the question posed by ICAEW when it launched its £5,000 VAT prize as part of its How to fix VAT campaign. Entrants were asked to submit research proposals that could be written up as a research paper and presented at a prestigious ICAEW conference.
The winning entry – Reforming the UK VAT System: A Comparative Analysis and Reform Design – was submitted by Sze Teen Wong, Cheryl Ong and Anna Poh, and is summarised below, with added insight from the paper’s authors. The three prize-winners all work for the Inland Revenue Authority of Singapore and wrote the paper in their personal capacity.
Problems with the UK’s VAT system
In principle, the VAT system is simple to administer. However, in the UK, many goods and services are zero-rated, subject to a reduced rate or exempt. Within these categories, further distinctions arise to determine what exactly qualifies for which rate.
This has led to the system becoming complex and costly for businesses to comply with and for the government to administer. Difficulties in determining the correct treatment for different products inevitably lead to a high level of litigation. Reduced rates and exemptions also create distortions to competition, since competing products may be treated differently for VAT purposes.
Narrowing the VAT base in this way has also reduced the government’s revenues. One way to measure this is the VAT revenue ratio (VRR), which represents the actual VAT collection in a country as a proportion of the revenue that would be raised if the standard VAT rate was applied to all consumption. The VRR in the UK for 2020 was 0.44, which falls below the OECD average of 0.56.
So why do we have multiple rates of VAT? Social and distributional goals, intended to make VAT less regressive, are often used to justify the application of reduced rates or exemptions for certain essential or merit goods. However, a growing body of studies casts doubt on the role of base-narrowing measures in achieving these goals. Further, there is growing evidence that consumers do not benefit fully from reduced rates, and that the retailers may be the primary beneficiaries.
It is also the case that some goods and services, such as financial services, are exempt from VAT because they are thought of as being too difficult to tax. However, other countries have shown that these difficulties can be overcome.
It soon became clear from our work that the impacts of a multiple-rate VAT structure call for urgent reform of the UK’s VAT system
A more progressive VAT
Singapore’s single-rate VAT system (where VAT is called GST) applies a flat 9% to most goods and services. In line with the destination principle, zero-rating applies to the export of goods and services. Exemption applies to only four categories of supplies: certain financial services, residential properties, digital payment tokens and investment precious metals. Instead of applying exclusions to the tax base, the VAT charged by public healthcare and education providers is absorbed by the Singapore government.
In 2012, a permanent GST voucher scheme (GSTV) was created, which directly links some of the country’s social transfers to the tax. The GSTV has four components:
- GSTV – Cash. Cash is paid to lower-income Singaporeans each year;
- GSTV – MediSave. Singaporeans aged 65 and above receive an annual top-up to their national medical savings account;
- GSTV – U-Save. Rebates are applied to the utility bills of lower- and middle-income households living in public housing each quarter; and
- GSTV – S&CC rebate. An offset against the maintenance fees of eligible Singaporean households living in public housing each quarter.
Eligibility for each component and the value of benefits distributed depends on factors such as annual income, property value and the size of the public housing unit. From 2018 to 2020, the permanent GSTV scheme offset an average of 84% of the annual VAT payable by the bottom 20% of Singaporean households on a per household member basis.
New Zealand, which pioneered the modern VAT system by addressing the regressivity of the tax through social transfers rather than exclusions, continues to operate a broad-based VAT regime with minimal exceptions to the single standard rate.
There is compelling evidence that a broader single-rate modern VAT regime may better serve the UK
Taxing financial services
In most countries, including the UK, financial services are exempt from VAT due to the difficulties in calculating the value-add of the supply, resulting in the problems outlined above. In addition, financial institutions must perform input tax attribution and compute VAT recovery, and often incur substantial costs to comply.
Other than the complexities in valuation, financial services are not fundamentally different from any other taxable services and should likewise be subject to VAT. Three possible ‘quick wins’ that could mitigate the distortions from exempting financial services, referencing the Singapore and New Zealand VAT systems, are to:
- tax ‘easy-to-value’ financial services – specifically, fee-based services;
- apply zero-rating to financial services supplied to VAT-registered business customers; or
- introduce a prescribed fixed recovery rate in lieu of the requirement to perform input tax attribution and compute VAT recovery by leveraging on industrial income statistics.
Reform design and public support
New Zealand and Singapore have shown that it is possible to achieve social and distributional goals through a broad-based, single-rate VAT system, coupled with targeted social transfers. Could a similar policy be transplanted to the UK, and if so, how?
Any reform to broaden the VAT base should be bundled with measures to improve both progressivity and efficiency of the overall tax system, and to compensate the losers from the VAT rate unification, using the additional revenue raised to fund the measures. To improve progressivity, the measures could take the form of cuts to the standard rate of VAT or to income tax rates for lower income bands, or targeted social transfers. Real-time technology could be utilised to refund VAT to eligible individuals at the point of purchase.
Significant reform of UK VAT will require broad support. Transitional measures may be needed to mitigate the impact of the changes on suppliers and customers
To obtain buy-in from the public, the government could consider a bottom-up approach, encouraging public input before deciding on the policy parameters. The SHEDD model, which is an extension of the Coordinated Management of Meaning (CMM) theory, can serve as a guide in designing the public discourse. It consists of five phases:
- starting;
- hearing all the voices;
- enriching the conversation;
- deliberating the options; and
- deciding how to move forward together.
Next steps
Announcing the result of the VAT prize, Ed Saltmarsh, ICAEW Technical Manager, VAT and Customs, said: “The winning entry’s innovative and practical ideas greatly impressed our research advisory board, and we believe their work will significantly contribute to the ongoing discussions on reforming the UK’s VAT system.”
With ICAEW’s funding secured, the authors are researching how the VAT base can be broadened through streamlining the VAT rates and exemptions, while addressing the inherent regressivity through measures outside the VAT system. This includes conducting a literature review of recent studies, undertaking a comparative analysis of modern VAT regimes in Singapore and New Zealand and exploring ideas to help formulate a strategy to solicit public support for VAT reform.
They will present their findings at the VAT conference to be held at Chartered Accountants’ Hall in London on 18 June 2025.
