Treasury Committee holds future of VAT hearing

7 Oct 2020

The House of Commons Treasury Committee held a hearing on Wednesday 7 October into the future of VAT, as part of their Tax after Coronavirus inquiry. They also questioned the Office of Budget Responsibility as part of the same inquiry.

Inquiry - Tax after coronavirus
Oral evidence
At 2.30pm: 
Richard Hughes, Chairman at Office for Budget Responsibility
Andy King, Member at Budget Responsibility Committee at Office for Budget Responsibility
Charlie Bean, Member, Budget Responsibility Committee at Office for Budget Responsibility
At 3.30pm: 
Stuart Adam, Senior Research Economist at Institute for Fiscal Studies
Alan McLintock, Chair, Indirect Taxes Committee at Chartered Institute of Taxation
Charles Seaford, Senior Fellow at Demos

You can watch the hearing here.


Office for Budget Responsibility

First question is from committee chair Mel Stride. He notes that the Fiscal Sustainability Report projects that public debt may rise 90-113% of GDP next year due to the current criris. Looking to the full 50 year projection you get 320-520%. Can you identify the main drivers of those figures and identify how much fiscal policy would need to tighten over the decades in order to keep that debt stable?

Richard Hughes says that rising debt-GDP ratio is driven by rising primary deficit - difference between non-interest spending and revenues. Much of that (vast bulk) is driven by a rise in the age-related spending items - pensions, health care and social care costs and demographic pressures.

What kind of increase in tax might we have to look at? Andy King says it depends where you want to get the debt ratio to. To get ratio down to 75% of GDP (5th year of government forecast pre-coronavirus) you would be looking at a 3% of GDP tightening per decade. That is what would be needed to stop the deficit rising to avoid the 'explosive path' Stride outlined. £20 billion is roughly one per cent of GDP in current terms.

Stride asked about tax reliefs in the context of fiscal risk. King said reliefs are more opaque than public spending. Because they are opaque it is possible for the cost of them to rise without it being immediately obvious. We looked at some of the larger ones. R&D tax credits are a relatively large relief. They have been evaulated by HMRC and are judged to work in terms of incentivising R&D spending but the cost of them has been rising quickly. The amount of spending that is tax relieved is now higher than the amount of R&D spending which BEIS records, which is worrying, he said, though he noted that definitions are different. Entrepreneurs' Relief - evidence suggests it acts less as an incentive and more as a reward at the end of an entrepreneurial career.

Angela Eagle took up the questioning. She noted the Chancellor's conference statement that it is his 'sacred duty to balance the books'. She wondered how he would do this without breaking his tax triple lock. Charlie Bean suggested that was a question for the Chancellor. He added that clearly if you lock down the three big revenue raisers you have to do more with other taxes, or bear down on spending. At the current juncture there it is not great urgency in closing the deficit. We've sen two 'once in a lifetime' shocks in the last decade - the economic crisis and covid. 

Eagle asked about digitalisation and use of platforms where it is unclear where value is being created. What can be done in terms of tax policy to capture that value? King said this was beyond the OBR's remit to speculate on. 

How did you model the digital services tax, Eagle asked. King said it was one of the more complicated costings. Some large companies report their turnovers in the UK, others had to be explored in 'innovative ways'. The types of things taxed by DST were reasonably well-known. Incidence of the tax is not on the multinationals it is generally on those who generate the turnover.

Eagle then turned to different employment statuses and how OBR model the tax take. King said HMRC models this area quite well. They have lots of information, the incentives are well known. OBR's forecast includes modelling of how behaviour will continue, assuming that more people will incorporate over time, for example.

Rushanara Ali asked how the Winter Plan and a possible second wave might affect things. OBR are working on this area and will publish something in November. It looked like our upside scenario until the start of the autumn, said Bean, but covid case increases were worrying. "It is reasonable to think that at a minimum this is going to put the recovery on hold for a while", he added.

Ali asked about future risks, mentioning climate change and other viruses. What thinking is needed to prepare for those shocks and the cost implications, she asked. Hughes said the IMF had done some work about future shocks - they are very varied in their impacts. They found on average a typical recession (which happens about once a decade) added about 10% to a country's debt stock and a financial crisis (which happens about everyt 20 years) added about 20%. These are the kinds of concerns governmens need to take into account.

Siobhain McDonagh asked about spending pressures driving the OBR's forecasts. Central scenario is 9% of GDP rise of which around 5 is based on assumptions around non-demographic pressures in health system (innovation etc pushes up costs) and the other 4 is demographic on health and pensions. These are to varying degrees within the government's control. We've seen government link state pension age to longevity.

McDonagh also explored whether increasing spending in line with GDP would mean cuts in service levels. Hughes said this wasn't really for OBR to say. He noted you had seen two 'peace dividends' come in historically post-WW2 and post-cold war. These gave government more space to increase spending elsewhere.

Felicity Buchan asked about debt-GDP ratio. Hughes said he was wary of saying there was a danger level. Our debt stock is getting more sensitive to interest rate shocks.

VAT panel

At 3.30pm the committee thanked the OBR and moved on to the second half of the session, focused on VAT, with witnesses Stuart Adam of the Institute for Fiscal Studies, Alan McLintock of CIOT, and Charles Seaford of Demos.

VAT retail export scheme

The first area the committee asked about was the VAT retail export scheme (RES) and the airside extra-statutory concession. The Government has announced end of VAT RES, following a consultation. What do you think motivated HMT to announce this, he asked McLintock.

Three main reasons, said McLintock. The extra cost of granting access to the scheme to EU citizens after Brexit, the scalability of the scheme, and maybe a concern that it is a very expensive relief that may be targeted at a very small part of the business environment, primarily benefiting retailers in central London.

Are other countries offering similar schemes? Most EU states have some variety of this relief, said McLintock. It may depend on whether people come into the UK for VAT relief or for other more traditionally tourist reasons. It has to have an impact on what tourists spend but not sure how much behavioural change will be driven by this. Adam wondered how much this might be reflected in prices charged, especially in airports. On the scale of things, cross-border shopping is important for the traders concerned but it is not all that important for the overall system. It has to have some impact, said McLintock, especially in luxury shops, but at UK level time would tell.   

Stride asked if McLintock was concerned that the consultation had not floated abolition of VAT RES. Yes, he replied. If at that point HMRC had seen ceasing it as a likely outcome it should have been flagged clearly.

Is that rare, asked Stride. McLintock said it was a mixed bag. We have consultations where HMRC are up front, very receptive, and you have them where even if the outcome is flagged they are not really listening to you.

If you were to try to discriminate against EU citizens it would be discriminatory and come back and bite us, said McLintock.

Felicity Buchan said she was concerned this change would be negative for the economy. A survey had found a majority of high spending international visitors said they would not visit if they happened. McLintock said there would inevitably be an impact on the businesses affected.  I can understand visitors would spend less money. Do these luxury items have different prices across Europe? Buchan noted that Frane had reduced their threshold for GDP spend after we announced our decision. Is this a good time to be doing this, she asked. McLintock replied that when it comes to narrowing a relief there is never a good time. At this point in time the retal sector is struggling a lot. Yes it's a bad time for anything to happen to British business. Buchan said her concern was the Exchequer would not get the money envisaged. She also observed that industry had offered to digitalise the scheme. McLintock noted that digitalisation could cut fraud but would not cut the cost of the scheme. 

Economic impact of VAT changes

Julie Marson observed that in the past VAT has been used to close fiscal blackholes. Is this something sensible after covid and how does it compare to other ways of raising significant tax revenue? Adam said we should not be looking to raise taxes at all at the moment. This is one for 3-4 years down the road. Yes VAT has been used in the past, it's a reasonable option with pros and cons compared to other. I would be more inclined to look at broadening the base than raising the rate, It is less progressive than income tax though it is not (conrary to popular belief) regressive. It is less uncompetitive to raise VAT than some other taxes.

McLintock said the EU VAT average is 21 per cent so there is room to raise a little from 20% without being 'outside the pack'. VAT exemptions are very significant - food about £19 billion, construction about £15 billion. You could look at increasing the tax base but there are obviously lots of people impacted who would lobby hard against. Areas like financial services and health care - harder to apply a rate of VAT to it. He said when to apply any tax increase was a policy decision - applying it now would be a bit of a blow to the economy.

Seaford said raising VAT by 1p was the second most unpopular tax change in a recent Demos study. Still net positive but raising income tax for those earning over £20K got much higher positive rating. Far more appetite for raising more money from income tax than from VAT. On exemptions, very strong opposition to increasing VAT on essentials such as food, but strong support for levying VAT on private school fees, gambling stakes and private medical fees. On financial services people couldn't really understand what it would mean.


Anthony Browne asked what the panel think the government should do with new VAT powers. McLintock said he would implement recent OTS recommendations of simplifying VAT, though these are mostly not dependent on leaving the EU. I'm sure Treasury have got lots of wish lists from business that would like to see lower VAT rates. There may not be a lot of overlap though. Adam said he very much hoped government would not introduce lots more zero rates. Given free rein he would take on financial services which is restrained by EU law. This is technically more difficult. Once would have been seen as impossible, but now a possibility though difficult. Also some stuff on administrative and operational side of VAT.

Any argument for returning to purchase tax or is VAT preferable? Adam said if you were starting from scratch either would be reasonable. He would still lean towards VAT. Given we have VAT upheaval would be great. McLintock agreed. Over last 20-25% almost every country has implemented VAT - US more or less standing alone. 

Simplification, reliefs and exemptions

Browne asked about how you would implement simplification. McLintock said quality of HMRC guidance is an issue. Adam said VAT ought to be simple but in practice is not, largely because of zero rates and exemptions.

Browne said it would be a brave government that would take on food or children's clothes exemptions. McLintock said every exemption is potentially politically sensitive - books, vehicles supplied to disabled people, water and sewerage services. Adam agreed they are all politically difficult but he emphasised it matters how you do it. Using part of the money for compensation can help, say putting VAT on children's clothes but increasing child benefit. While I would recommend increasing VAT base I would not recommend doing it in isolation.

Implications of change

Alison Thewliss asked whether there are any particular problems the panel see if particular things happen. McLintock said there is uncertainty at present on how things will settle down legally, extent to which ECJ case law can be relied upon. In some cases has the EU Directive been a control on HMRC and restrained them? That is something we will need to see how it turns out. Adam said the obvious danger was opening up scope for every sector of the economy to lobby for special VAT treatment. Especially the case in a weak economy.

Thewliss asked about the certainty principle and how that relates to how we do budgets. Measures need to be put in place? McLintock said Italy increased VAT rate and gave three days warning. Warning gives people a chance to do things ahead of that but also gives businesses time they need to prepare. Increasing VAT rate should be simple for business but if you are doing something more fundamental can be expensive and suck up huge amounts of time.

Is there more HMRC could do to pretend VAT avoidance and evasion after Brexit? EU rules still apply if you're trading with EU, said McLintock. I wonder if HMRC could be more business-friendly post-Brexit, giving rulings, etc to de-risk commercial transactions.

Differential rates of VAT

Thewliss asked about the potential for setting different rates of VAT within the UK. McLintock said that would be a policy decision. People wouldn't travel within UK for a lower rate for hot food, but might for a lower VAT rate for cars. There is an issue of complexity - this will be more of an issue if it's different rules than if just a different rate.

Thewliss also asked about assignment of VAT. McLintock said it was a political question.

Adam said he did not have a view on whether to devolve more tax powers. On VAT specifically the issue is you don't really want tax competition within the UK. Less of an issue for VAT than with corporation tax, though more of an issue for VAT than for income tax. He agreed it would add complexity.

Seaford said they had polled Scots on whether they would want any tax increase to go to the Scottish Government or UK Government and most said the former.

Mel Stride ended the session at 4.30pm.

By George Crozier