Tax without the Benefits

Our recent report, Unfair and Unclear, looks at how the UK tax system affects different income groups. Although the report acknowledges the importance of benefits in determining certain groups’ incomes, it does not specifically look at the combined impact of taxes and benefits.

There are two reasons for this. The first is simple; we wanted to better understand public awareness of tax alone, given the myriad misleading statements that are often made about how much the richest and poorest pay in tax. In many cases, these conversations do not touch on where different groups get their income from.

The second reason can be demonstrated by looking at a specific tax. Value Added Tax is considered by most to be a regressive tax – one that hits the poorest hardest.  Many people have argued that the current system is both nonsensical and inefficient, and with good reason. It makes little sense for example that sweet-tasting dried fruit for snacking faces 20% VAT and sweet-tasting dried fruit for home baking faces 0% VAT. One suggestion that has been touted therefore is to remove zero rating on a variety of items so that the vast majority of items charge the standard (20%) rate of VAT.

But there are problems with this approach. Firstly it does not make VAT more progressive, and secondly there is no easy answer as to how to compensate those who continue to lose out.

The current UK benefit system does not at the moment include any payment that goes to all of those on low incomes and as a result there is no straightforward redistribution mechanism. If the money recouped via VAT was spent on increasing tax credits, those out of work who would be worst hit by the change would receive none of the compensation. If the money was spent on increasing out of work benefits, those in work would receive none of the benefits and the gain from work would decrease. If the VAT increase occurred in the context of Universal Credit, then the personal amount could be increased but families with children would be worse off.

All of these options would also increase the size of the social security bill as a proportion of government spending. It is possible that a few years after one type of benefit was increased to compensate for the increased cost of VAT, a future government would seek to reduce the size of the social security bill. When this happens, it is highly unlikely that the past rise in the VAT rate would be considered.

When unemployment benefits were frozen recently the Government did not obviously consider any of the previous considerations of why benefits were at their current rates, instead they were simply deemed too high. Similarly the benefit cap was introduced to stop benefit claimants receiving an arbitrary amount regardless of the reason for them receiving that amount. The government even went so far as to claim that those receiving the £25,000 were receiving it tax free. This is simply not true. Those receiving this amount are spending a large chunk of that income in VAT, council tax and a range of other taxes. The same is true of the claim that those paid under £10,000 have been taken out of tax.

This separation between decision making on tax and decision making on social security (or even other parts of tax) means that when looking at the design of the tax system there are advantages to looking at the tax system alone without benefits, as we have in Unfair and Unclear.  This shows that by itself the tax system is hugely damaging to those on low incomes, and this must be considered whenever benefits are debated.

Tim Stacey, Policy and Campaigns Officer.

Unfair and Unclear is part of the Fairer Tax strand of The Equality Trust’s Fairer Stronger Economy project anticipating the 2015 general election. More information on this project and further policy recommendations are available on our website.