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The Government should abolish zero and reduced rates of VAT, the Mirrlees Review has recommended.
A new report from the body suggests that such a move would cut compliance and administration costs for business and government, interfere less with people's spending decisions and raise enough revenue both to improve the living standards of poorer families and cut other taxes by up to £11 billion.
The document's authors believe that applying zero or reduced rates of VAT to items on which poorer households spend a relatively large proportion of their budgets — such as basic foodstuffs and children's clothes — is a blunt instrument with which to help the less well-off.
The report claims that scrapping the existing zero and reduced rates of VAT would raise around £23 billion, adding that if £12 billion of this extra revenue were spent increasing means-tested benefit and tax credit rates by 15%, the poorest three-tenths of the population would be better-off on average, and £11 billion would still be available to cut other taxes or to spend in other ways.
Such a move, argues the study, would have only a modest and temporary effect on inflation, increasing the non-housing retail prices index by around 0.35%.
The authors go on to argue that the Government could impose a lower rate of VAT on work-related items, such as commuting costs, and a higher rate on leisure-related ones, so as to offset the overall disincentive to work created by taxation.
But the Mirrlees Review cannot be confident that the potential efficiency gains from differentiating VAT rates in this way would outweigh the costs of greater complexity and the advantage of a single rate in making it easier to resist political pressure to provide favourable treatment to particular sectors or items.
The study goes on to suggest that the Government urges its fellow EU member states to remove a range of outdated exemptions under the common European VAT rules, notably in respect of financial services.
