UK Labour budget VAT measures

What went ahead:

• imposing  VAT on private taxi and ride sharing platforms;
• increase betting and gambling taxes – which are exempt from VAT.
• VAT relief on goods donations by businesses to charities
• withdrawal of £135 customs exemption de minimis on small parcels

But pre-Budget speculation on other measures proved groundless:

• UK VAT registration threshold cut;
• a cut in domestic fuel VAT from 5% to 0% to help with inflation – but press reports this now abandoned;
• extending the deemed supplier VAT to all UK e-commerce; or
• and unlikely one – withdrawing the healthcare VAT exemption.

One unadopted VAT funding example is withdrawing the VAT exemption on private health care which could raise £2 billion per annum – based on existing £10 billion annual spend today. But the simple headline hides many problems. There would be the right to deduct introduced for private medical providers reducing the receipts. Plus, some of the largest customers are employers who can deduct the sales VAT – so no extra net receipts for the government.

Post-Brexit, the UK is now also free to impose VAT on banking and insurance services – exempt under EU rules.  See below for how this has worked in China and Australia.

In 2024, on returning to government, the Chancellor withdrew the VAT exemption on private school fees.

Revenue raising objectives aside, the varying rates add to the complexity of administration of the tax for businesses and HMRC.  Think about the already overburdened courts arguing about Jaffa Cakes!!  And the well-intentioned cuts to food and basics to help the less well off are highly inefficient since they also give the same tax breaks to the rich.

Over £100 billion lost per annum in reduced VAT and exemptions

Per the IFS, VAT zero rates and exemptions cost £100 billion in forgone revenue. They place a large compliance burden on firms and are a very poorly targeted way to redistribute income to lower-income households.

An expansion could be done via increases, or reallocating reduced-rate goods and services to the standard, 20% VAT rate. But a rise on the standard rate is still off the cards, with Rachel Reeves confirming just a month ago that she will stick to the 2024 election manifesto of no increase.

An alternative to tweaking rates would be to cut the VAT registration threshold of £90,000 which appears to demotivate small companies from expanding.

VAT exempt, zero or reduced-rated supplies open to rises

The key exempt or lower-rated VAT supplies include:

• Exempt: private health care; financial services; betting (separate tax); museum and cultural entrance fees; charities; post
• 0%: food; children’s clothing; books; newspapers; energy saving materials; some construction
• 5%: domestic fuel and power; children’s car seats

The UK is a relatively average incidence of reduced or nil-rating.  Its effective VAT rate – allowing for reduced VAT on the average spend – is just 9.3%. This compares to neighbours: France 9.4%; Germany 9.3%; and Spain 8.3%.

Post-Brexit freedom to levy VAT on banking, insurance and other financial services

Following the UK’s exit from the EU VAT regime, it is now free to withdraw the VAT exemption on financial services.  The EU VAT on financial services review is progressing; but the UK can now push ahead. UK VAT on financial services has been a prospect since 2023.

The likely outcome is VAT being imposed on fee-based services only, with a continuing exemption for credit & loan services. In addition to tackling long-standing problems over what to impose VAT on and outsourcing exemptions, the EC wants to emerging services into the review:

• Crypto currencies;
• Fintech services;
• Payment services; and
• E-money

China has already successfully imposed VAT on financial services. This includes 6% on loan interest, leasing and advisory. But inter-bank, securities trading and forex trading is still exempt.

Lowering the VAT registration threshold changes

Other options, include a reorganisation of the VAT registration threshold

• Effect: More small businesses would have to register, charge VAT, submit returns, and pay VAT to HMRC.

  • More sales would be subject to VAT.

  • Some businesses that previously stayed under the threshold deliberately (“bunching”) would no longer avoid VAT.

    Potential revenue impact: Could increase revenues, because:

• Trade-off: Could impose more admin costs on small businesses, and possibly raise prices for consumers. Might also reduce business activity if some choose to close or scale back to avoid VAT.

• Example: Dropping threshold from £90,000 (current as of 2025) to £60,000.

Freezing the threshold in cash terms

• Effect: If inflation and turnover grow, more businesses drift over the threshold over time without an explicit policy announcement.

• Potential revenue impact: Gradual increase in VAT receipts over time.

• Trade-off: More stealthy, but still increases compliance burdens.

Introducing a tiered or reduced-rate registration band

• Effect: Businesses below a certain turnover might register at a lower VAT rate (e.g., 5% instead of 20%).

• Potential revenue impact: Brings more businesses into VAT net without full 20% impact.

• Trade-off: Adds complexity, may distort incentives, and could create multiple “cliff edges.”

Reforming VAT accounting schemes for small businesses

• Effect: Could adjust the Flat Rate Scheme or Cash Accounting Scheme so smaller businesses pay a simpler VAT amount but are still registered.

• Potential revenue impact: Slightly broader base while reducing admin burden.

• Trade-off: May generate less than full VAT but still increases compliance coverage.

Changing the scope of what counts toward the threshold

• Effect: Could include certain exempt or zero-rated activities in turnover calculation.

• Potential revenue impact: Brings more businesses over threshold.

• Trade-off: Could hit sectors like education, finance, or health.

Key political and economic considerations:

• Lowering the threshold risks being seen as anti-small-business.

• The UK already has one of the highest VAT thresholds in the OECD — many countries require registration from much lower turnovers.

• The Office for Budget Responsibility (OBR) would forecast behavioural changes — sometimes, lowering the threshold doesn’t raise as much as expected because of reduced activity or avoidance strategies.

 

UK tax revenues (source: UK Parliament)

Low growth and high interest rates make grim fiscal picture

Labour has committed to get national debt down by the end of the next Parliament, aping the incumbent Conservatives’ targets.  But insipid growth and punishing interest payments make this a hard target. It will be stretch to stabilise still rising debt in five years, let alone start to reduce it. Pressures of rising welfare costs and a new found vigour for defence spending will make it near impossible.

This means major spending cuts and / or tax rises. The expectations after an election win on it to raise spending on depleted public services will be huge. But Labour boxing itself in on no payroll-related taxes to fund current or higher spending may not seem wise soon.

VAT increase – 2010 debt crisis all over again?

The UK VAT rate of 20% was last increased in January 2011 (announced 20210) from 17.5%. This was imposed by a new Conservative government blaming the previous administration for leaving the country finances in a dismal state following the 2007/08 financial crisis.

UK still lags EU average 22%

Finland has recently announced a rise from 25% to 26.5% from September 2024. This would make it second highest rate to only Hungary’s 27%.