Progressive VAT – will Rachel Reeves bring it in?

Today’s Blog concerns a proposal to introduce a progressive VAT regime via real-time adjustments to rates based on an individual’s economic position, as is currently been introduced in Uraguay.

Background
Uruguay is in the process of becoming one of the first countries (Uzbekistan was the first in 2024) to roll out live VAT rate adjustments for its population based on wealth and household expenditure. The aim is to tackle one of the principle criticism of VAT – that it is a regressive tax, charging the same amount of tax on all individuals, irrespective of income.

In a recent radio interview, Gabriel Oddone Uraguay’s new Finance Minister said that plans are in place to introduce live flexible rates based on relative wealth and said “we have enough information to establish differential rates for people instead of products.”

Technical practicalities aside, the new Uruguayan VAT regime presents a huge social policy opportunity, and also potentially changes the fundamental structure of VAT. If introduced in the UK, it would be a seismic change and have the potential to cure the problem of VAT being a regressive tax.

Digital wallets
Uraguay’s proposal builds on their government issued digital wallets, known as Tuapp cards. They were originally given to all adults to provide cash credits to distribute subsidies to people in need. The cards were used widely during COVID and provided support to help adjust the VAT rate and therefore the amount being charged to the consumer (either in-person or via online payments).

The cards will now be used to receive certificated VAT calculations on the transaction and provide a cash discount on the amount payable by the consumer – so ensuring the discount is genuinely passed onto them and not held back by the retailer. This has been a common failing of traditional reduced VAT rate discounts as happened in the hospitality sector in the UK in the immediate aftermath of COVID.

The calculation is then retained in the digital records of the retailer to ensure full transparency. Uzbekistan was the trailblazer Such personalised digital wallets have been suggested a number of times in academic studies. But due to a lack of technology infrastructure, very few have taken off. India had proposed it for its 2017 launch of a single Goods and Services Tax, but instead opted for direct bank payments because of technical issues over internet access in rural areas. Other countries have experimented with post transaction electronic compensation like the tuapp card, most recently in Columbia.

Since May 2024, Uzbeks on the social register can receive a VAT refund of 12% when buying various basic items such as heating oil, bread and rice. The individual must download an App on their mobile, register using Face ID and scan the purchase QR code in their App. This has the added bonus of moving expenditure away from the underground or ‘black’ economy which for obvious reasons, cannot offer the cash discount.

Can tax fairness be a reality?
The perfect tax system would effortlessly collect the information it needs before seamlessly applying any rules the government wishes to make, but In reality, the perfect system doesn’t exist. The Institute for Fiscal Studies (IFS) the UK’s leading independent economics research institute, recently issued a paper on the subject. They concluded that leaving aside the many IT issues, the political policy challenge will be fairness and suggested that any cuts for the less well-off will have to be met with compensatory rises for all other taxpayers.

This could be the opportunity for the Treasury to withdraw the ‘tax breaks’ afforded to everyone, rich and poor, by taking away the reduced VAT rates of 0% and 5% on essentials such as food, power and medicine, to name but a few. So, instead of wasting huge sums on anti-fraud methods and sometimes having to go to court to argue the toss over seemingly trivial or ridiculous matters about such things as Jaffa cakes and where is the line between adult and children’s clothes, a progressive VAT regime could be the answer.

Is now the time to change?
The various protections and court costs make it expensive for governments to collect data and police the boundaries, leaving taxpayers who haven’t tried to beat the system out of pocket. The measures currently in place to ensure fairness have pretty much ended up being unfair.

The IFS have suggested that personalised VAT would be a positive move in changing the UK’s tax system from being essentially a regressive system to one that is more progressive. They do however warn that the biggest problem facing any government planning to bring in such a change will be where to set the cut-off points to separate the haves from the have-nots.

In the case of personalised VAT, a number of tax experts have warned that rich individuals could employ personal shoppers, to save the VAT charge on say food. Whilst this could happen, in reality it will not make an appreciable dent in the increased tax take, especially as the biggest single area of subsidy is on heating oil, gas and electricity bills, which would be virtually impossible to get round.

Accountant’s view
Right now, I suspect that finance ministers around the globe will be monitoring the situation in Uruguay, which if successful, could see the scheme being introduce in many more countries. I also think that the likelihood of Rachel Reeves rolling out personalised VAT during this year’s Autumn Budget is highly unlikely, but Dear Rachel has to do something radical to bridge the tax gap and differential VAT rates might just be the answer.