Ritchie, busy little beaver that he is, has issued another policy paper, this time on VAT.  The title of Is VAT regressive and if so why does the IFS deny it? alone should leave you little doubt as to where Ritchie lies on the issue.  Needless to say, he's wrong.

His conclusion that VAT is regressive is largely based on his observation that, on an analysis of VAT paid as a proportion of income by quintile, the poorest quintile pays 12.1% of their income in VAT whereas the richest quintile pays 5.9%.  This is a slam-dunk, right?

Wrong.  The Office for National Statistics paper from which he draws these statistics ¹ takes great pains to stress that it is not always valid to compare VAT to gross income:

Carrera (2010) ² presented some of the most common alternative methods that were used to fund expenditure in households where their expenditure was at least twice the level of their disposable income. For these households the most common source of funds was savings, followed by credit/store cards and then loans. This may be due to a number of reasons. For example, the bottom decile in particular includes some groups who have, or report, very little income (for example people not currently in employment and some self-employed people). For some people this spell of very low income may only be temporary and, during this period, they may continue with previous patterns of spending. Secondly, some types of one-off receipts are not included as income in this analysis, for example, inheritance and severance payments. Finally, the income and expenditure data are measured in different ways in the LCF, and either could be affected by measurement errors of different kinds (see Appendix 2, paragraph 6).

Carrera is even blunter.  She concedes Ritchie's point, noting that "indirect taxes are progressive in expenditure distribution, but regressive in income distribution."

However, Ritchie's point is invalid, because it presumes that individuals have the whole of their gross income at their disposal.  In fact, as a direct result of our progressive direct taxation system, richer people must pay a greater share of their income as tax than poorer people.  From the ONS figures for 2008-09, we learn that the top quintile pays 24.7% of their income in direct taxes, whereas the bottom quintile pays only 11.3% ³.  This means that the top quintile has only 75.3% ⁴ available to spend on indirect taxes, whereas the bottom quintile has a much greater 88.7% ⁵.  Much more valid, and as identified in the ONS document, is to look at VAT as a proportion of disposable income and of expenditure.  This produces results that are, basically, progressive - at 7% of expenditure ⁶.

Yep, that's all in the ONS paper.  You see, you might have got the impression from reading Ritchie's briefing paper that the idea that VAT is progressive is all a wicked plot from the evil Institute for Fiscal Studies.  Yet, every single analysis in the IFS paper has a direct parallel in the article by the ONS.

The ONS paper, as highlighted above, also serves to rebut an entire section in Ritchie's paper entitled "Do the poorest really have savings?" ⁷  Carrera's paper draws upon the Living Costs and Food Survey, which asks households about their sources of income.  Savings are identified as a source within that survey ⁸.  So, again, his criticism of the IFS is ill-founded and, in any case, should be directed at the ONS.

People who read this post also read:

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• The flip side of progressiveness
• Ritchie and the optimal highest rate of tax

Filed under: Academic research, Other blogs, Taxation with tags institute for fiscal studies, office for national statistics, progressive, regressive, richard murphy, vat