Cutting VAT Will Be Regressive

The Government is proposing to reduce the VAT rate on domestic energy products.  This is likely to lead to more cash handouts to higher income groups as energy consumption increases as household income increases.

This data comes from the 2015/16 Household Budget Survey.  The nominal amounts will have changed.  However, the ratios are likely to be similar today.  The highest income decile spends, on average, nearly a third more than the average and nearly twice as much as the lowest decile.

Since VAT is a tax on spending, it will rise with the level of consumption.  Therefore, a cut in VAT will reflect that consumption structure.  Let’s get a sense of this by selecting some examples from Bonkers.ie based on the Regulator’s estimate of median household consumption.  In these examples, we estimate the annual cash benefit to households.

The regulator estimates that the median level of electricity consumption is 3,500 kWh annually.  50 percent of households consume less than this, 50 percent consume more.  Reducing the VAT rate from 13.5 percent to 9 percent would mean an average savings of €54 per year.  For those consuming lower amounts (e.g. 2/3 of the median), the savings would be €40.  But for those with higher consumption, the savings could rise to €94 and up to €134 for very high consumers.

We can do the same exercise with gas.

Again, using the regulator’s gas average consumption estimate, we get the same ratios.

Overall, combining the savings from cutting VAT on electricity and gas from 13.5 percent to 9 percent, we find:

• Average consumers will benefit by €110 annually
• High consuming households will benefit by €196
• Very high consuming household will benefit by €284
• Low consuming households, however, will benefit by €78.

These should be treated indicatively as savings will vary with provider and the energy plan a household is on.  However, this is the broad ballpark.

It shouldn’t be surprising.  The more you consume, the more VAT you pay.  Therefore, a reduction in VAT (equivalent to a cut of a third in the VAT rate) is likely to benefit higher consumption.

This is hardly equitable.  A better course – if one is determined distribute resources to households via this method - is to distribute an equal amount to each household.  This would be similar to the way the Government credited energy bills in their first round of reliefs.  A credit of approximately €110 to each household would be more progressive – giving extra benefit to half of all households (those consuming below the median), with no additional benefit because a household consumes more.

This course, while being more progressive, would cost approximately the same as cutting VAT for the full year. 

Of course, an even better way would be for the Government to regulate energy prices as discussed here, or set a wage increase target as discussed here.  Instead of reducing the tax yield as a VAT cut would do, a wage increase would increase tax revenue – revenue which the Government could use to help focus resources on fixed-income households (social protection and pensions).  Further, even a small wage increase such as 1 percent would benefit low and average-income earners far more than a VAT cut.

Understandably, the Government wants to be seen as being pro-active, helping out households.  The optics of cutting VAT can look positive. And it can be done quickly.  However, when we look under the hood, we find that cutting VAT could be regressive in cash terms.

We need a better, more progressive and fiscally efficient approach.

Comments

[Jerry Mlinn]

Maybe I'm cynical but with this govt. I believe this is a deliberate policy. The well-off seem to do a lot better whenever measures are introduced. The same occurs with loopholes in the housing measures that benefit landlords and developers