17 January 2019

Britain’s VAT system is not fit for purpose


An easy way of sparking five minutes of friendly but intense debate is to ask a group whether a Jaffa Cake is a biscuit or a cake. Those present would no doubt list the attributes explaining why they are biscuits: they’re small, located in the biscuit aisle, eaten with fingers etc. Those of the contrary opinion would explain that they are very obviously cakes — they are spongy, they dry out when left out in the open air, and the clue is in the name, they are not Jaffa Biscuits.

It may seem like an innocuous conversation, but, as Professor Tim Crane of Cambridge University points out, it actually has a deeper, philosophical relevance. It raises questions about language and how words can have meaning. It is an example of Ludwig Wittgenstein’s Family Resemblance explanation which he set out in his Philosophical Investigations.

In short, Wittgenstein argues that some words do not have a single essence that encompasses their definition. Take the word ‘game’, for example. Although we may think of the term as having a definite meaning, but in reality, no single thing is common to all uses of the word ‘game’. For instance, not all games are played for fun or as recreation; games like hockey and football are played professionally, and some casino games are played out of addiction. Not all games have scores or points, nor do they all have teams or any equipment that would define them as games and not some other activity.

So, rather than each use of the word ‘game’ having a relationship to a common feature of reality or of the thoughts behind them, that is, to a single essence, the relationship between the uses of the word is more interesting. The way in which family members resemble each other is not through a specific trait but a variety of traits that are shared by some, but not all, members of a family.

And so it is with the humble Jaffa Cake. There is no strict definition of the words ‘cake’ or ‘biscuit’ and so there is no good reason why it should be classified as either one.

This may be the case philosophically, but not fiscally. This is because, for the purposes of taxation, a cake is a staple food and so not subject to VAT. A chocolate covered biscuit, on the other hand, is subject to the standard rate of 20 per cent.

For tax purposes, a Jaffa Cake is not a biscuit, it is a cake. This was determined by a judge after a lengthy and expensive dispute over its VAT status. The tribunal heard all the arguments discussed above – it is said that a giant Jaffa Cake was baked in order to better demonstrate the cake-like qualities of Jaffa Cakes.

A similar matter has just been resolved concerning a ‘healthy brownie bar’ made by Pulsin. Judge Amanda Brown decided in favour of Pulsin after sampling the brownies alongside other cakes and biscuits. She accepted that the plastic packaged brownies would look out of place on a cake stand but they would “absolutely not stand out as unusual” at a cricket match. Therefore, on balance, they are sufficiently cake-like to be exempt from VAT.

This highlights the absurdity of the UK’s VAT system. There is no good reason why we should classify something as a cake or a biscuit, but we are forced to for tax purposes. Chocolate buttons attract the standard rate of VAT, unless they are to be used as a cake decoration in which case they are exempt. A gingerbread man who has two chocolate spots for eyes is zero rated. However, if it has chocolate buttons or a snazzy chocolate belt, then it suddenly becomes subject to VAT.

If the the UK ever manages to extricate itself from the EU, there have already been several suggestions for more exemptions to VAT. For example, UKIP promised to abolish VAT on fish and chips, while many campaigners have argued that sanitary towels should be exempt from VAT.

However, adding more exemptions would only further complicate an already confusing, illogical, and absurd system. Instead, we should introduce a flat rate and remove all exemptions.

Simplifying things would be particularly helpful to businesses. On average, it takes longer to comply with VAT than with corporation tax. A major contributor to this is the complex nature of of the VAT system, with its different rates and exemptions. All of that time and effort spent dealing with VAT could certainly be shifted towards more productive activities – one of our top priorities, given the UK’s sluggish productivity growth.

Better still, certain producers would no longer have to spend a small fortune on a QC to do battle with HMRC, arguing if their product is sufficiently spongy enough to be classified as a cake.

Removing exemptions and different rates would also be good news for consumers. A VAT system with a broad base would mean that the rate could be set lower, helping reduce the cost of living for hard-pressed households.

It could also result in more money being available to spend on essential public services. As a result of the lower rate and exemptions, HM Treasury gets billions of pounds less in VAT receipts then it would under a flat rate. This is money which could be spent on essential public services such as education, the police, or health and social care.

A broader VAT system with flat rates could also allow the Government to abolish other economically damaging taxes. For example, in 2009 the Danish government ended certain VAT exemptions in order to finance cuts to corporation tax. As the UK prepares to leave the EU it will need to signal to the world that it is open for business. We should abolish stamp duty and cut corporation tax which would be partially funded through removing VAT exemptions.

It would also allow us to more effectively help the poorest in society. One of the reasons behind lower rates and exemptions is to make certain goods, such as children clothes, more affordable. However, these things are purchased by rich and poor alike, so it’s an inefficient method of providing relief to people on lower incomes. We should instead scrap the exemptions and lower rates, and use this to fund increases to the income tax personal allowance and to take the lowest earners out of national insurance contributions.

Whatever happens with Brexit, a reforming government ought to make reforming our overwrought, ineffectual and baffling VAT system. A broader, flatter tax system would be good for businesses, good for the British economy and good for those on the lowest incomes.

Ben Ramanauskas is a Policy Analyst at the Taxpayers' Alliance.