12 June 2024

Don’t let private schools stand in the way of simpler taxes


Private schools are, on the whole, a good thing. They give parents greater choice in their children’s education, provide the state sector much needed competition and attract money from abroad by taking on foreign students. I start with this because where you stand on applying VAT to school fees is often treated as a proxy for whether you approve of private education in general. 

But it really shouldn’t be. VAT is a tool for raising revenue, not a means of passing moral judgement on each and every good and service. It works best when it is applied broadly with few exceptions. That private schools are good for the economy, are often good for those who consume their services and have some positive externalities are not sufficient grounds for making them tax-exempt. The same can be said for pubs, adult clothes and toilet paper which are all, quite rightly, subject to VAT. 

I recently took part in a debate (which you can watch here) against the Adam Smith Institute’s Max Marlow on Labour’s proposal to extend VAT to private school fees.  Max is the author of a recent report which has raised some important points. For example, it interrogates some of the evidence used to argue that private schools have adverse social consequences, and shows just how shaky it is.

However, I remain unconvinced by claims that charging VAT on fees will lead to a mass migration of 10%, 15% or even 25% of students from the private to the state sector. These figures rely on the price elasticity of demand for places in British independent schools being relatively high. 

But the independent school sector itself has provided – albeit unintentionally – very good evidence for the low responsiveness of demand to increases in fees.  

Back in 1997, the average annual fee for a ‘day’ student in a private secondary school was £4,182. If average fees had risen in line with inflation they would now stand at just under £8,000 per year. In reality, they are now more than double that. Since 2009, fees have risen 24% in real terms

What has been the effect on the proportion of British children being educated in the private sector? Essentially none. In 2002, 5.98% of pupils in British schools were educated in the independent sector. By 2022, the proportion had actually increased very slightly to 6.05%.

This is not a criticism of private schools. Increasing prices is a perfectly rational response to persistently high demand for a service. But it does make it tricky for independent schools to claim a fee hike will crater demand when they have spent a generation betting the opposite and being proved consistently right. 

There is also little reason to believe that schools will pass on the full cost of VAT at once. There is plenty of room in the industry to cut costs without significant competition from the state sector. The gap between private school fees (even subtracting bursaries) and spending per pupil in the state sector has grown from £3,500 in 2010 to £7,200 today. We have already seen several schools reassuring parents that any percentage increase in fees will be kept in the single figures. 

But aside from these practical questions there is a more fundamental question at stake. Just how serious are free marketeers about simplifying the tax system?

Currently, the VAT system in the UK is riven by thousands of exemptions, carve-outs and reduced rates. As with VAT exemptions for school fees, each can be justified by its supporters in isolation, but overall they create an increasingly absurd and byzantine system – one that even HMRC struggles to navigate. 

Many readers will be familiar with the legal battle fought by McVitie’s to prove Jaffa Cakes are in fact cakes, which are not subject to VAT, rather than chocolate biscuits, which are. But this case is straightforward compared to the question of whether a gingerbread man with chocolate decorations is subject to VAT. The answer is: not if he only has chocolate eyes, but add a smile and he’s a taxable chocolate biscuit. Pets are generally VATable, unless HMRC considers them edible – so non-ornamental rabbits, eels and five breeds of duck escape the tax. There is a flow chart for working out whether your goatskin coat is VATable: unlike most other adult clothes it isn’t, unless the goat came from Mongolia, Tibet or Yemen in which case it is taxed (obviously). 

This labyrinthine system is brilliant at creating work for tax lawyers and accountants but a complete nightmare for businesses. It is particularly tough on small and medium-sized firms, which often struggle with compliance. On top of this, the various exemptions and reduced rates, though often trivial in each individual case, add up to almost £100bn in forgone revenue each year

A broader-based, simpler and lower-rated VAT is not a fantasy. The UK is well above the OECD average when it comes to applying exceptions to VAT.  

New Zealand provides us an example which the UK would do well to follow. It applies its equivalent of VAT, known as General Service Tax (GST), to essentially all goods and services at a fixed rate of 15%. This is simpler for businesses and also raises more revenue. In Britain, VAT accounts for around 15% of total tax collected; in New Zealand, GST accounts for almost 30%. This allows New Zealand’s other taxes to be lower. 

New Zealand applies this tax to private education but also offers a small subsidy worth about £1,000 for each secondary school student attending a private school. This means that for the cheapest schools the effect of GST is mitigated to a large extent. If you are concerned about kids dropping out of the bottom of the private system, this sort of direct subsidy is a far more targeted means of doing so than using VAT exemptions. Under the current system, if you’re sending your child to Eton (termly fee: £16,666), the VAT exemption saves you about £7,500 per year, whereas if you’re at an independent school charging £12,000 per year it only saves you around £1,800. If you want to help the ‘squeezed middle’ it’s really difficult to think of a less efficient means than the status quo.

The perennial problem for achieving free market reform is that people like being winners. If the state stops picking winners, for example by simplifying VAT, those affected feel hard done by. But if we listen to special pleading on the part of industries we are sympathetic to, it only undermines the case for broader reforms we need to simplify the tax system and boost growth.

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Daniel Freeman is Managing Editor at the Institute of Economic Affairs.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.