Topic Videos

Indirect Taxes

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Last updated 22 Oct 2019

In this short revision video we cover the topic of indirect taxes.

The UK government raises over £785 billion a year in taxes – equivalent to around 37% of GDP. The majority of tax revenue comes from three main sources: income tax, National Insurance contributions (NICs) and value added tax (VAT). Overall, around 10 per cent of total tax revenues come from indirect taxes and this is worth bearing in mind when assessing changes to the UK tax system.

Indirect Taxes

What are indirect taxes?

  • An indirect tax is imposed on producers (suppliers) by the government.
  • Examples include duties on cigarettes, alcohol and fuel, the sugar levy (2018) and VAT.
  • A carbon tax is also an indirect tax. So is an import duty.
  • Indirect taxes are a form of government intervention in markets often with the aim of addressing market failure
  • Producers may be able and choose to pass on some or all an indirect tax to their customers by raising prices

Examples of indirect taxes

  • Value Added Tax
  • Plastic Bag Charge
  • Fuel Duties
  • Alcohol Duties
  • Tobacco Duties
  • Sugar tax
  • Carbon taxes
  • Landfill tax

Value Added Tax (VAT)

  • The standard rate of VAT is 20%
  • Reduced rate of 5% is applied to domestic fuel and power, women’s sanitary products, children’s car seats, contraceptives
  • Zero-rated VAT on Food, Construction of new dwellings, rail and bus fares, books, newspapers and magazines, Children’s clothing, prescription drugs
  • Exempt from VAT - rent on domestic dwellings, Private education, Health service, Postal services, Burial and cremation, Small traders below the turnover limit for VAT registration

The key point about an indirect tax is that the supplier may be able to pass on some or all of the burden of the tax onto the consumer in the form of a higher price. Or they might choose to absorb the tax by keeping their prices the same and therefore earning a smaller profit margin.

Are indirect taxes regressive?

When measured relative to household incomes, indirect taxes (around 45% of which are VAT) can be judged to be regressive: that is, those with lower incomes pay more relative to their income. However, when measured relative to household expenditure, indirect taxes are more evenly distributed across individuals.

  • The richest fifth of UK households paid £12,300 in indirect taxes in 2018; the poorest fifth paid £4,600.
  • For the poorest fifth this is equivalent to 27% of disposable household income
  • For the richest fifth it is equivalent to 14% of disposable household income.

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