Trump loathes VAT. Here’s why it might be time to kill it off in Britain

Donald Trump is hardly the first person to resent VAT.

The US president once again took aim at the tax this week, labelling it “exorbitant” and claiming countries that charge it are discriminating against American businesses.

It was this hatred that in part fuelled Trump’s explosive tariff war whereby he singled out the European Union – which imposes VAT north of 25pc in places – with some of the most punishing duties.

Many experts described Britain’s escape from the harshest tariffs as its “Brexit dividend”. But it has left some wondering: is it time Britain uses the full extent of its freedoms to overhaul VAT?

The seemingly arbitrary tax has long been unpopular, sparking endless pedantic wars over what does and does not fall within its scope.

The idea of scrapping VAT altogether gained traction following Britain’s exit from the European Union, which dictates countries must impose the tax to qualify for membership to its single market.

At the time, Michael Gove pledged to abolish the levy as part of his campaign to be leader of the Conservative party. He wrote in The Telegraph he would replace it with a “lower, simpler, sales tax, ensuring our business tax structure is the most competitive in the G20”.

The problem, however, is that it is an enormous cash cow for the Treasury, bringing in £169bn last year alone. And it is a cash cow that keeps on growing – ever since Labour opted to apply 20pc VAT to private school fees for the first time ever. The policy is expected to raise £1.5bn next year.

VAT is widely seen as one of the biggest barriers to healthy US-UK relations. If Sir Keir Starmer followed Mr Trump’s logic, he may consider cutting VAT to help secure more favourable trading terms with America.

The move would also hand a welcome tax cut to consumers too who ultimately bear the full cost of the levy.

And it could help turn the UK into the low-tax “Singapore-on-Thames” that Jeremy Hunt, the former chancellor, recently called for in response to Mr Trump’s tariff regime.

VAT is the global norm

The US is one of the few nations that has not developed a system of so-called “value-added taxation” and instead uses a wide variety of sales taxes.

Mr Trump believes the absence of VAT in America has unfairly benefited its trading partners who almost universally levy the tax against US-made products.

For example, Hungary has the highest VAT rates in the world and currently charges 27pc. US sales taxes are by contrast between nought and 11pc, and vary between states and even cities.

VAT was first introduced in Britain in the 1970s following its entry to the European Communities – an earlier version of the European Union.

The system was thought to be more sophisticated than the general sales taxes it replaced as it is levied at each stage of the supply chain where value is added.

But, British consumers have watched the tax double in that time from 10pc to 20pc today.

Critics of VAT have also pointed out that there are huge inconsistencies in what goods and services are liable for the tax.

It is subject to a number of exemptions that often hinge on pedantic arguments, like whether or not Jaffa Cakes are truly cakes and therefore tax-free. The courts ruled they were in 1991.

But while economists have argued that VAT is an imperfect form of taxation, its shortcomings are not thought to hurt trade.

The neutral tax

Rita de la Feria, a professor at the University of Leeds, told The Telegraph “a VAT reform should happen.”

She called for it to be expanded so fewer products are exempt but lowered overall. But, she said it makes “no sense” for the US to treat the tax as a tariff.

This is because the cost of VAT is paid by consumers in the destination a product is consumed, rather than by the country in which it is produced.

“Let’s imagine you are an importer of coffee and paid VAT at the border,” Ms de la Feria said. “When you sell it to coffee shops you deduct that VAT, so it does not apply to you as an importer and then it is applied to you and I when we go to the coffee shop.”

She added that consumers will “pay this regardless of where the coffee is imported from and it is neutral to international trade”.

“It makes no sense,” to attempt to respond to this with tariffs, she said. “There is no discrimination at all and VAT is designed to be a neutral tax. The importer deducts that VAT when he sells it on [and it] is treated the same way as any domestic supply.”

This means that despite there officially being no VAT in America, the country’s sales taxes of between naught and around 11pc operate in the same way.

“In essence, the VAT is economically equivalent to the US retail sales tax, [they have] exactly the same economic rationale and are meant to tax consumption,” she added.

A fortune for the Treasury

Sacrificing even one percentage point in VAT charged in Britain would lead to billions of pounds in lost revenue for the Government, at a time where Rachel Reeves has given herself almost no fiscal headroom.

In the EU, the tax raised 15pc of revenues across all member states in 2023, while in the UK it accounted for around the same, totalling £169bn.

Geriant Lewis, of financial planner Moore Kingston Smith, said any changes to reduce VAT would come with a significant cost.

He said: “Following Brexit, the UK has the freedom to amend its VAT system, or even to repeal the tax. However, between 2023 and 2024 VAT was the third largest source of revenue after income tax and National Insurance contributions.

“While the UK could in theory, either axe VAT entirely or drastically reduce rates, this would have a significant impact on government revenue.”

Trump could have dropped demand to axe VAT

While the Trump administration made repeated references to VAT being a trade barrier in the weeks leading up to “Liberation Day”, it does not appear to have played a direct role in determining the president’s new measures.

Stuart Adam, a senior economist at the Institute for Fiscal Studies, said that the tariffs levied on more than 50 countries last week were “based on what the trade deficit is as a percentage of imports which has nothing to do with VAT”.

He added: “It has not got anything to do with the formula they have used to calculate the tariffs. It’s not obviously on the agenda any more.”

He said that materials published by the White House during the unveiling of the tariffs mostly left out Mr Trump’s gripes with VAT.

“Trump did make various noises about VAT being in effect a tariff and penalising American exporters but if you look at the press releases and fact sheets they put out last Wednesday, there was very little mention of VAT.

“It [only] got a brief mention along with a whole litany of complaints about this allegedly awful behaviour of countries around the world,” he said.

There is no suggestion changing VAT in Britain would have any favourable impact on US trade. The White House instead appears to be more concerned with Britain changing its food standards so it can import more American-made meat.

“The only place [the White House] mentioned the UK specifically was about chlorine-washed chicken, what they want from the UK to do with VAT is even less clear,” said Mr Adam.