The question: Assess the influence of the European Union (and its predecessors) on the development of sales taxes in the UK since 1973
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Essay: Conventional sales taxes are levied on retail sales, typically at a percentage rate. As such, they are members of the class of so-called indirect taxes, which are impositions on things that do not depend upon the circumstances of the parties involved. In particular, they are independent of income or wealth, which is in contrast to
the usual feature of direct taxes, with the notable exception of a poll tax. Such distinctions are not however particularly helpful in attempting to distinguish the effective from the formal incidence of taxes (Prest, 1967).
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Prior to its accession to the European Economic Community (EEC) in 1973, the U.K. did not possess a sales tax in the form described above. Instead, its indirect taxes were of two major types. The first was known as purchase tax, which was in fact a levy on wholesale, rather than retail, sales. One of the major reasons for this choice of base was administrative cost, insofar as it has been estimated that, in the 1960s, there were about 60,000 wholesalers in the U.K. compared to 600,000 retailers (Prest, 1967). The tax was first introduced in 1940 as a means of reducing consumer demand as part of the effort to divert resources to the war effort. It was an ad valorem (in proportion) levy that was imposed at different rates on different classes of commodity, with various goods, most importantly food, being exempt.
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The second type of indirect tax prevailing in the U.K. prior to its joining the EEC was excise duty. This had a rather longer history than purchase tax, having first been introduced in the seventeenth century. Excise duties are a form of specific tax (so much per unit) and the major impositions in the early 1970s were those on tobacco, alcohol and petrol (Kay and King, 1980). As well as their role in raising revenue, at which they have always been extremely effective, they are often cited as discouragements to the consumption of commodities that have adverse personal or social consequences.
Note should also be made of one late addition to the U.K. government’s tax armoury. Purchase tax was imposed only on physical commodities and therefore service sector outputs were relatively unscathed. In an attempt to correct this imbalance, the government introduced a Selective Employment Tax (SET) in 1966 (Prest, 1967). Its title was, however, something of a misnomer as it was a complicated mix of taxes and subsidies. In particular, it was an employment poll tax levied on all firms, but refunded to those outside the service sector. The stated intention was to divert labour from services to manufacturing, but the system was riddled with anomalies and widely resented.
The U.K. purchase tax was unknown in Europe. In particular, all six EEC nations had adopted the value added tax (VAT) in 1967 (Pelkmans, 2001), following its original adoption by France in 1954 (El-Agraa, 2001). Provided that capital equipment purchases are treated as a deductible expense – which they are in the European model – it is very similar to a retail sales tax (Kay and King, 1980). Adoption of VAT was one of the harmonization conditions attached to the U.K.’s accession. As its name suggests, VAT – another ad valorem tax – is levied only on the value added at each stage of the production and retail process, with all prior VAT payments on the inputs at each stage being reclaimable. Preceding the adoption of VAT, the countries of the EEC had operated multi-stage turnover (cascade) taxes, which were both expensive to collect and created an artificial incentive for vertical integration (Prest, 1967).
What were the implications of the necessary switch to VAT for the U.K.? First, it signalled the end of both purchase tax and SET (Kay and King, 1980). In comparison, VAT is vastly more complicated and expensive than purchase tax, both for the Customs and Excise who administer it and for the many organizations, including small businesses, which have to comply with it. Second, purchase tax had been levied at numerous different rates, which meant that certain types of commodity – so-called necessities – could be taxed lightly, if at all, while items favoured by the rich could bear heavier rates. However, VAT was also levied at different rates, with zero rating permitted. In this latter regard, it might nonetheless be noted that the situation was and remains slightly more complicated than this, with an exempt class of commodities as well as those that are zero rated, with only the latter being able to reclaim tax paid on inputs.
The initial implications of accession for the U.K.’s excise taxes were rather more limited. As noted above, the principal extractions prior to membership were from the “classical” five – manufactured tobacco products, hydrocarbon oils, beer, wine and spirits – which was in fact a somewhat narrower base than that used in certain pre-existing member states (El-Agraa, 2001). Over time, members have retained the freedom to set their own excise taxes, subject only to them respecting certain minima for alcoholic drink, energy products and tobacco.
The need to harmonise tax systems within the EEC was brought about by the desire to complete the single market. Thus, with the abolition of tariff barriers, taxes become the major source of intra-EU trade distortion. However, taxation was and has remained a sovereign power. The form of harmonization adopted has therefore been more in the way of low-level co-ordination than outright unification (El-Agraa, 2001). In particular, while systems have been standardized, bases and rates have been allowed to vary, subject to certain constraints that will now be outlined.
In the field of VAT, a minimum standard rate of 15 per cent is currently maintained and this is levied in Cyprus and Luxembourg. However, actual rates vary and reach 25 per cent in Denmark, Hungary and Sweden. Furthermore, most countries have a reduced rate, which varies between 5 and 17 per cent, and some also have a super reduced rate. In addition, there is a transitional ‘parking rate’. It is also easy to find differences in the rate applied to particular commodities; for example, while the U.K. levies a VAT rate of five per cent on heating oil, the rate in Denmark is 25 per cent. Likewise, while medical equipment for disabled persons is zero rated in the U.K., the rate in Denmark is 25 per cent (Europa website, DG Taxation).
Such large differences in rates obviously raise the question of how the single market can function effectively. The answer, for the time being at least, lies in the retention by the EU of the destination principle for goods and services traded between taxable entities. This means that VAT is only payable in the member state that imports something from another. In accord with the principle of free movement, however, private persons can buy elsewhere in the EU without having to pay further VAT on their return home: that is, an origin based system (Europa website, DG Taxation). Notwithstanding these complications, future reforms are unlikely to attempt to undermine the principles of the internal market.