​Opinion - The VAT Threshold Dilemma

​Opinion - The VAT Threshold Dilemma

Posted by Stelios on 30th Apr 2024

As someone deeply interested in the intersection of small business development and tax policy, I've been following a concerning trend among small British enterprises. An increasing number of these businesses are intentionally capping their growth to stay below the VAT registration threshold, currently at £90,000. This practice, which has been on the rise, points to a significant tax policy challenge that the UK must address.

The implications of this "VAT cliff edge" are profound. Dan Neidle, founder of Tax Policy Associates, said, "I think this could be one of the UK's most critical tax policy problems." The data supports his concern, showing a sharp increase in companies clustering below the threshold. Neidle argues, "It doesn't seem fanciful to think that some of the 26,000 firms holding their growth below the VAT threshold might have thrived if they'd gone beyond it."

The current VAT registration threshold in the UK is significantly higher than the EU average of about £30,000. While this may seem beneficial at first glance, it creates a disincentive for small businesses to grow. For instance, plumbers may avoid hiring apprentices, and accountants might work separately instead of merging into more efficient entities. This could indeed be feeding into the UK's long-term productivity issues, where, as Neidle notes, "domestic product per hour worked lags France and Germany."

The Federation of Small Businesses suggests increasing the threshold to £100,000 to alleviate some pressure, but this is a short-term solution to a deep-rooted problem. On the other hand, economists like Ben Lockwood from the University of Warwick criticise the current threshold as "probably the worst of both worlds," as it allows businesses to operate effectively without VAT but discourages significant growth.

What, then, is the solution? Neidle proposes a gradual introduction of VAT, eliminating the drastic cliff-edge effect. "Instead of a dramatic threshold that takes VAT from zero to 20%, let's smoothly phase it in," he suggests. This approach would allow businesses to adjust more gradually and potentially be more politically palatable than dramatic increases or decreases in the threshold.

As a nation, we need to critically examine how our tax policies influence not only revenue but also the broader economic landscape, including productivity and business growth. Reform is long overdue. I invite all readers to ponder on this issue and contribute their thoughts and experiences in the comments section. How has the VAT threshold affected your business or those you're familiar with? What changes would you suggest to create a more conducive environment for small businesses in the UK?