Tax by tax, spend by spend

VAT

This Forecast in-depth page has been updated with information available at the time of the March 2024 Economic and fiscal outlook. We are aware of a technical issue with our tableau charts across the site. Access the data from our March 2024 forecast supporting spreadsheets directly.

Taxes on different forms of consumer spending provide the second-biggest source of revenue for government, with VAT (value added tax) by far the biggest of those. In 2024-25, we expect VAT to raise £175.6 billion (this measure of VAT excludes refunds of VAT made to certain public sector organisations). That would represent 15.4 per cent of all receipts and is equivalent to £6,100 per household and 6.3 per cent of national income.

VAT is levied on the purchase of many goods and services. It is reflected in the price paid when items are bought and is collected from traders. Unlike a simple sales tax, it is levied – as the name implies – on the amount of value added at each stage of the production chain. For example, a retailer would not be liable for the full amount of VAT if the good they sold had been purchased from a wholesaler.

The standard rate of VAT is 20 per cent, with around half of household expenditure subject to this rate. The reduced rate is 5 per cent and is applied to domestic fuel and power, children’s car seats and some other goods. Around 2.5 per cent of expenditure is taxed at this reduced rate. Other goods and services, such as books, newspapers, children’s clothing and many foods attract no VAT (i.e. they are either exempt from VAT or are ‘zero-rated’).

  Forecast methodology

Forecast process

The OBR commissions forecasts of VAT receipts from HM Revenue and Customs for each fiscal event. The forecasts start by generating an in-year estimate for receipts in the current year, then use a model to forecast growth in receipts from that starting point. We provide HMRC with economic forecasts that are then used to generate the tax forecasts. These are scrutinised in a challenge process that typically involves two rounds of meetings where HMRC analysts present forecasts to the Budget Responsibility Committee and OBR staff. This process allows the BRC to refine the assumptions and judgements that underpin the forecasts before they are published in our Economic and fiscal outlooks (EFOs).

Forecasting models

The VAT forecast is based on the concept of a ‘VAT total theoretical liability’ or VTTL – the total value of VAT that could theoretically be collected from the tax base. For outturn years, this is calculated using ONS data on total expenditure by sector. Respective VAT rates are applied to detailed breakdowns of this expenditure, to calculate a total theoretical liability. This liability is split into four main sectors: household, exempt, government and household investment. Each sector is then grown in line with the relevant elements of our economy and fiscal forecasts, including a disaggregated forecast of household consumption.

The difference between the VTTL and actual receipts in the current year represents an implied ‘VAT gap’. The gap is made up of error, fraud, evasion, avoidance and debts owed by firms to HMRC, as well as any errors in estimating the VTTL itself. We typically assume this gap remains roughly constant as a proportion of the VTTL over the forecast, we only make adjustments to reflect new or yet-to-be implemented compliance measures over the forecast. Combining the VTTL forecast and the VAT gap projection gives the final VAT forecast.

Main forecast determinants

The main determinants of our VAT forecast are those related to the tax base (in particular consumer spending). See the ready reckoners section below for more information on the effects of these determinants on VAT receipts

Main forecast judgements

The most important judgements in our VAT forecast are related to the economy forecast – particularly nominal consumer spending. Alongside, we need to make several other judgements. These include:

    • In-year estimate – year-to-date receipts provide valuable information about the likely outturn for the current year. Judgements are made whether to push any unexplained shortfall or overshoot through to future years;
    • Implied VAT gap – in general this is held flat prior to incorporating compliance measures over the forecast period. We could re-assess this assumption in light of information on compliance risks and trends in VAT debt; and
    • Standard-rated share of consumption – we forecast a disaggregated series of nominal household consumption, and project forward detailed ONS consumption data by sector using the most relevant disaggregated consumption category. This means we are often forecasting standard-rated, reduced, and exempt ONS consumption data using different growth rates, changing the standard-rated share of consumption.

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  Previous forecasts

VAT receipts have typically been stronger than our forecasts in recent years. Nominal household consumption growth was weaker than we expected in our earlier forecasts, but has been stronger more recently. This strength also reflects the implied VAT gap closing by more than we had assumed in our earlier forecasts.

Prior to November 2015, there was an error in the VAT deductions element of the model which had overstated the scale of deductions to the government sector and hence understated total VAT receipts. This was identified in our 2015 Forecast evaluation report and corrected in the subsequent Economic and fiscal outlook. Forecast differences since November 2015 have been significantly lower.

Receipts fell during the coronavirus pandemic but have since recovered faster than expected due to upwards revisions to nominal consumption. These upward revisions primarily reflect consumer price inflation being stronger than expected, even allowing for the more muted effects of rising food and energy prices on VAT receipts.

 

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  Policy measures

Since our first forecast in June 2010, governments have announced a number of policy measures affecting our forecast for VAT. The original costings for these measures are contained in our policy measures database and were described briefly in the Treasury’s relevant Policy costings document. For measures announced since December 2014, the uncertainty ranking that we assigned to each is set out in a separate database. For those deemed ‘high’ or ‘very high’ uncertainty, the rationale for that ranking was set out in our policy costings uncertainty database.

Key VAT policy changes since 2010 have included:

    • The rise in the standard rate of VAT to 20 per cent from January 2011 was announced in the June 2010 Budget. This was expected to raise VAT receipts by at least £12 billion from 2011-12 onwards.
    • o Anti-avoidance measures – these include measures aimed at closing loopholes, reducing the level of tax avoidance and evasion, and enhancing the compliance performance of HMRC. For example, compliance measures announced since the 2021 Spring Budget are expected to raise around £1 billion by 2026-27.
    • Making Tax Digital – this is an HMRC initiative to interact digitally with small businesses across taxes, working with the private sector to introduce software that will design out record-keeping errors in taxpayers’ returns. Use of making tax digital was mandated for VAT from 2019-20 onwards for companies above the VAT registration threshold and for companies below the threshold from April 2022.
    • In March 2020, a VAT deferral measure was introduced. This was to allow individuals with VAT payments due between 20 March 2020 and 30 June 2020 to defer them to no later than 31 March 2021. The date on which the deferred payment should be made was extended by the New Payment Scheme, which allowed deferred payments to be paid in instalments until February 2022. The large movements in cash receipts due to this measure only affected accrued receipts to the extent that some of the deferred payments are ultimately unpaid.
    • In July 2020 the Government announced a temporary cut to VAT for the ‘hospitality, accommodation and attractions’ sectors, from 20 to 5 per cent. It was initially due to last until 12 January 2021, but was extended until 30 September 2021. A rate of 12½ per cent then applied until the end of March 2022.
    • Between 2017-18 and 2024-25, the VAT registration threshold was frozen at £85,000. In March 2024, the Government announced the threshold would be increased to £90,000, and then stay frozen at that level thereafter. Box 3.3  in the March 2023 EFO looked at the impact of the frozen VAT registration threshold.

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  Ready reckoners

‘Ready reckoners’ show how our fiscal forecasts could be affected by changes in selected economic determinants. They are stylised quantifications that reflect the typical impact of changes in economic variables on receipts and spending. These estimates are specific to our March 2024 EFO and we would expect them to become outdated over time, as the economy and public finances, and the policy setting, continue to evolve. They are subject to uncertainty because they are based on models that draw on historical relationships or simulations of policy settings. More information can be found in the ‘ready reckoners’ spreadsheet available on our Data page.

The table below shows that:

    • around 70 per cent of VAT receipts are derived from household consumption, and these move largely one-for-one with changes in nominal consumer spending;
    • changes in spending from other sectors generally have smaller impacts on receipts. These sectors include the exempt, government and household investment sectors. Changes in nominal GDP, government procurement and household investment growth will feed into these sectors respectively; and
    • changes in the household standard-rated share of consumption, which is the proportion of household expenditure that receives the 20 per cent rate of VAT; and
    • changes in the VAT gap (holding VTTL constant) directly impact receipts by increasing or reducing the difference between actual receipts and the VTTL.
WordPress Data Table

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Other taxes

Boxes

Within each of our key publications we include topical ‘boxes’. These self-contained analyses are unique to this publication and tend to cover recent developments in the economy or public finances that complement the main discussion of our analyses.

Revisions to borrowing in 2016-17

Revisions to borrowing in 2016-17
Initial estimates of the deficit can be revised significantly over subsequent months as more reliable data become available. This box set out how our forecasts during 2016 and 2017 evolved and how the outturns for 2016-17 were revised over time.

The economic effects of policy measures

In each Economic and fiscal outlook we publish a box that summarises the effects of the Government’s new policy measures on our economy forecast. These include the overall effect of the package of measures and any specific effects of individual measures that we deem to be sufficiently material to have wider indirect effects on the economy. In our March 2012 Economic and Fiscal Outlook, we made adjustments to our forecasts of real GDP, business investment and inflation.

The receipts-to-GDP ratio since 1986-87

The receipts-to-GDP ratio since 1986-87
Strong overall receipts growth in 2016-17 took receipts as a share of GDP to their highest since 1986-87. This box explored how the composition of the public sector’s income has changed over the three decades since receipts were last at the latest share of GDP.

The Chancellor’s 8 July ‘Summer Economic Update’

On 8 July, the Chancellor announced further measures to support the economy as the lockdown is eased, which we were not notified of in sufficient time to incorporate into our scenarios. This box described the measures included in the package and the costs as estimated by the Treasury.

The impact of the frozen VAT registration threshold

Chart 3C: Bunching in the VAT turnover distribution at the registration threshold
In our March 2023 Economic and fiscal outlook, we evaluate the distorting impact of the frozen VAT registration threshold – the turnover threshold at which firms must register for VAT. This box looked at the tendency for businesses to bunch just below the threshold, as they limited their turnover to avoid needing to register. At the time of the box the threshold had been frozen at £85,000, and was due to remain at that level until the end of March 2026.

Why are receipts stronger since March?

Stacked line chart showing national accounts taxes (excluding PSNB neutral): Changes since March
We have made a significant upward revision to our pre-measures receipts forecast. This box explored the drivers behind the revision, which taxes drive the revision and how much of this change is due to real GDP, inflation and the effective tax rate.

Non-payment of tax liabilities in our scenarios

So far during the lockdown period, many businesses are struggling to meet their usual tax payment schedules and are seeking instead to delay those payments. In this box we considered the channels through which this might impact tax receipts and set out the key uncertainties in our medium-term scenario assumptions.

The fiscal implications of tax gaps

Chart 4A: Stacked bar chart showing tax gap as a share of GDP
The tax gap is the difference between taxes collected by HMRC and the theoretical liability, or what, in theory, should be collected. As a share of GDP, it has reduced from 2.3 per cent in 2005-06 to 1.5 per cent in 2021-22, two-thirds of which is explained by reductions in the VAT gap. In this box, we explored the recent drivers of changes in tax gaps, explained what assumptions we make about tax gaps in our forecast and outlined the associated uncertainties.

Why have receipts recovered so strongly in the wake of the pandemic?

Chart 3.A: Real GDP and tax revenues: October forecast versus outturn
Since our October 2021 EFO the real economy has performed largely as expected in 21-22 but tax receipts have come in well above that forecast. In this box, we examined reasons why tax receipts have recovered so quickly particularly in comparison to economic data.

Updates to fiscal forecasting models

Modelling changes were made to the deductions element of the VAT model and to introduce a new model for NICs. The box outlined the modelling changes and the likely effect on receipts.

The effect of incorporations on tax receipts

The effect of incorporations on tax receipts
Our PAYE, SA, NICs and corporation tax (CT) forecasts are affected by our assumption that incorporations will continue their rising trend. This box covered historical estimates, the modelling of the receipts effects from incorporations and the implications for the forecast.

Impact of inflation on the public finances

This box set out the various impacts that higher inflation has on the public finances. These include direct effects (e.g. on income tax and debt interest spending), the impact on nominal tax bases (such as household consumption) and the impact on departmental spending.