Fewer ingredients will best serve the VAT on food

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Most countries apply a reduced rate of value added tax to food. In Britain, that rate is zero. Food is the most basic of necessities and takes a much higher proportion of the income of low-income households.

But should this relief apply to a meal in Heston Blumenthal’s restaurant in Bray, Berkshire, where the set menu costs £180? Perhaps not. Britain, in common with many other countries, taxes catering at a higher rate. Food is a necessity, a meal out a luxury.

But what exactly do we mean by catering? We can see the difference between dinner at the Fat Duck, where you are treated to an exuberant show of molecular gastronomy, and buying an apple at Tesco and munching it at home or in the office. Pursuing that distinction, a Pret A Manger sandwich is catering – 20 per cent tax – if you eat it in the shop and food – zero tax – if you eat it at your desk.

But surely a takeaway pizza place or a fish and chip shop is in the catering business? Indeed: food intended to be eaten hot, and supplied hot, is subject to 20 per cent VAT. Food intended to be eaten hot, but not supplied hot – fish and chips bought in a supermarket – is zero rated. But what of food supplied hot and intended to be eaten cold such as freshly baked bread? Or food that is equally nice, or nasty, hot or cold? These are the dilemmas that George Osborne addressed in his most recent budget. His proposal to tax Cornish pasties served from the oven has aroused the nation.

Fine, but arbitrary, distinctions, are endemic in tax systems. But problems such as these are not confined to tax policy. When we regulate bank capital, we observe that a loan to another financial institution differs from a mortgage. But what of a loan to another financial institution whose repayment depends on the performance of a mortgage? We can create a rule for that, of course. Just as we can invent a rule to separate a pasty from a sandwich, a deposit from an investment and a table knife from a dangerous weapon.

Officials translate the incompletely formulated thoughts of policy makers into enforceable laws and regulations. But this is rarely an easy or trivial task. To tax income you must distinguish income from capital, and that distinction remains elusive even after thousands of pages of accounting principles. The common sense that says “I know the difference between a Cornish pasty and a ham sandwich when I see it” is appealing, but we would rightly find it unacceptable that the decisions of a tax inspector should be based on the principle that he knows what to tax when he sees it. And that is before you encounter the problem of tax advisers whose profession it is to make a Cornish pasty resemble a ham sandwich (or the reverse).

But to say that modern tax systems are inescapably complex does not mean that tax systems need be as complex as they are. Some distinctions are easier to make than others. Consumption is relatively simple – although not altogether simple – to define and monitor, which is why VAT has proved so successful. The difference between income and capital gains is more difficult, and the problems of implementing that distinction work to the advantage of the better off, whose finances are complex and who can afford good advice. Wealth taxes are everywhere hopeless, not because it is wrong to tax wealth, but because the practical problems of defining and identifying wealth in a modern society are so great.

The fewer arbitrary distinctions we need to make in our tax structure, the better. Every measure that uses tax or regulation for social or economic engineering requires us to differentiate between what is good and bad by reference to objective criteria based on the wording of a document or the physical characteristics of the taxed object. That is why we need legislation to distinguish a pasty from a sandwich. Whenever we find ourselves in that position, we should ask the question: is there a better way of achieving the underlying objective?

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