Decreasing the VAT threshold in the Autumn Budget would increase inflation

The Autumn Budget debate

As the Chancellor, Rachel Reeves, prepares her first Autumn Budget, rumours are swirling that she could look at lowering the VAT registration threshold.

Some think tanks have argued that pulling more small businesses into the VAT system could boost growth and level the playing field. But many business owners fear the opposite, that it would push up prices, add layers of red tape, and ultimately squeeze margins.

That’s exactly the concern raised by  Partner Gabby Donald, who says any move to reduce the threshold would be a risky experiment for the UK economy.

Despite concerted advocacy from some think tanks, the Chancellor, Rachel Reeves must not reduce the VAT threshold in the Autumn Budget. The initial impact would be inflationary as more businesses become obliged to charge 20% VAT on top of any price increases to cover their additional compliance costs. Businesses providing services to consumers would be particularly affected.

In other words, the first effect would be straightforward: higher prices. A small café, tradesperson or design studio that previously wasn’t VAT-registered would suddenly have to charge 20 % on its services. For customers who can’t reclaim VAT, that means paying more. Multiply that across thousands of small businesses, and you’ve got an inflationary hit just when the Bank of England is still trying to keep prices under control.

A complex tax, not a quick win

The UK’s current VAT registration threshold of £90,000 is one of the highest in the world. That’s been both a blessing and a frustration.

It keeps smaller firms out of the VAT system entirely, saving them time and admin — but it also creates what’s often called a “cliff edge,” where some businesses deliberately slow down growth to stay below the line.

Proponents of a lower threshold say it would encourage more consistent behaviour and stop this “bunching” effect. But as Gabby points out, the reality isn’t that simple.

The case for arguing that a significant cut to the VAT registration threshold will stimulate growth is far from clear cut. A sudden, material reduction in the current £90,000 VAT threshold would bring large numbers of small businesses into the scope of quite a complicated tax. The impact of higher prices on consumer spending is likely to hit business’s profitability and in turn investment and employment.

The added paperwork, cost of software, and need for professional support can be a big leap for a sole trader or small partnership. For many, it’s not the tax itself that hurts — it’s the compliance burden and how it disrupts pricing and cash flow.

A modest return for a major disruption

Some have suggested that lowering the threshold would boost Treasury revenues. But Gabby suggests:

Reducing the threshold is unlikely to yield a significant increase in the tax take for the Government. HMRC’s VAT statistics for 2023 / 2024 show that more than 77% of the total VAT take of £168bn is paid by businesses with turnovers of £10m+. Only about £3.9bn in total is paid by businesses with turnovers of £150k or less, with the total VAT payable typically lower the smaller the business. If the threshold was reduced materially, greater demands would be placed upon HMRC but very little would be gained fiscally.

That paints a clear picture. The UK’s VAT revenue overwhelmingly comes from larger companies. Even if tens of thousands more small firms registered, the overall gain would be small  but HMRC’s workload would rise sharply. For a tax authority already stretched by digital transformation and compliance backlogs, that’s a serious consideration.

Why comparisons with other countries don’t work

Supporters of a lower threshold often point to countries such as New Zealand, which operates a Goods and Services Tax (GST) system with no real exemption for smaller firms. But as Gabby notes, the UK is not New Zealand.

Many of the think tanks and academics that favour bringing the threshold down significantly or removing it often talk about the benefits seen in smaller countries like New Zealand. But the UK economy and VAT system differ significantly from New Zealand, which has a much less complex equivalent to VAT, the Goods and Services Tax (GST) system, and the number of registered businesses will be much lower than would be the case in the UK.

There are roughly 2.7m VAT registered UK businesses in comparison to the total population of New Zealand, which is about 5.3m. While there is some evidence that the current UK VAT registration threshold inhibits growth, with businesses limiting their activities to remain beneath the threshold, the case for a drastic reduction in a large economy like the UK’s is far from proven. To implement this type of change quickly would be an extremely bold experiment.

In a smaller, simpler tax environment, the policy might work. In the UK, with millions of small enterprises operating on tight margins, the consequences could be far less predictable.

A balancing act for the Chancellor

Rachel Reeves has been clear that fiscal credibility and growth are her two guiding principles. But a VAT threshold cut risks undermining both. With inflation still above the Bank of England’s target and consumer confidence fragile, measures that nudge prices higher could quickly backfire.

At the same time, small business sentiment is already under pressure. The Federation of Small Businesses recently warned that a lack of clarity on future tax thresholds leaves many entrepreneurs hesitant to invest or hire. In that context, predictability may be more valuable than reform.

What small businesses and entrepreneurs should do to prepare

If a lower VAT threshold is on the horizon, here are some sensible steps to take now:

Check your turnover carefully and forecast ahead. Know where you are relative to the £90,000 mark, and where you might be in 12 months. Factor in seasonal variations. If you’re close, model what happens if you cross the threshold.

Assess your cost base. Review what inputs you spend VAT on. If many costs have VAT, registering can help you reclaim input VAT (if eligible), which can soften the blow somewhat.

Review pricing strategy. Can your customers bear price increases? If most are not VAT registered themselves (for whom the VAT is a cost), you may need to absorb some or all of it to stay competitive.

Get your bookkeeping and systems in order. A shift over the threshold means more rigorous accounts, sharper invoicing, VAT returns. Good record-keeping and perhaps better software or advice will help.

Consider voluntary registration ahead of necessity. Sometimes going VAT registered early gives you time to adjust systems and customer communication, rather than being forced overnight.

Seek specialist advice. Talk to your accountant or tax advisor. They’ll help you understand your options, such as using VAT schemes (e.g. Flat Rate Scheme, Margin Schemes, etc.) that may reduce complexity or cost.

Communicate with customers. If price changes are unavoidable, transparent communication can help maintain trust. Explain carefully why costs are rising, especially in service sectors where VAT cannot be reclaimed by customers.

Talk to us

A lower VAT threshold might sound like a simple tweak, but as Gabby Donald highlights, it could have wide-ranging consequences – from fuelling inflation to piling pressure on the smallest firms.

If you think your business could be affected by any change announced in the Autumn Budget, talk to us. Our VAT specialists can help you assess your position, plan ahead, and make sure you’re ready — whatever the Chancellor decides.

At Blick Rothenberg, we’ll continue to analyse potential Budget measures as they emerge and share our insights on what they mean for businesses and individuals across the UK.

If you would like to discuss any of the above, please speak to your usual Blick Rothenberg contact or Gabby using the form below.