Labour Hasn’t Done its Homework: Plan to Charge VAT on Private School Fees Will Not Raise £1.7 Billion

The Labour party plans to end charitable status for private schools, applying 20% VAT and business taxes to raise £1.7 billion and help improve social mobility via the state education system. Conservative Chancellor Jeremy Hunt showed only lukewarm opposition in his Autumn Statement, appearing substantially to accept Labour’s calculation (incidentally, HMT confirmed in response to a FoI inquiry that they had no supporting analysis regarding VAT and school fees). Meanwhile Darren Jones MP (Labour) says it’s a bad idea and won’t raise money anyway. What to make of this?

I wrote to Shadow Education Secretary Bridget Phillipson – personally and via my MP – asking for Labour’s business case, and have been looking forward to a reply for several months. So neither Labour nor the Treasury has actually published any assumptions or cost/benefit. I was excited when the Institute for Fiscal Studies published a review. According to one of the IFS founders, “never again should a government, regardless of its political colour and intentions, introduce far-reaching tax legislation without the benefit of deep and thorough analysis of second- and third-order effects”. That sounds sensible.

Disclosure – I’m a private school parent. But I’m also a taxpayer and an economist, of sorts, and I care very much about the state education that taxpayers buy for other children. I can also see the logic in robbing Peter to pay Paul, even when I oppose it. But when Labour wants to rob Peter to punch Paul in the kidneys, we’d all really rather they didn’t. Surely, I thought, the IFS will go into all the unintended consequences and provide us with the clarity that is missing?

Disappointingly, the IFS recites Labour’s lines. Its headline is Labour is basically right – the 20% effective fee increase will cause only a small migration to state schools, which won’t cost much, and everyone else will suck it up and pay, so that there is “net gain to public finances of £1.3 to £1.5 billion”, only just shy of Labour’s £1.7 billion. It only briefly mentions risks, but they are buried deep in the report and omitted from the press release, which is probably the only bit journalists will read. It certainly doesn’t quantify them as in “…and if we are wrong, the net tax impact could be neutral or strongly negative”, which is ironic given the power of the “worst-case scenario” in climate and lockdown politics.

I remain convinced this policy is crackers. It is more likely to lose billions than raise them and it will harm not help state schools (as well as harming or closing private schools). We should expect the departure of significant numbers of children from private schools and their (disgruntled) arrival in the state sector, demanding places that are not funded and that physically do not exist; the “second- and third-order effects” that I indicate here are strongly tax-negative and remain ignored.

I don’t know many people who think Labour can be dissuaded from their crackpot policy. I’m more optimistic. I believe (1) it’s a rich political vein for Conservative and Lib Dems; (2) there’s mileage in simply demanding Labour publish their working; and (3) the Treasury will, in time, conduct proper cost-benefit analysis and it will be published. I’ll keep asking. For now I’ve written to the IFS author, Luke Sibieta, raising my questions as an economist, and await his response.

Here are the highlights from my letter.

Elasticity of Demand (how demand responds to effective price changes)

Mr. Sibieta states his “best judgment” that VAT on school fees will lead to a 3-7% reduction in private school attendance. His justification is to assert that “the effects of fee rises are quite weak” based on observations since 2010. Essentially, the rich will pay, they always do. But an economist of Mr. Sibieta’s standing ought to recognise that:

In general, we can’t predict the future based on the past. Specifically, predictive analysis can be quite accurate for markets with easy switching, frequent purchases, large but divisible quantities, and well-observed historical price shifts, such as groceries or forecourt petrol. It is “unusual” to rely on it where switching is costly, there are long-term relationships, decisions are binary, and where the main substitute is perceived (rightly or wrongly) as vastly inferior.
The link between past and present is completely broken given changes in the macroeconomy. Mr. Sibieta makes no mention of house prices, interest rates, earnings, core inflation, aging relatives, pensions or the tax increases which all parties agree should “fall on the broadest shoulders”, as if private school affordability is unaffected by these tectonic shifts.
Price elasticity is not (as Mr. Sibieta assumes) constant. Just because I accept a hike this time, doesn’t mean I will accept another hike next time. There is a risk of a ‘last straw’ effect.
Disposable income, and its distribution, is of greater importance than Mr. Sibieta’s blanket observation that “15-20% of household income goes on private school fees”. It is not even clear if Mr. Sibieta is referring to post-tax income; he should certainly deduct core expenditure, mortgages and pensions, and should review the distribution – because it is the families “at the margin” that drive elasticity of demand, not the existence of a few billionaires at our more famous schools.

School Closures or Contractions

Mr. Sibieta appears to assume no schools will close following the loss of 3-7% of pupils (let alone, as I believe, many more); for those schools surviving under reduced demand, he does not consider they will be forced to cut costs. In either case, Mr. Sibieta does not consider any effect on:

Lost VAT receipts and state school costs from pupils forced out of private schools not by affordability, but school closures.
Income tax and NICs; benefit claims if redundant staff are unemployed.
Payments to suppliers – and their income tax, NICs, corporation taxes, and benefit claims if they make redundancies that conclude with unemployment.
Tertiary impact of a+b+c via multiplier – in other words, the loss of (taxable) economic activity that those various firms and employees no longer generate from their own expenditure.

Labour Supply

One cheer for Mr. Sibieta who does at least mention “potential reductions in labour supply” as a risk, albeit not in the press release. He doesn’t explore the issue further – and it’s a big one, potentially costing the taxman some billions of pounds via secondary and tertiary effects:

People become high earners/wealthy mostly via some combination of hard work, personal sacrifice and ambition. “Top earners afford private school” is half-true, the other half being “people wanting private school become top-earners”.
For those at the margin – earning, let’s say, £150k across both parents, which covers mortgage, bills, groceries and two average day-school fees, leaving about enough for one elderly car and one holiday a year – for such people, life is not luxurious. If they are doing it on two full-time jobs, it’s genuinely hard. It’s not the same ‘hard’ as struggling on benefits as a single parent – but it’s hard.
If those families leave private school for the state sector, it’s like becoming £300,000-£500,000 richer (based on 10-13 years at a school for two kids, average fee estimates ranging from 15-17.5k, never mind more expensive schools at double that price or more), raising a significant chance they quit, work less, or retire earlier. Or, if you’re a younger family, making career choices to become a high earner and afford private school… well, perhaps you just won’t bother.
The motivation to reduce work could also be associated with (a) childcare issues (state school hours being less than private school hours); (b) wanting to manage extracurricular activities no longer provided at school; and (c) wanting to provide parental tutoring to support what may be seen (rightly or wrongly) as inadequate academic provision.
It doesn’t take many top taxpayers reducing or quitting work (or younger people choosing not to adopt high-paying career paths) before the consequences for NICs and income tax alone reach some £billions, and Labour’s policy is blown away…
…and that’s before considering the tertiary losses. At the risk of sounding repetitive, it’s the lost (taxable) value-add to those higher-earners’ employees, employers and customers (doctors, anyone?); it’s the lost (taxable) employment of armies of cleaners and gardeners who serve the time-poor, and otherwise risk claiming benefits; it’s the multiplier effect of all those people’s reduced (taxable) economic activity downstream… etc. ad nauseam.

Mr. Chips is a pseudonym for an employee of a private school.