Unintended Consequences of Charging VAT on Private School Fees Could Cost Treasury up to £1.8 Billion

Leading think-tank warns that parents who pull their children out of private schools may decide to work fewer hours, costing the Treasury millions

• Parents who are currently paying school fees, but who cannot afford to keep doing so if 20% VAT is levied, will experience a boost to their finances when they move their children out of their private school and into a state school. This could mean that they don’t need or want to work as much as they are now;

• Teachers, doctors and other skilled workers may decide to switch to working part-time, retire earlier than expected, or even quit immediately;

• This would have harmful knock-on effects to the rest of the economy- these parents would pay less tax, businesses would suffer, and the UK could become less productive;

• The Adam Smith Institute (ASI) has looked at the evidence on what happens when someone receives an inheritance or wins the lottery, and found support for the ASI’s concern that parents moving their children out of private school are likely to work less;

• Based on this evidence, the think-tank looked at what would happen if 40% of the money that parents earn, or the hours they worked, specifically to pay for the school fees was taken as leisure;

• It found that this unintended consequence alone could cost the Treasury between £360 million and £1.81 billion, depending on how many children migrate to state school;

• The ASI urges the Government and the OBR to take this into account ahead of the Autumn Budget on the 30th October.

A new report by the Adam Smith Institute (ASI) warns the Government about one of the many negative impacts that charging VAT on private school fees could have. Parents who take their children out of private school may decide to work fewer hours, retire early, or leave the labour force altogether. This doesn’t just mean that many of these higher earners will pay less in tax. They’ll also be reducing their economic output, making businesses less productive, and which in turn will pay less business tax and VAT. This will be a drag on growth for years to come.

In order to pay the average annual £17k of school fees for two children over 10 years, a family will need to make a total of £340,000 of disposable income. If this family cannot afford to pay the extra VAT on their school fees, they experience a big wealth gain- enough to buy them a house. 

Author Maxwell Marlow has looked at the evidence on what happens when people experience a similar wealth gain, for example when they inherit money, or win the lottery. This backs up the ASI’s concern that parents experiencing a similar ‘windfall gain’ will reconsider how much they need to work.

Based on evidence, the ASI looked at what would happen if 40% of the money that parents earn, or the hours they worked, specifically to pay for the school fees was taken as leisure. It found that this unintended consequence alone could cost the Treasury between £360 million and £1.81 billion, depending on how many children migrate to state school.

The ASI has built on its original report on the consequences of charging VAT on private schools, which found that the policy could make no money at all, or even cost money, overwhelm state schools, and harm underprivileged children. 

If parents decide to work fewer hours then, combined with the other unintended consequences outlined in the ASI’s original report, this could mean that, in the IFS’ highly optimistic scenario in which 5% of children leave their private schools, it could raise a net £0.84 billion. If 10% leave, it could raise no money at all. If 25% leave, then it could cost as much as £2.51 billion.

Maxwell Marlow, Director of Research at the Adam Smith Institute and report author said:

“There is very little evidence on what will happen if the Government imposes a tax on private education, because most countries have never tried it. The only exception has been Greece, which had to reverse it because it was such a disaster.

So the truth is we just don’t know what will happen when VAT is charged on school fees. It is not possible to exactly predict how many children will leave, how many parents will reduce their working hours and to what extent, and what kind of impact it will have on state schools. That is exactly why it’s so risky.

What evidence on people who have experienced other types of wealth gains tells us is that it is likely that parents will reconsider how much they want, and need, to work. That has a wider impact on society as well as the economy. Every Doctor who works fewer hours, for example, will perform fewer medical operations.

At a time of low productivity growth, a staffing crisis in sectors such as teaching and medicine, and a skills gap, it is vital we don’t create further disincentives to work. We urge the Government and the OBR to take these unintended consequences into account ahead of the Autumn Statement in October.

-ENDS-

Notes to editors:  

For further comments or to arrange an interview, contact press@adamsmith.org | 0758 477 8207.

In March 2024, the Adam Smith Institute released its original report on the topic, “Short-Term Thinking: Analysing the Effect of Applying VAT to School Fees.” This can be read here.

Maxwell Marlow is Director of Research at the Adam Smith Institute. 

The Adam Smith Institute is one of the world’s leading think tanks. It is ranked first in the world among independent think tanks and as the best domestic and international economic policy think tank in the UK by the University of Pennsylvania. Independent, non-profit and non-partisan, the Institute is at the forefront of making the case for free markets and a free society, through education, research, publishing, and media outreach.