VAT on UK private school fees?

Author: Vu H. Ngoc

The UK government announced the implication of VAT at the standard rate of 20% for private school fees from 1st January 2025. The “tax storm” is responsible for the severe increase in annual private school fees in the UK, leading to discussions of this controversial topic. Why did the authorities offer such a policy? What are their supporting arguments? What will be the potential effects of this measure?

The government's reasoning

The main objective of introducing VAT on school fees is to support the public finances, especially for delivering government commitments relating to education and UK youth. In simpler words, the government aims to use collected tax revenue from private education in the UK to increase state school spending and target students from disadvantaged backgrounds to the IFS report. What will be the influences? From the government's estimation, the policy is expected to grow up to around 1.7- 1.8 billion pounds (Exchequer impact) annually for the national budget from 2029-2030, which is a massive amount. 

According to the policy paper as well, though VAT will be imposed at a standard rate of 20%, the tuition will not increase exactly to that rate. Private schools in the UK have variations, based on each firm's commercial decision. In fact, to cope with this new measure, schools might reduce surplus and reserves, cutting excessive spending and increasing their tuition. Overall, some schools will absorb the tax partially, while others might pass the tax on to households through a rise of more than 20%. However, the government expects school fees to rise by about 10% and 15% on average. 

Another acknowledged risk of this policy on private schools that is worth mentioning is the school closures. The public authorities reckon these shutdowns are the result of transitional impact, not structural collapse. The natural closure rate of private schools is 3%, and might add a hundred more over 3 years. Empirical evidence from the historical context showed that pupils and the number of schools still remained stable despite increased fees. This supports the measure’s confidence, hence concluding that increased cost on educational firms' operation may not play a significant role. 

The effects on pupils, the main stakeholders of this policy, have both pros and cons. The policymakers believe that VAT will benefit the vast majority of school-age children who are attending public school. This is because the generated revenue will be used to contribute to government education priorities as stated above. Meanwhile, the minorities of school-age children who are attending private school may face some issues, but are not directly affected. Parents and Guardians are expected to pay for the increased fees, the result of this measure. In the case of being unable to pay or unwilling to pay, changing schools is inevitable. Pupils change either a state school or homeschooling, based on the family’s preferences. Though it might have a disruptive impact, especially on transition stages such as GCSEs and A-levels, the authorities believe the actual influences are negligible. However, the changes are not significant to the number of children in private schools, as only a small proportion of these students will be affected. Remaining students in the private educational sector still hold the majority. 

Nevertheless, it could be argued that households, specifically parents and guardians, will suffer greater effects compared to pupils. To cover increased fees, they may have to work more, which detrimentally influences their life balance. Despite these negative spheres, the state’s perspective is that this measure will not have a significant, direct impact on family formation, stabilisation and breakdown. School-age pupils are already offered state-funded school places, hence educational slot concentration will likely be alleviated. 

Overall, the governmental view on the official policy paper is pursuing the beneficial side of this policy, taxing the private sector to improve national well-being, specifically public education, while estimating that the side effects on stakeholders will be negligible. 

Critics' responses

Though the government may have predictions about potential risks and offer solutions, critics point out that they might underestimate in some aspects. Critical views suggest that the authority argument tends to “optimise” the policy in an optimistic perspective. At first glance, the policies draw anticipative scenarios- massive tax revenue with the least sectors being influenced. Understandably, they try to convince people of the advantages to achieve the greatest agreement. What about the side effects? Have they, the government, had thoughtful considerations before implementing the policy? 

The first point to argue for the VAT is that this measure could significantly increase pupil migration to state schools, which creates fiscal and operational risks. Maxwell Marlow, the author of “Short Term Thinking: Analysing the effect of applying VAT to school fees”, points out that the IFS (Institute of Fiscal Studies) estimated approximately 3-7% of school-age children will change their school into public status, which is not true. The IFS acknowledged that the evidence they drew on was “old” and “thin”. The analysis by Baines Cutler indicated that child migration can be up to 25%, and these cannot be excluded, as it is further based on elasticities research. He estimated a 25% migration could turn a projected £1.4bn gain into a £1.6bn loss for the Treasury. Why do we face such differences?

Estimation of elasticities drawn from a historical context is often unreliable and could potentially lack temporal validity. The study cited in the IFS analysis referred to Catholic schools in the US with sibling discounts in the year of 2002 (Dynarski, 2009). Clearly, the previous research does not apply to different cultures in further time duration, such as the British household in 2024-2025. Therefore, it is important to note that the present's parents cope with higher costs in comparison to the past, due to the higher price level. Even though the school fees are estimated to rise by 15%, it could break affordability, prompting students to migrate from private to state schools. Consequently, this phenomenon would force state education facilities to absorb from 90,000 to 135,000 extra pupils, thus operating at their maximum capacity and further leading to operational issues since the current infrastructure has not been modified for this change yet. The government might have to spend some extra budget on this scenario for renovating schools, so it loses more than it gains. The argument undermines the authorities' claims of predictable revenue and manageable migration, yet policymakers might overlook the analysis of elasticities and assumptions. 

Another point for evaluating is the loss of tax contribution from independent schools and labour. As stated above, the fiscal gain from the measure is fragile; further might also generate a massive loss of £1.6bn to the  Exchequer if migration rates reach up to 25%, making this policy fiscally risky. Also, according to the ISC (Independent School Council),  private schools contribute a substantial part- approximately £5.1bn to the national budget from direct, indirect and even induced taxes. This is considered a sizable pool at risk if the sector shrinks. And yet, school migration is inevitable in scenarios of increased fees, as parents may desire to switch to more affordable school tuition, further strengthening the arguments. Additionally, the switch between educational facilities may enable parents and guardians to work less because they are no longer needed to work as hard as before to afford tuition fees, so they might have spare disposable income and alleviate financial burden. The problem arises when these workers do not dedicate themselves to work as much as before the implication of the tax; a mitigation in income tax paid to the government is understandable. A paper from the Adam Smith Institution estimates the government might lose £90 million even if 1% of pupils leave the private schools (Maxwell, 2024). The theoretical loss remained a controversial topic.

Has the policy paper acknowledged these? The answer is “yes”; they already mentioned it in their statement, but why are there such differences? It is clearly observable that VAT on school fees alter households' behaviour: an Increasing trend of student migration into the state educational sector, the households' expenditure shifts to other VAT-free categories such as tutoring, housing, and labour withdrawal. This fragilized the government's justification for the tax, as it was against the “raising revenue” aim. These altered demeanours might turn the VAT into an uncertain net outcome, which used to be an ideal offer from the perspective of the state. In fact, policy makers predicted the results initially, but they might not weigh the variables properly and “overlook overall consequences”. Consequently, in the worst scenarios, the VAT risks fiscal loss and spreads uncertainty throughout households. The government might fail its objectives of funding £1.3–1.5bn for national education. 

These critical views emphasise some core limitations of the policy’s application in real-world scenarios. A critic's analysis is needed when there is an implication of a new policy because of brings wider, multidimensional approaches and thoughtful considerations of unexpected influences. 

Final thoughts

The policy aims to support and encourage state education, especially for children with disadvantaged circumstances, improving social well-being. Nevertheless, the occurrence of unintended consequences is unavoidable, and the severity of them might vary in different situations. The hybrid approach of governmental and critical views might aid in evaluating the policy holistically. However, individuals should be acknowledged that those analysis papers might assume the case in fictional, theoretical backgrounds, raising concerns about the actual validity of these predictions. Further conclusions need empirical evidence from reality observations. 

Reference:

• Marlow, M. (2024). Short term thinking: Analysing the effect of applying VAT to school fees. Adam Smith Institute.

• HM Revenue & Customs. (2024, November 15). Applying VAT to private school fees. GOV.UK https://www.gov.uk/government/publications/vat-on-private-school-fees/applying-vat-to-private-school-fees

• S.Dynarski et al, “Cheaper By the Dozen: Using Sibling Discounts at Catholic Schools to Estimate the Price Elasticity of Private School Attendance", NBER Working Paper No. 15461, October 2009

• L.Sibieta, ‘Tax, Private school fees and state school spending’, Institute for Fiscal Studies, July 2023.