How changing the VAT threshold affects UK revenues

The UK requires businesses to register for VAT and charge customers 20% on their sales once annual turnover reaches £90,000, up from £85,000 in 2024-25. The Telegraph reported that Chancellor Rachel Reeves is considering further increases to the VAT threshold.

We analyse how VAT threshold changes between £70,000 and £120,000 would affect revenues and the number of VAT-paying firms for the 2026-27 fiscal year. We constructed synthetic firm microdata to generate these projections and compare them with HMRC's official estimates.

We calibrated synthetic firm microdata to official UK business statistics from two sources: ONS UK Business statistics for overall firm distributions and HMRC VAT statistics for VAT-registered businesses.

Figure 1 shows the distribution of UK firms by turnover band in 2024 according to ONS business statistics.

ONS data shows 32.1% of UK firms have turnover between £100,000 and £249,000, with 14.3% below £50,000 and 19.7% in the £50,000-£99,000 range. Most UK businesses operate with turnover below £250,000.

Figure 2 presents the distribution of VAT-registered firms by turnover band in 2024-25 from HMRC statistics.

HMRC data shows 31.1% of VAT-registered firms have turnover between £1 and £90,000, just below the registration threshold, with 14.0% in the £90,000-£150,000 band.

We constructed synthetic firm microdata through multi-objective optimisation that matches both ONS firm structures and HMRC targets. The data captures firms by industry classification, turnover bands, employee counts, and VAT tax liability.

Figure 3 shows the resulting distribution of UK firms by annual turnover in 2024.

The distribution shows drops in firm density above both the £90,000 VAT threshold and the £150,000 VAT Flat Rate Scheme limit, which offers simplified VAT accounting for smaller businesses.

We construct the initial synthetic firm set for 2024-25, then age turnover and VAT liability values to 2026-27 using growth factors from the OBR's Retail Price Index forecasts, maintaining the same number of firms. Projections assume no behavioral responses to threshold changes.

HMRC published revenue projections for raising the VAT threshold from £85,000 to £90,000 across the 2024-29 period. My colleague Max Ghenis confirmed that HMRC assumed baseline thresholds of £85,000 in 2024-25, £87,000 in 2025-26, £89,000 in 2026-27, and £92,000 in 2028-29. Figure 4 compares PolicyEngine's estimates with HMRC's projections.

Both models project revenue losses in the first four years, followed by gains in 2028-29. HMRC estimates a £185 million loss in 2025-26; PolicyEngine projects £184 million. The 2028-29 revenue increase occurs because HMRC's baseline assumes the threshold would grow with inflation to £92,000 by that point, so fixing it at £90,000 captures more firms. PolicyEngine's estimates deviate an average 12.3% from HMRC's projections across all five years.

Figure 7 shows revenue impacts for different thresholds in 2026-27.

In 2026-27, a £70,000 threshold would generate approximately £642 million additional revenue while a £120,000 threshold would reduce revenue by approximately £1.1 billion.

Figure 5 shows how different threshold levels change the number of VAT-paying firms in 2026-27.

A £70,000 threshold would add approximately 109,000 firms to VAT registration in 2026-27, while a £120,000 threshold would remove approximately 116,000 firms.

Our synthetic firm microsimulation model shows that VAT threshold changes affect government revenues and the number of VAT-registered businesses. Raising the threshold to £100,000 would remove approximately 48,000 firms from VAT registration in 2026-27, reducing revenue by approximately £371 million.

This analysis represents PolicyEngine's first application of firm-level microsimulation to UK tax policy. In the coming weeks, we'll apply this VAT model to evaluate other policy alternatives, including sector-specific thresholds, phase-ins, and mechanisms to address cliff effects.