Regressive taxes: at a glance
- What do I need to know? Regressive taxes charge everyone the same rate, regardless of their financial situation.
- What does it mean for me? During times of financial crisis, businesses could feel the impact both directly and indirectly.
- Why does it matter? Understanding your tax responsibilities and how to minimise unnecessary losses can protect your business’s cash reserves.
Regressive taxes can represent a hidden challenge for CFOs. While they don’t scale with profits, they can introduce unpredictability, especially during economically challenging times.
Depending on your target consumers, regressive taxes can act as a drag on sales by reducing the purchasing power of your customers.
That’s why it’s more important than ever to protect your business’s safest asset, cash. Your cash reserves can act as a buffer to keep you resilient in difficult times and flexible when things improve.
In this guide, you’ll learn how regressive taxes can threaten your profits in ways you may not expect.
What is a regressive tax?
A regressive tax applies the same flat charge to goods and services, regardless of the buyer and how much they earn or own.
Although that may sound fair in theory, this means the cost takes up a higher proportion of wealth for people that have lower discretionary spend.
This can influence consumer habits. For example, shoppers may move away from independent retailers towards budget supermarkets during challenging financial times.
For CFOs of small businesses especially, these changes in consumer behaviour can impact earnings and even drive pressure to lower prices to stay competitive.
Who is most affected by regressive taxes?
Regressive taxes typically impact two groups the most - lower earners and small, consumer-facing businesses. And there’s often a direct relationship between the two.
During periods of high inflation, consumers’ cash can lose its purchasing power at a rapid rate. This means that not only are your customers spending more of their income on costs they can’t avoid, the cash they have left over buys less. This combination can cause some consumers to reevaluate their spending habits.
There’s also a more direct impact for businesses. Taxes like VAT and Fuel Duty directly add to business expenses (more on these later).
For CFOs of consumer-facing businesses, this represents a dual challenge. When customer demand falls at the same time that costs rise, it can be difficult to manage cash flow.
Types of regressive taxes and their on impact your business
There are various regressive tax structures in the UK that could risk your profitability.
VAT
Value Added Tax (VAT) is applied to the sale of most goods and services in the UK. HMRC mandates that you charge VAT at a flat rate of 20% for most products.
You’ll usually pay VAT on most of the goods and services you need to run your operations. You can often reclaim these costs through your VAT return.
VAT can still have an impact on your business, though. You’re required to charge VAT on goods and services you sell on behalf of the government. If VAT rises, you could encourage lower earners to switch to a lower cost alternative.
This can result in a balancing act for CFOs, adapting prices to remain viable for lower earners without compromising cash flow.
Fuel duty
The UK government applies fuel duty tax on the purchase of petrol and diesel, as well as some other fuels. This is in addition to VAT.
Fuel duty is currently applied at a flat rate of 52.95 pence per litre, regardless of the buyer. This makes it a regressive tax, as the cost to fill up a tank, or total transport costs for businesses, represents a more significant investment for those with less money.
Unlike VAT, you cannot reclaim fuel duty for petrol or diesel, meaning transport and fleet management costs can cut into profits, especially for CFOs of small businesses. And if you bake these costs into what you charge customers, you risk pricing out lower earners.
But there are ways to mitigate these charges, including exploring sustainable alternatives to petrol and diesel, and focusing on local sourcing (more on this later).
Tariffs
Tariffs are taxes applied by governments on any goods imported into their country. Tariffs are designed to encourage domestic production and investment by making imported goods more expensive.
While there’s no universal tariff charge, the taxes are usually applied at a flat rate based on the type of goods and their country of origin. The UK Global Tariff outlines how much you’ll pay on goods imported from different countries.
CFOs may face challenges navigating tariffs, especially during times of economic uncertainty. If you rely on imported goods, you’ll either need to absorb the cost of the tax or increase pricing. Both can negatively impact your profitability if you’re not careful.
You can restructure your supply chains to focus on local sourcing. But this could involve higher up-front costs or reduced reliability compared with a proven, long-term supplier relationship.
How can CFOs insulate businesses from the impact of regressive taxes?
While you can’t always avoid the negative impact of regressive taxes on your business, there are ways you can minimise your costs.
Access tax relief
There is tax relief available to small businesses. A few examples include:
- Employment Allowance: Depending on your circumstances, you may be able to claim up to £10,500 per year in tax relief. Whether or not you qualify is determined by how much you pay in National Insurance Contributions (NIC).
- Capital allowances: You can deduct the cost of machinery and essential business tools from your taxable profits. In general, you can’t claim capital allowances for a residential building, though there are a few exceptions to this rule.
- Research and Development (R&D): If your business invests in research, you can claim back tax. Not all research qualifies for the relief, so it’s important to check the details with HMRC.
Tax rules are complex and change on a regular basis. If you’re unsure whether your business qualifies, speak to an officially chartered accountant or a Chartered Tax Adviser (CTA).
Local sourcing
Prioritising local suppliers and partnerships could save you money if high tariffs persist. And keeping your network nearby could also save on fuel duty costs for businesses with high-volume transport requirements.
Protect your cash
During uncertain times, businesses fall back on cash. And while taxes can still impact your bottom line, CFOs can minimise unnecessary losses by protecting cash in high-interest accounts.
Leaving cash sitting idle in current accounts or low-interest savings accounts means it could lose purchasing power to inflation.
Keeping your cash in high-interest business savings accounts grows your reserves to create a valuable buffer, while making it accessible when the next opportunity or tax bill arrives.
FSCS protection
The UK’s Financial Services Compensation Scheme (FSCS) protects your business’s cash up to £85,000 if your authorised financial services provider goes out of business. So, for CFOs, spreading your cash reserves across multiple accounts to maximise your FSCS allowance can protect your total funds.
But remember, banks that share a license are treated as the same entity, meaning your cash is only protected up to £85,000 when spread across certain accounts. Moving money between banks with different licenses can give you full FSCS protection for each account.
Regressive vs. progressive taxes
The opposite of a regressive tax is a progressive tax. In a progressive tax system, different rates are applied depending on how much you earn or own.
An example of a progressive tax in the UK is Income Tax, which is applied in brackets based on how much you earn. The more you earn, the higher the rate of tax applied.
Frequently asked questions about regressive taxes
What are the advantages of regressive taxes?
Regressive tax structures are simple by design and therefore quite easy to enforce. They apply flat rates to certain goods, services, or industries. For CFOs, this makes it simpler to calculate your business’s tax bill and can support more straightforward cash flow forecasting.
You won’t face higher rates as your revenue increases, reducing some of the complexity that comes with financial planning as you grow.
What are the disadvantages of regressive taxes?
Regressive taxes can create hidden challenges for CFOs. Regressive taxes can impact operating costs during a financial crisis or when a significant amount of a company's expenditure goes on taxed goods or services.
During these times, your costs can increase while customer demand declines, making it difficult to protect cash flow.
You can either absorb these costs and reduce profits, or pass them on to customers and potentially impact demand. Ultimately, this can put SMEs (Small and Medium Enterprises) at a disadvantage compared with larger competitors with greater cash flow and flexibility.
Which countries have regressive tax systems?
Many of the largest economies in the world apply some regressive tax structures on certain industries, including the UK, the US, and Germany.
Are ad valorem taxes a regressive structure?
Ad valorem taxes are applied as a flat percentage to goods, rather than buyers.
This means they’re typically regressive, as the cost of goods or services represents a more significant investment to those with less money.
Are indirect taxes considered to be regressive taxes?
Indirect taxes are applied to goods and services, rather than businesses or profits. This means they’re often regressive, as products cost the same amount regardless of the buyer and their relative wealth.
Protecting and growing your business’s cash
Cash is your business’s most conservative asset, fuelling growth when invested with care and providing security during financial crises. Regressive tax structures weaken consumer demand, potentially threatening to wear away at your cash reserves.
At a challenging time for businesses, CFOs and Finance Directors can prioritise effective cash flow management to generate an essential buffer. This protects your business’s cash reserves and helps you become more financially resilient at the same time.
Holding cash in high-interest accounts allows you to grow your reserves, protecting it against inflation. This also provides the perfect accessible environment for your cash as you plan for next year’s tax bill.
This won’t make regressive taxes disappear. But anticipating their impact on costs and consumer demand, and protecting cash in the right accounts, can help your business adapt and grow in challenging financial situations.
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