Addressing the tax gap by increasing UK customs duties

Customs duties in most countries are charged on goods which are imported. The rate of duty varies from product to product, and is intended in part to provide some degree of protection for domestic producers, against cheaper imports from other countries. Most WTO members apply duty on the value of imported goods, with a range of reliefs and preferences available depending on the intended use of the goods and/or the economic origin of the goods. Over the last 30-40 years, a push towards globalisation has driven duty rates lower, helping to justify the off-shoring of labour-intensive manufacturing to lower cost economies.

The world of international trade is changing

The boom of Chinese manufacturing is showing signs of slowing down. As China’s economy has developed, there is an increase in wealth within the country, and a corresponding appetite for more luxury goods. This is challenging the capacity of Chinese manufacturers, and competing against the demands of its export markets.

Geopolitical events are disrupting international supply chains. Chinese goods can no longer enjoy safe passage to Europe through the Red Sea, with the sea route around Africa adding significant time and cost to supply chains. Sanctions resulting from the hostile activities of Russia are adding complexity and cost to supply chains. The US is becoming increasingly protectionist, imposing significant deterrent duties against goods from China, as well as applying pressure on other economies to follow suit. Certainty of supplies from distant manufacturers is under threat, raising questions about the future sustainability of globalisation.

The UK is far from immune to these threats. Departure from the European Union has created an additional international border with its closest and largest trade partner, leaving the UK to stand alone on the world stage. A new UK government is desperately short of revenue, and having made election manifesto commitments to not increase conventional taxes, must exercise some imagination to help repair its economy.

Customs duty

Since Brexit, customs duties on imported goods in the UK are no longer the sole domain of the European Commission but are now wholly within the powers of the UK Exchequer. This means that we now keep all customs duties collected, with no requirement to hand any over to Brussels. In the latest published annual report by HMRC, the UK collected c£4.5bn in customs duties, down from £5.8bn the previous year.

Current customs duty rates in the UK are low and actually zero on over half of all products, which does nothing to deter UK consumers and manufacturers from importing goods and materials from overseas. This consequently creates little or no stimulus to generate UK manufacturing and encourage sourcing from within the UK.

WTO commitment

However, customs duty rates for WTO member countries on all products are subject to “bound” rates. These are in effect upper rate limits, and many are significantly higher than those in place today, allowing scope for increases. WTO members are free to set their own rates of customs duty, providing they stay within their “bound” commitments.

The UK import tariffs are currently well within its bound commitments, allowing scope for increases in customs duties. The following table summarises UK data published in the WTO’s World Tariff Profiles 2024.

Tax gap

Whilst the “simple average” of UK duty rates applied is shown as 3.8%, HMRC’s Annual Report 2024 shows that the actual average rate of customs duty collected is just 0.8% of the value of imported goods, down from 0.92% in the previous year.

The reduction in import values can partly be attributed to the UK’s sluggish economy, but is also widely understood to derive from an increased use of low value facilitation, whereby e-commerce shipments to individual consumers below £135 in value are exempt from customs declaration formalities. It is widely believed that this threshold is being abused, in particular by Chinese exporters to online customers.

The difference between the simple average duty rate of 3.8% and the actual average of 0.8% indicates a significant tax gap, of which a large proportion could be attributed to abuse of the low value threshold.

If the simple average rate of 3.8% was actually achieved, this would yield revenue of £21.4bn, even on a (suppressed) value of imports at 2024 reported levels.

Measures needed

In order to make inroads to address this tax gap, there are two immediate measures which could deliver results quickly: 

1. Increase customs duty rates 
2. Remove the low value threshold for e-commerce imports.

Increasing duty rates

At face value, an increase in customs duty rates may seem unpopular and present a restriction on freedom of choice for UK buyers, whether for materials for manufacturers or finished goods for retailers. A staged implementation of small increases over a period of, say, ten years, however, would soften the impact and at the same time give UK importers the opportunity to restructure their supply chains, with support for reshoring and generation of new UK manufacturing to replace the current offending imports.

It would be unlikely that other countries would seek to impose retaliatory measures on UK exports. Instead, it is more likely that they may seek to agree trade deals in order to secure preferential duty treatment on their exports of qualifying originating goods. Overseas manufacturers may be encouraged to locate / reshore operations in the UK, such that resulting products may attain UK preferential origin status for export to FTA partner countries.

Removing the low value threshold

Many retailers in the UK are heavily dependent upon Far East manufacturers, however, are already facing increasing threats from a burgeoning e-commerce industry, with significant volumes of low value packages from Far East e-commerce suppliers direct to consumers. The existence of a low value threshold of £135, below which no duty or import VAT is declared, encourages fraudulent underdeclarations of value, and subsequent loss of revenue to the Treasury, as well as unfair competition for UK retailers.

In line with steps being taken by other major economies, including the European Union, a removal of the low value threshold on e-commerce imports would increase the burden of reporting and collecting revenue, and would increase the cost of goods to the consumer. This could also be seen as restricting the consumer’s freedom of choice to locally made goods, which needs to weighed against the benefits.

On the plus side, the abuse of the low value threshold would be tackled, and revenue collected to remove the unfair advantage of overseas e-commerce sellers over UK retailers. Removal of the threshold might not necessarily prevent underdeclaration of customs values, but the incentive to do so becomes one of reducing the liability, rather than evading it completely. Additionally the requirement to complete customs declarations provides HMRC with better quality statistics in order to target risk and deploy resources effectively.

With this in mind, the UK would be well placed to see benefits from removing the e-commerce low value threshold and increasing customs duties on imported goods, which could include: 

• More revenue collection – closing the tax gap 
• Stimulus for the generation of UK manufacturing and employment, through reshoring 
• In the longer term, less dependence on overseas suppliers 
• Reduction in environmental damage from long distance movements of goods 
• More sustainable and resilient supply chains, with reduced exposure to supply chain volatility arising from geopolitical events

Mitigations

The UK already has a range of customs reliefs and simplifications which can continue to provide duty free access for essential imports, including those necessary to produce goods for export from the UK, or for goods whose import has no detrimental impact on UK manufacturers. The UK’s commitment to existing and new trade agreements can also continue to benefit the import of goods which fulfil specific origin criteria, so an increase in customs duties need only impact supplies of goods which are not considered to be “essential”.

Conclusion

As mentioned above, other countries are also tackling the issue of e-commerce packages from China by reducing or removing their low value thresholds. There are also strong indications that Chinese manufacturers are focussing more heavily on their domestic market, with corresponding reductions in export capacity. This looks likely to influence a greater shift towards reshoring in the coming years, for which the UK should take an opportunity to prepare.

At a time when the UK economy is subject to supply chain volatilities, when its manufacturing sector has slipped outside the world top 10 rankings, when environmental sustainability is an increasing priority, and yet government is desperately short of revenue, surely there is a compelling need to consider the potential for addressing the tax gap by increasing customs duties and removing the e-commerce low value threshold.