Sunday 21 November 2010

VAT tomfoolery over at John Redwood's

The patron saint of Home-Owner-Ism trotted out the old propaganda yet again:

Some tax rises can be self defeating. VAT is probably the least bad tax option. Hiking the rates of CGT, Income Tax and profits tax might result in less revenue being collected. It is all too easy to put people off enterprise.

You can drive them or their profits and earnings abroad very quickly. Higher rates of Income Tax and CGT are more damaging to tax revenues and the rate of business investment and growth than higher VAT.


Nope. I left a comment as follows (ever so slightly tidied up):

Wrong. VAT is by far and away the most damaging tax.

1. It distorts massively between VAT-able and non VAT-able businesses (which are mainly those related to banking and finance, or land, i.e. food and housing, i.e. those things that got us into this recession).

2. Corp tax is a tax on the return on capital, but if you are making losses you pay nothing, so it does not eat into the capital itself. VAT has to be paid whether a business is profitable or not, so it eats into capital.

3. VAT acts as a barrier to entry/barrier to growth for new and smaller businesses, because the £70,000 threshold means that a business with a turnover of £69,000 has to leap straight to a turnover of about £90,000 before it even catches up. Further, new businesses tend to make losses in the first couple of years, so it benefits incumbents, see point 2.

4. As a simple matter of observation, VAT is largely borne by the producer, not by the consumer. Consumers cannot magic money out of thin air to pay 2.5% more than they were doing before.

5. One sign of competitive (i.e. efficient, i.e. successful) industries is where net profit margins on sales are very low (5% to 10% is about normal, across all businesses). So very profitable businesses earning more than 5% will become less profitable, marginal businesses with profit margins of 5% or less will be in the danger zone; and businesses in the danger zone, say 1% or 2% net profits will go bankrupt.

6. If you grind the figures, the knock on effect of trying to raise an extra £13 billion from VAT will be that corp tax receipts go down, PAYE receipts go down, unemployment and welfare costs go up. It is quite possible that incremental extra tax revenues minus additional welfare payments is so close to zero as to make this a very dangerous experiment indeed.

7. VAT is imposed by the EU, and as a Tory MP, you might be aware that the EU wants all Member States to harmonise VAT at 20% – to pretend that this is to try and reduce the deficit (which is not going down under the Tories, I might add) is a bit feeble.

8. If we are to try and tax ‘consumption’ rather than ‘production’, taxing the output of enterprise, labour and capital is NOT the way to do it. You have to try and identify something that has value, which people are prepared to pay for but which is not actually ‘produced’ in any meaningful way (and certainly not by individuals who can change their behaviour).

9. So how about a tax on the ‘consumption’ of land? This cannot be created, destroyed or taken abroad, so all you’d be doing is replacing privately collected taxes (ground rents) with publicly collected taxes (Land Value Tax) and reducing publicly collected taxes on output, income and profits accordingly.

12 comments:

Bill Quango MP said...

Very true about VAT. Its a bad tax that just happens to be fairly easy to collect.

The VAT is on mails in January, as you were mentioning some time back. But it only applies to add on services, rather than VAT on mail.
Silly way of doing it as its going to raise almost nothing, except confusion.

Mark Wadsworth said...

BQ, but it's not 'easy to collect', it is a pain in the arse to calculate and even more difficult to get right than PAYE (corporation tax is a doodle in comparison).

Further, actual VAT collected against what a static model predicts is about 85% - 90% (evasion, bankruptcy etc), as against Business Rates and Council Tax which have collection rates of 98% - 99%.

Bayard said...

Mark, it's dead easy for the Government to collect, as they get us poor sods in the productive economy to do it for them.

Electro-Kevin said...

Brilliant comment, Mark.

We already have hidden inflation* and we are about to get even more of it.

*Thinner matches, shorter-lived light bulbs, poorer quality shirts, smaller Wagon Wheels, fewer Pringles ...

Lola said...

MW your comment isn't up on JR's blog yet - so I added my two-pennorth.

It's daft really. JR runs an outfit called Evercore Investment Management. He aught to be able to see what VAT does.

Mark Wadsworth said...

B, sure, it's businesses doing nearly all the 'collecting and calculating' hassle, but that doesn't mean that the hassle is out of all proportion to the amount actually paid over (of which large amounts simply aren't paid over at all).

EK, thanks. The ugly flipside of producers bearing the tax is that 2.5% VAT hike only leads to (say) 1% increase in prices, but 'They' will be able to fob off half of the actual inflation rate of (say) 5% as being down to the VAT hike, so they can pretend it's underlying inflation of 2.5%, when actually it's underlying inflation of 4%.

L, ta for back up. He can see what VAT does. But he's an elected politician from the M4 corridor, so his prime motivation is keeping the Home-Owner-Ists happy and sod business.

Ed P said...

Business costs are mainly for processing and submitting VAT returns. VAT is only paid by the end-user, so has no other loading on suppliers, manufacturers & wholesalers.
I do not understand your points!

Mark Wadsworth said...

Ed P, look up the difference between 'economic incidence' and 'legal incidence' of a tax!!!!

Of course VAT depresses the income of producers! Just imagine that you are in a business that is currently zero-rated or exempt (let's say selling food or residential letting) and the government decides that it's now VAT-able. Do you seriously think that you can put up your prices by exactly 20%, or do you think that the total price you can charge will go up by a lot less than 20%?

This is the insanity of politicians and the media. With things like fatty food or fags or booze, they always say "Let's increase the taxes on these things, that will get consumption of fatty food, fags, booze down" (probably correctly).

So this hits manufaturers and retailers of fatty food, fags and booze as well - they sell less for a lower net selling price.

So in the next breath, to say that "Increasing the tax on the selling price most freely traded goods and services by 2.5% will not affect producer's net profits" is the height of absolute insanity.

Lola said...

Ed P - I am (really and actually) an expempt supply. I may be made to become a VATable supply. Poeple will be forced to pay 20% more for my services, hence, all other things being equal, in the future they will buy 20% less of my services. Or if I can afford now to go out for dinner (say) four times a month, if VAT was scrapped I could go out five times a month.

Shiney said...

I run a smaill(ish) VAT registered business that supplies FMCG products to large retailers.

They don't want to put up their prices after the VAT increase. There are 3 options

1. The large retailer takes the margin hit
2. The spec is lowered (as per E-K above) so the consumer gets less for the same price
3. I take the margin hit

Want to guess which one(s) are going to happen?

Mark Wadsworth said...

L, ta for back up.

S, good summary, it's a mixture of all three. I've looked in detail at the impact of VAT changes on supermarket gross margins, and they take more than half of it on the chin (option 1). Whether the rest is passed up the chain to you (option 3) or onto consumers in terms of higher price/lower quality (option 2) is unknown.

Shiney said...

It usually depends on who has the power in the relationship - big brand owners plus food companies tend to do a bit better at passing on cost hikes than own-label suppliers like us.