For all those who've fallen for the line that "VAT is a harmless tax because it is borne by the consumer", here's a fine article by Jerome Corsi (from a US standpoint), written three years ago to the day, which explains that VAT is in fact a subsidy to exporters, and hence a barrier to international trade. Which ties in with my overall suspicion that the French and Germans cooked up this particular tax to suit their own economies/prejudices - the French farmers made sure that agricultural produce is liable at lower rates than manufactured goods; and the mercantilist Germans made sure that it allowed them to subsidise the export of manufactured goods to outside the EU.
But let's ignore these concepts of "importing" and "exporting"; and ignore the distinction between "producers" and "consumers" - ultimately, individuals trade with individuals, and ultimately everything is produced by and consumed by individuals, and look at income tax and VAT in the context of Ricardo's Law Of Comparative Advantage.
1. Clearly, people will trade with each other if it is to their mutual benefit. Specialisation brings benefits, therefore the more people specialise the more it is in their interests to trade with others, and the greater the surplus that can be generated. For example, if you can produce £100 of haircuts in a day but are rubbish at repairing your own car, then you are happy to cut hair all day and pay a mechanic £100 to repair your car. The mechanic on the other hand is rubbish at cutting hair so he comes to your salon, and so on.
2. So if you can produce something at a cost to yourself (in terms of hours worked) of £100 which is worth £150 to somebody else (and for which he is prepared to pay £150 in terms of his own output), you will be happy to trade with him; if you can trade your own output for something worth £140 you will do so; the same with £130, £120, £110 or even £101.
3. If we only had income tax (and all its variants, like National Insurance and corporation tax) at a current average rate of 40%, then it is still to your advantage to trade £100 for £101; after tax, you have improved your income/consumption by 60p.
4. VAT works the other way round - it creates an entirely arbitrary cut-off point at £117.50. If you produce something at a cost of £100 to yourself, you can only gain an advantage by trading it for something that is worth more than £117.50 to you personally. It is no longer to your advantage to trade £100 for £101; after tax, you would end up £16.50 worse off.
5. We know that most businesses have relatively small net profit margins of about 5% - 10% (which is blindingly obvious - any profit margin in excess of this gets competed away - any less than this and it is not worth entering the market), which in reality are profit margins of about 25%, three-quarters of which is swallowed up by VAT in the case of VATable businesses.
6. Think it through, and then try and work out by how much wealthier we would be without VAT (your guess is as good as mine, but the answer must be "a lot"), even if the price of scrapping VAT were higher income tax (which I am not recommending, by the way).
Wednesday 3 February 2010
The VAT: Menace to Free Trade
Subscribe to:
Post Comments (Atom)
13 comments:
This is an interesting point. I had always thought of VAT in terms of the reseller...
Buy for 100 -> sell for 150.
The purchase is VAT free, because you reclaim it, the sale has VAT charged, so the VAT is only on the profit, and as with your income tax example any profit is still a profit, even if 17.5% of it gets pinched.
That isn't true though. You example makes it clear that it is the creation of wealth that is being taxed. The actual chain is:
Buy for X -> add value of P at a cost of Q -> sell for Y.
P = Y - X (obviously)
However, P must be at least 117.5% of Q in order for a profit to be made.
Appalling. Since the adding value stage is essentially the act that adds wealth to the economy. Hmphh.
Thank you for an eye opening post.
Well laid out for us - it is indeed a menace of the first water and ruins the chances of a other, fairer mechanisms to achieve the stated ends.
Andy (and Mark), you're not right I'm afraid. You've forgotten that the customer has paid you, not Y, but 117.5% of Y. And you've paid 17.5% tax on X, but reclaimed it.
So the real equation is
Buy for X + 17.5%
Reclaim the 17.5% so the net cost is X (NB this includes VAT paid on value added further up the supply chain).
Add value of P at a cost of Q.
Sell for Y plus 17.5%.
Pay the 17.5% to the tax-man. So net proceeds are Y.
If P (or Y - X) = 101% of Q, you have still made a profit.
VAT has many other reasons to be abhorred (e.g. complexity, admin costs, the fact that nobody understands it...) but this "cutoff point at 117.5%" simply isn't true.
Andy, JH, thanks. I'd been mulling this post for ages.
AC, ignore the input VAT you reclaim, that's a red herring! Remember that you cannot just merrily sell for Y + 17.5%, the Y includes the 17.5%! That is The Big Fat Lie that underpins our meek acceptance of this hideous tax (and even if it were true, it means we have to reduce our total consumption by 17.5%, so by definition, 17.5% of potential economic activity does not happen).
If goods or services are worth £100 to you and the cheapest supplier can only sell it for £117.50 then you simply won't pay for it.
Therefore, the simple fact is, that UNLESS a whole supply chain, starting with zero input VAT (by definition, the individual who extracts the coal or farms the potatoes or whatever does not pay VAT to the soil) has a total P that is > 117.5 x Q (as Andy expressed it), the supply chain either goes out of business or does not start up in the first place.
This effect is far, far, less marked with income tax (and does not exist at all with Land Value Tax, different topic).
The point made by Mr Collyer is a fair one once it is appreciated that he defines X and Y differently from Mr Andy and Mr W.
It is simply a matter of how much is paid-out nett and how much is received nett.
If you buy at £117.50 and can reclaim the VAT you are out of pocket by £100.
When you sell you must pass the VAT over to Mr Darling. If you merely buy-and-sell without having any costs you must sell for at least £117.50 to break even because you must pay £17.50 of it to Mr Darling, leaving you with £100 which is your initial nett cost.
Any additional costs you incur fall to be treated the same way - what is their nett cost to you and what are your nett receipts on sale?
Your final selling price must always be at least 17.5% higher than your total nett costs or you will make a loss.
The result is that you can add value and sell at a substantial mark-up over your costs without actually making a profit.
TFB: "The result is that you can add value and sell at a substantial mark-up over your costs without actually making a profit"
That's another way of expressing it - or as I would say, unlike corporation tax or income tax, VAT can turn an activity that adds value (from the point of view of society) into a loss-making activity (from the point of view of the business), so there is a lot of potential value that is not being added.
Not sure I agree about income tax, it rather depends what would happen without income tax.
The cost to the business is nett wages plus income tax, in other words, gross wages. But if there were no income tax it does not follow that gross wages would necessarily stay the same.
A job currently worth £15,000 to the employee in actual take-home spendable folding-stuff would, arguably, still be worth £15,000 to him after the abolition of income tax. In this scenario income tax is an additional cost to the employer.
OK, my eyes have been opened.
I was wrong.
Do I get a brownie point for admitting it? ;)
Oh my giddy aunt, this stuff is OBVIOUS. The government is taking a portion of wealth for itself therefore leaving less wealth for the participants to exchange. Everything else is detail.
BTW, I think much confusion comes from people's concept of "value". It's natural to assign value to the good / service being traded. That's wrong. Value is a subjective attribution in the mind of the consumer.
Hence things like 50 Cents music has negative value to me, but high value to da kidz on da street.
RLj, it is quite easy to rank taxes in order of "For a given required revenue, how much they dampen economic activity?" VAT is miles ahead, it is in a difference league; and property taxes are more or less neutral.
I take you point on tobacco duty, but in a purist sense, smokers do cause some extra costs (street sweeping, house fires, NHS treatment) so setting a duty to cover these is fair enough. The fact that tobacco taxes (and OAP savings) cover these costs five-fold is another topic.
TFB, splitting into "employer" and "employee" is artificial - what if a similar business were a partnership? Besides, the employer gets corp tax relief on the £15,000 so the net cost to employer is roughly the same as the net receipt by employee.
AC, have a brownie point :)
K, nope. What I am saying is more fundamental - that taxes like VAT prevent wealth being created in the first place - this missing wealth is called "Deadweight costs" - the wealth is neither there for the people to enjoy or for the government to steal.
The fact that governments subsequently waste a lot of our tax money is a separate topic, and the cost to society is in addition to the deadweight costs.
OK, gotcha
Fair argument & it will have an effect where people decide to go fishing/blogging etc when they could be working, as occurs with any tax on income. However if VAT applies to all goods the other effects are simply of government taking an across the board extra 17.5% of everything. Since VAT is not charged on everything this means some transfer from the VATed to non-VATed parts of the economy. Food, books, kids clothes & financial services gain - most luxuries, alcohol, cigarettes & new products lose. I would argue that fodd & books should indeed be encouraged for their own sakes & suspect financial services may have a significant positive effect on general investment. I also see nothing wrong with the state discourging alcohol & cigarettes - better both morally & financially to do so than to go around banning, indeed we could do the same with drugs. However I would change the default position that new products are VATable. New gadgets are the cause as well as the effect of progress & think it would be to our long term benefit to skew the system slightly in their favour.
NC,
1. With just income or corporation tax, every £ of extra value a business generates means it is better off after tax. A good pre-tax decision is always a good post-tax decision. With VAT that is not true, so there is a difference.
2. Yes things like housing and food are necessities - that's why we have a welfare system. Having a lower tax rate for housing and food (both land-based activities) just pushes up the price of land but does not push down the price of housing or food.
3. Plus, I never said we should put VAT on books, I said we should take it off everything else. I take your point on alcohol, fag and drug duties. But define "new" goods? Aren't all goods "new"? And if you want to encourage recycling etc then at the very least, second hand goods should be VAT exempt.
Post a Comment