According to George's Budget Speech, hiking VAT from 17.5% to 20% will raise £13 billion a year.
1. Presumably he looked at current VAT receipts of (about) £80 billion, divided it by 17.5 and multiplied it by 20 to get £91.4 billion, which looks like an increase of £11.4 billion to me, but let's not quibble over that, he is wrong in principle and does not understand the Laffer Rainbow.
2. In order to generate VAT of £80 billion, total gross VAT-able sales inclusive of VAT must be £537 billion (check: divide that by 1.175 and mutliply by 0.175 = £80 billion; double check £537 billion minus £80 billion = net sales of £457 billion x 17.5% = £80 billion).
3. Consumers only have as much money to spend as they have to spend; let's be charitable and assume the extra VAT he collects is redistributed to people and spent in the UK, so our total budget for VAT-able items stays at £537 billion. If you do the same exercise and divide £537 billion by 1.2 and multiply by 0.2, you'll find total VAT revenues will in fact be £89.5 billion, which is an increase of only £9.5 billion.
4. Because VAT is borne by the VAT-able sector (consumers have a limited total budget), gross income of businesses is now £9.5 billion lower. Let's assume that VAT-able businesses reduce their gross wages by £9.5 billion to stay in business. The effective marginal tax rate of basic rate taxpayers (once you take Employer's NI into account) is 39%*, so PAYE receipts will be down by £3.7 billion (£9.5 billion x 39%).
5. Further, it was estimated a couple of weeks ago that increasing VAT by 2.5% would mean that over 200,000 workers would lose their jobs (which is less than one per cent of private sector workers, and a corresponding number of marginal businesses would go under). Let's assume each of those workers is currently generating £10,000 a year in total taxes**, and once unemployed will be claiming £10,000 a year in various welfare payments***; that's a cash cost to the Exchequer of £4 billion.
Righty-ho.
6. Let's take our extra VAT of £9.5 billion from 3., deduct the PAYE shortfall of £3.7 billion from 4. and the deadweight costs of £4 billion from 5., and maybe knock off another £1 billion for extra fraud and evasion (the higher the tax rate, the more the fraud and evasion, let's assume that two per cent of VAT-able turnover goes missing) and we arrive at the princely sum of £0.8 billion (to within a very large margin of error). Not really worth the grief is it? That's about one-tenth of the budget for the Department For International Development, which has been 'ring fenced' and Will Not Be Cut.
* If the employer pays out £100 in total wages, the employee's headline salary is 100/112.8 of that, because the employer has to pay 12.8% Employer's NI = £89, and the employees income tax and NI is 31% of that = £28, so add the £11 and the £28 together to get a total tax rate of about 39%.
** That may be a tad on the high side.
*** Total non-pension age welfare bill excl. Child Benefit = approx. £70 billion, divided by 5 million adults on key benefits = £14,000 each, so this estimate is on the low side to even out.
Tuesday, 22 June 2010
Hey George! Buy yourself a calculator!
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22 comments:
Have you factored in inflation into your VAT calculations?
Anon, feel free to index up that £0.8 billion for inflation :-)
But CPI inflation is 3.4% therefore the VAT receipts for next year are projected to be over £94.5 billion. Hence, this is a conservative projection by the Treasury, surely you cannot criticise them for that.
Come on MW - be fair! Little George only has 8 fingers and 2 thumbs! He can't use them and work a calculator!
Bloody hell Mark, my head is spinning!
Anon, by all means increase every single figure in that calculation, you still end up with £0.8 billion + 3.4%.
WFW, he has hundreds of people working for him to do the calculations.
RR, I could have made it far more complicated than that if you want (there may be other adjusting factors that would increase or further reduce the overall tax take).
Therefore this whole post is irrelevant.
Yes, but these were chancellorfigures- they always add up.
Anon, as I said, feel free to do your own calculations, explaining your assumptions and adjusting each figure for inflation. You can email me the results and I'll have a look.
I know you hate VAT, Mark, but 4) is one hell of a leap. I'm sure there will be a tightening of belts but you are (if I read it right) 'assuming' that every business affected will cut exclusively from their payroll.
That's if they don't just swallow the cost (again, you assume that they will cut to 'save their business'). I have a business, and reserves, and I know that personally I won't be forced to shed any jobs or reduce any wages. I'll just pass it on as I have contracts which are unaffected by VAT.
Sorry to be a dampener, but you seem to be talking only about businesses which break even, are directly affected by consumer demand, and have no savings.
If I've got that wrong, please explain. :-)
Sorry, not 'swallow the cost' - should have read 'swallow the reduced sales'.
DP, sure, they might cut payroll, they might cut dividends, it's all taxed at about forty per cent. Or the sole trader might accept lower profits, also taxed at 41% or 51%. Same difference.
When you say you can 'pass on the cost' this is only true if you are supplying to zero-rated businesses or to local authorities, which is a minor issue. I am tallking about businesses in general.
And if you pay the extra tax out of your 'savings', then that is surely a 'tax on capital' that is far worse than corporation tax or income tax, which at least is only a tax on 'return on capital'?
Yeah but ... (sorry, still doesn't stack up for me). Aren't you assuming a very flexible elasticity of demand here? That every pound added will result in exactly the same loss in sales? We're talking the modern 'must-have' culture here, remember. Even in consumer-based industries (which mine isn't, admittedly) you're still unlikely to see a drop in sales which matches the increase in VAT - even if all the VAT is passed on.
Also, if a company survives such a hit by relying on reserves, then surely that would result in a lessening of tax liability in the following year which would help. Especially since Corporation Tax is being reduced?
Not trying to be obtuse, honest. :)
It's £13bn by 2015, so presumably the extra is made up from some economic growth and inflation.
Point 4, the crucial one, surely depends on to the extent prices rise to reflect the VAT increase, and demand changes? If prices rise 'cause of VAT and spending is maintained (not increased), then revenue rises (and is partly paid for by consumers). If spending increasea (savings fall) then the effect would be larger?
DP & Matthew, we don't need to guess what happens when the VAT rate changes. Total gross consumer spending stays much the same and net income of the VAT-able supply chain goes up or down by the change. Whether physical volume of goods and services provided and purchased goes up or down is a minor issue.
I compared the real life profit figures of Sainbury's and Wm Morrisons before and after the reduction from 17.5% to 15% and my theory stacks up. If it didn't, then I wouldn't advance it.
And yes, there might be a reduction of the tax liability in the next year as well (which would worsen the position from George Osborne's point of view) but that is highly speculative.
Don't forget that The Righteous argument for VAT is that it is on discretionary spending i.e. on things that people can cut back on (go to the cinema every five weeks and not every month), which cancels out the 'must have' argument.
Why buy a calculator when Sir Humphrey has already bought a whole department of them?
Personally, I reckon the GDP growth and inflation assumptions are the most interesting bit.
For those who question the assumption in point 4, you are welcome to revisit this blog in about a year's time when quoted plc's selling VAT-able goods and services are putting out their half year results for first half 2011 - we can then easily compare net profits with a 20% VAT rate (2011) and a 17.5% tax rate (2010) and a 15% VAT rate (2009).
I bet that gross profits in first half 2011 will be lower than in 2010; and profits in first half 2010 will be lower than in first half 2009. And the amount of the fall will be about 2% to 2.5% of gross sales in each case.
Anybody fancy taking me up on that?
I'll think about what bet I would accept. But I need to think about it some more (and get some more information) including, if VAT was 0% are you saying corporate profits would be £80bn/year higher? Or much more, as turnover would rise?
M, if we got rid of VAT, various things would happen:
1. Business profits would rise by up to £80 billion in the short term.
2. Prices would fall again as new entrants provide similar goods and services to compete away those juicy margins (see 1.); and activities which currently yield a gross profit of less than 17.5% (and hence are economically unviable) become viable.
3. Employment would rise (see 2.).
4. Welfare costs would fall (see 3.).
5. This would all spill over into more exports (businesses usually build up a domestic market first before exporting).
The long run dynamic impact on overall tax revenues less welfare costs might be that they fall by only a quarter to a half that £80 billion static cut, it's what I refer to as the Laffer Rainbow.
As the original post illustrates, the true additional revenues from a static £13 billion increase boil down to a dynamic long run increase in tax revenues of less than £1 billion.
Whether the precise figures given in step 4 are accurate really doesn't matter.
The extra money finding its way to the Treasury with the label "VAT" attached has to come from somewhere. Part of it might come from genuine new wealth, part might come from depleted savings, some might come from eliminating spending on one optional item in order to spend it on another. Whichever way it comes, it is used to pay VAT rather than being used in another way.
That other way would have had tax consequences - interest on savings would have been taxed and additional spending would have resulted in taxable income to the seller.
I can't see how the VAT rise could give huge additional revenues. A bit, maybe, but not much.
TFB, obviously, each of my four constituent figures is an estimate, each subject to a margin of error.
So the £0.8 billion is subject to a huge margin of error (it might be negative £2 billion, it might be plus £4 billion) but it's nearer what I say than what George Osborne says.
I agree with TFB, and it's amazing how this point is conveniently ignored by the government - if you raise taxes, where does the extra money come from? Unless it comes from savings (and who has those these days?) you're just robbing Peter to pay Paul. It's like working for your dad as a teenager. You may be richer, but the family's wealth remains the same.
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