The impact of VAT changes: more evidence

1. You may remember the UK car scrappage scheme, which ran from mid-May 2009 to the end of March 2010.

2. If you traded in your old banger (as defined), the government chipped in £1,000 (whence that came is irrelevant for the purposes of this discussion) and the manufacturer was supposed to offer you a further discount of £1,000 (which simply meant that most of them put up their list prices accordingly).

3. The maths of this is that the real rebate was slightly less than the VAT included in the price of a new car, i.e. it was tantamount to reducing the rate of VAT on new cars to (say) 5%. My theory is that increasing the rate of VAT (while leaving other elements of the tax system in place) raises far less revenue than you'd expect (while wreaking huge damage on the economy) (see here); and further that as VAT is a tax on gross profits (the clue is in the name: 'value added') it merely eats into business profits and wages.

4. The converse is also true. When the main rate of VAT was reduced from 17.5% to 15% for the period 1 December 2008 to 31 January 2009, the profits of supermarkets increased by the amount of the cut - very little was passed on to consumers (why would it be? Would businesses pass on a corporation tax cut to consumers?). See my analysis of figures for Sainsbury's and Wm Morrison's.

5. So, if my theories stack up, when the effective rate of VAT on new cars was reduced to (say) 5%, we'd expect the overall impact on tax revenues (minus welfare payments) to be quite minimal, and the motor industry to do far better than it otherwise would have done.

Is there any evidence for this, i.e. that VAT at current rates pushes us over the top of The Laffer Curve, and that a reduction in rates is broadly revenue neutral, or even revenue positive (especially if you take other taxes and welfare payments into account, which I refer to as Laffer Rainbow effects)?

Of course there is! You just have to know what to look for. I refer you to an article in The Times:

"There is speculation in the industry that the average selling price [of a new car purchased under the scheme was] between £7,500 and £8,000," said Paul Williams, chairman of the Retail Motor Industry Federation, who 18 months ago led the lobbying of Lord Mandelson to consider the introduction of a scrappage scheme.

"That would mean the Government has made more money than they thought they would. Scrappage was never meant to be a panacea for the motor industry but without the scheme, well, one has to remember that the industry was heading for a black hole.

"Consumers, manufacturers and retailers have all benefited and if the Government has made more money than they thought they would, then you have to balance that against the unemployment benefits they would have had to pay out to the tens of thousands who could have lost their jobs without scrappage."

Industry figures show that from May to the end of December, 290,000 cars were sold through the scrappage scheme. If the average selling price in those months was £8,000, then the Treasury would have reaped £348 million in VAT receipts against the £290 million paid out.

Lord Mandelson's decision to extend the scheme by a month ensured even greater profits for the Treasury. In the past three months, another 110,000 cars have been sold. If they, too, were sold at an average of £8,000, the sales at the restored rate of 17.5 per cent VAT would have reaped a further £153 million in the tax. That would make total VAT proceeds of £501 million against incentive payments of £400 million, and a Treasury windfall profit of £101 million.

Just sayin', is all.