Wednesday 23 June 2010

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.

16 comments:

bunbury said...

Isn't this just Paul Williams talking his book?. The scrappage allowance was paid in many purchases which would have been made in any case. Take the last 100,000 cars sold to yield £50m net. It would only have taken sales of 33,000 cars at the normal rate to bring in that much and I've seen no suggestion that scrappage trebled sales.

Not that I disagree with the thrust of your argument. Ken Clarke saying that the cut to 15% VAT was the right thing to do received precious little attention when he said it and I've not seen it yet today.

Still I think the plan is to be a big Ireland. It's much harder to offshore VAT.

Bill Quango MP said...

Not sure about the supermarkets not passing on the cut. Its an automatic model as part of the pricing structure. Cost+Vat X % markup.
Supermarkets operate a shelf price policy so cuts are not noticed as much as say, clothing stores, where the item is ticketed.
Most stores buy in stock pre ticketed and many only made the VAT cut at the till, and didn't mark down the ticket.There was also the header card point-of-sale problem. {Now only £9.93!}

Shows that the VAT cut was not really a driver to retail spending.
Many consumers made their purchases and were unaware of the discount until AFTER they had bought the item.

Tim Almond said...

What's the situation with VAT on international trade? If you're a French business selling to the UK, do you add in French VAT and can that UK business then claim it back?

(I nearly did some work for some Americans recently but as it didn't come off, I never went through it with my accountant).

Mark Wadsworth said...

Bunbury, re 33,000 cars, that's very true. But

a) We have to look at the whole ten month period (and mentally adjust the figure down for accelerated purchases and minus off purchases that would have taken place anyway), and

b) We shouldn't just look at VAT minus scrappage vouchers. For every £1 VAT raised, another £2 was paid in corporation tax or PAYE; and for every two extra cars sold one fewer person lost their job, so that's another £1 in welfare payments that didn't have to be paid out.

That gives us extra revenues of over £1 billion for a £290 million subsidy. For sure, the £1 billion comes down for the adjustments in a) above, but the bottom line is, the net cost to the Exchequer was a fraction of £290 million static cost of the quasi-VAT cut; and was possibly even revenue positive.

Bunbury, re Ireland,that scam won't work for the UK economy, which is twenty times as big. There are plenty of captive offshore finance type companies who moved to Ireland, so Ireland 'lost' half of their domestic corp tax base (say EUR 2 billion) but gained EUR £3 billion from the offshorers (or whatever the figures are).

If the UK cut its corp tax to 12.5% we'd lose half the corp tax revenues (say £15 billion) and maybe win all that EUR 3 billion from Ireland, so it would be revenue negative.

Mark Wadsworth said...

BQ, that's why I looked at supermarkets when assessing impact of VAT cut. In any event, if the price of coats go up, people just buy a new coat every ten years instead of every nine; if the price of cinema tickets goes up, people just go to the cinema nine times a years instead of ten, and so on.

A VAT hike takes a larger slice of a same sized cake and NOT a larger slice of a larger cake.

JT, business services to outside EU = zero-rated; to registered traders in EU = zero-rated (but reverse charge in other country) and to non-registered traders or private individuals = VAT-able in UK (as far as I'm aware).

Matthew said...

This is a follow up question to my one a few posts ago, but I thought I'd stick it here to keep things up-to-date.

In your Sainsbury's example, the profit increase from 519m in 09 to 610m in 10 is modelled reasonably well by your application of a VAT cut to gross revenues. However wouldn't the better measure of profits to use be 'underlying operating profits' (as these exclude a big change in financing costs) which rose from 616m to 671m. If 'modelled' VAT cut would still have been 121m (640m - 519m, I think in practice it will be slightly lower) then this would suggest Sainsbury's only captured 55m of 121m, ie slightly less than half?

Mark Wadsworth said...

M, good question.

VAT paid 2009 = £1,472 m.
VAT paid 2010 = £1,457 m (per 2010 accounts).
So VAT 'saving' = £15 million

Step 1; estimate 2010 und. op. profits assuming that they increase by the VAT saving:

Und. op. profit 2009 = £616 m.
Add on £15 million VAT saving = £631 m

Step 2; adjust this estimate upwards for increase in net sales (I assume und. op. profit = proportion of net sales).

Net sales 2009 = £18,911 m
Net sales 2010 = £19,964 m
Increase in net sales = 5.57%

Estimated und. op. profit plus 5.57% = £666 million
Actual und. op .profit = £671 million

That's close enough for me.

Matthew said...

I follow the workings, but don't follow how this tells us that Sainsbury's were the sole (or almost sole) beneficiaries of the VAT cut?

Mark Wadsworth said...

M, that's the problem with the scientific approach.

No matter how many times I give examples to explain why I draw the conclusion that VAT is nor more 'passed on to the consumer' than any other tax on profits (like corporation tax or PAYE) there will be always people who adhere to the Basic Lies About VAT who ask for another example and another example.

If I ask these people to provide real life examples using real life accounts to support their contentions, then none are forthcoming.

As Einstein said, madness is repeating an experiment again and again and expecting a different outcome. We've done the experiments, we've got the results, it accords with the theory (which in turn is derived from the results), I'm not sure what more I can do.

Matthew said...

Ok, but I hope I'm not doing that or giving the impression of doing that.

What I'm saying instead is that I don't think your Sainsbury's example does show what you assert, if you take the underlying profit measure, which I also believe is the measure which should show up what you are asserting. Indeed I think* am also saying that I think the underlying profit measure does support my contention**.

* I'm hedging this as I am doing this on Windows Calc on a beach, and you've been looking at these things for years.
** Also my contention is that some, which is not trivial, of the VAT change is paid by/goes to the retailer. So small changes in big numbers can mean quite a lot.

Mark Wadsworth said...

M, well yeah, maybe.

The full rate of VAT went down from 16.735% to 15.56% because Sainsbury's accounts years don't overlap with the VAT change dates.

£10 bn gross VAT-able sales/1.16735 in 2009 = £8,566 net

£10 bn gross VAT-able sales/1.1556 in 2010 = £8,653
= expected VAT saving = £87 million.

So if underlying profits went up £55 billion, then about two-thirds of VAT cut went to Sainsbury's and one-third was 'passed on'.

But don't forget, in a recession we would expect profits margins to tighten considerably - rather than widen slightly as is the case here.

If we assume that the recessionary tightening would have been one-third of the profit margins anyway, then in effect Sainsbury's retained the whole of the cut.

It'll be far more interesting when we can compare 2009, 2010 and 2011.

GDolan said...

Here are some videos on the Laffer curve from the Cato Institute's Dan Mitchell that you might find informative!

Part 1 - http://www.youtube.com/user/afq2007#p/u/41/fIqyCpCPrvU

2 - http://www.youtube.com/user/afq2007#p/u/40/YsB_rnzBA08

3- http://www.youtube.com/user/afq2007#p/u/37/Mw7LtVwDCbs

Mark Wadsworth said...

GD, those videos are fair enough, and I agree with them that governments spend far too much, but the Cato Institute seem to be in favour of a) Sales taxes (the worst taxes) and b) a flat tax on incomes, and the obvious answer c) "tax land rental values" completely escapes tham.

Derek said...

Ah, yes. The propaganda subdivision of Koch Industries Inc., otherwise known as the Cato Institute. You have to be very careful in interpreting what they say. Their stated mission may be to broaden the parameters of public policy debate to allow consideration of the traditional American principles of limited government, individual liberty, free markets, and peace but I suspect that their real mission is to further the business activities of their "parent company". Since the prospect of income tax or LVT would be anathema to that company, I am not surprised that the Cato Institute pushes the idea of sales taxes.

Mark Wadsworth said...

D, thanks, I didn't know that.

As Koch industries are in mining, farming etc (i.e. land-based stuff), I can see why LVT is anathema to them. I suppose in relative terms, that explains why they prefer sales taxes to income tax as well, because sales taxes tend to benefit incumbents who add little value but have high incomes.

Derek said...

My pleasure. The Koch Brothers seem to be behind a lot of the Faux Libertarian think tanks and pressure groups which to my mind partly explains why those groups are often so hostile to Georgists despite their big overlap in philosophy and goals with the FLs. Many of the original American libertarians, including party founder David Nolan (who I am saddened to learn died yesterday) are actually quite LVT-friendly, although they would probably baulk at a Citizen's Income.