Allister Heath uses his favourite adjective twice in today's editorial about Blinky:
Ed Balls’ series of proposals probably amount to a debt-financed boost to demand of £18bn, roughly 1.2 per cent of GDP. This includes his proposal to cut VAT back to 17.5 per cent, and his bid to move forward infrastructure projects, partly compensated for by yet another crippling £2bn-£3bn tax on banks (additional to Osborne’s own new tax) (1).
From a Keynesian perspective, it would make only a small difference. Even on its own terms, it is only just better than a gimmick. It certainly wouldn’t mark a major intellectual shift. Even if it did trigger more consumption, quite a lot of this would be on imported goods, which reduce GDP. A lot of the construction spending would be conducted via imported labour, thus failing to dent domestic unemployment by much. So even if one were to believe Keynesian models in an open-economy context, and pretend that the markets wouldn’t panic, the boost to GDP would be marginal, probably half a per cent or so in the first year and less in subsequent years.(2)
In the longer run, taxes would have to be hiked; given that Balls is obsessed with (3) cutting taxes on consumption (4), that would mean even higher incentive-destroying taxes on income and capital (5). It was interesting that Balls said yesterday that "the issue of land taxation is one which we should actively look at" – in other words, he is moving closer to the kinds of crippling wealth taxes (6) beloved of Vince Cable.
It is strange that Balls appears to think that what the UK needs more of today is debt-financed consumption; in reality it needs to rebalance towards investment, savings and exports. (7)
1) UK banks are in rude financial health (partly propped up with subsidies), swiping £2 or £3 billion back again (or not giving it to them in the first place) is not going to "cripple" them.
2) I'd pretty much agree with this paragraph. UK government spending is wildly out of control, it's far beyond the point where it can possibly add to output and is well into the level where it decreases it.
3) Note the use of the emotive word "obsessed". It just so happens that VAT is the most damaging tax, economically (whether Blinky wants to cut VAT for good or bad reasons is secondary). It's just that Allister Heath's paymasters are ultimately banks and so on, who are hardly affected by VAT, so he's following the rule that a tax is a good tax as long as somebody else is paying it.
4) VAT is NOT a tax on 'consumption'. Taxes on fuel, fags, booze are taxes on consumption thereof for the simple reason that demand is price inelastic and supply is price elastic; but a general tax on gross profits ('value added') of non-favoured industries is NOT a 'consumption tax', however you dress it up.
The fact that VAT appears on till receipts and not in company accounts is a red herring, you cannot change the economics with accounting rules. It is more or less impossible to design a general spending or consumption tax which doesn't act in exactly the same way as income tax, but far worse.
5) Tax on income = bad, but not as bad as VAT. He doesn't define what he means by "capital" so let's ignore that.
6) Aha, "crippling" again? "Crippling" to whom? Will all the mansions in London and the South East keel over sideways if Vince gets his way? Nope. Might their selling prices drop a bit? Yup. But who will ultimately end up living in them? Why, people who live and work in London, instead of them being forced to commute in from God knows where. Would that not a tad better for the economy? So who's been crippled here exactly, the poor South East home owners who see prices knocked back to 2005 levels (or whatever)? The people who will find it easier to trade up to somewhere more convenient for work? Who?
In any event, a tax on land values is NOT a tax on wealth because land values aren't really wealth and certainly not net wealth; they are a measure of the wealth that flows from non-land owners to land-owners, so the income and the expense net off to precisely £nil.
7) As a front man for the financial services sector, Allister loves high house prices because they enable/force people to take out more debt; some use the debts to buy the house (that's good for banks and vendors) and others use the new borrowings for, er, "debt-financed consumption". It's a simple fact that had house prices not risen so much, there would have been less debt-fuelled consumption - during the boom years, mortgage equity withdrawal alone added about six or seven per cent to people's disposable incomes.
We don't need no stinkin' objectivity
31 minutes ago
23 comments:
"VAT is NOT a tax on 'consumption'. "
Erm didn't you admit that at least one third of the incidence of VAT falls on consumers in the LVT comments thread the other day? When you wanted to include savings from the abolition of VAT on a private individuals tax savings?
Whether VAT is ultimately paid by the consumer or the businesses in the supply chain depends very much on the business in question. For example fuel has VAT on it. If VAT were abolished, the competitive market in fuel would cut the price by the amount of the tax cut immediately. Thus the consumer gains the benefit of the tax cut, and must be considered to be bearing the vast majority of the tax when it is applied. Yes the business may now sell more fuel as the price is cheaper, and make some more profit, so VAT has depressed profits slightly. But the overall incidence is on consumers.
Whereas if you take a business in a less competitive market (lets say CORGI gas boiler repair men). A VAT registered plumbing and heating business would be able to keep the same price level despite the VAT cut as the barriers to new entrants are high, so there would be less competition to push prices down once the VAT is removed. Thus the business would experience a nice boost to profits, by the amount of VAT they would have paid to HMRC. So in that case the incidence falls mainly on the business, and can be considered a tax on turnover.
However in the long run competition will depress prices in all sectors, even CORGI gas men, as super-profits attract new entrants. It will just take time for the benefits to consumers to work through in some sectors over others.
S, VAT is a tax on gross profits which keeps new entrants out of the market, enabling incumbents to push up prices slightly. Most human beings are producers and consumers, so there's no need to be too scientific about the incidence. It's a very bad tax on economic activity, full stop.
Your two examples illustrate the point very well, I completely agree.
Demand for fuel = price inelastic (and supply is price inelastic), so tax on fuel is paid nearly entirely by consumer. Which is what exactly I said in the post.
Conversely, let's assume there are high barriers to entry to being a CORGI installer, i.e. supply is price INelastic. (Demand for emergency plumbing is also price inelastic, but demand for new boilers or kitchens generally). Therefore the tax is mainly borne by the supplier.
The same goes for land, of course, supply is price inelastic, so any tax thereon is borne 100% by the supplier, i.e. land owners.
Mark, how is a tax on gross profits a barrier to entry in that market?
A distorting tax, a disguised subsidy, yes. I don't see why it's a barrier though (albeit a pain in the backside generally).
Allister Heath says Balls said "The issue of land taxation is one we should actively look at" but I can't find it in the text of yesterday's speech.
Well yes, everyone is a consumer in some way. We all eat, drink, live somewhere and use products and services. But it is possible to have two hats - business owner and consumer, and for the effects a VAT cut would have to be measured upon both. Indeed its important to know what the effects would be so we can predict what would happen if VAT were abolished.
If your contention that VAT is effectively a gross tax on profits (thats only your description BTW, by definition VAT is a value added tax - a tax on the additional value every business adds by its business process) then one would expect that abolition of VAT would not affect prices, any more than a cut in corporation tax (say). Abolition of other taxes that fall upon businesses (lets say business rates) would not affect price levels, at least not in the short run. As profits rose they would attract new entrants, extra competition and downward price pressures. But there would be no 'business rates are abolished, I must cut my prices' moment, which there would be if VAT was abolished.
Ergo my contention that VAT is borne by consumers to a large degree, possibly nearing 100% in the long run.
@Jer, Mark has already covered the reasons why VAT is a barrier to entry. Read the posting on the topic which he wrote last year and things should become clearer.
"But there would be no 'business rates are abolished, I must cut my prices' moment, which there would be if VAT was abolished."
I can't see how the opposite isn't true. If the customer is prepared to pay £X for a product and 1/6 of X was VAT, would not the business continue to charge £X and simply pocket the difference? After all the customer doesn't care (so long as he isn't VAT-registered) whether 1/6 of the price he pays goes to the government and 5/6 to the businessman or whether 6/6 goes to the businessman. So as far as the business is concerned, its prices would go up by 1/6.
There would, of course, be an initial period where prices to the consumer fell, as consumers aren't all that stupid, and at least some would expect a price cut, but they would soon creep up again to the prices the customer was prepared to pay previously.
Jer, Derek has linked to the relevant post. You can argue it any way you want, the fact is, in relative terms, VAT hits small, growing or marginal businesses far harder than it hits large profitable established businesses. Corporation tax is quite the reverse.
Ergo, corp tax is not the best tax in the world (learn to look at HMRC as an unwelcome shareholder who takes 26% of the profits), but nowhere near as bad as VAT.
D, thanks.
DBC, me neither.
S, B, you can claim what you like, the fact is, it is simply not true that VAT is borne 100% by the purchaser. If they scrapped VAT, then in the short term, businesses might maintain their prices and rake in a lot more gross profit (also known as 'value added', it is the same thing conceptually, mathematically or economically), but new entrants would quickly enter the market and compete these super-profits down.
You fail to accept that for most businesses, the net profit margin, after VAT, is tiny, maybe 5% or 10% of the selling price. So with no VAT, these margins would treble (or whatever), and as we know, absent barriers to entry, super-profits like this will be competed away with lower prices/higher output.
S, for God's sake, don't drag Business Rates into this, they are just part of the rent - there is a wealth of evidence (statistical or you have seen it with your own eyes) that freely transportable goods sell for much the same wherever they are sold in the UK, DESPITE THE FACT that rents and hence Business Rates are much higher in some locations than in others.
Rent and rates are NOT an input cost, they are the landlord's PROFIT SHARE, which is everything above the basic 5% - 10% minimum profit margin which businesses expect.
You can argue, if you wish, that a VAT cut would thust partly lead to higher rents, which may well be true, but however much of those rents are collected in Business Rates makes absolutely NO difference to prices and hence the consumer.
VAT is NOT a tax on 'consumption'. Taxes on fuel, fags, booze are taxes on consumption thereof for the simple reason that demand is price inelastic and supply is price elastic; but a general tax on gross profits ('value added') of non-favoured industries
Yes, yes and yes.
@Bayard: of course businesses would want (and try) to maintain prices in the event of a VAT cut/abolition. As I have pointed out the ability to do so depends on how competitive a marketplace they work in. Some prices would drop by the full amount, some by a bit, some not at all, although as you admit, in the long run new entrants would reduce prices to the non taxed level.
The reason why the abolition of VAT would more likely result in lower prices is simple: 1) People know VAT exists and therefore will demand its removal from the price. 2) the amount to reduce the price by is easily calculated. If corporation tax was cut how would a company even begin to work out how much less it should charge for its goods and services?
Its pretty simple. VAT is a tax added to the price of stuff people buy, and by and large increases the cost of said items above what they would be in its absence. That to me is a tax on consumption. You consume, you pay it. Yes there are effects to depress profits in certain sections of the economy as well, but as far as I can see the biggest beneficiary of zero VAT would be the consumer, not businesses.
JH, yes.
S, OK, let's imagine that they abolished VAT entirely and replaced it with a flat 16.667% tax on the turnover of non-favoured industries selling to the end consumer; or with a flat 16.667% tax on the gross profits of non-favoured industries. How would that in any way affect end prices to the consumer, net profits of suppliers or output generally?
Or contrast two extremes: a small business below the VAT threshold sells stuff and pays 21% small companies rate corporation tax; a competing business next door sells the same goods, pays 20% VAT but does not pay corp tax on its profits (because it has losses b/forward or because it magics its profits away with cross charges from a parent company overseas)?
Assuming that their cost base is otherwise identical, which business ends up paying more UK tax?
Of course the first pays less tax. They're paying 21% of profit only and the others are paying 20% of all sales revenue.
But thats a result of there being a turnover threshold for VAT, not the principle of VAT. Its obvious that companies/individuals just below the VAT threshold have a price advantage over those above it - why do you think so many tradesmen keep under it by fair means or foul?
As to the first point - obviously if you replace tax A with tax B that is calculated slightly differently, but has a similar monetary effect, then prices will remain unchanged. But that's not how you work out who pays a tax. You compare the situation with tax A and without tax A. And with tax B and without tax B. And see who is better off before and after.
If you start with no tax at all on sales and introduce a VAT, what will happen to prices?
And if you start with no tax at all on sales and introduce a turnover tax what will happen to prices then?
S: "You compare the situation with tax A and without tax A. And with tax B and without tax B. And see who is better off before and after."
Correct.
And as I know and understand how supply and demand curves wotk, I can tell you straight away that where demand is price inelastic, the tax is borne largely by the consumer; where supply is price inelastic, the tax is borne largely by the supplier.
The added kicker with VAT is that the consumer only has a limited budget - so if all suppliers try to put up their prices across the board by 20%, consumers will of necessity consume 1/6 less by volume, which is another way of illustrating that VAT is largely borne by suppliers.
I have never said anything else.
It's you who keeps changing his story. You are the one who insists that "If we had LVT then landlords would pass it on to the tenant" and "VAT is borne by the consumer" and "If Business Rates were increased then retailers would be forced to put prices up".
In any event, it doesn't matter because SUPPLIERS ARE PEOPLE and CONSUMERS ARE PEOPLE and by and large THEY ARE THE SAME PEOPLE so for convenience we might as well assume that VAT is like an extra 7% income tax.
"In any event, it doesn't matter because SUPPLIERS ARE PEOPLE and CONSUMERS ARE PEOPLE and by and large THEY ARE THE SAME PEOPLE so for convenience we might as well assume that VAT is like an extra 7% income tax"
So you are admitting that VAT is a tax borne ultimately by consumers, the equivalent of 7% of income, but one that can be avoided by not buying stuff? Ie a tax on consumption?
S, all taxes are ultimately paid by people, so what's your point?
The point is that some taxes are very damaging economically (VAT, NIC, to a lesser extent income/corp tax) and others have no such effect (LVT, or their closest equivalents Bus Rates, Fuel Duty, 3G licence auctions).
In any event, one man's production is another man's consumption...
a) Let's say you are a home-builder, for sake of argument, and the government decides to slap VAT on new builds (as they do in many EU countries). Do you seriously think that you can just hike your selling prices by 20%?
b) If you seriously believe that you can, the remember also that the selling prices of new and 'second hand' homes are in equilibrium, so if you can magically hike your selling prices by 20%, then the potential selling price of all other homes would also go up by 20%, which is clearly nonsense.
c) Remember also: LVT is very much a tax on consumption, it's a tax on consumption/use of land. But as land is not produced (and land values are not created by individuals) there is no corresponding production, so LVT cannot possibly be a tax on production. Result!
The quote from your original post was "VAT is NOT a tax on 'consumption'". If consumers end up paying it and it can be avoided by consuming less, then I'd call a spade a spade, and say its a tax on consumption, that's all.
I don't disagree with you on its negative effects on the economy, but then I think all taxes have negative effects on the economy.
S, OK, let's assume we all decide to spend £nothing on VATable items - that means no clothes, no electricity or gas, no petrol, no nights out, no CDs etc. How's that going to work?
I note that you resolutely refuse to address the issue of supply-demand curves (and price elsaticity/inelasticity), which is basic O-level economics, and there's not much point discussing this further until you do.
I already have pointed out those very facts - with the two examples of petrol vs CORGI gas installers. I accept that. But the balance lies between the two, and for the vast majority of people who are purely consumers of goods and services, not producers, VAT causes them to pay more for goods and services than they would otherwise have done so. Maybe not by the full amount (ie 16% of all vat-able purchases) but by some figure approaching that (you suggest 7% of income, which given not all income is spent on vat-able items means the loss on vat-able stuff must be more than 7%).
I really don't know what you're trying to prove. VAT is avoidable, maybe not 100% (any more than LVT is 100% avoidable - you have to live somewhere, unless under a hedgerow) but can be reduced significantly by astute purchasing.
I really can't see how a tax that raises prices to the consumer and can be at least partially avoided by not consuming cannot be called a consumption tax.
S: "VAT causes them to pay more for goods and services than they would otherwise have done so."
Correct, the same applies to NIC, PAYE and corporation tax (although not to the same degree).
"I really can't see how a tax that raises prices to the consumer and can be at least partially avoided by not consuming cannot be called a consumption tax."
OK, go along with the pol's who pass it off as a 'consumption tax' which sounds very cosy and harmless. This fits in nicely with your cosy Home-Owner-Ist view that LVT is the worst kind of tax, even though it is about the only tax that does not affect PRODUCTION.
But VAT is not a harmless 'consumption tax'. Mathematically, legally or economically it is exactly what it claims to be - a tax on VALUE ADDED, i.e. gross profits.
Do you understand the maths of VAT?
You take your selling price (as capped by the market/competition), minus off input costs on which VAT has been paid and that's your VAT bill.
We could rejig corporation tax so that instead of nearly all costs being allowable expenses, things like interest, rent and salary are not allowable expenses, and then charge corporation tax on this much higher figure. How is that not a tax on gross profits (or some measure of profits)?
It just so happens that VAT drives all the small and marginal businesses out of business, so competition and output is reduced, so the smaller group of remaining suppliers can charge higher prices.
The same applies to PAYE, NIC, corporation tax as well, but not to the same extreme degree: cluebat - VAT raises £100 bn a year; corporation tax raises £30 bn.
>VAT causes them to pay more for goods and services than they would otherwise have done so
No!!! VAT causes them to buy LESS goods and services than they would otherwise have done so
AC1
AC1, indeed. As I said above (a point which S resolutely fails to address): "if all suppliers try to put up their prices across the board by 20%, consumers will of necessity consume 1/6 less by volume, which is another way of illustrating that VAT is largely borne by suppliers."
So consumer has £6 to spend and items cost £1 each in a VAT-free world, production and consumption is six units.
Slap VAT on them, the producer has to charge at least £1.20. But if the consumer only has £6 to spend, production/consumption goes down to five units. But this leads to one-sixth of producers going bankrupt, so less profits, less wages, so the consumer no longer has £6 to spend, he only has £5 to spend, so that's made the consumer £1 worse off and the producer £1 worse off (ultimately they are the same or similar people, you can't add £1 and £1). But there is clearly a dead weight cost of rather more than £1.
You are arguing against strawmen just to avoid admitting I'm right. I've never said VAT is harmless, or that consumption taxes are harmless. Of course they affect production, its the opposite of consumption. Taxes on consumption = less consumption = less production.
And I very well understand the maths of VAT - I run my own business, fill in my own forms and sign for their veracity.
I ask you this simple question - if VAT were added to items currently zero rated would they go up in price or stay the same?
S: "I've never said VAT is harmless, or that consumption taxes are harmless. Of course they affect production, its the opposite of consumption. Taxes on consumption = less consumption = less production."
Splendid, then we are in full agreement. All that remains is for you to realise that LVT (and its variants) is the only tax which is not a tax on consumption and has no dead weight costs :-)
"if VAT were added to items currently zero rated would they go up in price or stay the same?"
As anybody will tell you, that depends entirely on the relative price elasticity of supply and demand:
1. Tax on rent (demand very price elastic, supply nigh on fixed) = no affect on gross rents.
2. Tax on essentials, like mains water, largely borne by consumer (demand is price inelastic, water companies are quite happy to pump a bit more or a bit less water).
3. Tax on books, non-essentials, but supply is very price elastic as well, so about half the tax would be added to the gross price, the other half would be borne by producers, output would drop and some publishers would go out of business.
4. Clearly, the amount of money which people have to spend would fall (all the unemployed book printers) and prices payable would rise, so this leads to a vicious circle, the results of which you can suss out for yourself, or check unemployment statistics or something.
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