VAT Incidence Fun

Tesco's results for the six months to August 2011 are out, so we can now compare and contrast four periods in which the main VAT rate was 17.5%, 15%, 17.5% and 20% respectively:

Six months to August 2008, VAT 17.5%
Gross sales £28.1 bn, net sales £25.6 bn, trading profit £1,367 m = profit margin 5.3%

Six months to August 2009, VAT 15%
Gross sales £30.4 bn, net sales £27.8 bn, trading profit £1,551 m = profit margin 5.6%.

Six months to August 2010, VAT 17.5%
Gross sales £32.6 bn, net sales £29.5, trading profit £1,710 m = profit margin 5.8%.

Six months to August 2011, VAT 20%
Gross sales £35.5 bn, net sales £31.8 bn, trading profit £1,773 = profit margin 5.6%.

Ho hum, that fits in with my observation that VAT is partly - or even largely - borne by the supplier. There are four ways of looking at this:

i. If it were true that 'the consumer pays the tax', then we'd expect trading profit to be fairly stable as a % of net sales, and to fluctuate rather more as a % of gross sales. If (as common sense suggests), the consumer has a fixed budget and the supplier bears a large chunk of the VAT, we'd expect the opposite. Trading profits as a % of net sales (as shown above) fluctuated between 5.3% and 5.8%, but trading profits as a % of gross sales fluctuated between 4.9% and 5.2%, i.e. rather less.

ii. Even though the recession started in 2008, Tesco managed to improve their gross profit margin in the next year (because VAT went down to 15%) and after VAT was increased to 20%, their margin went down, as we'd expect. The figure that throws this is the increase in gross margin between 09 and 10, even though VAT went back up to 17.5%.

iii. Look at how customers shifted their spending between non VAT-able items (basic food) and VAT-able items (everything else). Back in 2008, when VAT was 17.5% (and had been for a very long time), 55.8% of Tesco's sales were of VAT-able items. When VAT went down to 15%, this went up quite markedly to 62.4%, then it went down to 60% and then to 58.2% (all as you'd expect).

iv. If VAT were entirely borne by the consumer, the trading profit + VAT ('TP+VAT') would increase/fall when VAT increases/falls; if VAT were borne entirely by the supplier, then TP+VAT would stay the same. Let's assume that 60% of Tesco's sales are VAT-able (from iii.), so a 2.5% VAT change = 1.5% of sales.

In 2008, TP+VAT = 13.8% of turnover, that's our starting point.

In 2009, VAT went down, so if the supplier bears the tax he also benefits from a reduction and TP+VAT would stay at 13.8%. If the consumer benefited from the cut, TP+VAT would go down to 12.3%. As it happens, TP+VAT fell slightly to 13.7%, so the supplier kept 14/15 of the tax cut.

In 2010, VAT went up again. TP+VAT went up to 14.8%, not to [13.7% + 1.5% = 15.2%], so the supplier bore 4/15 of the tax hike.

In 2011, VAT went up yet again, and TP+VAT went up to 15.4%, not to [14.8% + 1.5% = 16.3%], so the supplier bore 9/15 of the tax hike.

We can average out 14/15, 4/15 and 9/15 to 9/15 = 60%, i.e. in summary, my rule of thumb that suppliers bear two-thirds of the VAT seems to be fairly reliable.