Thursday, 29 May 2014

VAT is borne by the supplier, part 94: Japan.

From the BBC:

Retail sales in Japan fell 4.4% in April, compared with the same period last year, as the effect of an increase in the country's sales tax began to be felt. Japan raised the tax from 5% to 8% on 1 April - the first hike in 17 years.

The country faces rising social welfare costs due to an ageing population and is trying to rein in public debt.


So that hopefully puts to rest this nonsense which the politicians bandy about, and which so many armchair economists trot out, that "The consumer pays the sales tax". The consumer only pays the tax if demand is price insenstive (tobacco, booze, petrol/diesel); the supplier pays the tax if supply is price insensitive (fixed supply, such as land, or fixed high overheads/low marginal costs).

Analysts said sales had dropped in part due to consumers rushing to make purchases ahead of the tax rise. That trend was evident in March, when sales surged 11% - the fastest pace of growth since March 1997.

Illustrating why it is a bad idea to announce changes to tax rates in advance.
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UPDATE: Dinero says:

A lot of the time, where the word consumer is approriate, the consumer does pay the sales tax. It is often a very competitive market with items being sold close to the cost of production, and so VAT along with the cost of raw materials are included in what establishes the price.

Problem is, there is no evidence to support that and plenty of evidence to debunk it.

The UK ran the real life experiment of changing VAT from 17.5% to 15%, back to 17.5% and then up to 20% over consecutive years.

The ONS publishes separate retail price indices for the main categories of consumer spending, some VAT-able, some not. If you look at total selling prices for VAT-able and not VAT-able (inclusive of VAT, where appropriate), rather unsurprisingly, overall inflation, from the point of view of the consumer was exactly the same for each.

If Dinero's theory held water, then RPI for VAT-able supplies would have been 2.5% lower than for not VAT-able in the first year and then 2.5% higher in the two subsequent years.
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Dinero again:

... if a bar of chocolate is being sold in a supermarket for 100p inclding 20p VAT and VAT is removed - what is the process that enables the price to stay at 100p?

Supermarket retail is very competitive and a retailer who left the price at 100p would be undercut by a competitor who would be removing the full 20p to attract the customers to himself.


That's all supposition. I do facts. Then I try and discern patterns and only then do I try and work out the logic. Charles Darwin knew bugger all about DNA and molecular biology, but he accepted and refined the theory of evolution.

1. I did some more number crunching looking at Tesco's gross margins during the period of VAT changes and their gross margin went up (or down) by about two-thirds of the VAT reduction (or increase).

2. During the recession, the EU graciously allowed a couple of Member States to experiment with VAT cuts in labour-intensive businesses. Sweden did quite a significant VAT cut for restaurants and pubs (from 25% to 12%). Menu prices only went down slightly; what happened was a huge increase in custom and hence employment.

3. Although supermarkets are competitive inter se, they act as a cartel to the outside world and have already set prices at the profit/revenue maximising level. If they can get away with making an extra 20p profit per chocolate bar, why would they give it away again?

4. Every penny they reduce the price is 5% off their extra net profits; would people eat 6% more chocolate if a bar costs 99p instead of £1? Would people eat more than twice as much chocolate if the price were 90p instead of £1?

5. Look at the whole supply chain; manufacturers are geared up to a certain level of output; supermarkets only have so much shelf-space etc. Even if their pricing guru tells them that they could sell more than twice as much chocolate if they cut the price to 90p, it simply physically can't happen. So supply is fairly fixed; suggesting that the tax is borne by suppliers.

18 comments:

Dinero said...

a lot of the time, where the word consumer is approriate, the consumer does pay the sales tax. It is often a very competative market with items being sold close to the cost of production, and so VAT along with the cost of raw materials are included in what establishes the price.

Dinero said...

Those are interesting stats, ONS, but if a bar of chocolate is being sold in a supermarket for 100p inclding 20p VAT and VAT is removed -

what is the process that enables the price to stay at 100p -

supermarket retail is very competative and a retailer who left the price at 100p would be undercut by a competitor who would be removing the full 20p to attract the customers to himself.

Pablo said...

Charles Darwin knew bugger all about DNA and molecular biology, but he accepted and refined the theory of evolution.

See here:
http://homepage.ntlworld.com/janusg/evolut/evol.htm

Shiney said...

I'm a supplier to all the supermarkets of Vat-able goods... so I KNOW what I'm talking about.

And MW is right, if VAT goes down they may drop their prices 'a bit', do a few promos here and there but most prices would stay the same.

@D said "It is often a very competative market with items being sold close to the cost of production, and so VAT along with the cost of raw materials are included in what establishes the price."

You're having a laugh, right? In a competitive market cost of products has sweet FA to do with the market price. It'll be about relative market and supply chain power.

Mark Wadsworth said...

Sh, ta for hard info from the front line, that always keeps us on track.

Mark Wadsworth said...

Sh, ta for hard info from the front line, that always keeps us on track.

paulc156 said...

@Mark I was wondering how come Sweden saw such a boost to restaurant custom if "Menu prices only went down slightly"?

Looking at the link the claim is made by the 'restaurant industry body'... ahem. Sure they boosted their profits and perhaps this enabled them to employ more staff which meant better service[I dunno] but it sounds mickey mouse. If menu prices were barely changed then they got barely changed custom...surely.

Mark Wadsworth said...

PC, you can wonder "why" as much as you like.

I read lots of articles about this (and similar in Ireland) at the time and they all said the same.

So don't go supposing that the one article I linked to more or less at random out of hundreds of articles somehow disproves my point, it doesn't.

So let's not argue and bicker about the "why" and "would" and "should", what is important is what happened.

And I have no reason to lie about any of this, why would I? That's boring.

Dinero said...

I was wondering why Mark cited a rise in VAT with a year on year fall in retail sales in Japan as evidence that VAT does not affect retail prices.

Dinero said...
This comment has been removed by the author.
Mark Wadsworth said...

Din, I said absolutely no such thing and drew no such conclusion, you are misquoting me and then criticising what I never said in the first place.

What I pointed out was that it was complete and utter nonsense to say "The consumer pays the VAT therefore it does not affect the supplier" and produced evidence, as per usual, from Japan to show that suppliers suffered quite significantly from a VAT hike.

You then started talking about price changes.

How prices are affected is a different topic (although all the evidence points to the same conclusion).

I then explained what happens to prices using real life evidence.

If we then draw all the real life evidence together, including what Shiney said, we conclude that after a VAT rise, there are some items which the retailer can no longer sell profitably, so he stops selling them. So output goes down. Manufacturers and employees suffer. It's all shit.

Dinero said...

I refering to the first 60 words of your post the quote in italics


"Retail sales in Japan fell 4.4% in April, compared with the same period last year, as the effect of an increase in the country's sales tax began to be felt."

thats is what your post quoted

paulc156 said...

I'm trying not to 'bicker' Mark. Honest. Nor would I suggest anyone is telling lies [except the Swedish restaurant lobby...perhaps!]
I'm quite prepared to accept that people suddenly went out to eat more in Swedish restaurants just when the VAT was reduced even though they were effectively paying the same prices as before the VAT decrease. I don't have a dog in the fight. Perhaps people didn't realise the menu prices were virtually unchanged or else like I said, perhaps there were more staff which meant better service, or maybe the restaurants gave larger portions rather than cheaper meals...

It's just that I'd quite like to know the mechanism through which hungrier than normal Swedes suddenly beat a path to restaurants when there is no monetary explanation for them doing so.



Mark Wadsworth said...

Din, thanks, now we're back to the original topic.

If it were true that "the consumer pays the tax and the supplier is unaffected" then the retailers would have just bumped up their prices, the consumer would have happily paid the higher prices. That didn't happen, did it?

PC, this is all basic economics.

The demand for restaurant meals is price sensitive, it is not an essential and there are cheaper substitutes (cook your own).

So a small drop in price means a large increase in quantity demanded. Plus the other factors you mention - if the restaurant has a higher margin, he can provide a better service in a virtuous circle.

Just Google it and read a few articles for example here.

Lola said...

Surely the clue to VAT's depressive effect is in its name - Value ADDED Tax. It's designed to tax the value that has been added by production. This cannot be a Good Thing as it must reduce the returns to the producer as the price of the good or service must be at the market clearing level. Thinking about it, this must then also reflect through in the other factors of production - less employees will be taken on, less capital equipment will be purchased etc etc.
Anyway, as it is recognised that consumer behaviour can be changed by applying high taxes to things that prodnoses think are bad for us - that is we will buy less of it - it follows that high taxes on production, e.g. VAT discourage production.
Or have I go this arse about face?

The Stigler said...

Lola,

Exactly. It's a tax on specialisation, the thing that makes us richer.

But I suspect it taps into a certain "righteousness" about work, that we should be baking cakes rather than paying Mr Kipling to do it for us.

Lola said...

TS. Except that I actually bake a better cake than Mr Kipling - if I have the time, which is rather the point of specialisation. But I do not bake as good a cake as the local WI, which returns us to the specialisation bit.

I wonder how it applies to masturbation and prostitution? Or is that too coarse? And would applying VAT to prostitution encourage or discourage it? And what would be the substitutions? What is the market clearing price for a tarts services....? I think I'll stop this now...

Mark Wadsworth said...

L, you have got it exactly right. VAT is quite simply the worst tax.

TS, VAT taps into Righteousness by masquerading as a "tax on consumption". As if somehow there can be consumption without production (which there can't be apart from land and natural resources, which unsurprisingly are largely EXEMPT from VAT).