Wednesday, 26 November 2014

Economic Myths: "VAT is a tax on luxuries"

You have to remember that VAT is not a tax on "consumption" (whatever that means). It is a tax on gross profits-plus-wages, the clue is in the name "Value Added Tax". There is then also a tax on net profits, known as corporation tax (which is not a tax on "capital", whatever that means, it is a tax on income). So if this myth were true, then producers of more basic goods would pay a lower tax rate than producers of luxuries.

(VAT's fig-leaf is that taxes on "necessities" like food and rent are exempt. Is it a coincidence that both of those are land-based sources of income? Interest payments are not liable to VAT either. But that is just a fig-leaf.)

Remember also that "luxuries" are status goods, people will pay extra to have such-and-such a label on their car, clothing, musical instrument, whatever, so producers who have attained this reputation can charge larger mark-ups*. So let's put VAT and corporation tax together and do some numbers.

1. A luxury/status item costs £500 to make and retails for £1,000. The overall profit before any taxes is £500.

The VAT is £167, leaving £333 liable to 20% corporation tax = £67. Total tax = £233.

£233 out of the original £500 = 47% overall tax rate.

2. A more basic item costs £50 to make and retails for £75. The overall profit is £25.

The VAT is £12, leaving £13 liable to 20% corporation tax = £3. Total tax = £15.

£15 out of the overall profit of £25 = 60% overall tax rate.

Here endeth.

* From Robert Benchley's "Jaws":

The young man was tall and slim. He wore sandals and a bathing suit and a short-sleeved shirt with an alligator emblem stitched to the left breast, which caused Brody to take an instant dislike to the man.

In his adolescence Brody had thought of those shirts as badges of wealth and position. All the summer people wore them. Brody badgered his mother until she bought him one - 'a two-dollar shirt with a six-dollar lizard on it', she said - and when he didn't find himself suddenly wooed by a gaggle of summer people, he was humiliated.


James Higham said...

VAT is an iniquity but you knew that.

Ben Jamin' said...

We want capital to turnover. That's how things get better. VAT penalises this.

Another step in the wrong direction.

Mark Wadsworth said...

JH, yup.

BJ, that article and the objections are full of technical errors and inaccuracies and the arguments stack up no more than the argument against VAT generally.

1. Most other EU countries have a low or no registration threshold, the UK is unusual in this regard (about £80,000 turnover). So why shouldn't small UK firms selling to German customers pay the same VAT as a small German firm?

2. The stupid thing is that for a small business to retain its exemption under the threshold for UK-only turnover, it cannot use the MOSS and would have to register for VAT in all the other countries where it might sell something. Which is clearly insane.

3. "I will likely stop direct digital sales to customers & use only big corporate platforms."

Stupid woman.

If she sells via some other website the same rules apply and VAT is still payable on the final selling price, although it might be a bit less hassle. But that's what people like eBay and Amazon are charging for, making it easy to market and sell your stuff to lots of customers.

mombers said...

MW, what a nightmare re no threshold. I'm assuming they just turn a blind eye on minor eBay / Amazon / flea market sellers?

ontheotherhand said...

Mark, whilst I like your assessments on VAT and I'm with you, this luxury vs. basic needs more analysis. What something 'costs' to make and sell is not only the marginal cost of production, but the costs of R&D and marketing.
To support a luxury brand, the owners spend on marketing. For example, some entrepreneurs set up a new cricket bat company a few years ago called Woodworm, outsourced the manufacturing at a standard cost, and charged more for their premium product. Nearly all their start up money went to pay Flintoff and Pieterson to play with the bat.

All luxury goods spend more on marketing and distribution - rates on the Bond Street flagship shops, adverts in expensive magazines, product placement in films and sponsorship of Grand Prixs. etc. Probably only £20 of that £400 golf driver goes to the factory in China. £50 goes to Tiger Woods, the rest is transport, import duty, golf distributor margin, retailer margin, and yes, then VAT and profit.

Derek said...
This comment has been removed by the author.
Bayard said...

OTOH, VAT isn't "a tax on luxuries", not just for the reasons Mark gives, but simply because it's not. What is so luxurious about clothes? OK you get luxury clothes, but ALL clothes, apart from children's clothes, are subject to VAT. Also, all drink, including water, FFS, is VATable, except milk. You don't get a much more luxurious luxury than solid gold. Gold is not VATable.

Mark Wadsworth said...

M, I don't know.

OTOH, you're not disagreeing, you're actaully agreeing.

You have to do a worked example with your fancy Woodworm bat and a run of the mill one, and put all the real costs into one column and all the profit or rent into the other column.

For example, the money paid to Flintoff or Pietersen is their profit or rent; the money paid to the chaps in the factory is a cost in both examples.

Then calculate the VAT plus corporation tax as a % of the total rent+profit column and you'll find that the overall rate is lower for the Woodworm bat.

B, exactly, ta for back up.