## Saturday, 29 August 2015

### The dynamic 'cost' of getting rid of VAT would be a lot less than current VAT receipts

Here's a simple diagram showing how VAT reduces economic activity (assuming a certain fixed level of costs) and sketching in the receipts from VAT (about £100 bn) and PAYE/corporation tax. This assumes that the overall average rate paid by employees (income tax and NIC), company and business owners averages out at 40%. So mathematically, PAYE and corporation tax receipts etc are about £200 bn and total tax paid by the VAT-able sector is £300 bn:

Now, what happens if we got rid of VAT but left other tax rates the same?

Output, in units, increases by one-fifth and the 40% average rate, now applied to a much larger tax base, would raise about £281.25 bn (if my geometry is correct). So although VAT taken in isolation is £100 bn a year, getting rid of it would only mean total revenues falling (a 'cost' from the government's point of view) by £20 bn.

For sure, I have made a lot of assumptions here, the higher the fixed cost line, the more dramatic the effect and vice versa. But even if the fixed cost line is set to zero, total receipts would only fall from £300 bn to £240 bn, a dynamic 'cost' of only £60 bn.

And the 40% is just an overall average rate, the average rate for low earners will be lower, but all those extra jobs means millions off the dole queue into low paid jobs at least, and the welfare savings is well in excess of 40% of the extra money they earn.

Perhaps we can split the difference between £20 bn and £60 bn and call it £40 bn?

#### 16 comments:

Shiney said...

Yeah, OK but we'd have to leave the EU. Which I'm OK with, BTW.

Mark Wadsworth said...

Sh, no we would;t have to leave.

We could just do it, and if the other countries want to throw us out, we just point at all the extra businesses and workers and ask whether they want the businesses to close again and all those people to go back in the dole.

And if they still chuck us out, well, that proves what arses they are and nobody will mind.

Lola said...

The graphs also imply that scrapping IT/NI/CT would also increase output?

Mark Wadsworth said...

L, yes, but not as dramatically.

To show those, we need to draw a different graph with "demand for labour" and "demand for capital/cash investment".

Lola said...

Another way to think of it might be that if the market clearing price is x, by adding 20% tax the producer, unable to raise prices above x gets only 80% of the market clearing price going forwards. Or his costs have risen by 20%?

Lola said...

...or he can only sell 80% of his production. (smart phone posting failure)

Mark Wadsworth said...

L, no, he only gets 80% of the market clearing price, we've got enough evidence for that (supplier = inelastic, demand = elastic).

So VAT does not affect businesses with a high profit margin (which is why incumbents prefer it to corporation tax), but it turns marginal ones into loss making ones and low-profit ones into marginal ones (the lost output).

Shiney said...

M

OK... I see the point

However, because we in the UK tend to play by the rules, and the rules mandate VAT, then the argument that will be used is 'we'd have to leave the EU' rather than making any other substantive argument as to the merits, or not, of your suggestion.

Shiney said...

M

Which is what I did. Sorry.

Mark Wadsworth said...

Sh, ah yes, I have heard that one before but it is easily circumvented.

Although VAT is the worst tax and Employer's NIC the second worst, what probably matters most is the overall total tax rate, which we would like to reduce to about 20% "flat tax".

So if we want to be sneaky and not piss off the EU, we could reduce VAT to 15% and reduce the rate of corporation tax for VAT-able businesses to 8%, so you would keep 80p for every £1 turnover (100/115 x 92/100 = 92/115 = 80%).

And politically, Employer's NIC is a better tax than income tax ("making those wicked employers pay for the NHS") so there would be 9% Employer's NIC on their gross wages but their gross wages would be exempt from income tax and Employee's NIC.

So for every £1 or your turnover that goes towards their wages, they would keep 80p (100/115 x 100/109 = 80%).

For non-VATable businesses, the usual rate of corporation tax 20% applies, and wages paid out would be liable to 9% Employer's NIC and 12.8% Employee's NIC (100/109 x 87.2/100 = 80%), but no PAYE income tax, of course.

Sorted.

Lola said...

MW. Yes. That was the point I was making - badly.

Lola said...

How about doing a supply / demand graph for land?

Mark Wadsworth said...

L, easiest thing in the world. Supply is to all intents and purposes inelastic = vertical and demand is a normal demand line that slopes downwards.

Lola said...

MW. Yes, that's what I drew. But although land supply is fixed planning permissions aren't....?

Mark Wadsworth said...

L, no they aren't.

But total rental values for any country or area are pretty much a constant, they just slosh around.

So in practical terms, a new shopping centre opened up in Stratford to use the new transport links laid on by the British Olympic Committee (i.e. the UK taxpayer) and it's a really popular shopping centre.

But all other shopping centres in the catchment area (old Stratford, Ilford, Romford etc) all saw footfall and takings and rents nose dive. More vacancies, pound shops, charity shops etc.

So on a more subtle level, it is "rental value of land" that has a more or less vertical line. Which is clearly beyond the influence of any individual.

Lola said...

MW. Beyond the influence of any individual - except king John?