Friday, 29 July 2016


I recently received another email extolling the virtues of VAT and saying that it fixes perceived problems that LVT can't.

Firstly, there is allegedly massive corporation tax avoidance, so VAT is a way of collecting a share of (taxable) profits at source. Nonsense, in relative and absolute figures, there is far more VAT avoidance/fraud that corporation tax avoidance/fraud. For example, Google were invoicing UK customers from the Rep of Ireland to avoid VAT, allegedly.

Secondly, it discourages consumption - the logic being that it thereby encourages investment instead. Duh. You will only invest in a business if it can produce and sell stuff profitably. If the amount of stuff it can produce and sell profitably is significantly reduced by VAT, then there is significantly less investment.

Thirdly, VAT falls more heavily on services (cutting each other's hair) than on exports of goods (which are zero-rated for VAT). That is blatant mercantilism and the opposite of free trade. Plus what's wrong with cutting each other's hair if it adds to the sum total of human happiness?

Finally, to the extent that you perceive the trade deficit as a problem, clearly, having 20% VAT has not reduced the trade deficit at all, unless some maniac wants to suggest massive import duties and 40% VAT? So it's an interesting theory but fails completely in real life.

Ask yourself, if we buy stuff from abroad, what is the foreign exporter going to do with its GBP?

A buy UK government bonds
B buy land (and collect rent in future which worsens deficit)
C buy shares in UK monopolies (railway, utilities, banks etc)
D buy shares in productive UK businesses
E invest directly in expanding a UK business
F buy goods and services from us

If the government is not running a deficit then A is not a problem, and deficits would be lower with LVT. Even if it is running a deficit, what matters is whether the money is being spent/invested wisely. Ultimately, those UK govt bonds will never be repaid and the interest cost is minimal, with or without LVT.

B - If we have a significant reduction in taxes on production and a corresponding significant increase in LVT, then they can't do B. If they acquire land, they will end up paying back their GBP to the government. The accumulated trade deficits melts away. So this also reduces future trade deficits (rental stream won't be going abroad).

C- Remember that what foreigners really like buying is rental stream/monopoly profits - railways, utilities, banks. This is not really "investment" at all. We can collect that rental stream at source via the tax system i.e. under the same principles as LVT.

D - If they want to buy existing businesses, then fine. Somebody builds a business and he can sell it to who he likes. The UK government always retains a 20% via corporation tax anyway.

E is always cheaper than D. UK shares trade at three times real assets, the rest is "rent", so why not buy plant and machinery and set up on your own? Clearly, whoever sold us "stuff" is good at making "stuff" and is well placed to make "stuff" in the UK, especially if the worst taxes on UK business (VAT and NIC are reduced/scrapped). He can spend £1 on shares for 4p a year dividends or spend £1 on plant and machinery for a 12p return. So more real foreign direct investment.

F - what are foreign exporters going to do with their remaining GBP, having exhausted A to E? They will spend it on UK goods and services.

(The foreign exporter could of course just leave the money in the bank, which the banks can then lend to UK businesses, which achieves D by the back door).

As a result of which, the trade deficit melts away, output goes up, unemployment is reduced, this is one of those things that LVT sorts out on its afternoons off, it is not the main event.
Or we can start from the other end.

The UK's trade deficit is about 6% of GDP, so if we increased output by 3% and reduced consumption by 3%, we'd be all square. Getting rid of VAT and NIC would increase our total output by far more than 3%, but let's call it 3% for now.

The 'UK' is merely the sum total of all its resident individuals and businesses. Any individual who produces more than he consumes is not contributing to the deficit. It is those who consume more than they produce who are. Most of those who consume more than they produce are living off rents; choke off the rental stream and they will either have to consume less or produce more.

Think about a Boomer/retired couple doing Mortgage Equity Withdrawal - they buy themselves a nice imported car and go on foreign holidays while producing nothing. MEW is 2% or 3% of GDP, so the total rental stream supporting the lifestyles of the non-productive (whether collected as capital gains, straight rent or mortgage interest) is a large multiple of 3%.

I really don't know what is so difficult to understand. This is not idle and untested theory, it is observation.When Denmark introduced modest LVT in the 1960s, their trade deficit quickly turned into a surplus (and back to a deficit again when the next government reversed it). Hong Kong has always had a surplus, and so on.


Lola said...

What's wrong with it is that everyone aspires to be a rentier and you're (we) are recommending a system that cuts that aspiration off at the knees. Also it with CI destroys the reason d'etre of the bureaucratic class. No wonder it's such a struggle.

George Carty said...

Would the Eurozone be in much better shape if the PIIGS countries had introduced LVT just after joining the Euro, to stop excess German capital piling into their property? Maybe not Greece due to their rampant tax evasion (plus their more fundamental shortcomings, such as their heavy defence spending and forbidding terrain) but certainly the others?

On the other hand, what would such a policy have meant for Germany – where would their excess capital have gone instead?

Mark Wadsworth said...

L: "everyone aspires to be a rentier" Very true, but for every rentier there have to be five tenants, and who would be brave enough to admit that?

GC, the PIIGS generally would be in better shape and Greece would probably still be in a mess.

Where would German money have gone? Well, where did it go, it appears it was lent back to the Greek government/banks (possibility A). That in itself is neutral… until you have to start paying it back or paying interest on it.

Where 'would' it have gone? No idea, your guess is as good as mine, choose from the list.

Stephen Stretton said...
This comment has been removed by the author.
Stephen Stretton said...

The 'what will foreigners invest in' argument is a favorite of mine, and pretty much a basis for my book. So I'm glad we are in agreement on that. I take it a little bit further, but not to a different conclusion and that's not my main concern here.

And remember this isn't about VAT per se, but rather whether we should have more of a consumption basis to our taxation.

In terms of exports adjusting are we in agreement that this happens through the exchange rate? And also is it clear that the UK trade position is pretty insensitive to the exchange rate?

Mark Wadsworth said...

SS, as is easily observable, UK inflation and imports/exports are surprisingly insensitive to exchange rates changes. I think that is a side show.

As to taxes on 'consumption', you can target things where demand is price insensitive (booze, fags, fuel) and it raises lots of money but doesn't depress quantity consumed much.

And then there are import duties, which sort of work, despite being damaging overall.

Or you can do general spending tax like VAT and that just depresses output and demand in equal measure, thus doing bugger all for the trade balance.

So the point is, look beyond the superficial political appeal of taxing "consumption" and ask "what will foreigners invest in?". They are most likely to invest in productive stuff (new businesses) if we are a low tax, free trade economy, whereby LVT isn't really tax, it's rent which they would have to pay anyway to relocate here.