Monday 29 June 2020

Why monopolists prefer VAT to corporation tax

Dinero, in the comments here:

"It occurs to me that VAT has a monopoly profit tax element to it. [In that it taxes the profit margin on a transaction rather than the profit of the balance sheet aggregate turnover]. I was thinking of the word monopoly in that where a vendor sells something unique and in demand, without competition then that vendor can successfully pursue a high profit margin.

Ignore the sentence in square brackets, which betray a deep misunderstanding of basic bookkeeping and economic concepts.

VAT does precisely the opposite! It doesn't tax the profit margin and helps the monopolist.
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Consider our monopolist, who is insulated from market forces (by some combination of economies of scale, barriers to entry, customer loyalty, patents etc). He pays his workers £50 per unit and sells them for £100 incl. VAT. The UK VAT is one-sixth of the selling price, so he pays £16.67 VAT and has a net profit of £33.33 per unit, or 33.33% of the selling price.

Our new entrant or challenger, subject to competition pays his workers £50 per unit and sells them for £70 incl. VAT. He pays £11.67 VAT and has a net profit of £8.33, just under 12% of turnover.
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If the unit selling price is squeezed by a £5 and costs go up by £5, the monopolist's profit per unit is still £20, or 21% of the selling price. The little guy still has to pay £10 VAT and ends up with a net loss of £5 per unit.

So the little guy goes out of business and his ex-workers are all looking for work. The monopolist survives and can push up the selling price to £100 again and push down wages to £50.
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In our first scenario, the two businesses had pre-tax profits of £70 and tax man collected £28.33 in VAT.

What's the position if the tax man scrapped VAT and imposed 40.5% corporation tax instead (£28.33 ÷ £70 gross profits)?

The monopolist pays £20.23 corporation tax on £50 gross profit (more than he paid in VAT) and the little guy pays £8.10 corporation tax on £20 gross profit (less than he paid in VAT). That's a good start.

If selling prices drop by £5 and wage costs go up by £5, the little guy's after tax profits fall to £5.95 per unit, so he still making a living. The monopolist is still doing very well. We end up with more new entrants and challengers; lower unit prices for consumers; more employment; and higher wages.

What's not to like?

52 comments:

Andrew Carey said...

Our new entrant or challenger, subject to competition pays his workers £50 per unit and sells them for £70 incl. VAT. He pays £11.67 VAT
I think this is where the arithmetic falls apart. VAT is a charge on the value-added, in this case the £20 added value. It might indeed appear to be on the £70 selling price, but there are reclaimable steps before that.

Mark Wadsworth said...

AC, have you worked in tax for the last 30 years? I have. The value added by little guy and his employees is £70. The VAT is levied at 20/120 of that. Fact.

KJP said...

Wow, late for me so I won’t look at the arguments now as to who is right or wrong. But it seems a massive argument from authority.

ThomasBHall said...

AC- for this example MW has ignored any deductable input costs. Labour is not a deductible from VAT- so the value add includes it.

Mark Wadsworth said...

AC, TBH, I assumed that non-labour costs are negligible to make the maths easier.

Dinero said...

Oxford dictionary definition of Value added tax -
a tax on the amount by which the value of an article has been increased at each stage of its production or distribution.

Investopedia definition
The amount of VAT that the user pays is on the cost of the product, less any of the costs of materials used in the product that have already been taxed.

Encyclopedia Britannica definition
Value-added tax (VAT), government levy on the amount that a business firm adds to the price of a commodity during production and distribution of a good.

So what on earth has happened to VAT since its introduction !!!!!!!!!!!!! .

As we can see here a lot of commentators are, or were, under the impression that it worked like the dictionary definition of it.

Mark Wadsworth said...

Din, have you ever completed a VAT return for a service business with minimal overheads?

Dinero said...

Stop trying to being a smart alec, a bit of research reveals that it doesn't actually make any difference . There is something much more interesting to see here. Your example was not a repost to my point as I was talking about a perceived margin tax that turns out does actually exist but only for for antiques. So what is the real story here. According to .gov uk

quote - VAT margin schemes tax the difference between what you paid for an item and what you sold it for, rather than the full selling price. You pay VAT at 16.67% (one-sixth) on the difference.

You can choose to use a margin scheme when you sell:

second-hand goods
works of art
antiques
collectors’ items

You can’t use a margin scheme for:

any item you bought for which you were charged VAT
precious metals
investment gold
precious stones

https://www.gov.uk/vat-margin-schemes
end quote


SO VAT in transactions of non antiques is not a VALUE ADDED tax any more !!!!
Hence the confusion. Even politically , maybe politicians maybe even the chancellor of the exchequer think that VAT taxes the margin.

Mark Wadsworth said...

Din, I know what the second hand goods margin scheme is. That only applies when you are selling second had stuff you acquired from the general public.

It clearly does NOT apply to a normal business which produces something fairly labour intensive; the value added = the cost of labour plus business profit.

Now can you answer my question?

Dinero said...

When a shop sells a TV The VAT on the sticker is always 20 % regardless of the wholesale price. And so VAT as it is in the UK, can not be a value added tax.
Now with that unvarying 20% on the retail price in mind, read those definitions that I submitted and you see the problem with VAT.

Mark Wadsworth said...

Din, VAT is a very specific tax. There is not point coming up with examples of how it works with the second hand goods scheme or TV retail. There is no point quoting Wiki, this is real life.

I was making a comparison between two labour-intensive businesses with minimal raw materials costs.

The VAT is not 20% of the total selling price, it is one-sixth!!

The monopolist sells goods or services for £83.33 + £16.67 VAT per unit = £100 total. The business adds total value of £100 and pays 1/6 of that in VAT.

The little guy sells for £58.33 + £11.67 VAT per unit = £70 total. The business adds total value of £70 and pays 1/6 of that in tax.

I can see the problem with VAT. That was what the whole post was about. I'm not sure that you understand it.

Mark Wadsworth said...

"VAT cannot be a value added tax"

Wow! That's exactly what it is. You might as well argue that income tax is not a tax on income.

Dinero said...

I understand you example. Lets move on.

VAT can not be a value added tax. It is always 20% !!!! or as you like 1/6 selling price, regardless of the Value added .
If it was a value added tax the percentage on the retail price would have to change according to what the retailer's mark up was.

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

Andrew Carey
Thomas B Hall

Has the penny dropped with you guys .
According to https://www.gov.uk/vat-margin-schemes
There are no deductible input costs not just labour, there are no deductible input costs.

Mark Wadsworth said...

Din, I suggest you buy yourself some tax and accounting text books and read up. I am wasting my time trying to explain the VAT system to you.

The margin scheme ONLY applies to second hand shops and second hand car dealers.

Unlike you, TBH had his own business providing services and he knows how to complete a VAT return and how much it costs him.

Dinero said...

You are not actualy reading my comments.
It only applies to second hand shops, thats the point.

So you are overlooking that by specifying a labour-intensive businesses with minimal raw materials costs. As it wouldn't make any difference.


So are you saying there are deductible input costs or not.

Mark Wadsworth said...

Din, seriously?

Normal VAT applies to normal businesses.

The VAT margin scheme ONLY applies to a tiny minority of businesses, second hand shops and second hand car dealers.

For a labour intensive business with no input costs apart from wages, the VAT is 1/6 of the total value added i.e. wages plus profits (or 1/6 of the selling price, which is the same thing).

So, having filled in a fair few VAT returns in my life, I can confidently tell you how it works.

Dinero said...

The idea that VAT is a tax on the margin between item cost and selling price is commonplace.

You complain that parliamentarians do not agree with you on VAT, maybe that is because they think VAT is this -

Parliament definition of VAT
quote
"VAT is charged on the additional value of each transaction,"

Which it clearly is not.

https://commonslibrary.parliament.uk/research-
briefings/sn00963/

Mark Wadsworth said...

Din, the statement that "VAT is charged on the additional value of each transaction" is correct.

So in my example, the additional value of the transactions are £100 and £70 respectively, and the businesses have to hand over 20/120 of that.

Instead of making stuff up, why don't you just read some books on the topic?

Dinero said...

No its not it is not correct , VAT it is clearly tax on the GROSS value of each transaction.
And here are some more examples of the misconception.

Book - GCSE Accounting PH Turner

" VAT , The amount of this tax is base on the difference between the purchase price and the selling price. "

https://books.google.co.uk/books?id=DDddDwAAQBAJ&pg=PA206&dq=gcse+value+added+tax&hl=en&sa=X&ved=2ahUKEwjH95qA9qnqAhWRoFwKHSPBCmAQ6AEwAHoECAUQAg#v=onepage&q=gcse%20value%20added%20tax&f=false

And if you do not find that alarming see the Cambridge dictionary.

VAT " Businesses in the production process take away the cost of inputs (= labour, materials, etc.) from the cost of outputs (= products and services sold) to calculate the amount that they must pay: "

https://dictionary.cambridge.org/dictionary/english/vat

Mark Wadsworth said...

Din

"VAT, The amount of this tax is base on the difference between the purchase price and the selling price." This is quite simply correct.

"VAT Businesses in the production process take away the cost of inputs (= labour, materials, etc.) from the cost of outputs (= products and services sold) to calculate the amount that they must pay". This is bollocks. Wages are not taken into account when calculating VAT.

Do you not even notice that those two statements say different things?

In my simple example, we assume input costs of raw materials are negligible, so that is not an issue.

Dinero said...

They say the same thing . They both say that VAT is a tax on the difference between purchase price and selling price. In my links found by 1 minute of google search, show that in a GCSE book and Parliamentarians briefings the system is taught that VAT is a tax on the difference between purchase price and selling price.

Mark Wadsworth said...

Din "They both say that VAT is a tax on the difference between purchase price and selling price"

Ah, sorry, I didn't realise you couldn't read, because clearly they don't.

The second and incorrect statement says "Businesses in the production process take away the cost of inputs (= labour, materials, etc.)"

I bolded the word labour because that is the bit that is incorrect. 'Labour' is another word for 'wages and salaries'. Those are not taken into account when calculating VAT.

Dinero said...

That is the point I am making . They are incorrect.
Every comment I have submitted in this thread is in agreement with you.
But you reply in the terms of a disagreement.
What is the problem.
Is it that you find find my whimsical google blooger nickname irritating and thus distracting. Should I comment under my real name.

Mark Wadsworth said...

Din, that is the point I am making

One of those statements is correct.

One is incorrect.

It is not a question of 'being in agreement'. This is not a question of opinion or discussion. My original post assumes a basic understanding of the VAT system. And illustrates how it favours monopolies, that's all.

Dinero said...

I don,t agree that Labour is the outstanding mistake. Material costs are not deductible either.

On Blogger You have been saying that VAT is a bad tax for ten years.


But the political issue is worse than you have alluded to .

Here is another example from

- Collins dictionary.

VAT : tax based on the value added to a product at each stage of production or distribution:

value added is arrived at by subtracting from the total value of the product at the end of each production or distribution stage the value of the goods bought at its inception.


Mark Wadsworth said...

Din: "Material costs are not deductible either"

By and large, materials are bought in from a VAT registered supplier and so are deductible.

But in my example, I said (and have repeated this about a dozen times) that materials costs are negligible and can be ignored.

Labour is not and never will be deductible from selling price.

Which is why VAT is a tax on 'value added' i.e. the labour and skill that a business and its employees apply.

Bayard said...

Mark, Din,

As I understand it, VAT works like this. A business buys stuff, labour, materials and services and claims back the VAT it paid on the stuff it bought, so nothing on labour and 20% on some of the materials and services. It then charges 20% VAT on what it sells. To be truly a tax on added value, it should only be paying the tax on the value it adds, i.e. its sales less its input cost. However, any cost for which a business is not charged VAT is taxed as well as the value added to it, so the effective tax on added value is more than 20%.
Mark, you are confusing the issue by having an example where all input costs are zero-rated for VAT, which is about almost as niche as Dinero's antiques trade example. Much more commonly, our monopolist would be paying say £12 for materials, of which £2 is VAT. So his input costs would be £62, of which he would claim back £2. His sales would be £100 and he would now be paying £14.67 VAT (£16.67-£2). His profit or value added would be £23.33 so he would have paid £14.47 tax on an added value of £23.33 or a tax rate of 62%.
So VAT would only be a value added tax if everything had VAT levied on it. Perhaps that was the original idea, but the usual suspects pulled strings and got themselves exempted.

Dinero said...



Bayard

Thank you for your input. You state " To be truly a tax on added value, it should only be paying the tax on the value it adds, i.e. its sales less its input cost."

That is the point I have been referring to since my first comment in this thread.

Mark is stuck in a rut with this . And so for other commentors here is a resume that shows there is a problem with VAT.

Cambridge dictionary

VAT " Businesses in the production process take away the cost of inputs (= labour, materials, etc.) from the cost of outputs (= products and services sold) to calculate the amount that they must pay: "


Oxford dictionary

a tax on the amount by which the value of an article has been increased at each stage of its production or distribution.

Investopedia

The amount of VAT that the user pays is on the cost of the product, less any of the costs of materials used in the product that have already been taxed.


Encyclopedia Britannica

Value-added tax (VAT), government levy on the amount that a business firm adds to the price of a commodity during production and distribution of a good


Parliament definition of VAT

"VAT is charged on the additional value of each transaction,"


- Collins dictionary.

VAT : tax based on the value added to a product at each stage of production or distribution:

value added is arrived at by subtracting from the total value of the product at the end of each production or distribution stage the value of the goods bought at its inception.


GCSE Book - GCSE Accounting by PH Turner

VAT " The General principle is that every person in the chain charges a tax on the value they have added to the value of the goods , The amount of this tax is base on the difference between the purchase price and the selling price. "


Cambridge dictionary.

VAT " Businesses in the production process take away the cost of inputs (= labour, materials, etc.) from the cost of outputs (= products and services sold) to calculate the amount that they must pay: "

Mark Wadsworth said...

B, you are doing a diagonal comparison.

You can take my example and split up that £50 into raw materials (excl. VAT) and labour any old way you like, the overall effect is the same.

Din, and what is "the problem"?

Bayard said...

I am not doing any sort of comparison. It appears that the point that you are missing is that Din and I have moved on from the topic of your post, about how VAT benefits monopolists, and are talking about how VAT is not a tax on value added, despite the name. So not only is it not a tax on consumption, nor a tax on profits, nor a tax on luxuries, it is not even a tax on the thing that its supposed to be a tax on.
Perhaps I should do a separate post.

Mark Wadsworth said...

B, it is very much a tax on 'value added'.

Employees and 'the business' add value.

Start with patch of forest. No costs other than labour. They grow a tree and sell it for £12 gross, VAT £2.

Furniture manufacturer buys tree for £10 net of VAT, make a chair (main additional input is labour), sell it for £24 gross, pay £2 VAT (or £4 output VAT minus £2 input VAT).

Retailer buys chair for £20 net of VAT, sells it for £36 gross (main input is labour, plus a a bit of rent etc), pay £2 VAT (or £6 output VAT minus £4 input VAT).

Total VAT paid £2 + £2 + £2 = £6.

Consumer sees chair being sold for £36 incl £6 VAT.

Value added from forest floor to consumer's front room = £36. VAT is 1/6 of that.

"Value added" is another word for "profit" (whereby wages are workers' share of that profit).

Dinero said...

Bayard , Mark

Here is some background from the European parliament library of Economics papers

Quote " SOME PROBLEMS OF VAT THEORY -

It is possible to place the blame for the difficulties facing the Community in the field of indirect taxation squarely on the shoulders of Maurice Lauré. By coining the phrase "Value Added Tax" he created the impression that it was a tax on value added. As at present applied, it is not . "



Options For a Definitive VAT System, Economic affairs series.

https://www.europarl.europa.eu/workingpapers/econ/pdf/e5en_en.pdf

mombers said...

VAT messes things up when there is a significant proportion of value added by labour. Take for example a hairdresser. Ex VAT cost of a £24 haircut is £20. Say the hairdresser gets paid £14 after £6 for expenses and profit for the shop. Basic rate NI and income tax on the £7 haircut would be £5.63 (20% income tax, 12% NI, 13.8%). If the tax on labour was VAT deductible like the tax on goods, the barbershop would be due a VAT refund because the tax on labour is so much higher than VAT! This is precisely how marginally profitable businesses are not viable under VAT - because you can't deduct all input taxes, you can still pay tax when you don't make a profit.

Mark Wadsworth said...

M: "VAT messes things up when there is a significant proportion of value added by labour"

Yes. But ultimately nearly all value is added by labour. What would you have to pay for the iron ore if you drove to the mine and asked them to load up enough tons of iron ore for you to smelt into steel for the car? £5? £10?

Or you could buy a ton of finished steel from the steel works for £100. Their profit/value added is either day to day labour costs, or the embedded labour costs of building all their machinery and equipment.

And so on and so forth.

Your final point is the one I always bang on about - it puts marginally profitable businesses out of business (and hence helps incumbents and monopolists).

Bayard said...

Mark,

Ok fair enough, if you count labour as "value added", but it isn't really, is it? It's a cost of sales. If I buy £12's of wood and pay a man £120 to make it into a box and sell that box for £144, I have only made £12, but I am supposed to have "added value" of £132, of which I must pay 20% tax, or £22. How can I have "added value" to something that I have incurred a loss on? This applies to any non-vatable input cost. Say I am a VAT registered building contractor. I employ a non VAT-registered plumber. He presents me with a bill of £600, labour and materials. He has paid £50 VAT on the materials, but he isn't VAT registered, so I can't claim any of that back, which means that the entire £600 is "added value" and I will have to charge my customer 20% on all of it and hand that 20% over to the government, even though £50 of that "added value" is actually "value added tax", so a tenner is VAT on the VAT.
So VAT is only a tax on added value for very special meanings of "added value". It's very easy to compare apples with oranges, when all you have to say is "see those round orange things? I calls them 'apples'".

Mark Wadsworth said...

B, "Ok fair enough, if you count labour as value added"

I very much do.

"It's a cost of sales"

Nope. Wages are workers' share of the overall value added/profits of the business.


"If I buy £12's of wood and pay a man £120 to make it into a box and sell that box for £144, I have only made £12, but I am supposed to have added value of £132"

Assuming this man is your employee, your business as a whole has added value/made a gross profit of £132. His share is £120 and yours is £12, which after VAT is a loss to you of £10.

So you either cut his wages, sack a few people or go out of business. That's the whole purpose of VAT. To fuck people over.

Bayard said...

What about my second example, where I am being charged VAT on VAT? How can a tax add value?

Mark Wadsworth said...

B, in the grander scheme of things you don't get charged VAT on VAT. That's one of the few good things about the system. If your plumber can't be bothered to register that's his lookout. A sensible contractor would just buy the materials himself.

Bayard said...

"If your plumber can't be bothered to register that's his lookout."

It's not the plumber's problem. He pays £50 in VAT and gets it back from me, so he's happy. He doesn't have to charge his private customers VAT on his labour, so they're happy. Why should he change?

"A sensible contractor would just buy the materials himself."

Have you any idea of the hassle involved in this? Presumably not, because you are not in the building trade. As a thought experiment, try to think when you last did a bit of DIY and were able not only to buy all the materials beforehand, but also not use anything you already had in your cupboards, nor had anything left over.

Bayard said...

"Nope. Wages are workers' share of the overall value added/profits of the business."

That still doesn't apply to my box maker if he is a non-VAT-registered subcontractor and you get the same problem if a large proportion of your materials are VAT exempt, too, e.g. I am a confectioner. A customer wants a cake covered in gold leaf, for which I charge £240, consisting of £40 labour, £160 materials and £40 VAT. All the materials are VAT-free, including the gold, which is, of course, an essential, not a luxury, so the tax on the added value is 100%

I am beginning to suspect that VAT was intended to be a universal tax, but three things happened, firstly it was realised that it was going to be extremely difficult to levy VAT on very small businesses, secondly all the usual suspects pulled strings so that their sectors of commerce would be exempt and thirdly the politicians started fiddling around with exemptions to try and make it look more like a "tax on luxuries", with the result we've ended up with the usual dogs' dinner that happens when politicians get involved in anything.

Dinero said...

If a seller does the opposite of adding value and removes value by damaging an item and sells at the reduced value a 20% tax is still due on that price , that is an illustration that it is not a tax on added value.
Or the more general case that the tax sent to the government on a £200 item is the same regardless of the wholesale price.
It seems to me that it works as a sales tax . Like the British purchase tax that was in place prior to it.

Mark Wadsworth said...

B, what is the economic difference between an employee and a non-VAT registered sub-contractor?

Din, why don't you look up the *actual* rules instead of making them up? If you buy goods for £100 incl. VAT and sell them for £80 incl, VAT, you don't pay VAT. There's £16.66 included on the goods you bought, your VAT return shows £13.33 output tax and a reclaim for the £16.66 input tax = refund £3.33.

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

"B, what is the economic difference between an employee and a non-VAT registered sub-contractor?"

It depends on your interpretation of "economic", but a sub-contractor costs can't be said to be his share of the overall value added/profits of the business, because he's not part of the business. Anyhow, as I pointed out, it doesn't have to be labour, any VAT-free input cost has the same effect.

Mark Wadsworth said...

B: "Anyhow, as I pointed out, it doesn't have to be labour, any VAT-free input cost has the same effect."

Yes, that is the whole point of VAT. It has to be a tax on something, and what it is a tax on is any VAT-free inputs (plants or rocks, labour, non-VAT registered businesses, business mark-ups/profits etc). All of those are mainly labour or 'enterprise' or whatever.

Bayard said...

"Yes, that is the whole point of VAT. It has to be a tax on something"

If it is called "value added tax", you'd expect that tax to be on added value. However, I suppose that is being a bit naive, when we have a labour tax called "national insurance". All very Orwellian.

Mark Wadsworth said...

B, "If it is called "value added tax", you'd expect that tax to be on added value. However, I suppose that is being a bit naive, when we have a labour tax called "national insurance"."

Workers add value! VAT taxes that the same as the value that 'the business' adds.

There are three layers of tax on productive businesses and their employees - income tax/corporation tax, NIC, and VAT.

They just pretend it isn't triple taxation of the same thing (and could do with being merged into one single tax) by saying "income tax is a tax on income", "national insurance goes towards your pension" and "VAT is a tax on consumption".

mombers said...

'National Insurance goes towards you pension' what a crock. We spend ~£100bn on state pensions, should be £0 if it was a funded system. Much simpler and honest to have an old age citizens income that is given regardless of how you've dressed up your income. And marginal tax rates should not be higher for under 66's - what's the justification exactly?

Mark Wadsworth said...

M yes it's a crock.

What we have - in practice - is close to Citizen's Pension. Which is fine, but we should be honest about it. Pensioners should be grateful to today's workers for paying their pensions (in turn, today's pensioners paid the pensions of those who went before them). I will be when I am old. Some kids somewhere will be handing me £9k a year, for nothing in return.

The reason for the myth that "pensioners have paid for their pensions" is because they vote and younger people don't, so the pol's are scared of offending them. The same with the double taxation of wages.

Bayard said...

"Workers add value!"

VAT exempt materials and unregistered subcontractors and their materials and the VAT on them don't though. There's no point in trying to counter me saying "this is where the theory doesn't fit the facts" by saying "this is where it does, but only if you use my special meaning". To anyone but an accountant or an economist, "adding value" means "making something worth more than what you paid for it" and I am prepared to bet that the special meaning where workers' wages are added value dates only from the introduction of "value added" tax that wouldn't actually be a value added tax if it wasn't for this new revised meaning.
Anyway, this is the second time we've been round this dance, can we stop now, or do you want a third go?