VAT is a turnover tax (part 94)

In response to Peter Risdon who said "A value-added or sales tax is levied on transactions ... but they aren't income taxes". (Comment 2 here) or Snafu who said "I like VAT as it's one of the few taxes that those on benefit have to pay!" (Comment 8 here), let's just imagine that the gummint announces that from next week, VAT at 17.5% will be scrapped and replaced with a flat turnover tax of 14.89% for all businesses who make supplies that are currently VAT-able; and furthermore that supplies between businesses liable to the new turnover tax to other such businesses are exempt.

Ignoring the fact that this would save businesses some administrative hassle, how would businesses respond?

1. The originator (the manufacturer or importer, who for sake of argument suffered no input VAT) only makes supplies to other businesses, so instead of adding 17.5% to his turnover and handing that over to the taxman, he stops adding VAT and is no better or worse off.

2. The wholesaler, or a self-employed person who only makes supplies to other businesses, can stop charging VAT and doesn't have to pay VAT on inputs. But they would only have had to hand over that VAT (less input VAT) to the taxman, so they are no better or worse off.

3. The end-retailer, or a service business, who make supplies to private individuals or exempt businesses (schools, banks etc) currently charge £100 plus £17.50 VAT per unit. They no longer have to pay input VAT to their suppliers, but they could have deducted that from the VAT they pay to the taxman, so that's plus minus nothing.

They also know that under VAT, to make net turnover of £100 per unit (which for the sake of this exercise, we assume to the minimum they require to cover wages, material costs and a reasonable profit margin), they had to charge their end-customers £117.50. Under the turnover tax, they can't drop their price from £117.50 to £100, as they are only going to keep £85.11 thereof - not enough to stay in business. But they also know that their end-customer was happy to pay £117.50. So what they would do is hike their price per unit from £100 to £117.50. Instead of handing over £17.50 VAT to the taxman (£100 x £17.50) they now hand over 14.89% x £117.50 = £17.50.

So, administrative hassles aside, VAT is in economic terms exactly the same as a turnover tax.

If the gummint were to replace VAT with a turnover tax (as above), wouldn't people realise that the turnover tax is in fact a particularly harsh form of income tax on the producer? (it makes no allowance for expenses - you pay the same amount regardless of whether you make large margins or small margins or indeed losses). Imagine the political fall out every time a business goes out of business as a result of its costs rising from £80 to £90 for every £100 turnover (flipping a 5% net profit into a 5% net loss)! Would anybody say that this is somehow not as bad as corporation tax, that is only levied on net profits (so a loss making business is at least spared the expense until it can, hopefully, recover)?

Would anybody seriously suggest that the end-user (be he on benefits or not) pays the tax?*

* Of course, the economic incidence of such a turnover tax is exactly the same as the economic incidence of VAT - it results in lower income for the producer, higher end prices for the consumer and reduces output levels. All it does is transfer the legal incidence from consumer to producer.

See also "Why politicians love VAT".