Saturday, 17 March 2012

Why Big Business quite likes VAT

Here's a chart showing the break even point for an industry where the fixed costs of setting up in business are £100 a year and the marginal extra cost per unit manufactured and sold is £1. The selling price for these items happens to be £5.

The average cost per unit is simply [fixed costs plus total marginal costs] divided by output, so the break even point is an output of at least 25. At that level of output, your total costs are [£100 fixed + 25 x £1 per unit} = £125 and you can sell them for 25 x £5 = £125. In this country, Country A, there are no taxes on income, profits or turnover, so that is the end of the matter (click to enlarge):The government of Country B (which is run by the landowners and banks) says "Sorry lads, but we need to raise taxes from you, so we are going to slap you with a corporation tax of 46%". So the marginal businesses, who have only just managed to break into the market, or who are in danger of going out of business, pay nothing, and the large established businesses with an output of 70 units are paying £1.18 tax per unit sold. The good news is that the break even point is largely unchanged at 25, so the economy still benefits from free competition and output is not unduly stifled:The area between the green line and the red line indicates how much corporation tax is raised.
The large established businesses in Country C see which way the wind is blowing. Taking a lesson from their land owning and banking chums, they lobby hard against corporation tax but admit through gritted teeth that they'd accept the imposition of a turnover tax instead (called Value Added Tax in the UK*).

So the turnover tax is imposed at 50p/unit sold, this pushes a few marginal producers out of business (those with output less than 30 units), so the turnover tax is increased a bit more and a bit more (and each time a couple of marginal producers go out of business).

In the long run, all businesses with an output of less than 34 go out of business and the turnover tax ends up at £1/unit sold so that the total tax raised (the area between the red and green lines) is the same as in Country B (to make it a fair comparison):As you can see, having a turnover tax rather than a profits tax has two big advantages for the large established producers in Country C:

1. They actually pay less tax per unit (£1) then they would in Country B (where the tax per unit would be £1.18). And businesses with an output of 55 or less are paying more tax per unit, in the case of the smaller businesses, considerably more.

2. They are nicely insulated from competition, because it is much more difficult for new entrants to get their annual sales up to 34 units than it was to hit the old break even level of 25 units; all those producers with output of 34 or less will struggle badly and go out of business. All those businesses with output of less than 55 will be paying more turnover tax than they would be paying in corporation tax. So with a bit of luck the volume of business the really big businesses gets increases; or it might be that GDP falls and unemployment increases. But that is not the problem of the Chairman of a really big business, is it?
To illustrate those points, here is a straight comparison between net profits of businesses in Country A which has corporation tax (the red line) and in Country B which has a turnover tax (the blue line):* Surprisingly, a lot of people in the UK believe the myth put about by politicians that VAT somehow magically doesn't affect economic activity and that consumers blithely pay it without spending less money on other things. I usually get a comment to that effect every time I do a post on VAT. Just goes to show whom people really believe, when all economic logic and actually looking at hard evidence says that VAT is borne at least two-thirds by the producer.


Rich Tee said...

Apparently small businesses often stay small to avoid registering for VAT which obviously restricts output and employment potential.

Also, VAT is a compulsory EU tax, a condition of EU membership.

Mark Wadsworth said...

TM, the £70,000 threshold is particularly spiteful. It is explained to the gullible public as a tax relief for "small businesses" but actually it is a barrier to entry which protects those businesses which have managed to leap frog it and have turnover of (say) £150,000 or so.

VAT is simply the worst tax, EU-imposed or not, the fact it is EU imposed is yet another reason for leaving the EU.

Robin Smith said...

Good one.

VAT is inherently a trade tariff. Except it artificially raises prices by protecting our own people from competition from ourselves. Duh!

In the end, VAT is protectionism, for landowners. And then so is all tax on production of course.

The big corporates who love VAT, benefit more directly from it through monopoly profits are only skimming rents for that part of their income. It protects their monopoly profits by keeping the innovators and competition from starting up.

Monopoly profits are really a tax on production. On top of all other taxes on production.

Mark Wadsworth said...

RS, yes, fair summary. But most of the sheeple still believe that "production is good but consumption is bad and consumers pay the VAT so it does not affect producers".