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Written by Giles Wilkes

Tuesday, 11 August 2009 15:09

Mark Wadsworth maintains that VAT is not a consumption tax but a tax on gross margins.

I personally disagree. By his admission, (see response to this comment) if VAT was removed, prices would not stay where they were - they would fall, as competitive pressures would erode the (very short-lived) high margins that would pertain in the VAT-free world. Hence the effect of there being VAT on objects is higher consumer prices. Hence the consumer is paying it.

I wonder what I am missing? I think margins are set as much by industrial structure, availability of capital, and so on: if industry X had its VAT cut to zero, and industry Y had its VAT doubled to 30, I don't think that the return on capital from investing in industry X would rocket compared to industry Y, because companies would enter industry X and drive prices down, and prices would rise in industry Y, as existing companies could not profitably operate at the pre-existing prices.

But MW claims to spend all day working on VAT and corporate tax receipts, so I am willing to believe I'm wrong.

I see that the Tax Justice Network disapproves of VAT rises too (mostly quoting Paul Sagar from before)

Amazingly, their principles of how the tax system should work seem to entirely miss out the effect on economic incentives, or the way taking more than a certain amount at the margins can seem unfair.

The US is by far the world's leading manufacturer. I think the UK is sixth.

Some economists stand up for the German Fiscal Rules. I'm still not convinced, but they make a decent case:

Concerns with regard to the limits the new German rule may place on counter-cyclical policy, however, appear greatly overstated. First, Germany has large automatic stabilisers (see chart), which will have full play under the new rule. Second, since there is no limit on the surplus that could be run, the authorities could choose to maintain a positive structural balance during “good” times, allowing some discretionary scope when needed. Finally, the provisions allow for an escape clause that can be invoked by parliamentary majority in the event of natural catastrophes and other emergencies outside the control of the government.

Comments (47)

Ta for link.

Of course VAT leads to higher prices, but that does not mean that somehow VAT magically 'taxes consumption without taxing production', which is the Big Fat Lie that politicians use.*

My argument is, in economic or in mathematical terms, VAT is a tax on gross margins (i.e. actual selling price minus actual cost of VAT-able inputs, with no deduction for salaries or interest costs x 3/23 = the VAT liability).

Therefore it pushes businesses with high labour or interest costs out of business. Unlike corporation tax, a business has to pay VAT even if it is making losses. Therefore supply contracts to the point where remaining businesses can get away with charging a higher price to be able to pay the tax and still make reasonable profits.

Therefore, VAT is the most damaging tax of all. Even the EU have done various studies on this and have also found that a VAT hike slows growth more than a corresponding income or corporation tax hike.

* As a general rule, one man's consumption is another man's production, so you can't tax one without taxing the other. The exceptions to this rule are use of natural resources like oil or occupation of land, where there is consumption without production.

Thanks for this Mark - your are taxing my brain agreeably (no pun intended).

What I don't get is this. The statement that VAT is a tax on gross margins implies that the gross margin for a company would be, say, 20%, but thanks to VAT it is something less than 20%. Whereas the way I see it is that, by implying a uniform marked-up cost (almost like pretending your factors of production are X% more expensive), the effect is simply to put the end-price up, but the share within that end-price that goes to the various factors (the labour, the capital, the physical resources, the tax man) is changed.

I don't see why/how gross margins in the VAT-free world would be higher than in the VAT-ed world (because of competition) which I why I can't see them functionally as a tax on gross margins. Whereas I CAN see how they effectively raise prices, which makes a consumer able to buy less for the same income, which reduces his real income and ought to have a substitution effect towards saving and away from consumption.

I can't see how it pushes business with high labour or interest costs out of business, unless that business has competitors which have lower labour or interest costs - in which case (a) good, it should go out of business and (b) it would go out of business even if both firms did not face the same identical VAT mark-up. The cheaper competitor is just as able to undercut it with or without VAT.

On your point about VAT being the most damaging to economic growth,

http://www.oecd.org/dataoecd/36/35/43117806.pdf on page 234 says

"Insofar as tax increases may also become necessary, recent OECD evidence (Johansson et al., 2008) finds that among taxes, corporate taxes are the most harmful for growth, followed by personal income taxes, then consumption taxes, with recurrent taxes on immovable property having the least impact."

I'm not saying I like VAT: the size of the fiscal hole is such that none of the solutions will be nice. But I can't see it as uniquely bad, and I think it does have genuine effects on the choice to consume more than on the choice to invest, which are broadly OK (in the long run) for Britain.

I did actually reply to your comment a day or two ago but it didn't seem to register.

I like the bit you quote about "recurrent taxes on immovable property having the least impact."

Well duh, that's what the Land Value Taxers have always said. And they are right, of course.

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