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:

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 would be 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, but 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 in long run tax works out at £1 per 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 getting your annual sales up to 34 units than it is getting them up to 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 tax. So with a bit of luck the volume of business the 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 big business, is it?

* Surprisingly, a lot of people in the UK believe the myth put about by politicians that VAT somehow magically doesn’t affect economic activity 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.

10 comments for “Why Big Business quite likes VAT

  1. March 22, 2012 at 8:23 am

    Many businesses do not sell to consumers but are caught up in the VAT nonsense.

    Since my customers are VAT registered or abroad the rate of VAT is irrelevant. I pay VAT on purchases, charge it on sales and hand over the difference to HMRC. If this is 5% or 25% doesnt matter one jot. I am just a tax collector sitting in the middle of a long chain of businesses.

    To illustrate. I buy £100 of goods in a VAT free world, process them and sell for £200. That’s £100 gross profit. With VAT at 20% I buy £100 of goods and pay £20 VAT. Total £120. I sell for £200 plus £40 VAT total £240. I offset the £20 input tax against the £40 output tax and give HMRC the difference. I still have a gross profit of £100.

    The point is only consumers end up paying VAT and consumers are only a small part of the economic cycle. Remember government, local and national, is about half of all spending.

    • March 23, 2012 at 3:19 pm

      I know all that stuff, I work in tax, I do this for a living. But that misses the point.

      You think that VAT doesn’t affect you, but it affects your [ultimate] customers. The economic damage flows upstream and hits you nonetheless. End consumers are 100% of the economic cycle, people don’t manufacture things for fun. And 60% of government spending is cash wages or welfare paid to individuals, who then suffer the VAT.

      But I suppose this is all part of the genius of VAT and why politicians love it, because so many people fall for the lies that VAT is a harmless tax which doesn’t affect the economy, unemployment, profits etc.

      I prefer real life evidence to what the politicians say, but as usual, I find that I am in a minority.

    • 555PPS
      March 25, 2012 at 12:37 pm

      You forget the cost of administering the VAT.
      This may be low for you but in some industries it is much much higher.

  2. EForster
    March 24, 2012 at 4:49 pm

    Consumers are unwittingly the ultimate “Taxpayers”.

    Consumers’ cash necessarily supports the entire hierarchy of commerce. There is not a commercial entity that can survive without ultimately servicing the needs of consumers, directly or indirectly. From whom else do you suppose businesses and employees make money? Every tax incurred in the supply chain shows up as a hidden tax in consumer prices.

    Consumers should now realise that no one else could reasonably claim to be paying any of those self same taxes.

    ‘Income Taxpayers’ are simply involuntary intermediaries in the collection of tax from consumers. ‘Income Taxpayers’ are not always reliable as third party tax collectors, as we know, but their use provides great scope for confusing the issue of who really pays tax and concealing the full crushing cost of Government from voters.

    We all pay an average 50p tax rate, because that is the effective cost of tax today in everything we buy as consumers. It would be a tremendous simplification to admit this fact and tax retail purchases alone, but it would be political dynamite too, unfortunately.

  3. March 24, 2012 at 5:00 pm

    EF, yes, the overall average tax rate is a smidge more than 50%, yes, it would be better to roll this into a single flat tax of 50% (to the extent that we should be taxing economic activity at all, and we shouldn’t), but for the reasons given, it will cause less damage to the economy to tax income at 50% than to tax purchases at 50%.

    Further because 50% income tax means they take away 50% of what you earn, if they tax spending, the rate would have to have a 100% sales tax. And then there is the dispute over what exactly is a sale – what about bank interest paid or earned?

    Plus it would be far more honest to have 50% income tax, people are far more aware of how much income tax they pay than of how much VAT or National Insurance they pay.

    • EForster
      March 25, 2012 at 4:26 pm

      My intention is to point out the misconceptions that voters have about paying tax.
      1. Employees do not pay income tax, their consumer customers do that. We might just as well say that retailers pay VAT, they do, but only in the process of passing on customers’ money.
      2. Employees earn what they take home in cash. They only begin to pay tax when they spend it, rich or poor.
      3. If voters knew that everyone is subject to an average effective tax of 50p in the pound on their purchases, then they might have some reservations about electing politicians who have inflicted it on them.

    • EForster
      March 25, 2012 at 4:26 pm
    • EForster
      March 25, 2012 at 4:26 pm
    • EForster
      March 28, 2012 at 1:18 pm

      In the ordinary sense of the word, “pay” means that someone hands over cash, that was held by them free and clear of any obligations to third parties.
      But, economists do not use the word “pay” in such terms. They talk of the “incidence of taxation” or who bears the real burden of taxation or what we would normally understand as paying tax. So when they say tax is paid, in these terms they do not necessarily mean paid by the payer. According to economists and tax accountants, they mean transfer.
      And so it is with income taxes. Income taxes are calculated as a percentage of income. Sales taxes are calculated as a percentage of income less the tax. It can be seen that there is no difference between these taxes except in calculation of the rate as both take from the total income a given proportion of tax. Income taxes presume that total income includes tax, while sales taxes presume that total income will include tax. In the former we think we pay, but actually the buyer of our work pays just as he does when he pays the sales tax. What we actually earn from employment is income less tax just as the seller earns income less sales tax.

  4. Daedalus
    March 24, 2012 at 7:04 pm

    For goodness sakes you all seem to think that 50% tax is OK you should all be saying it should be less than 20%, no matter how its collected.

    Daedalus

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