The dead loss of VAT – September 2022
It would be difficult to conceive of any tax more damaging than VAT. It applies precisely at the point where supply meets demand, which makes it as bad as a tax can get. One of the remarkable things about VAT is that it violates all four of the Canons of Taxation, as formulated by Adam Smith. That is a considerable achievement. One of the opportunities that was offered by Brexit was that it gave the UK a golden opportunity to get rid of a regressive and troublesome tax. Sadly, the opportunity has not been taken.
There cannot be a more irrational and harmful tax than one on the sale of goods and services – VAT in the UK, GST in Australia, and similar ones in India and Saudi Arabia. There is no rational reason for the widespread adoption of this tax; it is just a meme, like wearing one’s baseball cap back-to-front. A rapid phase-out delivers an immediate boost to the economy, since it removes a severe obstacle to the exchange of goods and services.
What about the “lost revenue” that would have to be replaced if VAT is scrapped? It is nowhere near the headline figure. At a conservative estimate, half of this apparent revenue (about £110 billion at the time of writing) is swallowed up in costs and losses. Every hard working trader and enterprise can immediately do something useful with the time wasted in helping government collect this tax. Government gets rid not only of the substantial cost of administration, but also, in the longer term, of the costs of paying people such as pensioners, benefit recipients and public sector employees, large amounts of taxpayers’ money which is then paid back in VAT.
Its abolition also raises the revenue base on which other taxes are levied: profits, incomes and rents all go up, due to the widespread increase in productive power now that the burden has been lifted.
There is no need for scientific precision. We have tried to put together some ball-park figures for what would happen if VAT were scrapped, but we do not have the resources to come up with better estimates. Whatever happens, however, will be gain.
THE LOSSES FROM VAT
A THE VAT GAP
Even the authorities admit that for every five pounds of VAT revenue received, one pound is lost due to
- Payments in cash
- Fraudulent claims for refund of inputs
- Carousel fraud
The VAT gap is estimated at £12.7 billion in 2014-15. This equates to 10.3 per cent of the estimated net VAT total theoretical liability (in other words, the net VAT total that should, in theory, be paid). It is of course not a loss to be deducted from the figure of the actual headline revenue raised.
http://www.gov.uk/government/uploads/system/uploads/attachment_data/file/561312/HMRC-measuring-tax-gaps-2016.pdf href=”http://www.gov.uk/government/uploads/system/uploads/attachment_data/file/470540/HMRC-measuring-tax-gaps-2015-1.pdf
B THE ECONOMIC LOSS DUE TO VAT
B1 COMPLIANCE AND ADMINISTRATION COSTS
An official figure of 4.7% of the yield has been given
http://www.publications.parliament.uk/pa/cm200304/cmselect/cmtreasy/269/269.pdf http://www.ifs.org.uk/uploads/mirrleesreview/dimensions/ch12.pdf https://tarc.exeter.ac.uk/media/universityofexeter/businessschool/documents/centres/tarc/publications/discussionpapers/13_09_24_Evans_Tax_compliance_costs_in_SMEs_Exeter.pdf
This Swedish study, based on a survey in 2006 (text in English) draws attention to the interest costs of VAT due to the adverse effects it has on business cash flows.
http://www.skatteverket.se/download/18.906b37c10bd295ff4880002550/
B 2 DEADWEIGHT LOSSES
Deadweight losses are due to economic activity which does not take place but would have done in the absence of the tax. Any figure must be conjectural. What counts here is supply/demand price elasticity. A deadweight loss of 1% of GDP is £15 billion. A part of this results in a loss of tax revenue, and in addition, contributes to welfare costs.
The reduction of VAT from 25% to 12% in the Swedish restaurant sector led to an 3500 additional full-time jobs.
This newer report estimates that 11,300 additional jobs were created by this cut in VAT.
http://nationalekonomi.se/sites/default/files/NEFfiler/44-5-bfjmst.pdf
The IFS Green Budget of 2009 worked on the assumption that a 1% cut in VAT would lead to a 0.5% increase in demand for goods and services. (Chapter 10). On this basis, abolition of VAT would lead to a growth in GDP of around 5%, ie worth £75 billion, of which tax revenue would be about £25 billion.
C THE COST OF VAT TO THE GOVERNMENT
C1 CHURNING LOSSES
This is the part of the cost of VAT to the government itself. It comprises, for example, payments to pensioners and recipients of welfare benefits – child benefit, incapacity benefit, unemployment benefit, etc. The total of these benefits is £195 billion. If 50% of spending is on VAT-charged items, at least 7% of this being paid out in VAT, ie £14 billion.
http://www.bbc.com/news/business-15519727
http://visual.ons.gov.uk/welfare-spending/
In addition there is the component of VAT which is paid by public sector employees out of post-tax income. There are 5 million workers in the public sector, average earnings £25,000 per year. This gives a total wage bill of £125 billion. Assuming 7% of the spending of this group is comprised of VAT, that is another £9 billion. Thus, total churning losses are £23 billion.
C2 DOWNSTREAM LOSSES
VAT results in the abstraction of revenue from other taxable sources eg incomes, profits, rental values (UBR valuations). A 10% loss of the total of income tax, national insurance, corporation tax and the UBR (£330 billion) is £33 billion. This is over and above the loss in tax revenue due to deadweight losses (section C3, below).
C3 CONSEQUENTIAL TAX LOSSES DUE TO DEADWEIGHT LOSSES
C4 CONSEQUENTIAL ADDITIONAL WELFARE COSTS DUE TO DEADWEIGHT LOSSES
Total spending on pensions and tax credits 2015/6 is given as £213 billion. Of this amount, about £60 billion is accounted for by welfare and housing benefits for the unemployed and low-paid. Assuming that this is 10% higher than it would be with an economy that was no longer diminished by the deadweight loss from VAT, a cost of £6 billion can be attributed.
C5 ADMINISTRATION COSTS
These are given in ¶ B1 above.
D TOTAL LOSSES ARISING FROM VAT
- Compliance and administration £5 billion
- Churning £23 billion
- Downstream @ 10% £33 billion
- Deadweight @ £25 billion
- Consequential additional welfare costs @ £6 billion.
This indicates a total loss of £69 billion ie two-thirds of the revenue is swallowed up in costs and losses.
POSTSCRIPT
This is a work in progress. The original article on this subject generated an extraordinary amount of hostility. Strangely, this hostility has not attempted to examine the actual figures and assumptions quoted. So far as I am aware, there has been no double counting, which is an easy trap to fall into. The weakest of the assumptions concerns deadweight losses and consquential losses in tax revenues, which have been revised downwards. However, an additional loss has been inserted: the consequential welfare costs to government arising from the deadweight loss.
The topic requires a depth of analysis for which the Campaign lacks the resources. However, given the proportion of VAT that seems to be swallowed up in costs and losses, and given also the opportunity that has existed since 2020 to scrap this tax, it can at least be argued that abolition needs to be seriously examined.
FURTHER READING
IMF report
https://www.imf.org/external/pubs/ft/wp/2007/wp07183.pdf
HMRC statistics