The Tory leadership race really is starting to look like the silly season for policy ideas. Michael Gove's suggestion that we get rid of VAT and replace it with a ‘simple sales tax' is the latest such idea.
Value added tax is an idea embraced by more than 150 countries around the world. The only major exception is the USA. China has one. The USA doesn't have a VAT because sales taxes are local in the USA and they just can't get their heads around how to make VAT work as a result.
There is a reason why so many countries have VATs. They work. When there is a need for a broad and diversified tax base (and there is) then a tax on sales is always going to happen. They may be regressive, but that can be addressed, at least in part. And when this tax raises over £150 billion a year in the UK we are not getting rid of something like it.
Gove's simple sales tax will, I suspect, be very different from VAT. VAT is complicated because it is always charged when required but most VAT registered traders can reclaim the VAT they are charged when paying over what they owe to HM Revenue & Customs. As a result VAT is not an expense for them. The tax only hits when it reaches a non-VAT registered person. That's a consumer - like you, or me. The merit of all this complexity is that VAT does not distort business decision making, much (and I know there are exceptions). And the VAT charge should be the same however many times goods change hands during the production process before reaching the consumer, and from wherever they come. Imports should carry VAT in full in most cases. The tax is at least neutral in this sense.
The problems implicit in Gove's plan are fourfold. If his sales tax is ‘simple' it will be charged on everything. So get ready to welcome sales tax on food then, for example. This tax is, then, much less likely to be fair then. In fact, we can be sure it will be more regressive: it will be paid in higher proportion by those on low income than high income.
Second, there is no guarantee of there being a tax reduction. A sales tax may be at a lower rate, say 5%, But it is charged right throughout the supply chain. Suppose goods change hands five times before reaching the end consumer. A 5% tax could actually increase end price by more than 27% in that case. Prices matching current VAT are likely. Reductions may well be few and far between. I am not saying there will be none: I am simply saying there will be big winners and losers.
Third, there is the massive bias in favour of imports to consider. Suppose something is made in the UK. By the time everything is assembled, through several layers of supply chain, sales tax of maybe 20% might be included in the price. An almost identical product can, though, be bought from Europe, where they would have VAT still. There would be no VAT charge for the European exporter of that product and they would have just 5% sales tax to pay in the UK. So their product would be substantially cheaper than the UK made equivalent. This tax would then massively undermine UK business and favour imports.
And, fourth, it would also bias against exporters. That's because only the final exporter would not charge the sales tax. All the sales tax on the way through the production process would be a cost. UK exports would, then, be much higher than EU (and other country) equivalent domestically made products. So our exporters would not be able to compete because of Giove's sales tax.
As incompetence in tax design goes suggesting a sales tax takes some beating. But Gove has done it, with a guarantee to destroy British jobs built into the idea. Maybe he was high at the time he thought it worth suggesting. Those who are stone cold sober will not see anything of merit in what he is proposing.
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Obviously its not just Gove’s mucus membranes that have been addled by his self confessed cocaine use!!
Twat.
(sorry)
Richard – I completely agree with you. One of the constant things I hear about Brexit is that “most of the politicians think we should remain so they must be right” and then Gove comes out with this! Yeah, I think most have no idea how economics works!
One thing you forgot to mention is that in the US, most companies have to apply for exemption certificates in order not to pay the sales tax when they are a reseller or manufacturer say which in itself is a nightmare.
Where exactly are the complexities with VAT? Reduce it sure but replace it? Doh!
Thanks
For example, partial recovery of VAT on inputs can get very tedious where you have a mix of VATable and non-VATable outputs. Got very fed up with this issue when I was economically active. FWIW.
I made it clear in what I wrote that there are issues
Most businesses simply do not face that one
I was responding to AB’s query about complexity, which has only an indirect bearing on RM’s post (although Gove might be said to have some very confused ideas – or is simply ignorant about – what constitutes complexity in this context).
However I do think partial exemption is a fairly significant issue given that it has an impact on real estate, financial services, health, education, and some leisure activities, which are collectively very non-trivial. If AB really meant to query that VAT might not be simple he could follow the links here for starters https://ion.icaew.com/taxfaculty/b/weblog/posts/who-uses-vat-partial-exemption-and-how-it-affects-the-vat-cost-to-business
But still only a small part of the system
We do have the option, under the Principal Directive, to Opt To Tax a chunk of financial services (exactly the same as the OTT on Land & Property) removes the problem of Partial Exemption (which is only really a problem when advisors construct weird and wonderful PESM’s) but I’m not sure the public would like it.
Regarding Tory party leaders promises, Johnson’s ‘plan’ to renege on the 39 billion owed to the EU.
This would amount to a sovereign default, is that correct? If so what are the implications?
As I have mentioned previously, just when you think things can get no worse they actually do! I am also certain that at this instant, there is a majority for remain so if this disaster under Johnson (and all MPs in my region think he deserves his turn in the sun) comes to pass it will be against the wishes of the majority yet I have hope that because of that there will be a step change.
It will be sudden and unexpected.
I gather my last paragraph was quoted on Channel 4 news this evening. I did speak to them this afternoon. They were utterly baffled as to his objective. I could assure them that they were right to be so.
[…] wrote about Michael Gove’s bizarre plan to scrap VAT this morning. It transferred to Channel 4 news this evening, wth credit given, Start at about […]
All the Tory candidates are talking about money as if it is a closed loop system – we only have what is already in circulation. They completely forget about QE or any new (base) money that could be brought into use (was the DUP bung new money or was another budget sacrificed?).
On this basis alone, such a level of ignorance precludes any of them from high office in my view.
BTW I think Jeremy ‘Nice but dim’ Hunt could be a strong contender because it is just what the Tories need at the moment – a ‘nice guy’ fronting a criminal and cruel organisation. Hunt smiled and charmed all the way through the debasement of the NHS whilst he was minister.
It’s not necessarily the case that sales tax has a cumulative effect through the chain. Even in the USA they address this through provisions that effectively relieve sales to another trader so that tax is then collected at the consumer end.
Whilst somewhat bonkers, the Gove idea is only slightly worse than the current German/Franco inspired idea from the idealistic 1950’s that involves in many cases the same VAT amount being passed around in a circle. As a VAT specialist of some 32 years now, even I can admit that almost all of the passing around of VAT is pointless and is actually tailor made for VAT to be stolen, costing many billions a year, funds that should be enriching society.
The EU and others are slowly starting to deal with this, using reverse charges (almost completely in some countries), so getting closer to the US model. The pace of change is criminal though.
Just my prediction. In 10 years time we will have VAT but it will largely be dealt with in-house through the return.
But Give said he wanted a simple sales tax
And the US does not have that
So what I suggested was what he appeared to have in mind
I don’t trust Gove and I would never vote for him. But I do object to VAT.
As a consumer, I see VAT as a very unfair tax, levied at the same (very high) rate on almost everything except food. A low earner has to pay VAT at exactly the same rate as a millionaire.
The sales tax that was in place in the UK before VAT was introduced only applied to luxury goods. There was a public outcry when it was announced that it would be applied to music records.
The EU sets the benchmark rate for VAT and rules on how it has to be applied. If a UK sales tax was introduced that was too high and unfair, people could use the democratic process to protest against it. That is something that seems almost impossible via the EU.
Regarding your third objection to a sales tax, the US has a sales tax in place, and its goods are not significantly less competitive on price.
As a former small business owner, I struggled to run a healthy food cafe. Takings didn’t meet the threshold for VAT, but if I had been VAT registered, I would have had to pass on the cost to the consumer, which would have made my prices unsustainable. That meant that I was unable to reclaim VAT on capital expenditure goods. So high VAT rates were crippling for me as a small business owner.
I won’t be supporting Michael Gove, but I’m glad he’s opened this topic.
There are weaknesses with VAT
In general sales taxes aimed at raising £140bn would be worse
And you overstate the EU requirements on this tax
What would you do instead?
Thanks for your reply.
I would a) have a full audit of what VAT is spent on, and b) transfer it to income tax, which in my opinion is a much fairer tax. If people objected to the increase in income tax, that would hopefully introduce a democratic debate on what is funded by this taxation.
You would effectively nearly double income tax rates
That would be nigh on impossible at the top end
So you would massively increase rates at the bottom
That would also be regressive
And, I should add, would massively increase the incentive to evade
A wide tax base has significant merits
The idea that we can replace one of the big three taxes (income tax, NICs and VAT each raise about a quarter of our tax revenues) with a “simple sales tax” is for the birds.
* Will it apply to services as well as goods?
* Will it have one rate? (in which case goodbye to the zero rates we have kept since our last sales tax, and the exemptions under VAT)
* Will it apply to sales of real estate? New homes? Commercial property? How about materials incorporated into new buildings?
* Will it apply at each stage in the supply chain and so compound up the chain? (Ouch.) Or will intermediate sellers (wholesalers, etc) be relieved? (If so, not so simple.)
Anyone that thinks a “sales tax” would be “simple” has not had to think about the complexities of US style state and local sales and use taxes.
This is kite flying of the highest order. Just wait until Gove speaks to the Treasury.
Thanks
We are in agreement….
[…] Source:Â taxresearch.org.uk […]
Excellent post!!!! To expand on your “massively increase the incentive to evade” comment – A VAT also creates more of a paper trail and makes tax evasion harder.
Am I mistaken but doesnt the EU take all our VAT tax income for itself?
We pay the EU
But to say that comes from VAT is arbitrary
I don’t know what the details of Gove’s indirect tax proposals are as I couldn’t find them online.
However, I would be interested in what people think of the general principle of replacing the cascading tax of vat with a sales tax on end users only.
This would, at a stroke, eliminate the considerable cost to the state of administering the tax as it ‘circulates’ between vat registered traders and remove the vast cost of repayment fraud.
Of course the difficulty would be determining who has to register and charge the new tax i.e. who is supplying to an end consumer? Any ideas?
As a matter of fact, administering the sales tax in the US is not in any way simple
You claim is as untrue as I think the name you are using might be
“When there is a need for a broad and diversified tax base (and there is) then a tax on sales is always going to happen. They may be regressive, but that can be addressed, at least in part.”
Richard, seeing it is regressive, wouldn’t a sales tax on luxury items be fairer, ensuring that the higher tax brackets pay it rather than the lower socio-economic brackets?
I have suggested higher VAT rates
But remember some taxes have to be big. Even with MMT that is the only way to have the levels of government spending we need and lowish inflation. So a tax on luxuries is simply not an option for replacing VAT