Monday, September 24, 2012

To VAT or to not to VAT

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Just your friendly, neighborhood VAT inspector

Free-market economists love Value Added Taxes (VATs) because they tax everything the same across the board. No distortion of prices of one set of good over another. America is discussing implementing a VAT, Canada has a 5% VAT (used to be 7%), and in Europe it is 25%+. 

 FYI, the difference between a Sales Tax and a VAT is that sales taxes only applies to the transaction between the business and consumer. The last step in the supply chain. Whereas the VAT applies to every transaction along the way. Every step of a supply chain. The two are not mutually exclusive. Canadian provinces operate under a Harmonized Sales Tax, which combines a provincial sales tax with a VAT for a single percentage (13% in Ontario).

Some people are going to be like, "Great! Tax the Corporations! Sign me up!" - but there is a big difference between the person who physically pays the bill and the person who ends up bearing the brunt of the costs. Economists call this concept "tax incidence". If the incidence falls on you, then you are the one who is really paying for it - even if you don't notice it. Most taxes are built into the price before purchase. There is no "this is how much you paid in taxes" at the end of the receipt.

In there lies the problem with VATs, as costs are passed down the supply chain - they end up hitting the consumer in the end. If you ever have been to Europe, you probably noticed that things - from gasoline to food to souvenirs - were quite a bit pricier there than they are here. Many reasons exist for this, but the several layers of hidden taxes are the main one.

Society is not without justice though. Taxpayers get what they pay for. The people who pay the most in taxes (as a percentage of their income) receive the most benefits of those taxes. When a taxation system becomes more progressive, the redistribution of that money decreases.

More likely you are to be in the top left corner means less likely you are going to be in the bottom right corner

I created my own easy way to understand this chart (using excel):

Switzerland and Somalia found something in common.

The English-speaking world has a tendency to have a more progressive tax code, as well as benefits that help the upper class. We're talking tax deductions for long-term investments, home purchasing, as well as social benefits that are not means-tested; meaning that everyone gets them regardless of income. Case in point, more you pay into the US Social Security system - the more you get back in retirement benefits. In these countries, the tax of choice is the income tax. The United States is the extreme in this regard, but Canada, Australia, and the UK are not far behind.

Europe has a different model. Cradle-to-grave social protection for everyone. We're talking homeless benefits, unemployment insurance, health care, university education, etc. Anything and everything you can think of and in quite generous quantities. The catch is: the people who receive the benefits are paying for it through incredibly high taxes - a VAT mostly.

When the government is asked to tax the rich (income taxes) and redistribute the money in benefits to the poor (Health care), then taxpayer revolts occur. This is what happened in the US 2010 Congressional elections - the tea party. 

but... but... medicare is a government program... sigh....

Developed countries, for the most part, cannot sufficiently fund their governments by taxing the poor and redistributing it in benefits to the rich. Switzerland is the exception that proves the rule. I normally hate that saying because it is so misapplied, but here it actually works. In a world where everyone does what Switzerland does, everyone would be worse off. Development would halt as there would be no middle class. Call it Medieval Europe. Or Africa. 

If the free-market economists got the VAT that they wanted, then they would also probably end up with the government benefit system that they don't. So when asked the question: To VAT or not to VAT? Think about what kind of society you want to live in, instead of just what form of taxes you want to pay. 


  1. Just trying to further distinguish b/w VAT and sales tax: would VATs be something that a gov't would collect from a supplier prior to distribution ? I.E. a petroleum company distributing gasoline to a business and getting taxed for the amount they send to this business, the tax showing up in the sticker price and not at all in the receipt?

    1. Yes. You got it.

      Different VATs in different countries operate differently. It's possible that the total amount taxed will show up on the receipt for simpler products, like oil. Especially if we are talking about how much a wholesaler sold it for to a retailer and who then sold it to a customer. That's easier math.

      But think higher up in the supply chain for more complex products. Take cars for instance. There are so many suppliers of so many different chemicals, alloys, paints, parts, etc. That it is will never be clear to the consumer how much they are paying for the product verse how much they are paying for in taxes.

      Thanks for commenting!