18 Mar 2011

An Alternative to VAT

As you probably know, I'm pushing to have all the main taxes (VAT, income tax and corporation tax) replaced by a single flat-rate Financial Transaction Tax. One major obstacle for this is the fact that the EU is largely financed by VAT, making it hard for individual countries to opt out.

Interestingly, I've just discovered that the EU is currently looking at the future of VAT, and there is a Green Paper called "Towards a simpler, more robust and efficient VAT system" and you can download the pdf here

I also discovered that there is a period of consulation that started last december and runs until the end of May. The EU invites those affected by this initiative – all citizens, organisations, businesses, public authorities, tax practitioners, tax experts and academics -  to provide their views on this matter. So, of course, I did. Here's the mail entitled "An Alternative to VAT" that I sent them yesterday. It would be great if they actually paid attention to it...

Dear colleagues,

I read with interest that the EU is currently looking into ways of reforming the current VAT system.

I would like to draw your attention to a paper that I published in october 2010 that proposed that it would be possible to replace essentially all the current taxation methods (VAT, Income tax, Corporation tax) by a single flat rate Financial Transaction Tax.

The paper can be downloaded here and I have provided a good deal of updated information on my blog.

The basic idea is simple. Financial transactions within the countries covered by the Bank for International Settlements are running at around 1000 times the total tax revenue of the countries in question.  A more recent set of figures that covered the period including the financial crisis in 2008 can be found here  and shows that while this ratio dipped, it was still at least 729:1.

I have been unable to find full figures for the EU (maybe you know where they can be found), but it is worth pointing out that the numbers provided by the BIS are very clearly underestimates because of the very large numbers of transactions that are not covered.  For example, according to the triannual BIS report (based on a single month of activity for which april 2010 was the last example, activity on the foreign exchanges was something like $4 trillion a day of which 37% was in the UK, together with a further $2.1 trillion per day of activity in the OTC global interest rate derivatives market (46% in the UK).

Imagine replacing all the current VAT mechanism with a single FTT at say 1%. This would give a tremendous boost to real economic activity within the EU, since effectively the only economic activity that would be discouraged would be speculation - including the currency speculation that has proved so damaging the the European Union.

In my paper, I pointed out a number of features of using financial transactions that I believe are significant advantages compared with conventional VAT-based mechanisms. In particular, I believe that collecting an FTT would be vastly less complex to implement than VAT - it would literally simply involve adding a line of code to the software used for handling financial transactions.  Secondly, it would be far less easy to cheat - whereas the current arrangements for VAT have provided a wealth of opportunities for criminals to illegally obtain money from the EU by filing bogus VAT statements - I presume that I don't need to provide documentation for this.

But there are other interesting advantages of FTTs over VAT.  Specifically, on page 8 of my paper, I make the following observation :

"Increased incentives to short production supply chains
Value added taxes of the type used within the European Union are not only complex to implement - they also have additional disadvantages compared with a simple FTT based mechanism. When the production of a particular commodity involves a large number of different stages, VAT-based mechanisms mean that in the end the total amount of tax recovered does not change, irrespective of the number of production stages because at each stage, the producer can recover tax paid at earlier stage. The consumer will pay the basic rate of VAT, irrespective of the number of steps involved. In contrast, under the FTT based scheme, the 1% transaction fee will need to be paid at each step in the sequence, every time money is paid from one person to another. For foods that have a VAT rating of (say) 5%, the total amount of tax would only be more for an FTT based system if there were more that roughly 5 steps in the sequence. However, for many other goods, the effective VAT rate is often 20% or more. This means that the cost of the goods would often be lower using an FTT based system.

But there is another positive feature of the system. Imagine the effect for goods that are produced locally with very short supply chains. For example, consider a farmer who grows his own crops, grinds the wheat to produce his own flour, bakes his own bread and transports the goods to a local market using his own transportation. In that case, only the final purchase of the bread at the market would be subject to tax with the result that the effective tax rate would drop to just 1%.

This sort of price advantage for locally produced goods would greatly reduce the tendency of supermarkets to supply goods that are flown in from the other side of the world (with all the ecological consequences involved) simply because the current VAT based taxation system fails to penalise long supply chains."

Together, I believe that these various arguments make a strong case not just for reviewing the mechanisms used for collecting VAT, but for actually scrapping the whole thing.

I would be very interested to hear your reactions.

Yours sincerely,

Simon Thorpe
Senior Research Director with the CNRS

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