At last, an idea that makes economic sense: reduce VAT instead of stamp duty!

[intermission]

The quoted article doesn't even mention stamp duty!

All it states is that cutting VAT is less inflationary and more equitable than cutting income tax.

Cutting income tax gives people extra spending power straight away, creating extra demand in the economy.

However, cutting VAT will still be inflationary in the long run as the total price of goods/services is ultimately controlled by supply and demand. Demand will raise the price to the level it was before, given that consumers were prepared to pay that price originally.

All cutting VAT does is temporarily skew the Retail Price Index, which is what we use to measure the rate of inflation.

To control inflation:
1/ Reduce public expenditure by raising taxes / raising interest rates / tightening credit.
2/ Reduce Govt expenditure by cutting services / benefits - not popular!
3/ Place limits on wage increases - not popular!
4/ Limit the growth of money supply

 

[baby_tooth]

interesting suggestion,

reduce vat ..thus reduces price / cost to consumer of staples..like esb gas, etc....

now raise income taxes.

off sets loss of revenue in vat cut and also reduce money supply.
economicaly sound if the pursuit is to reduce inflation, or couse other repurcussions to consumers spending patterns.

 

[dontaskme]

However, cutting VAT will still be inflationary in the long run as the total price of goods/services is ultimately controlled by supply and demand.

Yes, you are probably right insofar that prices would mostly stay the same i.e. 0% inflation, which benefits the consumer. In this case there would also be more money in the system but it would be in the pockets of businesses. Therefore it would be more likely to spur investment, rather than blind consumer spending.

Demand will raise the price to the level it was before, given that consumers were prepared to pay that price originally.

And this is why house prices always only go upward! :lol:

All cutting VAT does is temporarily skew the Retail Price Index, which is what we use to measure the rate of inflation.

Yes, the VAT cut would have a temporary effect on inflation.

 

[room305]

Essentially dontaskme, you are looking to use our tax money to bribe retailers in the hope they will reduce prices. If we introduce this measure, in year's time, everyone will be standing around scratching their heads wondering why the retailers continued to charge what the customer was willing to pay.

As a customer I couldn't care less about how much of a good is VAT, what the running costs of the business are or if the owner of the business just had a good win on the horses. If the business is operating in a competitive environment the price will already be set to what the market will bear. Where is the incentive for the retailer to pass on a reduction in VAT? When the price of oil increased dramatically retailers largely absorbed the costs (even though it hurt their margins) and are unlikely to reduce their prices now that oil prices have fallen again. Remember it is the consumer that sets the price for the good by paying for it, not the retailer.

In Zimbabwe inflation is running at over 1200% a year, crippling their already poor economy. In an effort to curb inflation, the government intervened and fixed the price of petrol. Result? Petrol owners refused to open their garages to sell the petrol and the army was called in to force petrol station owners to serve petrol at gunpoint. Has this reduced inflation in Zimbabwe? No, the money has to find a home somewhere and no doubt with petrol costs fixed, the price of something else increased correspondingly. It is the amount of money in the system that is the problem, not the price of the goods.

Interesting suggestion babytooth. Reducing VAT will improve the retailers profit margin and increasing income tax will reduce the consumer's spending power with the likely result that the retailers will be forced to reduce their prices (and will have the means to do so).

 

[darag]

I don't agree. There is a remarkable level of VAT fraud in this country, and indeed internationally - if you don't believe me, ask anyone who has ever paid cash for domestic service work. That's leaving aside the spectacular international VAT frauds that cost the UK government alone a number of Billions last year. The VAT system, as currently structured, creates an immediate and direct competitive advantage for tax-dodging businesses at the expense of compliant businesses. In certain sectors this advantage is so pronounced that the dellboys flourish while legitimate businesses find it difficult to survive.

And these people who commit VAT fraud are fully compliant with respect to all their other tax obligations? It is riskier committing VAT fraud as it either requires the complicity of the customer ("cash price") or leaving an external paper record that you charged VAT (in the form of an invoice or receipt) which can be used as evidence that you committed VAT fraud. Fiddling taxes which involve nobody but the fraudulant company and revenue is far more common. These "delboys" you refer to are likely to be fiddling far more income tax than VAT.

The case of the international VAT fraud is a product of the relatively recent international tax agreements which allow refunds against foreign VAT which were enacted without putting in the relevent bureauocracy to check such refunds. Again there is nothing particular to VAT in this regard. There is huge international fraud of income taxes (e.g. non-declaration of foreign investment property rent) yet no-one claims that we should scrap income taxes. Or at an even bigger scale is international transfer pricing to avail of lower taxes on corporate profits - currently under scrutiny by the US authorities; the figures involved here dwarf any international VAT fraud. The UK loophole has been closed in any case.

Aren't forms of taxation which are unfairly incident on lower wage earners generally considered poor and inequitable?

Most people agree that progressive taxation is appropriate for income. Fewer would argue for progressive taxation on wealth - e.g. rates on property. But I've yet to hear an arguement for progressive taxation on consumption. Making VAT progressive would achieve nothing that couldn't be achieved with adjustments to income tax and would be impossible to collect. People pay VAT on what they spend from their take home pay - if you want higher earners to pay more you can take the money off them before they even get to the shop.

 

[room305]

Yes, the VAT cut would have a temporary effect on inflation.

No, it would have a temporary effect on the measure we use to observe inflation. You do not seem to be able to make the distinction between the two. When I am driving I cannot reduce speed by tampering with the speedometer.

 

[dontaskme]

No, it would have a temporary effect on the measure we use to observe inflation. You do not seem to be able to make the distinction between the two. When I am driving I cannot reduce speed by tampering with the speedometer.

According to Wikipedia

"In mainstream economics, inflation is a rise in the general level of prices, as measured against some baseline of purchasing power. The prevailing view in mainstream economics is that inflation is caused by the interaction of the supply of money with output and interest rates."

But maybe, it would make it clearer to you if I said that reducing VAT would have a positive effect on price stability.

 

[dontaskme]

Essentially dontaskme, you are looking to use our tax money to bribe retailers in the hope they will reduce prices. If we introduce this measure, in year's time, everyone will be standing around scratching their heads wondering why the retailers continued to charge what the customer was willing to pay.

Not necessarily to reduce prices, but to at least slow the level at which prices are increasing. But it would also be up to consumers to look for the lower prices and to spur competition.

 

[room305]

Not necessarily to reduce prices, but to at least slow the level at which prices are increasing. But it would also be up to consumers to look for the lower prices and to spur competition.

But why would they look for prices to not increase if the money supply is increasing and there is an expectation of inflation? If consumers want lower prices they should look for them and they will get them. How much of the good is tax and how much is pure profit for the retailer is irrelevant unless you are suggesting that goods in Ireland are currently priced as low as the retailer can sustain.

The idea seems to be based on a principle of "cut tax and hope" rather than any sound economic reasoning.

 

[dontaskme]

As a customer I couldn't care less about how much of a good is VAT, what the running costs of the business are or if the owner of the business just had a good win on the horses.

Large shopping chains like Tesco and Aldi and Lidl tend to drive a harder bargain.

If the business is operating in a competitive environment the price will already be set to what the market will bear. Where is the incentive for the retailer to pass on a reduction in VAT?

I would imagine they would pressure their suppliers, and then if the market is competetive, they should compete on price. And if one of them reduces prices to consumers, the others should have to follow.

 

[room305]

According to Wikipedia

"In mainstream economics, inflation is a rise in the general level of prices, as measured against some baseline of purchasing power. The prevailing view in mainstream economics is that inflation is caused by the interaction of the supply of money with output and interest rates."

This doesn't contradict anything I have said.

But maybe, it would make it clearer to you if I said that reducing VAT would have a positive effect on price stability.

In which case, as I have already pointed out cutting VAT will have the opposite effect. To stabilise prices during periods of inflation we need to take money out of the hands of the consumer. To do this, we need to increase taxes not reduce them.

 

[dontaskme]

Re: At last, an idea that makes economic sense

You are making the mistake of thinking inflation can be controlled by lowering the prices of goods and services. Inflation is an increase in the money supply (usually faciliitated by loose credit) which results in an erosion of the purchasing power of that money.

This is what you said.

Now I'm asking you, what happens if prices of goods and services go down? Are you trying to say that has no effect on inflation?

I'm not saying the lowering of the prices controls inflation, however by lowering prices, inflation, by definition, goes down.

The definition is in terms of consumer prices, not in terms of the money supply.

 

[dontaskme]

In which case, as I have already pointed out cutting VAT will have the opposite effect. To stabilise prices during periods of inflation we need to take money out of the hands of the consumer. To do this, we need to increase taxes not reduce them.

But if the consumer has extra money, where did it come from?

From price reductions, where the VAT decrease has been passed on.

And, if the reductions are not passed on, the extra liquidity is in the pockets of businesses, who can use it for investment, not in the hands of the willing consumer.

 

[room305]

Re: At last, an idea that makes economic sense

This is what you said.

Now I'm asking you, what happens if prices of goods and services go down? Are you trying to say that has no effect on inflation?

It will have an effect on inflation measures not on inflation itself. If the prices of goods are low then the money will find a home somewhere else. For years now we have had a rapidly expanding money supply but controlled prices by importing deflation from countries like China. This didn't eradicate inflation because during this time the price of houses exploded.

I'm not saying the lowering of the prices controls inflation, however by lowering prices, inflation, by definition, goes down.

Yes but we would need to lower the price of everything which is simply not possible. Lower the price of one good and the money will just push up prices somewhere else. To follow your argument to its logical conclusion we could pump out all the money we want - make everybody rich on paper - and then prevent hyper-inflation by directly intervening in the market to keep the prices of goods and services low.

The definition is in terms of consumer prices, not in terms of the money supply.

Yes because that is how we observe inflation. When your money can purchase less goods then it is clear that the purchasing power of that money has been eroded.

 

[room305]

But if the consumer has extra money, where did it come from?

From price reductions, where the VAT decrease has been passed on.

And, if the reductions are not passed on, the extra liquidity is in the pockets of businesses, who can use it for investment, not in the hands of the willing consumer.

This doesn't make any sense.

 

[dontaskme]

Re: At last, an idea that makes economic sense

High prices are not inflation they are the result of inflation. The only way to combat inflation is to reduce the money supply and tighten credit lending practices. Since we cannot set our own lending rates, the government should be looking to increase taxes rather than reduce them.

I've thought about this and I don't buy it. You seem to say that inflation is an increase in the money supply rather than an increase in prices.

If the money supply were to double overnight, and the number of people in an economy doubled and the amount of goods and services available for sale doubled overnight as well, then prices would not go up.

Another example, if the money supply were to stay the same but there were sudden shortages of goods and services, then prices would go up. This is inflation.

There are a number of factors that have a bearing on inflation e.g. supply and demand, monetary policy, fiscal policy, growth of the economy, demographics and money supply is one of these factors.

 

[tyoung]

Re: At last, an idea that makes economic sense

If the money supply were to double overnight, and the number of people in an economy doubled and the amount of goods and services available for sale doubled overnight as well, then prices would not go up.

Another example, if the money supply were to stay the same but there were sudden shortages of goods and services, then prices would go up. This is inflation.

I think you're right on the first point. Under a strict gold standard mild price deflation is the norm due to rising productivity and rising population. Nothing wrong with that though.
On the second point I would disagree in theory anyway. If there was a shortage of certain goods and sevices certainly their price would rise but if the money supply is fixed wouldn't the price of other goods/sevices have to fall? less money to spend on them etc.
The Ecomonist mag had an article on the link between monetary inflation and price inflation a couple of months ago. The take home message, if I remember correctly, was that monetary inflation is a useful predictor of price inflation but with about a 3 year lag.
When monetarism was in high fashion everybody used to pore over the latest monetary data for clues as to the direction of interest rates.
Now the ECB looks at monetary data when setting the course of interest rates. It's been sky high for the last few years.
The US Fed does not. It stopped publishing M3 figures last year.
Regards

 

[room305]

Re: At last, an idea that makes economic sense

I've thought about this and I don't buy it. You seem to say that inflation is an increase in the money supply rather than an increase in prices.

If the money supply were to double overnight, and the number of people in an economy doubled and the amount of goods and services available for sale doubled overnight as well, then prices would not go up.

Inflation is an increase in money supply as the purchasing power of said money is eroded by simply having more of it. If the money supply is doubled then the purchasing power of the money is halved and prices will double.

Otherwise, we could print all the money we want and never fear an inflationary payback once we contrive to keep the prices of goods low. So despite there being more money in circulation, somehow the purchasing power of money would never be eroded.

It's simply not feasible. Look at the current situation, the price of goods was kept in check by globalisation and increased competition but the price of houses simply expoded. That's inflation.

 

[room305]

Re: At last, an idea that makes economic sense

If the money supply were to double overnight, and the number of people in an economy doubled and the amount of goods and services available for sale doubled overnight as well, then prices would not go up.

If we double the number of people, double the money supply and double the amount of goods and services then nothing has really changed has it? We've just increased everything by a factor of 2.

 

[dontaskme]

Re: At last, an idea that makes economic sense

If we double the number of people, double the money supply and double the amount of goods and services then nothing has really changed has it? We've just increased everything by a factor of 2.

well, not according to my definition of inflation. The money supply has doubled but prices remain the same so inflation is 0%.