Economic Myths: "VAT is a Tax on Luxuries"

Posted on the 26 November 2014 by Markwadsworth @Mark_Wadsworth

You have to remember that VAT is not a tax on "consumption" (whatever that means). It is a tax on gross profits-plus-wages, the clue is in the name "Value Added Tax". There is then also a tax on net profits, known as corporation tax (which is not a tax on "capital", whatever that means, it is a tax on income). So if this myth were true, then producers of more basic goods would pay a lower tax rate than producers of luxuries.
(VAT's fig-leaf is that taxes on "necessities" like food and rent are exempt. Is it a coincidence that both of those are land-based sources of income? Interest payments are not liable to VAT either. But that is just a fig-leaf.)
Remember also that "luxuries" are status goods, people will pay extra to have such-and-such a label on their car, clothing, musical instrument, whatever, so producers who have attained this reputation can charge larger mark-ups. So let's put VAT and corporation tax together and do some numbers.
1. A luxury/status item costs £500 to make and retails for £1,000. The overall profit before any taxes is £500.
The VAT is £167, leaving £333 liable to 20% corporation tax = £67. Total tax = £233.
£233 out of the original £500 = 47% overall tax rate.
2. A more basic item costs £50 to make and retails for £75. The overall profit is £25.
The VAT is £12, leaving £13 liable to 20% corporation tax = £3. Total tax = £15.
£15 out of the overall profit of £25 = 60% overall tax rate.
Here endeth.