Tax is part of the cost of doing business, not an optional extra

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Politicians of various parties seem to be lining up to support a proposal from some in the hospitality sector to reduce the rate of VAT to 10%. There’s no doubt that the sector is currently facing a number of challenges, and it’s easy to see why governments and politicians may wish to aid the sector in order to maintain levels of employment. Tax cuts are probably the easiest way for governments to provide more support, since they can do little about the other costs being faced by those businesses. There is a problem, though, with the basic premise of the campaign, based around the slogan “VAT’s the problem”. The suggestion that ‘tax’ is causing the problem is fundamentally misleading, not to say dishonest: it owes more to neoliberal ideology than practical economics.

It may well be true that if businesses in a particular sector didn’t have to pay so much tax their profits would improve. But it would also be true that their profits would improve if they didn’t have to pay for raw materials, staff wages, or the costs of their premises. It’s not one element of their costs which causes the problem, it is the fact that they are unable to sell enough of their ‘product’ at a sufficiently high price to cover all their operating costs and make a profit. In terms of market economics, any business in such a position is technically non-viable. The most basic law of economics, the one that almost everyone knows, is the law of supply and demand, and that law tells us that if competition is so intense that prices cannot be raised to a viable level, then there is an oversupply in the market. And the natural economic solution to that is to reduce the supply – capitalism requires some companies to fail in order that price levels can rise. It’s another example of supporters of capitalism failing to understand how capitalism is supposed to work.

There may well be social and economic reasons why politicians may not consider that a desirable option, and there’s nothing inherently ‘wrong’ with taking a decision to find a way of delivering subsidies. We should not pretend, though, that a tax cut in such circumstances is somehow not a subsidy. Reducing government revenue in order to cut the costs of private businesses is always going to be a subsidy, however it’s presented. VAT, in particular, is supposed to be added to the bill after the business has set the price based on its costs and profit margin: theoretically, it isn’t paid by the business at all, but by the customer. Reducing it, whilst keeping the final price constant, simply allows the businesses to underprice their product by treating the cash they are no longer handing over to HMRC as part of the revenue generated from their business activity. 

The biggest danger of all is that politicians caught up in the demand for a VAT cut end up reinforcing the neoliberal narrative that tax is in some way an ‘extra’ cost rather than part of the financial environment in which businesses have to operate.