My blog last week discussed best-selling economist Thomas Piketty’s proposal for EU reform, and looked at how his plans for European taxation are part of his campaign against what he sees as capitalism’s inevitable tendency to both reinforce and accelerate inequality.

Piketty, who, despite his ‘rebel’ status, turns out to be extremely pro-EU, believes that the way for Europe to secure its social model for the future is to adopt shared tax standards and rates across member states. His particular concern is to avoid corporation tax competition within the EU – so as to avoid a ‘race to the bottom’ (bad news for Ireland and the UK, who both try to incentivize companies through lower taxes), and ensure that businesses make an appropriate (i.e. major) contribution society as a whole. For Piketty, this would have the double benefit of stabilizing revenue in the EU, and redistributing wealth away from rich unaccountable multinationals.

Piketty believes that the way for Europe to secure its social model for the future is to adopt shared tax standards and rates across member states.

Perhaps surprisingly, Piketty has relatively little to say about VAT in his piece on the EU – other than to be dismissive about centralized attempts to harmonize the tax: ‘All too often today’s Europe has proved to be stupidly intrusive on secondary issues (such as the VAT rate on hairdressers and equestrian clubs)’.

Ed Miliband is known to be an admirer of Piketty, and, this week, Miliband’s Labour Party made its first tax policy intervention for some time. However, rather than corporation or income tax, Labour chose to attack the Conservatives for rises to VAT while George Osborne has been Chancellor.

On the face of it, VAT ought to be strong territory for Labour, and its one-nation, fairness, agenda. VAT is a regressive consumption tax; it does not differentiate between purchasers; you pay the same amount of VAT on your car, mobile or chocolate chip cookies, whether you are a prince or a pauper. Any VAT increases – and income tax reductions – introduced by a Tory government should feed naturally into Labour’s plan to portray Cameron and co as a bunch of affluent wastrels, divorced from the concerns of ordinary people.

So, naturally, Labour went for an advert to hammer home the impact of ‘Tory VAT increases’ on normal domestic expenditure.  ‘THEY PUT £450 EXTRA VAT ON YOUR SHOPPING BILL’ shouts the ad, which shows David Cameron and Nick Clegg as peas in a pod, against a backdrop of the contents of an average shopping trolley – vegetables, detergent, chocolate chip cookies and so on.

The trouble, as John O’Neill of the Spectator and many others have pointed out, is that most of the products appearing in the image are zero-rated for VAT. Whatever else he may have done, George Osborne has not increased their cost by hiking up VAT. As O’Neill merrily notes, chocolate-chip biscuits are specifically excluded from the standard rate.

A classic backfire, then. And it’s easy to laugh at the irony of Labour itself being so out of touch that it doesn’t know the cost of a carrot. But the truth is that hardly anyone in government or elsewhere really grasps the complexity of VAT regulation, or the principles behind it, despite the tax’s immense importance to the economy. Labour has been caught out by zero rates; but so was the SNP just a couple of weeks ago. Even now, no one knows what will happen to VAT in Scotland if the country goes independent. The EU appears to say one thing (that most zero rates will be lost), Alex Salmond another (that they won’t).

Hardly anyone in government or elsewhere really grasps the complexity of VAT regulation, despite the tax’s immense importance to the economy.

But there may be a real, and much deeper and problematic, VAT issue for Labour – and for all progressive political parties in Europe. Responding to Piketty, many reviewers (Mervyn King being the latest) of Capital in the 21st Century have questioned the validity of Piketty’s claim that returns on capital are inevitably greater than general economic growth – which is how Piketty justifies taxing the wealthy at ‘confiscatory’ rates. A contributor to Forbes makes the opposite point:

Let’s say we wanted to be thoughtful about addressing the problem of economic inequality. How would we do it? We’d want to do everything possible to reward activities that promote economic growth. We’d want to lower the cost of living for as many people as possible, by reforming health care, mortgage finance and college tuition. And we’d want to finance our safety net by slashing taxes on income and replacing them with taxes on consumption (sales or value-added taxes) and wealth (property taxes).

If economic growth is stifled by progressive income taxes (because the wealthy no longer reinvest their earnings), then the best taxes for the poor may paradoxically be regressive consumption taxes – such as VAT – even though they treat rich and poor alike.

One piece of evidence for this view is the European social model itself. It is commonly acknowledged that VAT (invented and introduced in Europe) is a terrifically efficient and collectable tax, and that it has been a major factor in allowing and funding the development of the Europe’s uniquely extensive welfare state (think of the eye-watering VAT rates in Scandinavia). Indeed, conservatives in the US have resisted the adoption of VAT because they fear it will allow liberals to pay for the kind of ‘social engineering’ that bedevils Europe.

Here, then, is the rub, the paradox. It seems that the best way to finance large-scale progressive projects – such as the EU – could be through large scale regressive taxes. These counter-intuitive implications make ideological purity hard to sustain. We may understandably long for something simpler, as does Piketty when he says ‘we feel it is essential that the budget of the eurozone comes from a European tax, not from contributions by the states’.

But the EU does have its own tax, though Piketty does not mention it, and though the fact is not commonly understood. Since the recasting of the sixth directive in 2007, a certain proportion of the VAT take (which varies from member state to member state) goes directly to the EU. Somebody in Brussels realized that VAT was just too good a potential source of income for the union to ignore. And not VAT from ‘contributions by the states’ (always up for argument), but straight from sales. At the last count, VAT accounted for 11% of the annual EU budget – somewhere in the region of 12 Billion euros.

Whatever the complexities and ironies of VAT policy, there’s no danger of inequality for the technocrats of Brussels!

By |May 13th, 2014|