University:
London School of Economics and Political Science
Course:
L400 | International Social and Public Policy
Academic year:

2024
Views:

203

Pages:

9
Author:

Prerna T

every cutput, VAT al Prices are lover VAT rates for goods and services Rate % of VAT What the rate applies to Standard 20% Most goods and services Reduced 5% rate Some goods and services, eg children's car seats and home energy Zero rate 0% Zero-rated goods and services, eg most food and children's clothes Most modern economies charge VAT a form of a consumption tax on the purchase price of the final good. It is an indirect tax because the retailer is responsible for paying the tax, though the consumer will pay higher prices. As it is an indirect tax a rise in VAT will not cause a fall in disposable income (this is only achieved with a rise in a direct tax such as income tax) but it will tend to cause a rise in prices which will lower real disposable income. Illustrating VAT using AD/AS is a little tricky. It would actually be shown with an upward shift in the SRAS, which would cause an increase in price due to a movement along the demand curve. So, although there would be a reduction in output demanded due to higher prices, there would be no AD shift. This is a little confusing, as it is a consumption tax, we think it should affect consumption and indeed it does but only through the change in prices, not at every price. As we mentioned above, VAT is a tax that the retailer is responsible for paying that is passed on to the consumer, rather than one that the consumer pays directly. This is an important distinction to remember. Use the space provided to draw the effects of a cut in VAT using an AD and SRAS diagram. Page | 11 S Juiput due to LOVOV therefere Shawkyting denoud Why is VAT regressive? woning AD CUND. Rel Output inemase inequality One important thing to understand about VAT is that it is a regressive tax, this means that it tends to increase inequality. An increase in VAT will increase inequality and a fall in VAT will lower inequality, ceteris paribus. The effects of VAT changes on inequality are a good evaluation, e.g. you may be proposing a cut in VAT to boost economic growth but you get an additional benefit of a reduction in inequality. Let's illustrate this using an example. Here are two women on very different incomes. Doris is a pensioner and Octavia is a film star. and up with Page | 12 Income Spending Subject to 20% VAT VAT paid VAT as a % of total income Doris £100 per week £100 per week* £50 20% of £50 = £10 10% Octavia £1000 per week £400 per week" £200 20% of £200 = £40 4% *Assuming that about half of their spending is on food, which is not generally subject to VAT. So you can see that despite the fact that they both pay 20% VAT on their spending, Doris ends up paying a much higher proportion of her income in VAT. Why? This is because those on low incomes tend to spend a greater proportion of their incomes, so they end up paying a lot of VAT relative to their income. One concept which is useful to mention here is the Average Propensity to Consume. This is the proportion of income that someone spends. For example Doris' Average Propensity to Consume is 100% whereas Octavia's is 40%. Those on low incomes tend to have a high average propensity to consume which usually means more of their income is subject to VAT. Page | 13