Why, if you have to put up taxes (and you don't), VAT is the right tax to raise

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Much noise has been made about the intention to raise VAT in January 2011. Now, I’d better start by saying that I’d rather the money came from spending reductions than from tax rises. But, if we’re to have tax rises I’d prefer them to be taxes on spending rather than taxes on working and earning.

The debate about the increase in VAT has boiled down to a rather sterile, ‘did-didn’t’ argument about whether the tax is or is not regressive. The argument goes that increasing VAT is really really bad because it falls hardest on poor folk who spend (rather than save) more of their income. The Labour Party produced some rather dodgy stats showing how terrible was this impost (and before anyone asks, the stats are dodgy for a whole host of reasons the biggest being a classic rule of metrics – not comparing two scales measuring different things – but I digress).

Now I’m absolutely sure that those who have high levels of saving pay a lower proportion of their earnings in VAT. But, I’m also sure that those folk (largely in the third quartile rather than the bottom quartile) for whom housing costs are proportionately highest also pay less of their earnings in tax. Indeed the VAT changes – relatively if not absolutely – are good news for those mythic “hard-working families”.

But yes, VAT does tend to be regressive. And, you know, I don’t care. The use of the tax system as a tool for social engineering is a moral affront – whether it’s ‘sin’ taxes on booze, fags and driving or a so-called ‘progressive’ income tax system. But worse – and this is important because economics is, of course, amoral – such uses for the tax system are inefficient. Progressive tax systems are less efficient at securing the funds needed for the government to deliver its programmes.

Worse still progressive systems are market distorting – the tax system sends out sub-optimal incentives that affect behaviour as people seek to maximise their post-tax income (a situation that can and does lead to actual and virtual international flight). Taxing spending is less likely to result in these distortions (unless – as is the case with booze and fags – special extra, market-distorting taxes are imposed) and is therefore fairer and less damaging to the economy.

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