Government Spending is like a Hamburger Store

THERE IS ONLY ONE. 100% TAX. BIG GOVERNMENT!

(with apologies to McDonald’s Big Mac packaging)

At times when money is tight and our resources are stretched to the limit, it pays to spend our money wisely.  That is why it makes so much more sense to reduce the costs imposed on private industry instead of increasing spending by government.  Industry takes their earnings and reinvests them to create sustainable wealth creation: they hire and train workers, conduct research, build and perfect machinery and robotics, and develop brand equity and a reputation for quality. All of these endeavors represent lasting value creation. What is spent on these things this year will continue to create revenues, wages, and profits for years to come.

100% Beef (or is it tax!)

Government spending is pure consumption.  Think of a hamburger store.  While it may taste  good at the time, it is temporary and fleeting, and will likely do more harm than good in the end.   It keeps the beast alive for one period, and then the process has to start all over again next period.

When we approve a massive spending bill, it covers government purchases of goods and services for the next year, maybe less.  In one end; out the other, with nothing left to show for it, except a hungry program that needs to be fed again next year, and the next and the next.

Government programs in and of themselves never produce lasting value; only in conjunction with private industry is any wealth or value created. And even then the government purchases have pushed aside, prevented, crowded out, or priced out purchases that would have been made by the private economy.

So, please, keep this in mind whenever you think of any type of government spending or tax increase: it is here today, gone tomorrow.  Oh, and skip the fries!

By Sherry Jarrell

33 thoughts on “Government Spending is like a Hamburger Store

  1. An example of a government program in the USA: World War Two. No lasting value?

    Another example: The FDIC, insuring bank deposits (which disappeared during the Great Depression, making it great for all to see).

    Still another government program: Social Security.

    Another government program: Medicare. No value?

    Still another: the National Institute of Health (NIH). The world’s largest biology and medicine research institution. No value?

    Little known to American economists, the USA is actually a socialist country. Socialism for the rich, with their maximum 15% tax rate. But also the home mortgage interest tax deduction, a unique socialist subsidy for home owners and bankers (France adopted an emergency very small partial subsidy, on 20% of the interest payment, but it could be revoked anytime). No other country has that. Anyway: home mortgage deduction, a government program: no lasting value?

    Obama actually wanted to reduce it, but to take it out would reduce home values by up to 50% (on high end homes). Thus; value or no value?

    Free freeways: an Eisenhower program: no lasting value. In “welfare” France, freeways were built, and are exploited by private for profit companies. Everybody thinks it’s only fair that users should pay for their roads.

    Government subsidized water in the USA; another government program of no lasting value? In “welfare” France, private companies, the largest in the known universe, sell water to the citizens. recently some local governments found that by paying directly their own engineers and workers, they could save money, and improve service. Why? Because a giant French private company has to show profits (which a city government does not have to). And a giant French private company has to pay dividends on its shares, and also invest in new technologies and ventures. So, locally, government can be cheaper and better. But the Reaganosaur does not want to understand this: its survival depends on not understanding it.

    What is value? The Reaganosaurs answer that it comes from “profit”. That is something they put in their deep pockets. What is the difference with greed and gouging?

    But the “economy” is not a field that the Reaganosaurs created. They waddled therein as crocodiles in a China shop. The Economy was named, defined and created by great philosophers, people such as the amazing general and writer Xenophon, who named a treaty of his by that neologism. Actually, the Greek philosophers even named and founded what they called “political economy”. In economic matters, philosophers reign.

    Of course, the American establishment created for itself the “Nobel” prize in economy, and then distributed it to themselves, with the occasional Frenchman to look “fair and balanced” as the Fox says. The idea was to shroud themselves in an aura of authority. Nothing like getting a handshake from a king, for the small minded.

    Then the Reaganosaurs play a comedy among themselves, “opposing” each other to better reach the nirvana of profits for themselves. Krugman, Sherry Jarrell’s preferred villain, for example, spent a year advising Reagan at the White House (1982-1983). with his good friend Larry Summers. Krugman advised on how to export the industry of the USA overseas, for profit, and Summers advised on how to reduce government programs inside, also for profit. Profits galore, but profits do not an economy make.

    The profit motive actually corresponds to the part of the economy that would not exist otherwise. Thus, paradoxically, it is the weakest part of the economy.

    The greatest motive for having house-management (=eco-nomy) is sheer necessity. The caveman did not have a cave (= house, in cold glaciated Europe) because he could make a profit, but because it was necessary for him to have shelter. Neither did he go hunting because there was profit in it.

    The partisans of Reagan, the oligarchs, found their profit in selling the cave to aliens from other tribes. That should have been forbidden by law. When the “Boeing” 787 takes off, the well-informed observer sees Japanese wings, British engines, Italian fuselage, and an impressive set of French titanium and carbon fiber landing gear. What happened to the good old USA? Disappeared down the bottomless profit well?

    Krugman considers himself a liberal, and the Reaganosaurs make a great show to scream and flee for high ground each time they see him. But that’s all for show. Krugman was a prime agent for unrestrained globalization, with his “new trade theory”, and, to this day, Krugman defends the zero interest rate policy, so advantageous to Big Bonus Bankers, and disastrous for most people, as I pointed out explicitly many times before (and, on this specific point Sherry now agrees).

    It is not just because one says something that it becomes true. To assert that ” Government programs in and of themselves never produce lasting value; only in conjunction with private industry is any wealth or value created.” contains actually two universal statements. For example, the National Park system, in and of itself has no “lasting value”, according to Sherry. Only in conjunction with hamburger stands is value created.

    In other words: nature has no value, only money does. But what is money, ultimately? Power on people, immediate or differed. But what is power on people if “the planet explodes” (as Carlos Goshn, the French CEO of Renault-Nissan, put it cogently)? Nothing. That is why Krugman started to change his notion of value. If an old Reaganosaur can so evolve, others can do it. There is hope.

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  2. “But also the home mortgage interest tax deduction, a unique socialist subsidy for home owners and bankers .. No other country has that. Anyway: home mortgage deduction, a government program: no lasting value?

    Patrice, I think you will find that England, Wales, Scotland, Ireland, Australia at the very least offer tax deductions for home mortgage interest payments.

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    1. Hi Paul:
      Is the following not up to date?

      “In the 1980s, Britain had its own version of the mortgage deduction, known as MIRAS, or “mortgage interest relief at source.” With the top income-tax rate at 60 percent (25 percentage points above ours today), the MIRAS break mattered a lot.

      Then in 1988, Nigel Lawson, Margaret Thatcher’s finance minister, the Chancellor of the Exchequer, changed the rules. He pulled the top tax rate down to 40 percent and cut back on MIRAS.
      …in 1999 Gordon Brown, then Chancellor of the Exchequer, did away with MIRAS altogether.”

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      1. H’mm, you may be correct. I was working from memory and it has been many years since I had been a house purchaser using finance.
        Let me check on this.

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  3. Hi Paul:

    Thanks for the correction. I sort of maintain that the sacred home mortgage interest tax deduction is a US socialist program to an extent not seen anywhere else. India has it, true, but with a low limit.

    It was my understanding that some of the deductions, in some other countries were small, or had been struck down. Actually, to my amazement, I found that the French one had been struck down. See below. PM Brown has been busy changing quite a few tax rates in the UK, no?

    from Wiki:
    Canada
    Canadian federal income tax does not allow a deduction from taxable income for interest on loans secured by the taxpayer’s personal residence. But homes used in businesses as a landlord who owns a rental residential property can deduct interest as any other reasonable business expense. …
    The home ownership rate in Canada is about the same as in the United States,[2] but Canadians have about 70%[3] equity in their homes on average (i.e., 30% mortgage debt), compared to only 45% average home equity in the United States.

    France
    France does not allow a home mortgage interest deduction. In 2007, newly-elected President Nicolas Sarkozy proposed creating the deduction as part of his legislative plan for sparking the French economy.[4] In August 2007, the Constitutional Council, the highest court in France, struck down the mortgage interest deduction as unconstitutionally creating a tax advantage that goes far beyond its stated goal of encouraging non-homeowners to buy homes. The Court noted that the deduction would apply to people who already own homes.[5]

    From New York Times, 2006: http://www.nytimes.com/2006/03/05/magazine/305deduction.1.html?_r=1&pagewanted=print

    “One reason is that homeownership in the U.S. is about the same as it is in Canada, Australia and England, where interest isn’t deductible.”

    I thought some deduction existed in Australia, since then changed…

    PA

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  4. Patrice: The value impact of government spending on goods and services that can and would be offered by the private sector is negative — yes, I am saying that such government programs destroy value.

    For one, the private economy invests each dollar of earnings more efficiently than the government spends the taxes collected.

    Two, government spending is here today, gone tomorrow. We have to start all over again with next year’s government spending. Government spending is one period. With private spending, the whole point is to direct as much of that spending to equipment and labor that will create value and profits for as many periods as possible to come. Private spending is multi-period, focusing on sustainable value

    The value impact of government programs that purchase goods and services that would not have been provided by the private economy is more complicated, because some spending support goods and services that protect the environment within which the private economy thrives (like defense spending), while others (like $10 million of the stimulus program spent on two exotic animals in the Washington Zoo!) are clearly wasteful. The common question is “where the tax dollars would have been spent otherwise” and the common answer is almost always “if in the private economy, value is higher.”

    And, Patrice, you make a false claim when you say that I now agree with you on interest rate policy. I respectfully request that you specifically retract that statement, for nothing could be further from the truth, and the authors on Learning from Dogs are nothing if not truthful. We can be completely wrong, but we do not make false claims.

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    1. Sherry:
      Just to adress the specific point you made, that I misrepresented you about interest rate policy. Sorry if you think I did. But I seemed to me that your post on “Gov is paying banks to NOT lend”(or words to this effect), was EXACTLY about that.

      Indeed as I pointed out many times, the gov lends short to the banks at 0% (roughly) and then they put back the money at 3.5%… I really do not understand what I misrepresented there…

      Respectfully,
      P

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      1. Hi Patrice,

        You implied that I agreed with you that banks should not be able to borrow from the Fed at 0% and lend at 3.5%. I did not say that. Here I repeat my explanation of the misrepresentation:

        “Patrice,

        Either you misunderstood what I said, or you are trying to put words in my mouth. My point was that the Obama Administration is being hypocritical: while wagging their fingers at banks for not lending enough, they are quietly paying them to not lend as much. All for a public show. All to point the finger of blame to someone else, anyone else. It is childish, and deceitful, and it insults the intelligence of the U.S. public. I simply want President Obama and his advisors to take ownership of their policy decisions — all of them, whether good or bad.

        Banks should lend. It is a good thing. It is not a racket, it is not evil. Derivative trading is not rigged. There is no conspiracy. The cause of the financial crisis is much simpler than that. The truth of the matter is fairly boring, apparently way too boring for the fertile imaginations of the world.

        The fact that the system has fractional reserves is a mere detail; 100% reserves would simply mean that the Fed has more direct control of the money supply. Either way, the Fed controls the money supply.

        The money supply, by the way, is distinct from the equilibrium quantity of money, which occurs at a particular interest rate given money demand. So the Fed either targets the interest rate (and allows money supply to rise or fall as needed to maintain that rate), which it now does, or it targets the money supply (allowing the market interest rate to rise or fall as needed, as we did under Volcker in the early 1980s).

        So, our “thoroughly agreeing” on something, I’m afraid to say, was a false alarm!”

        Respectfully,

        Sherry

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  5. I think Sherry has clarified something important for me. The realisation that the way that governments ‘collect’ income will always cost more, because of the collection costs, than the way that private enterprise ‘collects’ income (net profits).

    This shouldn’t be turned into a political issue because we all understand that there are some services that we elect and expect our Governments to perform – open to debate on the fringes, of course, but policy disagreements are the essence of a democratic society.

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    1. Hi Paul,

      Ah. I am so glad my comments clarified something for you! Yes indeed there are some goods and services the government needs to provide, and the difference between a healthy private economy and socialism is just a matter of degree.

      The issue I struggle with is that, while the debate between the two should center on philosophy and preferences, it seems instead to rely on contradictory economic principles.

      For example, “efficiency” is a well-defined economic concept, and desirable in my view, while “fairness” is philosophical, and also desirable, but the two are not the same. I am happy to struggle with questions of efficiency, but find issues of fairness to be in the eye of the beholder.

      As usual, your tempered comments are most welcome and centering!

      Sherry

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  6. Paul:
    Collection costs and cheating can be eliminated with an AVT, Added Value Tax. That’s why so many countries have adopted this French invention from the 1950s.

    Yours truly has strongly advised the big O to do just the same, thus skirting campaign promises… It will happen someday…

    PA

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    1. Statements such as “For one, the private economy invests each dollar of earnings more efficiently than the government spends the taxes collected.” have to be put in context. Always.

      Say the “private enterprise” is a casino in Las Vegas. So is it “more efficient” to put up another massive tower in Vegas than to give money to researchers at NIH looking for a cure for cancer or aging? Is it more efficient to send Vegas money to some tax heaven, than to have the Federal government pay some private enterprise to make thousands of millimetric bodyscanners, and pay for more efficient intelligence services?

      I am very far from a statist fanatic. The US gov should not have saved General Motors, for example. It should be sold to Renault (if the later is still interested by devouring it).

      But, ultimately, in a democracy, it’s the government that calls the shots, not the rich. In the later case, when the Rich calls the shots, all the shots, it’s called a PLUTOCRACY. And, in the fullness of time, it does not work as well. History, and theory, show.

      PA

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      1. No, it’s the voters who call the shots in a democracy. And I do not equate “business” with “rich.” I equate business with economic freedom.

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    2. Patrice, I’m not sure where you get that notion but a very quick search comes across a book written in 1981 by Cedric Sandford with the saucy title ‘Costs and Benefits of VAT’ from which is quoted:

      “Because of the multiple stages of collection of VAT, with payments and claims occurring at each point in the production process, administrative costs which are small in relation to turnover may, nevertheless, be large in relation to the net revenue obtained. It seems this is indeed the case; compliance costs are put at £400m ($640m) in 1977-8, a figure that is almost 10% of VAT revenue in that year and five times the direct administrative cost of operating the system.” http://www.jstor.org/pss/2232524

      As someone who ran a UK business for many years, I can tell you that it is not a process without significant overheads.

      The degree of VAT fraud,also, in the UK is enormous.

      Governments have adopted VAT/AVT because they are able to pass so much of the collection cost onto the heads of private enterprise – that’s a fact!

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      1. OK, this is important, because I want to understand this thoroughly, and the entrepreneur’s point of view is important to me (and I never was one). As I said, I have been advising the powers that be rather stridently (making myself a “thorn”), so I want to make sure I am not missing a point here.

        1) How does “VAT fraud” proceed? It is my understanding that taxation is higher the less one reveals of one’s business, the more tax one pays.
        Basically the VAT taxes even organized crime, which has interest to reveal its even own business to reduce it.

        2) As wikipedia, http://en.wikipedia.org/wiki/Value_added_tax, puts it: “most of the cost of collecting the tax is borne by business, rather than by the state. VAT was invented because very high sales taxes and tariffs encourage cheating and smuggling.”
        So I agree 100% with your conclusion, which was meant to be my point to start with. When I said: “Collection costs and cheating can be eliminated with an AVT, Added Value Tax.”, I should have be even more precise: ” Collection costs TO THE GOVERNMENT and cheating can be eliminated with an AVT, Added Value Tax.”

        I agree that having to struggle to make precise accounting to reduce one’s VAT to the legal level has got to be disagreable to the entrepreneur, but that seems to me besides the point.

        Now I brace myself to learn how one can cheat witha VAT…

        Happy New Year, BTW, and enjoy the lack of VAT in the USA while it lasts… EU law imposes a minimum of 15%… Sale tax in the SF bay Area is 10%…

        PA

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    3. The only way a VAT should be contemplated is if it replaces income tax so we first need to eliminate the income tax in the U.S., which will never happen, thus VAT should never happen.

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      1. France gets 52% of government income from VAT. VAT was started in 1954, took 30 years to ramp up. There are also huge energy taxes and user taxes in France. Both systems have been adopted in the EU and are even part of its basic law (in the case of VAT; legal minimum is 15%, as in the UK now; France and germany are at 17%).

        Meanwhile the income tax is getting crowded out. 50% of French people do not pay it at all (or thereabout).

        The VAT will happen, in the USA as anywhere else, and the basic reason is precisely fairness, and it’s not in the eye of the beholder: A VAT is self taxation, and impossible to avoid. Even the Mafia pays it. Ah, yes, fairness means also that everybody pays it, so it’s a huge income generator. For the government, let me be precise (to avoid being brandished as having said something else…)

        PA

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  7. And a Happy New Year to you and your family. Indeed, the new year is upon you as I write this.

    With regard to VAT fraud,that will take a little research. Happily undertaken but my daughter’s visit to us in Mexico is taking priority, as you would want it!

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    1. Indeed, one must cultivate one’s family… Or one will not be able to cultivate anything worthy.

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  8. Hello Patrice,

    I hope you had a nice New Years!

    I feel like we are going off on a tangent here. To theorize about the relative amount of cheating on a particular sort of tax seems to me to be a waste of precious time and energy. The real fraud is how Congress, with Obama’s complicity, diverts tax revenues to programs and districts with the express purpose of buying votes and retaining power. Never has it been more blatant and obvious than in trying to buy votes for passage of the health care bill.

    You have been advising the Obama administration on taxation policy without understanding the entrepreneur’s point of view? Without exposure to microeconomics? That explains a lot. President Obama clearly lacks this critical background as well, as do most if not all of his advisors. Tell you what, if you really have the ear of the President, why don’t you recommend to him that he contact me? I will be more than happy to explain the basics of economics, finance, capital markets, corporate governance, and entrepreneurship to him and his advisors. President Kennedy got advice on economics when he first entered office, and ended up passing the first major tax cut during peacetime. We should be so lucky!

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    1. Sherry:
      Happy New year to you too!

      Um, I am low key about all this. If you read very carefully what I wrote I did not say I advise an administration, but I evoked a particular person.

      Secondly, the circles and groups about Obama are thick on the ground, especially in economics> Obama has thousands of would-be advisors in hundreds of universities. Goldsbee, Volcker, etc… are out of it, although they have nice titles, and the old disastrous Clinton-Goldman Sachs-Summers team calls all the shots at this point.

      Good luck trying to explain economics to Summers… Summers, in particular is Mr. Derivatives, and the anti-FDR. As long as Summers decide everything it will be more of the same. I am not happy. I do agree with your complaints about the buying of votes.

      The problems is, at the bottom, psychological: some people believe it’s all a matter of everybody making friends with everybody, and wisdom will come out. But, then, on the other hand, although I hate the health care bill, it’s the first one of significance rolling through since Medicare.

      Something has to be said about doing stuff rather than no stuff. And Summers will have his reckoning. Because sweeping this sort of problems below the rug will result in an explosion. Some advisors have been expanded, and more can be in the future.

      In 1940, more than 90% of Americans did not want to go to war against Hitler. American public opinion has to be manipulated…

      PA

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  9. Patrice! Good Morning! Does the following overview sound correct to you? Sherry

    As with most industrialized democratic systems, France’s tax system is complex and nuanced., though also subject to recent movements to reductions and simplifications. The basic corporate income tax rate was for filings in 2003 was 33.33%, with surcharges of 3% (as of January 2002, reduced from 6% in 2001 and from 10% in 1995 when first introduced) and 3.3% (since January 2000, for large companies only), giving an effective rate of 35.43%. For smaller companies with annual revenues less than €7,630.000 and in which individuals own at least 75% of the equity, the basic corporate tax rates in 2002 were 15% (an effective 15.45% with the 3% surcharge and down from 26.5% in 2001) on profits below €38,120, and 33.33% (effective 34.33%, down from 35.33% in 2001) on profits above €38,120. Long-term capital gains were taxed at a basic rate of 19%, with effective rates ranging from 19.57% to 20.20%, in 2002, down from effective rates of 20.14% to 20.77% in 2001. Short-term capital gains are taxed according to the progressive individual income tax schedule. above a threshold of €15,000 (up from €7,650 in 2001) were taxed at 26%. The main local tax is the business tax, charged on 84% of a value derived from the rental value of the premises, 16% of the value fixed assets, and 18% of annual payroll, and at rates set by local authorities each year. The business tax (taxe professionelle) varies significantly from place to place, with a range of 0% to 4%.

    Individual income tax in France is assessed in accordance with a progressive schedule of statutory rates ranging from 0% (up to €4,121in 2002) to 52.75% (in 2002, on the increment of annual income above €46,343), with intermediate brackets of 7.5%, 21%, 31%, 41%, and 46.75%. French tax law contains many provisions for exemptions and targeted reductions from taxable income, so that the actual income tax paid is highly individualized. According to a 2002 OECD report, the disposable income of the average production worker was 73.2% of gross pay, and 79% of gross pay for a single-earner married couple with two children. Non-industrial businesses that do not pay value-added taxes on consumption (banks, insurance companies, the medical sector, associations, non-profit organizations, etc.) pay a wage tax to cover social levies assessed according to a three-bracket progressive schedule: 4.25% on the portion of annual wage below €6,460; 8.5% on the portion between €6,460 and €12,900, and 13.6% on the portion above €12,900. Inheritance taxes (succession duties) range from 5% to 60%, as do gift (donations) taxes. There is also a patrimonial tax of 3% on the fair market value of property owned in France, although foreign companies whose French financial assets are more than 50% are exempt. Also, foreign property holders may be exempt according to the terms of a bilateral tax treaty with France. (France is party to a numerous bilateral tax treaties with provisions that can greatly reduce tax liabilities for foreign investors.) Local taxes include a property tax, charged to owners of land and buildings, and a housing tax, charged to occupants of residential premises, assessed according to the rental value of the property. The social security system is operated separately from the general tax system, financed by contributions levied on earned income in accordance with four regimes: a general regime covering 80% of French citizens, a regime for agricultural workers, a special regime for civil servants and railway workers, and a regime for the self-employed. Tax levies have been used, however, to shore up the finances in the social security system.

    The main indirect tax is the value-added tax (VAT) first introduced in January 1968. The standard rate in 2003 was 19.6% (down from 20.6% in 1995), and there are two reduced rates: 5.5% on basic foodstuffs, and 2.1% on medicines and newspapers.

    Read more: Taxation – France – average, annual, system, sector http://www.nationsencyclopedia.com/Europe/France-TAXATION.html#ixzz0bSe7kuUM

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  10. Sherry:

    VAT was introduced in 1954, on large companies, and progressively generalized. The idea is in the spirit of Colbert.

    The VAT is tinkered with all the time (it was lowered to 5.5% on restaurants in 2009, and on construction in the last 28 months; restaurants were supposed to lower the cost of their meals by as much, and the gov has grumbled that they are not doing it, the guild in on the problem).

    The UK lowered its overall VAT from 17% (the overall Franco-German level) down to the EU legal limit of 15% to resist the great Recession better.

    As Sarkozy became president he instituted part of his program that had the meta principle of an overall MAXIMAL income tax of 50% on individuals. (Bonus fat cat bankers should be exempt, as France adopted the Darling-Brown fat cat bonus baker surtax on financial piracy.)

    The list above missed the “professional tax”, a local tax that can be enormous, and that Sarkozy is trying to cancell. He faces a possible rebellion from 38,000 irate mayors.

    My local village, fed by this tax, applied to the Compagnie Des Alpes, a state owned public company (with shares!), the world’s largest ski resorts owner, and also to Club Med, spends like crazy (bridges, dams, medieval churches, archeological work, etc). Yes, we had several excellent fireworks for New year’s eve. And City Hall sent magnificent plants for the birth of Athena.

    The carbon tax just got blocked by the Constitutional Court (no equivalent of that extremely powerful supreme Court exists in the USA), 3 days before implementation. The gov is scrambling to implement the modifications ordered by the Court, and will send the law back to parliament Jan 20.The Carbon Tax is supposed to be revenue neutral.

    Things move fast in France, way faster than in the USA, and, as in the rest of Europe, because of the European construction, the Constitution is always on the move. (Thus Britain was forced to institute a Supreme Court.)

    PA

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  11. This is an interesting discussion although, most likely due to my paucity of economic understanding, I am not sure where it is leading.

    Nevertheless, a couple of comments about VAT in the UK come to mind.

    Firstly, the standard rate of VAT in the UK rose from 15% to 17.5% on 2010 January 1 returning, following a temporary reduction to attempt to stimulate consumer demand, to its long-standing previous level.

    Secondly, I think that the costs to businesses of administering VAT are higher and more difficult to measure than many might expect. For any amount of VAT repaid to the government for a purchase by a “consumer” (i.e. a purchaser who is not registered for VAT), the goods and services and their components purchased will, in the vast majority of cases, have traversed a number of transactions between VAT registered parties (both individuals and companies). Each of these parties will have both charged and repaid, as well as been charged and reclaimed, VAT. The pair of accounting activities on either side of each of those transactions will have generated zero net tax to the government. Only the last step returns revenue to the government, yet all the steps along the way have taken valuable time, effort, systems, etc. to administer. I also suppose that, depending on how one accounts for the contributions of spending on contributions to eventually produced goods, those eventual purchases which are made by VAT registered parties yield zero revenue overall, despite the multiple transactions along the way.

    The administration of this tax seem fairly daft to me. For example, I have no idea why transactions between VAT-registered parties cannot be conducted without VAT being paid; this systems already operates in some cases between businesses in different European countries but (at least, in the UK) not within the country! However, I am sure that this would reduce the administration costs.

    Perhaps these points are of interest.

    John

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  12. John, as I mentioned earlier the cost of collecting VAT is very significant and it is by no means a financially efficient tax. But to correct one small point. You said, “The pair of accounting activities on either side of each of those transactions will have generated zero net tax to the government.”

    This is not true unless an accounting unit charges out at the same price as paying for those goods or services, unlikely in most cases. Each step in the chain will pay VAT as a tax on the gross profit of each transaction.

    I can well remember those VAT payments being extensive as the cost of producing Wordcraft was 25 GBP and we sold it to the dealer for 225 GBP! This raises another important point.

    VAT is paid to the government quarterly. Thus it is much more onerous on a small business’s cash flow than the annual taxation on the taxable profits. Indeed, many small businesses have failed through running out of cash because of VAT payment demands.

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    1. Yes, Paul, there are several ways of looking at the mechanics of VAT. It is true that if you look at the inputs and outputs for one company, on the face of it the company is collecting VAT for the government, (although it is not actually paying tax, on the contrary it is temporarily holding tax [on which it can collect interest] on behalf of the government).

      However, I find it simpler to look at the behaviour in respect of each transaction between customer and supplier, as it is each transaction on which VAT is possibly paid and, if so, possibly reclaimed. On each transaction, of course, the VAT registration status of the supplier determines whether VAT is charged (and therefore paid by the customer) and repaid (to the government); whereas the VAT registration status of the customer determines whether any VAT paid is reclaimed (from the government). And it is for each of these transactions that, if both parties are VAT registered, the net tax revenue is zero. This is, I believe, as it is intended to be: VAT is a tax on end consumers who are not VAT registered levied on behalf of the government by businesses that are registered.

      This is one of the difficulties in explaining the tax to people from the US, who simply cannot understand why every individual does not register for VAT. When I half-think about it, I can’t either! But, of course, HMR&C will not allow it!

      I agree that it is possible to be caught out by VAT payments; now into my 20th year of administering a VAT registered company, it has happened to me many times! But it is all my fault because the VAT is only being collected on behalf of the government, it is not a tax on my company; for example, it is completely ignored in the company accounts. In fact, the vast majority of my transactions are with customers (and suppliers) who are VAT registered; the customers could not care one way or the other whether they are charged VAT because they simply reclaim it; and, of course, all prices are quoted ex-VAT for that reason.

      According to this viewpoint, when selling Wordcraft you, being VAT registered, collected payments from the dealers in excess of what you would have charged them if you had not been VAT registered and, quarterly, repaid the difference to the government. However, presumably the vast majority of those dealers were VAT registered too, so they simply reclaimed the same amount, and so the government, “net-net”, got nothing out of the transaction. Only the last party in the chain, and only if not VAT-registered, ends up being taxed on the final price.

      You are right that cash flow issues can arise if customers take longer than 30 days to pay, something I try to avoid. But, in that case, operating on a VAT “cash accounting scheme” solves that because repayments are not made until received.

      The fun starts when VAT inspectors get agitated at being enlightened that, even (and especially) in years when turnover is below the registration threshold, a small company makes money by being VAT registered. This is not just from interest on holding some VAT on sales for a short while, but more importantly from reclaiming VAT on purchases, which otherwise actually would be a tax.

      In my view, for chains of entirely business-to-business transactions, the whole tax is pure bureaucracy and a complete waste of everyone’s time and effort yielding no government revenue.

      John

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  13. Thanks John, I did not know the UK had already returned to the 17.5% overall rate. As I said, things change fast in Europe…

    The main idea of the VAT is that EVERYBODY HAS INTEREST NOT TO CHEAT!

    As a business buys good to make stuff and add value, they pay the VAT.. But that VAT can be deducted from their own cost, so they have interest to reveal it entirely. Hence nobody cheats.

    In a normal sale tax environment, the Mafia can just kill the tax guy. in A VAT environment, the Mafia tells the tax guy how horrible tax they had to pay already for all the bullets.

    Elementary, my dear Watson…

    When the USA wants to stop serving bankers with credit in a life of serfdom, and switches to a saving and investing economy, they will switch to VAT. I am happy to report that the otherwise challenged Obama administration has perked up its ears on said concept.

    The concept of VAT was first adopted by France in 1954. By 2000, it was used by Canada and 40 other industrialized countries, including the entire EU, with a mandatory minimal 15%, because the EU is reluctant to use alien primates to save and invest, thus becoming their thing.

    PA

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    1. You are welcome, Patrice! I am no expert on taxation, and have no idea about the advantages and disadvantages of different schemes.

      However, I am not sure that VAT is “whiter than white”. It seems that all taxation is open to (legal) avoidance, as distinct from (illegal) evasion, whenever there are different rates for different types of transaction.

      I know of a large computer company which owned and operated blocks of flats (apartments) entirely as a VAT avoidance scheme; there is no VAT on rent!

      John

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  14. As I mentioned earlier there is significant VAT fraud in the UK. But I will happily concede that levels of fraud may be lower than collecting tax via more ‘traditional’ means!

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