This month brings triumphal news that Google and Facebook have, after a two year battle, started paying vast amounts in VAT to the Bangladeshi treasury. Other foreign companies too, like British American Tobacco, have paid further vast sums. Which is excellent of course. These big foreign companies are pouring revenue into the government with which great things can be done for the people.
Google has paid Tk2.29 crore for the months of May and June alone. Facebook has paid more than Tk2 crore, Amazon recently ponied up Tk53 lakh, and Microsoft has now registered to pay VAT as well.
Congratulations and free ice cream all ’round, obviously.
Except tax does not in fact work that way. The person or organization sending in the cheque is not necessarily the person really paying the tax. This is called “tax incidence”. A tax is incident upon whoever it is that, in the end, has a smaller wallet thanks to that tax. Who is it that really, in the end, pays?
With VAT it is not Google, Facebook, nor BAT that pays the tax. They collect it, and – now at least — they pass it over to the government. But they are not suffering the economic burden of VAT. It is us out here, we who buy their products, who are really paying it. This is why VAT is called a consumption tax: It’s we lowly consumers pay it.
Think it through. A company adds VAT to the prices is charges consumers. Those consumers have to pay that extra amount. Then the company deducts the amount of VAT it has had to pay out to other companies, its suppliers. The remainder is sent off to the government. OK, so who has paid that VAT then? You have, of course.
For all the cries from some quarters to bring low the tech giants, there will be a little effect upon the company itself. VAT makes things more expensive, so we will buy fewer of them; this reduces sales. But the major impact is felt by us. VAT is a consumption tax.
So, when it is said that Google and Facebook are now paying Bangladeshi VAT that’s not quite what’s happening. The correct statement is that the two companies are now collecting VAT from Bangladeshi buyers in a way that they were not before.
VAT is still a “good tax” even though it is us paying it. For taxing consumption is a good idea. We do need tax revenue, we’ve got to get it from somewhere, and we might as well get it in a way that causes less economic harm than more. So a VAT is preferable to taxes on profits.
This idea of tax incidence is a powerful and important one. Think, for example, of the popular idea that companies should pay more tax on their profits. At one level we can say this is impossible because any tax means that the wallet of some live human being becomes smaller. Incidence is the idea of tracking who that person is. Companies are not live human beings, so it cannot be them really paying the tax.
Even if we don’t want to accept that logic it is still true that tracking tax incidence is important. Say we’re going to tax the profits of companies. Who is it that, in the end, carries the burden of that tax? Which live human beings get their wallets lightened?
There are two groups who lose out here. The owners of the company, they get smaller profits because the government now has some of those profits. But it is also all the workers in the country that’s imposing that profit tax. Some foreigners will be willing to invest without the tax on profits but will invest elsewhere if the tax is in place. So, some investment is lost by having the tax. Some homegrown capital may be invested without the tax but will instead go overseas with the tax in place.
Wages rise when productivity does, productivity rises when we add capital to labour. Or, another way to say the same thing, wages rise when we’ve got full employment, and investment leads to employment. So, if there’s less investment then wages won’t rise so far or so fast.
The workers in the country with the profit tax get lower wages because of that tax. The incidence of a profit tax is upon both the owners of the business and also on workers across the economy.
Sure, how much of the burden each carries is debated, but here is the generally agreed answer to the incidence of profits taxes: Shareholders and workers – never the company itself – pay the profits tax. Further, the general burden on workers is higher when it is foreign investment we are talking about, especially in smaller economies. So a profits tax in the US falls more on shareholders than the same profit tax in Bangladesh. The impact falls harder on Bangladeshi workers than American workers.
This isn’t how we normally think about things but it is how the real world works. Which is why this idea of tax incidence is so powerful. It clarifies who, really, is carrying the burden of a tax. Which is where we started. Google and Facebook aren’t now paying VAT. They are, instead, collecting VAT. It’s consumers in Bangladesh who are paying the tax.
Tim Worstall is a senior fellow at the Adam Smith Institute in London
